Berkshire Hathaway's Next Elephant Acquisition

NEW YORK (TheStreet) -- Berkshire Hathaway's (BRK.A) next elephant deal could come in the utilities sector after MidAmerican Energy acquired of NV Energy in 2013 and stated a plan to invest as much as $100 billion in the sector over the next 10 to 15 years. In fact, Berkshire's annual letter to shareholders, released on Saturday, read like pitch to investors and regulators for another transaction.

Berkshire's 2013 letter to investors generally was a little light on newsworthy developments. Language CEO Warren Buffett used to describe major acquisitions, or so-called "elephant deals," was weaker than in recent letters. Little new was said about Berkshire's succession plans and the conglomerate also appeared to have pushed off concerns about its performance for another year.

In 2012, Berkshire Hathaway projected that if markets rose last year, it would be the first five-year stretch when the company's book value per share didn't grow faster than the S&P 500 index. That prediction proved to be true, as Berkshire's book value growth underperformed the S&P in 2013. Buffett, however, didn't discuss five-year performance.

"Over the stock market cycle between yearends 2007 and 2013, we over-performed the S&P," Buffett said. Investors can decide whether that represents a slight change of Berkshire's yardstick, something Buffett vowed not to do in 2012.

Utilities, Utilities, Utilities

Discussion about Berkshire's MidAmerican Energy utilities division was chock full of new information. The "Oracle of Omaha" also directly said MidAmerican will continue to make large acquisitions.

MidAmerican purchased Nevada-based utility NV Energy for $5.6 billion in 2013, in a deal that, Buffett said, "fits nicely into our existing electric-utility operation and offers many possibilities for large investments in renewable energy."

"NV Energy will not be MidAmerican's last major acquisition," Buffett added.

Berkshire said in its 2013 shareholder letter that MidAmerican's renewable energy investment will hit $15 billion, up from last year's total of $13 billion. The $2 billion increase in renewable investment likely is due, in part, to Berkshire's acquisition of NV Energy, announced last May.

"We relish making such commitments as long as they promise reasonable returns," Buffett said. "And, on that front, we put a large amount of trust in future regulation" he said of Berkshire's renewable energy investment, echoing a similar refrain from 2012. MidAmerican's utilities serve regulated retail customers in 11 states and the company is the industry's leader in renewable power generation.

Berkshire may be bracing for rising renewable energy investment and another deal, given that Buffet certainly took more time in his shareholder letter to pitch such a maneuver. Buffett even explained why he believes MidAmerican is seen by regulators as operating at an advantage versus peers.

MidAmerican can handle its debts in "all circumstances" according to Buffett. Meanwhile, he said MidAmerican leads the industry in retained earnings.

"At MidAmerican, meanwhile, two factors ensure the company's ability to service its debt under all circumstances. The first is common to all utilities: recession-resistant earnings, which result from these companies exclusively offering an essential service. The second is enjoyed by few other utilities: a great diversity of earnings streams, which shield us from being seriously harmed by any single regulatory body," Buffett said.

From a standing start nine years ago, Buffett said MidAmerican now accounts for 7% of the country's wind generation capacity and an even greater share of solar energy generation when a handful of in-construction plants are completed.

"MidAmerican can make these investments because it retains all of its earnings. Here's a little known fact: Last year MidAmerican retained more dollars of earnings -- by far -- than any other American electric utility. We and our regulators see this as an important advantage -- one almost certain to exist five, ten and twenty years from now," Buffett said.

Berkshire also spent time in its letter trying to show that its acquisitions in the utilities sector have benefited customers. MidAmerican ranked No. 1  in a customer satisfaction survey across the electric utility industry, Berkshire noted in its letter.

"All three of our companies were ranked far lower by this measure before they were acquired by MidAmerican. The extraordinary customer satisfaction we have achieved is of great importance as we expand: Regulators in states we hope to enter are glad to see us, knowing we will be responsible operators," Berkshire said.

Evidence of Utilities Focus

Put those statements together, it's hard to read Berkshire's letter and not wonder whether Buffett preparing for another utilities deal.

After all, many of the advantages that Buffett sought to explain about MidAmerican underscore weaknesses in the industry. Publicly traded utilities are generally high dividend payers, meaning they retain only a portion of their earnings. In some cases, dividend payments appear to more important to management and investors than capital investment.

As a result, many publicly traded utilities are behind the curve in investing in renewable energy. Capital expenditure across the regulated utility industry is also forecast by Moody's to fall in coming years.

Berkshire's MidAmerican Energy unit, by contrast, could be a source of investment for the industry.

It's hard to know where Berkshire might want to expand in the utilities business. NV Energy seemed a perfect fit for MidAmerican's increasing exposure to western power markets and its deployment of billions in capital on renewable energy projects.

In a 2012 column, TheStreet pointed to NRG Energy (NRG) as a company that MidAmerican has partnered with on many renewable energy projects. The company's market capitalization of less than $10 billion would also fit within Berkshire's elephantine deal parameters.

On the East Coast, where MidAmerican has little exposure, utilities are suffering. Exelon (EXC) is currently mired in a four-year slump that's seen the company's share price fall from nearly $50 a share at the beginning of 2010 to just $30.30 a share as of Monday morning trading.

Jefferies utilities analyst Paul B. Fremont recently equated a recovery at Exelon to "waiting for Godot," given forecasts that gross margins will continue to fall at the company through 2016. Maybe, in Exelon's case, Buffett's MidAmerican Energy unit can play the savior role.

Given Jefferies analyst Fremont's price target of $24 a share for Exelon, continued underperformance could put the $26 billion market cap company within the reach of Berkshire's elephant guns.

It's also worth noting that Berkshire Hathaway attempted to buy Constellation Energy in the market panic of 2008, after providing the company $1 billion in preferred financing. However, Berkshire's proposed $4.7 billion takeover fell apart and Constellation was eventually sold to Exelon or $7.9 billion. Maybe Buffett and MidAmerican will eventually get their deal.

"A century hence, BNSF and MidAmerican Energy will still be playing major roles in our economy," Buffett said in his 2013 investor letter.

If Berkshire is playing the 100-year game, Consolidated Edison (ED), the nation's oldest electric utility may be another East Coast utility to watch. Since Superstorm Sandy battered the greater New York, New Jersey and Connecticut regions in October 2012, ConEd's shares have fallen from above $60, given recovery capex and a political maelstrom from duration of some power outages.

After ConEd agreed to a new two-year rate settlement with the New York Public Service Commission (NYPSC) that contained no revenue increases, Fremont, the Jefferies analyst, upgraded his rating on the stock to 'hold' from 'underperform.' ConEd said in February it will invest nearly $1 billion in capex for solar energy projects in its unregulated business.

Buffett said Berkshire Hathaway will always keep $20 billion in cash in the company's bank account to maintain financial flexibility. He also said Berkshire will carefully weigh any share issuance for acquisitions, a strategy the company employed to buy railroad BNSF in 2009.

Berkshire Hathaway reported year-end 2013 cash and cash equivalents of over $42 billion, meaning few utilities deals are out of the company's reach.

-- Written by Antoine Gara in New York

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