The Sage Seizes on Energy's Distress

When Warren E. Buffett acquired MidAmerican Energy Holdings Co. in late 1999, Wall Street snickered. At the time, investors were enthralled with New Economy stars like Enron Corp., which had glamorized the energy business by reinventing itself as an "asset-light" deregulated trading company. MidAmerican was the Old Economy epitomized, a boring electric and gas utility--based in Iowa, no less. Buffett, the famously technophobic chairman and CEO of Berkshire Hathaway Inc., (BRK) just didn't get it, various bull market savants scoffed. He was history.

What a difference a bear market makes. Today, Enron is bankrupt, and Buffett's $1.24 billion purchase of a 76% stake in privately held MidAmerican--a deal that marked Berkshire's entry into energy--looks prescient. And now, the solidly profitable MidAmerican is capitalizing on the sector's distress by scooping up prime assets at a discount from beleaguered energy merchants and traders. On July 29, Dynegy Inc. (DYN) agreed to sell its Northern Natural Gas pipeline to MidAmerican for $1.9 billion. The deal, which should close by the end of August, followed on the heels of MidAmerican's $956 million purchase of a pipeline from Williams Cos. (WMB) in Tulsa. And on Aug. 1, Berkshire itself got into the act, loaning Williams $450 million as part of an emergency restructuring.

Buffett's energy-industry dealmaking is likely to continue and could even increase in coming months. He is drawn to businesses that reliably throw off a lot of cash, and both utilities and gas transport fit the bill. With more than $30 billion in Berkshire's coffers, America's premier value investor can well afford to continue his bargain shopping in the energy patch as the selling continues. "The bow is tightening, and pressure from credit agencies and investors will lead to more quality asset sales," says President Jeff Gildersleeve of Argus Research in New York.

Buffett said last year that he was prepared to sink an additional $10 billion to $15 billion into the electric utility industry if Congress repealed the Public Utility Company Holding Act (PUHCA), which effectively prevents a company from owning more than one regulated utility. Capitol Hill insiders say that the final version of the energy bill now making its way through Congress likely will do just that. On Aug. 6, Buffett told BusinessWeek that he is still willing to invest as much as $15 billion "for the right opportunity."

Buffett says that Berkshire might buy minority stakes in utility companies, but that any acquisitions would be made through MidAmerican, which posted pretax income of $398 million on revenues of $5.3 billion in 2001. In effect, Buffett will continue to look to David L. Sokol, MidAmerican's 45-year-old chairman and CEO, for acquisition ideas. Sokol, a former Peter Kiewit Sons' Inc. executive, became CEO of a predecessor company to MidAmerican in 1991. "I would say that valuations in the utility sector are more reasonable right now than at any time in the past 10 years," says Sokol, who often works out of an office in Omaha right across the street from Berkshire headquarters.

Analysts say that MidAmerican is likely to face increasing competition as Duke Energy (DUK), American Electric Power (AEP), TXU (TXU), and other energy companies step up their own bargain-hunting. But the depth of Buffett's pockets and the speed of MidAmerican's decision-making won't be easily matched. "The great thing about those guys is that they make up their minds," says Hugh McGee, head of Lehman Bros.' energy and power banking group. "It's awesome how quickly they can make a decision."

But even Buffett sometimes errs. When MidAmerican bought the pipeline from Williams Cos. in March, it also bought $275 million of preferred stock convertible into about 4% of Williams' common stock. Sokol says that MidAmerican investment in the preferred stock was not a quid pro quo for the pipeline. "It was totally separate," he insists.

In any event, by July MidAmerican was looking at a $275 million wipeout as Williams Cos. ran short of the cash needed to make an Aug. 1 interest payment. With Lehman's help, Williams was able to avoid default--and likely bankruptcy--by selling $1.4 billion in assets and borrowing $900 million--$450 million of it from Berkshire Hathaway.

If Williams remains solvent, Buffett might well be able to turn even this mishap to his advantage. Williams is expected to sell yet another pipeline soon, and it's a safe bet that Buffett and Sokol will be near the head of the line of potential buyers. By Anthony Bianco, with Emily Thornton in New York

The Good Business Issue
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