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Warren Buffett Is Buying a Utility Giant for a $7 Billion Discount

By Matthew Frankel, CFP® - Jul 9, 2017 at 7:03AM

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Investors shouldn't be surprised that Berkshire is getting Oncor Electric Delivery for billions less than a competitor was willing to pay.

Berkshire Hathaway (BRK.A 1.69%) (BRK.B 1.64%) recently announced that it had agreed to acquire Oncor Electric Delivery in a $9 billion transaction, which represents a massive discount over the company's reported enterprise value, as well as what another energy giant was willing to pay for it. Here are the details, as well as why this is just the latest in a long series of attractive deals Warren Buffett and his team have been able to deliver for shareholders over the years.

Berkshire is adding Oncor to its portfolio of utilities

Berkshire Hathaway Energy, the utility-owning subsidiary of Berkshire Hathaway, announced that it intends to acquire Oncor Electric Delivery Company, a Texas-based power transmission company that serves roughly 10 million customers.

Warren Buffett at Berkshire Hathaway's annual meeting.

Image source: The Motley Fool.

Berkshire Hathaway Energy already owns several utilities that serve the electric and/or natural gas needs of 11.6 million customers, so this deal will nearly double the number of utility customers of Berkshire's subsidiaries. In a nutshell, Buffett loves utilities because of their recession-resistant revenue streams and profits that they provide for Berkshire.

Oncor is 80% owned by Energy Future Holdings, which Berkshire has agreed to pay $9 billion to acquire. This values the company at $11.25 billion.

Interestingly, NextEra Energy had previously agreed to acquire Oncor for $18.7 billion, although that deal was shut down by Texas regulators. So, if Berkshire is successful in achieving regulatory approval, it will acquire the utility giant for about $7.5 billion less than another major player in the industry was willing to pay. In addition, Kirkland & Ellis, a law firm representing Energy Future Holdings, has said that the enterprise value of the transaction was about $18.1 billion, which further indicates that Buffett and company are getting an attractive discount.

Just the latest in a long history of savvy Buffett moves

Buffett and his team have a long history of finding attractive deals like this, and not only when it comes to acquiring businesses at a discount.

Buffett's deal-making skills extend to Berkshire's stock investments as well, as the Oracle of Omaha has a history of obtaining deals that the average investor simply couldn't get.

An excellent example is Berkshire's Bank of America (NYSE: BAC) investment, where Buffett agreed to buy $5 billion worth of the bank's preferred stock at a 6% dividend yield. So far, nothing out of the ordinary. Everyday investors can buy high-yielding Bank of America preferred stock.

However, here's the part that was especially savvy, and that you and I can't do. With the investment, Buffett received warrants to purchase 700 million shares of Bank of America for $7.14 per share at any time before September 2021. At the time, the warrants had no intrinsic value. However, Buffett felt that Bank of America's stock was undervalued, so it made the deal much more attractive. Now he had a combination of steady income and potential long-term upside. Fast-forward to 2017, Bank of America's stock price is just under $25. The value of the warrants that were given to Buffett as a freebie with his preferred stock investment? About $12.5 billion.

I'm often asked by friends how to pick stocks like Buffett, and my response is typically "You can't." While anyone can go out and purchase the stocks in Berkshire's portfolio, some of the company's positions originated with deals that the average investor simply couldn't get.

Would Buffett have purchased 700 million shares of Bank of America if the preferred stock and warrant deal hadn't been an option? We don't know for sure, but I seriously doubt it.

Another reason Berkshire shareholders should be happy

As a Berkshire shareholder myself, I'm thrilled to see that the company has been actively putting its mountain of cash to work, which was nearly $100 billion at the end of the first quarter. About a week before the Oncor acquisition was announced, it was revealed that Berkshire had made a $377 million investment in net-lease real estate investment trust Store Capital.

As far as the Oncor deal goes, consider that the company generated a profit of $431 million last year and similar profits in other recent years. Based on Berkshire's $11.25 billion valuation of Oncor, this translates to an annual cash-on-cash return of just over 3.8%. This may not sound too high, but I'll bet it's much more than Berkshire would earn by leaving $11.25 billion in cash in the bank. Furthermore, Oncor brings a revenue stream that has the potential to grow over time.

The Foolish bottom line

My top two reasons to invest in Berkshire Hathaway are the diversification of the company's revenue stream and Buffett's ability to buy companies and other investments for far less than their intrinsic value. The Oncor deal is an excellent example of both, and also puts billions of Berkshire's unused cash to use, which should be music to the ears of shareholders.

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