Recently, Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) lost its bid to buy Oncor, Texas' largest regulated utility. Oncor is part of Energy Future Holdings, which was formed by KKR & Co. (NYSE:KKR), TPG Capital, and Goldman Sachs (NYSE:GS) Capital Partners in the largest leveraged buyout in history in 2007. When natural gas prices plummetted due to the shale revolution, EFH was unable to meet its debt obligations, and EFH has been looking to sell Oncor in bankruptcy to pay off its creditors.
Reading headlines such as, "Buffett's Latest Dealmaking Flop," and "Buffett Encounters Rare Miss," might make some Berkshire investors wonder if the Oracle of Omaha has lost his touch. Adding insult to injury, the deal fell through too quickly for Berkshire to qualify for its $270 million breakup fee, so Buffett and Berkshire will walk away with nothing.
In this light, it might seem strange that I think Berkshire investors should be encouraged. Certainly, Buffett and Berkshire would have loved to have bought Oncor for $9 billion ($18.2 billion with debt) to add to the Berkshire Hathaway Energy platform. So why wouldn't Buffett pony up a mere 5% more for the prized asset?
Berkshire made its offer for Oncor in July, after Texas regulators had rejected a previous $18.7 billion bid by NextEra Energy (NYSE:NEE). The Texas Public Utilities Commission objected to NextEra's unwillingness to give Oncor an independent board, among other issues. Berkshire came back with its lower offer in July, along with 47 points of assurance to the PUC.
Meanwhile, Elliot Management, a hedge fund headed by Paul Singer, had been buying the distressed debt of Energy Future Holdings after its bonds plummeted following the NextEra rejection. Unsatisfied with Berkshire's offer, which would have basically had Elliot coming out even on its investment, Elliot bought even more debt from Fidelity Investments, giving Elliot the clout to block the deal.
Elliot has a reputation for being tough in negotiations. Rather than take a haircut, the hedge fund waged a 15-year legal battle with the government of Argentina on its defaulted bonds, and eventually made $2 billion in profits for its patience.
Elliot was successful once again on Oncor, when Sempra Energy (NYSE:SRE) swooped in with its own $9.45 billion offer ($18.8 billion with debt), and the offer was approved by the PUC. That meant Elliot will get a much larger payout.
Long-term vs short-term thinking
While Berkshire shareholders (and, I'm sure, Buffett himself) may be disappointed, they should take comfort in Berkshire sticking to its principle of not getting involved in a bidding war. Bending on that principle this time could cause potential acquirees to negotiate harder in the future -- and those could be even larger deals. One wonders if 2015's $32 billion acquisition of Precision Castparts -- a deal 3.5 times bigger than Oncor -- would have happened on attractive terms had Buffett not stuck to his "one offer" policy.
As longtime Berkshire shareholder Steve Walman said in a recent Bloomberg article, "the minute he starts negotiating, he becomes everyone's favorite stalking horse and ends up as 'bid 'em up Buffett.'" Since Berkshire is built on acquisitions, cultivating a reputation for bending on price is not something Buffett wants to do. As he himself once said, "The smartest side to take in a bidding war is the losing side."
By sticking to his principles, Buffett has kept his eye on the long game. While he has recently been lamenting the $100 billion-plus of insurance float Berkshire carries in cash, this sets Berkshire up to be aggressive if a new deal -- or even, a 2008-type recession -- occurs. If no deals arise, it's likely Berkshire may distribute a dividend at some point.
Thus, Berkshire shareholders can rest easy knowing management has kept its long-term perspective, has tons of dry powder, and a potential dividend could be coming their way. That's not the worst thing in the world by any stretch.