A recent article in the Financial Times on Warren Buffett (Trades, Portfolio)'s latest acquisition of pipeline assets included a quote from Andy DeVries of CreditSights, who stated, "As soon as the Dominion deal was announced, bankers were getting deal pitches ready for Buffett for other distressed midstream (pipeline) assets in the East."
This suggests that Berkshire Hathaway BRK.A BRK.B could do more deals in the sector in the near future. While I don't usually give much weight to speculation about what Buffett will or won't buy next, I think this hypothetical is worth looking into, even if it doesn't come to pass.
A good deal at the right price
Buffett's deal with Dominion D made a lot of sense. mainly because of the cost. At eight to nine times Ebitda, Buffett was able to buy the infrastructure assets at a discount to the price Dominion agreed for another deal only a few months prior.
Specifically, at the end of last year, the company sold a 25% share in its LNG Cove Point plant to Brookfield for 11 times Ebitda (25% was also included in the Buffett deal).
Two factors appear to have helped Buffett in this case. Firstly, Dominion was a willing seller. The company wanted to reduce its exposure to dirty, out-of-fashion hydrocarbon assets and increase exposure to regulated, predictable cash flows. Second, Berkshire is a cash buyer. It can do a cash deal quickly, providing much-needed financing to cash-strapped midstream operators.
Given the struggles of the energy sector, there could be plenty of other deals out there if Buffett can find assets at the right price. Many companies in the midstream MLP space have been badly managed over the past decade. They've taken on a lot of cheap debt while returning all excess profits to partners. Several of these businesses might be willing sellers at any price if they can tidy up their balance sheets. Buffett could act quickly to take advantage, which I think would be a wise move.
Berkshire's advantage
These assets may also be more productive in Berkshire than in other public companies. As I've noted in previous articles, the return on invested capital on oil and gas infrastructure assets is in the high single-digits. That's significantly above the near-zero return on cash Buffett can get today.
Also, Berkshire benefits from not having to pay high-interest rates on its debt. The group has been able to borrow at nearly 0% in Europe. This reduces the cost of capital of the energy business. Not only that, but unlike MLPs, which are compelled to return most of their cash flow to shareholders, Berkshire does not have to pay dividends. Once again, this leads to a reduced cost of capital.
All of the above implies that these assets may perform far better inside Berkshire than outside. This could justify a higher price for the assets, but readers of this article should know that's something Buffett would never rush into. Instead, he's more likely press hard for a reasonable price with distressed buyers who've not been able to achieve acceptable returns on their assets.
How should Berkshire shareholders view all of this? Well, the group is going to have to make do with lower returns in the short term, although it will get higher returns than it's currently getting on cash.
Also, as I noted in a recent article, while these utility assets won't make investors wealthy overnight, they're great for preserving wealth (if owned by the right investor). As Buffett said earlier this year, the energy business is "not a way to get real rich," but it is "a way to stay real rich."
Overall, I think it's worth keeping an eye out for more utility deals from Buffett this year. It seems he's willing to acquire some of these assets at the right price.
Disclosure: The author owns shares in Berkshire Hathaway.
Read more here:
- Index Funds: Stocks Only Go Up?
- Warren Buffett: Growth Stocks Are Not Always the Best Option
- Charlie Munger's Advice on How to Get Rich
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