- A managerial "wish list" will not be filled at shareholder expense. We will not diversify by purchasing entire businesses at control prices that ignore long-term economic consequences to our shareholders. We will only do with your money what we would do with our own, weighing fully the values you can obtain by diversifying your own portfolios through direct purchases in the stock market.
- We will issue common stock only when we receive as much in business value as we give. This rule applies to all forms of issuance, not only mergers or public stock offerings, but stock-for-debt swaps, stock options, and convertible securities as well. We will not sell small portions of your company and that is what the issuance of shares amounts to on a basis inconsistent with the value of the entire enterprise.
Obviously, the deal is not cheap by any financial metrics, but Buffett must believe that it will be beneficial to shareholders. Time will tell.
One item that has not been mentioned in the press is how the BNI deal fits into the Berkshire Hathaway model. As we all now by now, Buffett prefers owning entire companies as opposed to owning smaller positions. There are at least two major benefits from owning entire companies:
1) Buffett can allocate the excess capital (as opposed to the previous management handling excess capital not used for future business purposes).
2) There is a tax advantage on the repatriation of dividends for wholly owned companies.
Let’s look closer at the BNI deal:
1) The annual dividend for BNI is $1.60 a share, or about 2% when the stock price was in the $75 range.
2) By paying $33 - $34 billion for the company, Berkshire will get all of the $1 billion in free cash flow. That equates to a 3.3% cash flow stream (as opposed to the 2% cash flow from 20+% ownership)
In addition, dividends from 20% or more owned companies are taxed on 20% of the dividend, multiplied by a 35% tax rate. As an example, if Berkshire were to receive $1,000 from BNI, $200 would be taxable at a rate of 35%, or $70. In short, 7% of every dividend Berkshire Hathaway would receive from BNI (before the deal) would go to the U.S. government.
Now, 100% of the distribution (assuming the BNI deal closes) will go to Berkshire Hathaway tax free. Over time, the 7% haircut is not immaterial.
It is certainly difficult for Berkshire Hathaway to make deals that “move the needle.” The BNI deal certainly is a significant transaction. I would expect that in three years time, there will be another large transaction. Keep an eye on the utility sector.