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Buffett Outguns NextEra

Somehow it seems fitting that Wall Street’s favorite utility would be outbid by the market’s favorite investor.

On Friday, Berkshire Hathaway Energy, a subsidiary of Warren Buffett’s Berkshire Hathaway Inc. (NYSE: BRK/B), announced that it has agreed to acquire Energy Future Holdings Corp. (EFH), the entity emerging from bankruptcy that owns the valuable Texas electric transmission company Oncor.

Berkshire’s all-cash offer is for $9 billion, but would also include the assumption of significant debt, giving the deal a total enterprise value of around $18 billion.

Texas regulators had previously spurned two earlier offers to take over Oncor, first by a consortium led by oil-and-gas producer Hunt Consolidated, then later a bid by Florida-based NextEra Energy Inc. (NYSE: NEE), the current darling of the utility sector.

The sticking point for NextEra’s deal was the utility commission’s proposed ring-fencing provisions, which would have helped Oncor maintain some degree of autonomy. NextEra CEO Jim Robo repeatedly described these terms as a “deal killer.” Turns out his spurning of those terms was also a deal killer.

Such conditions, including an independent board, are usually a theoretical good. But in the case of Oncor, they had a very real application, ensuring the company continued to reliably serve ratepayers even as its holding company foundered from overwhelming debt taken on in the largest leveraged buyout in history.

That experience meant that regulators were unusually leery of the leverage NextEra planned to take on in order to complete the deal.

Nevertheless, NextEra had been preparing to make a third run for Oncor (its first bid had fallen short of the one made by Hunt). But toward the end of June, Texas regulators refused to grant the company a rehearing on its deal.

Pitching Woo

That effectively cleared the way for Berkshire to swoop in with an offer that should satisfy regulators and EFH’s stakeholders alike. In addition to having incredibly deep pockets, Berkshire has told Oncor that it will have an independent board and that it will maintain an arm’s length relationship with the company.

Interestingly, Buffett’s history with EFH includes one of his biggest busts. In 2007, the legendary investor bought $2 billion worth of one of its subsidiaries’ bonds, only to dump them in 2013 for just $259 million as EFH neared bankruptcy. However, the bonds had paid $837 million in interest, so Berkshire’s actual pre-tax loss on the investment was considerably less than the sale price suggests.

Even so, as Buffett wrote in a shareholder letter the following year, “Most of you have never heard of Energy Future Holdings. Consider yourselves lucky; I certainly wish I hadn’t.”

In this case, however, Buffett would be scooping up plum assets at a reasonable price—Oncor is one of the country’s largest transmission companies, with about 122,000 miles of electric transmission and distribution lines that serve 10 million customers across Texas.

Berkshire already has a transmission footprint in Texas through an indirect stake in Electric Transmission Texas—so Oncor’s operations would provide a nice complement.

And the transaction would further expand the already sizable Berkshire Hathaway Energy, whose utility and midstream pipeline operations serve customers in 18 states and contributed about 9.5% of consolidated earnings last year.

If the deal is consummated, we’re betting Buffett won’t regret this particular purchase.

Of course, while Berkshire is moving quickly, a lot can happen between now and a potential fourth-quarter close. Indeed, other suitors are reportedly preparing rival bids, including Elliott Management Corp., the $31 billion hedge fund that also happens to be one of EFH’s biggest creditors.

Still, Buffett’s imprimatur is worth a lot—other entities would likely have to offer substantial sweeteners to push him aside.

The Un-Closer

As for NextEra, you can’t help but marvel at its lengthy record of ill-fated deals. Since 2000, the utility giant has had several major deals fall apart, including one with Entergy Corp. (NYSE: ETR), Constellation Energy (later acquired by Exelon Corp. (NYSE: EXC)), Hawaiian Electric Industries Inc. (NYSE HE), and now Oncor.

In retrospect, it was a good thing those three earlier deals were terminated. And while Oncor would have further improved NextEra’s long-term growth story, the utility giant is already on track to grow earnings by an industry-leading 8% annually without it. Additionally, the acquisition would have temporarily elevated NextEra’s leverage to uncomfortable levels.

Still, we’re confident NextEra remains on the prowl for its next acquisition. Maybe, fifth time’s the charm.

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