IN DEPTH: The Buffett billions
When Warren Buffett commits $13bn to an emerging industry, a lot of people are going to sit up and take notice.
The world’s most successful investor knows a thing or two about making money, having amassed a personal fortune of $53.5bn through his Berkshire Hathaway holding company since 1965 — largely due to his legendary ability to spot undervalued assets that can deliver superb long-term profits.
In a burst of energy last year, Buffett accumulated a 1.27GW portfolio of utility-scale solar projects through his MidAmerican Energy Holdings Company, including what will be the world’s largest PV array, the 579MW (AC) Solar Star 1 and 2 in California; the 550MW (AC) Topaz, also in California; and 49% of Arizona’s 290MW (AC) Agua Caliente. His companies also own 3.7GW of wind farms across the US — the third-largest portfolio in the country after NextEra Energy and Iberdrola.
The cyclical solar sector is notorious for having burned global investors. Scores of players in Asia, Europe and the US left the business as prices tumbled, countries slashed subsidies and the pace of technological change accelerated. Buffett won’t be joining them.
Yet it is important to note that Buffett is not investing his hard-earned billions in renewables because he wants to save the planet (or to support his friend Barack Obama’s policies, as some have suggested). After all, Berkshire owns 17.8 million shares in Suncor Energy, which is heavily involved in Canadian oil sands; it is investing large sums to prolong the life of some of its coal power plants; it owns two major gas pipeline companies; while Buffett also opposes cap-and-trade measures to limit CO2 emissions.
Buffett is investing in renewables because he can make attractive returns. He is looking at double-digit after-tax profits of up to 15% for solar projects — far higher returns than from other long-term investments, such as 30-year Treasuries (about 3.7%), corporate bonds or any similar infrastructure opportunities.
“At the end of the day, it’s about a return on investment and making money,” says Jeff Matthews, founder and general partner at hedge fund Ram Partners, who has written several books on the billionaire. “Buffett is not doing anything to make a point. But he does think about things in the very long-term — 50-100 years out. I think he believes that solar is an eventual long-term winner.”
When MidAmerican’s renewables unit issued solar bonds, all were oversubscribed. Investors snapped up notes totalling $850m in early 2012, a further $250m in April for Topaz and $1bn in June for Solar Star — even though Berkshire does not guarantee MidAmerican’s debt.
“Solar and wind have become very bankable,” says Todd Foley, senior policy and government relations vice-president at the American Council on Renewable Energy. “Renewable energy is a growth sector and investors are always interested in [areas] where there is significant growth and return.”
Analysts say Buffett’s involvement in solar helps the industry in several ways. His buy-in, regardless of motive, gives the sector more credibility and helps renewables become more mainstream as an investment vehicle. It draws in portfolio managers and reassures conservative institutional investors such as insurance companies and pension funds that might have been adverse to sector exposure without government loan guarantees or other support.
It also focuses attention on higher-yielding project bonds — other less-heeled but creditworthy developers may now find it easier to issue notes for projects, with solar gradually becoming part of the broader capital market.
But not everybody can do what Buffett and MidAmerican can do.
Large renewables projects require billions of dollars in capital investment. Only a few developers, such as NextEra and NRG Energy, have sufficient internal cash flow or can tap external financing to move $1bn-2.5bn solar projects forward to completion.
By being able to finance plants of this size, MidAmerican can benefit from economies of scale and generous renewables subsidies in states such as California — reaping much higher profits compared to conventional energy sources.
Through MidAmerican’s development of solar and wind, Berkshire has also been able to offset some of its hefty tax bill by using federal incentives such as the investment and production tax credits. “There is growing interest in corporations that have tax appetite to look at investing in renewables to lower their tax basis,” says Foley.
Berkshire has an advantage here as it has enough tax to be able to utilise these credits without external help — whereas smaller developers with less of a tax liability have to sell their credits to large banks, which often charge upwards of 14% for the privilege. This tax-equity market is also limited by a small number of participants and roughly $6bn size, equivalent to the cost of a handful of large solar or wind projects.
And when it comes to accessing capital, privately owned MidAmerican also has several key advantages.
It doesn’t pay a dividend to Berkshire, so retains its cash flow — which it uses to help fund growth and improve already solid credit metrics, should it need to borrow. And more importantly, MidAmerican has quick and ready access to cash from its parent, so it can pounce on market opportunities faster than most potential rivals.
Berkshire is, in fact, floating on a sea of cash generated by its large underwriting operations and $100bn equity portfolio.
To slow cash accumulation, Buffett expects his top managers to invest in their businesses to widen their “economic moats”, or competitive advantage. He also gives them wide latitude to make acquisitions — so-called bolt-on deals that are relatively low-risk and increase earnings.
Greg Abel, who became boss of MidAmerican in 2008 (and is a possible candidate to succeed Buffett as Berkshire chief executive), is doing just that. He has invested $7bn since 2011 in wholesale solar and wind projects, forming MidAmerican Renewables in 2012 to oversee the assets.
The company’s three US rate-regulated utilities, which serve ten states, began adding wind last decade — they now have 3.7GW — with a large chunk of the estimated $6bn investment occurring under Abel. Wind will be 39% of Iowa-based MidAmerican Energy’s generation capacity in 2015 when build-out of 1.05GW of additional capacity is completed.
“We relish making such commitments if they promise reasonable returns,” Buffett wrote in the 2012 Berkshire annual report.
His ability to spot long-term returns from an industry that has burned countless others is what has made Buffett such a savvy operator. With him in the game, other investors are increasingly recognising the financial potential of one of America’s fastest-growing industries.