While this is Buffett's first direct stake in a pure-play merchant generator, he is familiar and comfortable with the utility industry. Over the past decade, he has acquired both MidAmerican Energy and PacifiCorp, which together make Berkshire one of the largest utility companies in North America. In his 2005 annual shareholder
letter, Buffett summarized his thesis on utilities:
"You can't expect to earn outsized profits in regulated utilities, but the industry offers owners the opportunity to deploy large sums at fair returns--and therefore, it makes good sense for Berkshire."
Unlike regulated utilities, you can expect to earn outsized profits (or losses) in the merchant generation sector. This capital-intensive business's fortunes are highly dependent on energy prices, and the last four years have provided a windfall. But keep in mind that just five years ago, NRG was emerging from bankruptcy.
Like regulated utilities, merchant generation does offer sizable capital-deployment opportunities. The capital-intensive nature of this business often requires hundreds of millions--if not several billion--of dollars to construct a single generation facility. Given the dramatic increase in materials and labor costs over the past four years, the construction of new baseload generation facilities has been prohibitively expensive, which has prevented substantial amounts of new capacity from breaking ground. NRG could give Buffett means to deploy his perpetually growing cash hoard. NRG has filed an application with the Nuclear Regulatory Commission to build two additional reactors at its South Texas facility at a cost likely exceeding $6 billion. NRG is ill equipped to finance the project on its own.
NRG could also tap Berkshire in making a second bid for fellow merchant power producer Calpine sometime in the next year. Warrants granted to pre-bankruptcy shareholders have now expired, so NRG could increase its offer price without having to compensate a new basket of shareholders. Furthermore, Calpine just appointed Jack Fusco as CEO, and he was successful in combining his previous company, LS Power, with Dynegy. A large contingent of Calpine shareholders would like to have their shares acquired, especially if a nice cash offer emerged. Calpine's environmentally friendly assets would be a nice fit structurally and geographically with those of MidAmerican and PacifiCorp, so a partnership with NRG would be a logical move.
Additionally, we believe that NRG has attractive competitive advantages. The deregulated geographies where it operates lend themselves to power prices that are set by expensive natural-gas facilities. Given that about 39% of NRG's portfolio comes from low-cost coal and nuclear plants, its returns will likely remain robust.
