144 THE WARREN BUFFETT WAY
a government agency. However, the problems of Projects 4 and 5 were
so severe that some were predicting they could weaken the credit posi-
tion of Bonneville Power.
Buffett evaluated the risks of owning municipal bonds of WPPSS
Projects 1, 2, and 3. Certainly there was a risk that these bonds could
default and a risk that the interest payments could be suspended for a
prolonged period. Still another factor was the upside ceiling on what
these bonds could ever be worth. Even though he could purchase these
bonds at a discount to their par value, at the time of maturity they
could only be worth one hundred cents on the dollar.
Shortly after Projects 4 and 5 defaulted, Standard & Poor’s suspended
its ratings on Projects 1, 2, and 3. The lowest coupon bonds of Projects 1,
2, and 3 sank to forty cents on the dollar and produced a current yield of
15 to 17 percent tax-free. The highest coupon bonds fell to eighty cents
on the dollar and generated a similar yield. Undismayed, from October
1983 through June the following year, Buffett aggressively purchased
bonds issued by WPPSS for Projects 1, 2, and 3. By the end of June
1984, Berkshire Hathaway owned $139 million of WPPSS Project 1, 2,
and 3 bonds ( both low-coupon and high-coupon) with a face value of
$205 million.
With WPPSS, explains Buffett, Berkshire acquired a $139 million
business that could expect to earn $22.7 million annually after tax (the
cumulative value of WPPSS annual coupons) and would pay those earn-
ings to Berkshire in cash. Buffett points out there were few businesses
available for purchase during this time that were selling at a discount to
book value and earning 16.3 percent after tax on unleveraged capital.
Buffett f igured that if he set out to purchase an unleveraged operating
company earning $22.7 million after tax ($45 million pretax), it would
have cost Berkshire between $250 and $300 million—assuming he could
f ind one. Given a strong business that he understands and likes, Buffett
would have happily paid that amount. But, he points out, Berkshire paid
half that price for WPPSS bonds to realize the same amount of earnings.
Furthermore, Berkshire purchased the business (the bonds) at a 32 per-
cent discount to book value.
Looking back, Buffett admits that the purchase of WPPSS bonds
turned out better than he expected. Indeed, the bonds outperformed
most business acquisitions made in 1983. Buffett has since sold the
WPPSS low-coupon bonds. These bonds, which he purchased at a