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Buffett lost nearly $900 million exiting biggest buyout ever

By
Stephen Gandel
Stephen Gandel
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By
Stephen Gandel
Stephen Gandel
Down Arrow Button Icon
March 1, 2014, 1:00 PM ET

FORTUNE — Warren Buffett wishes he never got involved in the largest private equity deal ever. Given the outcome, that’s not much of a surprise.

In his annual letter to shareholders, released Saturday morning, Buffett says Berkshire Hathaway (BRKA) lost $873 million on his wrong-way bet on Energy Future Holdings. And Buffett says it was his bad bet. He says he made the investment without consulting his long-time lieutenant Charlie Munger. He also said Berkshire no longer holds any of Energy Future’s debt, having sold its remaining stake last year.

“Most of you have never heard of Energy Future Holdings,” Buffett writes in the letter. “Consider yourselves lucky; I certainly wish I hadn’t.”

In a deal, struck at the peak of the pre-financial-crisis deal boom, Texas energy giant TXU was bought by private equity firms KKR (KKR), TPG Capital, and Goldman Sachs’ private equity arm for $45 billion, making it the biggest leveraged buyout in history. TXU was later renamed Energy Future.

MORE: In a first, Buffett gets beat by the S&P 500 over five years. (But wins over six.)

The deal was highly leveraged. KKR, TPG, and Goldman (GS) put up $8 billion for their ownership stakes. And the company came with $13 billion in debt already on its books. The rest of the deal was financed by issuing more debt, and Buffett bought just under $2 billion of those bonds.

On top of the excessive leverage, falling natural gas prices made Energy Future’s coal-fired power plants much less profitable, hobbling the company. It’s widely believed that Energy Future will soon file for bankruptcy. Buffett predicts that outcome in his letter as well.

From the start, the investment was an unusual one for Buffett. He has generally criticized leveraged buyouts in the past. And Buffett has already publicly declared the investment a mistake. Starting three years ago, Berkshire began to write down the investment, already booking at least $1.4 billion in losses prior to last year. (So, oddly enough, the fact that Berkshire didn’t lose that much money in the end may have resulted in an accounting gain last year.)

But for the first time in this year’s letter, Buffett fully accounts for Berkshire’s loss on the deal. He said Berkshire sold its bonds for $259 million. Add that to the $837 million Berkshire had collected in interest payments during the time it held the bonds, and you get to a nearly $900 million loss.

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Buffett has been involved in bankruptcy fights before. But apparently he thinks it’s best to not take part in Energy Future’s potential proceedings, which are likely to be messy. Energy Future has nearly $40 billion in debt. Berkshire held debt in Texas Competitive Electric Holdings, an unregulated subsidiary of Energy Future that sells power in wholesale markets to big companies and other utilities. Energy Future wants creditors to take over Texas Competitive at a value of $7.5 billion. Creditors say it is worth $10 billion more than that. Buffett must have thought he could get a better deal getting out now, or that he could get a better return investing his money elsewhere.

That is certainly the case for the original investment.

About the Author
By Stephen Gandel
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