If you’re into this kind of thing, which is to say that examining financial statements is a source of stimulating mental gymnastics, figuring out the value of Berkshire Hathaway (BRK) could keep you entertained. BRK released their third quarter’s earnings over the weekend. It’s an insurance company transforming itself into an operating business as Whitney Tilson has pointed out before. It’s true that the acquisition of Burlington Northern has pushed their non-insurance operating earnings to a new level. Breaking the company into its two pieces (insurance and non-insurance) and adding its securities portfolio is an interesting exercise.

Non-insurance businesses generated pre-tax operating income of $5.4BN during the first nine months of the year. There are many moving parts, but assume positive surprises will net out with negatives and you get $7.3BN of full-year pre-tax earnings. Most insurance companies operate an underwriting loss (i.e. they only reach profitability because of investment earnings on the float) but BRK seeks to make a profit on underwriting. Averaging the past two years and annualizing the result generates $765MM in pre-tax operating income. In fact over the past eight years underwriting has produced $17BN, or over $2BN per year.  These two add up to $8BN of pre-tax income, after 35% tax $5.2BN.

Using the S&P500’s trailing P/E multiple of 13 values this at $68BN. This is the value of Berkshire’s insurance underwriting and disparate operating businesses but excluding investment income.

But in addition, BRK has an investment portfolio consisting of marketable securities, non-public investments and cash worth $147 BN. Adding this cash and investment portfolio to the businesses above produces $215BN, compared with BRK’s current market capitalization of $190BN, or in other words the company’s valued at a 12% discount.

Aspen Reinsurance noted that around $95BN of global reinsurance capacity has gone following many events from the earthquakes in Japan and New Zealand to weather-related losses in the U.S. and Australia. Given a harder market (i.e. one of rising premiums given the reduced industry capacity) it’s not unreasonable to expect BRK’s underwriting results to improve next year. If they get back to the eight year average, the company’s worth almost $230BN or is at a 17% discount.

This is a summary of how we look at BRK. It seems to trade at a conglomerate discount. But their underlying businesses are going well, they’re buying back stock and they had their most active quarter of investing in fifteen years, putting almost $21BN to work. We think it remains an attractively priced investment.

The FT notes in an article this morning how M&A activity in the shale gas arena reached almost $50BN during the third quarter, a 135% jump on a year ago. Some deals were large and notable, such as Kinder Morgan’s (KMP) purchase of El Paso. Others took place out of the spotlight, but what is clearly taking place is a growing acknowledgment by the major energy companies that domestic natural gas in the U.S. will represent an increasingly important source of energy production. It’s here in the U.S., it’s cleaner than other fossil fuels (though global warming is yesterday’s story) and it’s persistently cheap. They very success of so many E&P companies in drilling for natural gas has depressed its price, helping consumers but hurting profitability. When Petrohawk sold their business to BHP Billiton  it confirmed CEO Floyd Wilson’s oft-stated belief that the assets Petrohawk owned better belonged within a larger company with a lower cost of capital. That statement really is the key to the natural gas story. In a time of abundant and cheap natural gas, the company that has the lowest overall cost structure (including the cost of financing the necessary capex) will win.

As an investor, you have to choose carefully though, and definitely avoid companies that use too much leverage. As a result we’ve never invested in Chesapeake (CHK). Aubrey McClendon is a great cheerleader for the industry but has exhibited a wholly different risk appetite in the past than we would like. We continue to like Comstock (CRK) a name that’s fallen too far. We also think Devon Energy (DVN) is a solid investment trading as it does close to the value of its proved reserves (providing a cheap option on likely but not yet proven assets) and with half its revenues now coming from crude oil production. It’s also all onshore, having divested its offshore and non-U.S. assets in recent years.

But Master Limited Partnerships (MLPs)  also allow an interesting angle on the development of shale gas assets. Once the gas is extracted it needs to be processed, refined, transported and stored. This is to a large degree what drove KMP’s acquisition of El Paso; positioning for the huge infrastructure investments required to move natural gas from under the ground to the U.S. consumer. I found it interesting that earlier this month JPMorgan initiated research coverage of MLPs. They used to cover them but the analyst left several years ago and they dropped their emphasis on the sector. But JPMorgan estimates $130BN in capital investment over the next ten years as the industry responds to a shifting mix of fuels to provide energy. The tax status of MLPs precludes them from retaining much of their earnings, so new projects are usually funded with freshly raised debt or equity capital. For an investor this imposes discipline on management, since a poorly conceived project won’t easily attract cheap financing. JPMorgan no doubt sees an attractive long term fee opportunity. Meanwhile, there are ways to participate in shale gas development for the equity investor through E&P companies and the income seeking investor through MLPs. The sector has also recovered strongly from the sell-off in equity markets through September – the Alerian MLP Index (AMZ) is back within 5% of its high reached in April. 6% distribution yields and steady growth help.

In sorting through the wreckage of the past quarter’s bear market, I’ve spent some time reviewing Comstock Resources (CRK). We own CRK – we liked it at $30 a share truth be told, although we did have the good sense to lighten up the position at those heady levels. CRK is a natural gas E&P name drilling for shale gas mainly in East and South Texas and North Louisiana. We’ve long liked natural gas as a replacement for coal in fuelling America’s power plans. It is cheap, abundant, clean(er) and here, in the U.S. But the very abundance of natural gas has depressed its price for some years now and forced the E&P companies exploiting it to operate at successively lower costs. CRK qualifies, in that it has estimated extraction costs of around $1.26 per MCF (thousand cubic feet) although that continues to fall. It also has manageable debt. They operate in a similar area to Petrohawk, which was acquired earlier this year by BHP Billiton. We think CRK may ultimately be acquired, although today’s market environment offers much less immediate prospect of that given the difficulty of financing acquisitions.

Meanwhile, CRK’s stock price recently sank as low as $14 (and even now has only rebounded to just over $16). At current prices you can buy the entire company for less than $800 million. Assuming they can realize $1.25 per MCF on the proved reserves of 1.05 TCFE (trillion cubic feet equivalent), and after adjusting for debt net of cash the company is trading for approximately the value of its proved reserves alone.  This doesn’t account for their reserve potential which could be 3-5 times as much again. CRK’s problem is that the market always worried they won’t have enough cashflow to fund their drilling program and as a result will need to come to the market for additional equity , and this along with the disappearance of any imminent takeover explain the precipitous drop in the stock. The company believes they will fund all their capex needs from internally generated cashflow, and they expect to spend $610 million on capex (i.e. drilling new wells) in 2011 for which they don’t expect to tap the equity market.  In addition they have $400 MM in unused credit through their bank revolver.

I’ve met Roland Burns and chatted with him several times over the past year. We think this stock offers an attractive risk/return at current prices, and will be looking for opportunities to add to our position.

Disclosure: Author is Long CRK