Burlington Northern Santa Fe: What's Buffett's Strategy?

Ever since the first quarter of 2007, Warren Buffett’s Bershire Hathaway (BRK.A) has been buying into Burlington Northern Santa Fe Corp. (BNI). By April 5, 2007, he bought more than 39 million shares. The Berkshire Hathaway 2007 Annual Report states that as of December 31, he held more than 60.8 million shares or 17.5% of the company. Throughout 2008, Buffett just kept on buying, either in the open market or sold put options and got shares “put” to him as the exercise price. As of December 11, 2008, GuruFocus reported that Warren Buffett held a little over 70 million shares of BNI, or 20.47% of all the shares outstanding.

Through subsidiaries or subsidiaries of subsidiaries, Berkshire Hathaway has woven together an empire consisting of 10 insurance companies and 66 non-insurance businesses. Besides that, as of December 31, 2007, it holds $141 billion worth of investment: stocks, bonds, and cash equivalent. BNI is bought as a stock holding. But as the percentage of ownership changes, one could not help speculating that it may one day become a Berkshire Hathaway controlled operating company.

Warren Buffett has stated on several occasions that good investment ideas are hard to come by; 15 years ago he stated that between him and Charlie Munger, combined, they were quite happy if they could come up with one good investment idea each year. Undoubtedly, BNI is one of those ideas, else it would not worth spending more than $5.5 billion dollars and two years to accumulate a little over 20%.

Warren Buffett does not buy more than 20% of a company from the open market easily. As of December 31, 2007, his top stock holdings in terms of dollar amounts include American Express (AXP) (13.1%), Coca-Cola (KO) (8.6%), Procter & Gamble (PG)(3.3%) and Wells Fargo (WFC) (9.2%); his top holdings in terms of percentage of ownership include: Moody’s Corporation (MCO) (19.1%), Washington Post Company (WPC) 18.2%), Burlington Northern Santa Fe (17.5%), and USG Corp (USG) (17.2%). Numbers in the parentheses are ownership percentages. Like his operating companies, most of the significant investment positions, once established, rarely change. Many of the positions have been established and stayed there forever. It's worth noticing that there are several names in which he has held close to 20% for many years. Breaching the 20% line is a big deal for Warren Buffett.

In theory, Warren Buffett can own any percentage between 0 and 100%. In practice, however, he seems to prefer either under 20% or above 50%; in other words, either as investments or as a controlled operating company. This is especially true in recent years. In his 1980 Chairman’s Letter to Shareholders, Warren Buffett gave a crash course on Non-controlled Ownership Earnings. For companies 50% owned, one needs to fully consolidate all financial results; for companies between 20 to 50% owned, only the proportional earning needs to be included in the Income Statement; for holdings with less than 20% ownership, only dividends received are reported as earning.

Warren Buffett does not base his investment decisions on how the earnings are treated in accounting, so it is not obvious from these accounting rules why he avoids holdings between 20% to 50%. I guess when the acquisition price is not of concern, if an idea is good enough to justify a 20% ownership, it might as well justify a 50% ownership.

Perhaps Warren Buffett’s acquisition of GEICO offers a case study for what might be happening with BNI. In his 1995 Letter to Shareholders, Buffett gave a good account of his investment love affair with GEICO. Aside from flirting with the stock as a young investor in the 1950s as the Chairman and CEO of Berkshire Hathaway, he started to buy into GEICO in 1976. By the end of 1980, Berkshire Hathaway owned 33.3% of GEICO. During the next 15 years, he did not make any further purchases, but his interest in GEICO grew to about 50% because the latter was a big purchaser of its own shares. Then, in 1995, Berkshire Hathaway offered $2.3 billion for the other 50% of the company and took the company private.

BNI has also been a diligent purchaser of its own stock, according to GuruFocus data. From December 1998 to September 2008, the company’s shares outstanding shrank from 469 million to 344 million, declining at an annual rate of 2.9%. If the company continues to reduce its shares outstanding and/or Buffett keeps on adding to his position, it won’t before too long before he owns more than 50% of the company.

Will that happen? Many Warren Buffett watchers are anxious to see; some of them even have some money invested along with the guru.

2009 will be an interesting year for the story to unfold.

Disclosure: no positions

Comments

[ustaad:]

Good, insightful article.

Jan 11 08:08 AM

[long_on_oil:]

It is not hard to figure out why Buffet is buying up BNI or any rail road for that matter. What is the cheapest way to move goods long distance...rail. We have already seen how the rail business picked up during the last jump in fuel prices. Well, in the future that will be the norm.
In the future, in order to save energy we will be using more and more rail. Buffet will never see the day when rail makes a gigantic comeback but our kids, kids will.
In the future rail will make a comeback to every small town, just as it once was.
Heck, every Wal Mart will have rail right up to the back door.
Warren's heirs will be saying, damn, he really was ahead of his time.

Jan 11 08:34 AM

[TripleG:]

I think Buffett is betting that Rail will replace a large percentage of the trucking (over-the-road) transportation in the future. I too believe that is a safe bet. Rail is cheaper, albeit slower and more cumbersome, that short haul truckers. We need to conserve fuel in the US. Computers have allowed purchasing managers to be able to make large, timely orders instead of last minute just-in-time stockage.

Jan 11 08:36 AM

[Paul Killinger:]

Excellent article and insightful commenting, Long Oil.

Jan 11 08:43 AM

[CaptainJJack:]

I own both BRK.A and BNI. BNI is not a company Buffet would normally buy because it is so capital intensive. Buffet likes companies that have low capital and low R&D because he measures success of an investment against what he, as an owner has to put into it --i.e. he looks at ROE.

So, why BNI? I think he sees that the monopoly margins that are now built into the division of the country's rail infrastructure into five railroads means that BNI can more than cover its capital costs.

Further, there is more to the rail story than just energy efficiency. Look at the side of any long haul truck on the highway, and you see advertisements for owner operators.

The trucking industry is not able to keep enough truckers, and there has been a big labor shortage developing. This is more than just finding someone to drive a truck; they want someone who will drive HIS OWN truck for them.

Jan 12 11:45 AM