Buffett's Big Rail Buy: What It Means for Berkshire Shareholders 38 comments
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As reported earlier today, Berkshire Hathaway (BRK.A) has entered into a definitive agreement with Burlington Northern Santa Fe (BNI) to acquire for $100 per share in cash and stock the remaining 77.4 percent of outstanding BNSF shares not currently owned by Berkshire. In addition, Berkshire Hathaway will split its B shares 50-for-1 in order to accommodate a share exchange for smaller owners of BNSF shares.
This transaction, which will bring Berkshire’s investment in BNSF to $44 billion including shares already owned, is the largest acquisition in Berkshire Hathaway history. What does this acquisition mean for Berkshire Hathaway shareholders?
Using Stock in Acquisitions
Much of the initial chatter on Twitter and elsewhere related to this transaction centers on Warren Buffett’s decision to use stock for part of the purchase. Does this mean that Mr. Buffett considers Berkshire Hathaway shares to be overvalued and suitable as currency for acquisitions? While it is possible that Mr. Buffett considers Berkshire shares to be fully valued or overvalued, this is not necessarily the case. Let’s look at what Mr. Buffett had to say about using stock in acquisitions over twenty five years ago when Berkshire acquired Blue Chip (from the 1982 Chairman’s letter):
Our share issuances follow a simple basic rule: we will not issue shares unless we receive as much intrinsic business value as we give. Such a policy might seem axiomatic. Why, you might ask, would anyone issue dollar bills in exchange for fifty-cent pieces? Unfortunately, many corporate managers have been willing to do just that.
I highly recommend reading the entire section of the 1982 Chairman’s letter entitled “Issuance of Equity” for more of Mr. Buffett’s thoughts on using stock in acquisitions. Berkshire’s use of stock, based on these principles, does not indicate that Berkshire shares are overvalued. Instead, it indicates that management believes that at least as much intrinsic value is being received as being given up through the new share issuance.
Terms of Agreement
The terms of the agreement provides BNSF shareholders with the right to receive either cash payment of $100 or a variable number of Berkshire Class A or Class B common stock. The mix of cash and stock will be subject to proration if the elections made by shareholders of BNSF do not equal approximately 60 percent in cash and 40 percent in stock.
If Berkshire Hathaway Class A shares trade in the range of $80,000 to $125,000 per share, the value of the share exchange for BNSF shareholders will be fixed at $100 per share. However, if Berkshire Hathaway Class A shares trade either below $80,000 or above $125,000 at the close of the transaction, BNSF shareholders will receive a fixed number of Class A shares (at either 0.001253489 per share below the “collar” range or 0.000802233 per share above the “collar” range). BNSF shareholders may elect to receive the economic equivalent in Class B shares as well.
The “collar” terms create a situation where BNSF shareholders who elect stock rather than cash could potentially receive less than $100 per share if the price of Berkshire Hathaway A shares are below $80,000 at the close of the transaction. BNSF shareholders could receive greater than $100 per share if the price of Berkshire Hathaway A shares are above $125,000 at the close. At any share price between $80,000 and $125,000, BNSF shareholders will receive enough Berkshire shares to result in a valuation of approximately $100 per share.
Bet on the United States Economy
There is no doubt that this transaction represents a bullish bet on the United States economy as Mr. Buffett stated in the press release:
“Most important of all, however, it’s an all-in wager on the economic future of the United States,” said Mr. Buffett. “I love these bets.”
We know that Mr. Buffett closely follows railroad statistics and has even said that he would choose railroad data as his only economic indicator if “stranded on a desert island“. Rail car loadings have been far below levels reached during the peak of the last expansion but have recently shown some signs of improvement. Mr. Buffett has been appearing on television frequently in recent months and has made bullish comments about prospects for the United States economy in the long run. The transaction is a massive bet on this bullish sentiment.
Stock Split: No, It’s Not April Fool’s Day
My initial reaction to the stock split announcement was total shock, but when one considers the terms of the BNSF transaction, it appears that Berkshire had no choice but to either split Class B shares or force small shareholders of BNSF to accept cash instead. With the post-split Class B shares likely to trade well below $100, it appears that even a small holder of BNSF shares will be able to elect Berkshire stock rather than cash. This is important for BNSF shareholders who wish to defer payment of capital gains taxes.
What is interesting about this stock split is the fact that it shows great concern for very small holders of BNSF shares. After all, any BNSF shareholder with more than 35 shares could elect to receive one pre-split Class B share of Berkshire based on current prices.
Make no mistake about it: The stock split has absolutely no impact on the actual intrinsic business value owned by Berkshire Hathaway shareholders. However, the split has some interesting implications in terms of potential inclusion in the S&P 500 index in the long run. It may also result in greater trading liquidity which could theoretically benefit shareholders who wish to enter into transactions.
The jury is still out on whether this transaction will benefit Berkshire Hathaway shareholders in the long run, and much will depend on the trajectory of the economic recovery in the United States.
Resources:
Berkshire Hathaway/Burlington Northern Santa Fe Press Release
Berkshire Hathaway Press Release on Class B Stock Split
Burlington Northern Santa Fe Investor Presentation Webcast
Burlington Northern Santa Fe Presentation Slides
Burlington Northern Santa Fe Transaction FAQ
Disclosure: The author owns shares of Berkshire Hathaway
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This article has 38 comments:
> Clearly, Buffett considers Berkshire Hathaway stock "overvalued"
> relative to Burlington Northern. Whether or not that means it's overvalued
> relative to everything else, that's another question.
Agreed, he must think that what he is paying is worth less than what he is receiving or the deal wouldn't be done.
The big question: What is the intrinsic value of Burlington Northern Santa Fe? I'm sure many Berkshire shareholders (myself among them) are reading BNI's 10K today to come up with an estimate.
Does the deal not make sense if ..........The net replacement value of BNI has currently some tangible relationship to the current BH share price? This "relativity" may be amplified in the months ahead if the market declines to retest the March 2009 lows. If it does Mr Buffett has cleverly locked in "hard assets" against an appreciating USD replacement value and the potential of sustained inflation in 18-24 month's time? This against shorter term share price decline. If the markets do capitulate in a deflationary shorter term horizon (next 12-18 months) whilst "cash value" will increase where would you hold such cash during this "financial risk" period? Hmmm I think this is a very strategic move by Mr Buffett to ride out the coming storm in "Hard Assets". It's always dangerous when a "right brain" marketing guy comments on financial matters - but hey we all have our opinions right or wrong - and this is mine. All I need now is a railway that I can afford to protect my hard earned "cash".
Railways? It sounds like back to the future... The railroad is coming! Perhaps the Sacred Cow of Omaha has been watching too many re-runs of Dr. Quinn Medicine Woman.
Also bear in mind that RRs transport over 40% of goods in the US, are more efficient than trucking/air, and are a primary mode of transportation in developed areas such as Europe, Japan, and the urban East Coast of the U.S. So we're not exactly talking Dr Quinn Medicine Woman stuff here.
In my book, Building the Next Berkshire Hathaway (page 12) - I note that the future for Berkshire Hathaway is the expansion of its railroad holdings and its utility holdings. Thus, I am not completely surprised by the move.
I am a little surprised by the issuance of stock. Ravi points out the Berkshire philosophy rather well - and Buffett is the one who makes the valuation decision (stock of BNI is worth more than stock of BRK issued). Time will tell.
I would like to point out that future acquisitions may focus on the energy (utility) sector, as well as gas pipeliness. This is a big time contributor to Berkshire that doesn't get a lot of press.
I think it is worth looking out how these things are rolled out and when...
On Nov 03 11:33 AM najdorf wrote:
> bottoms-up: It's hard to pump a dump a company by buying 100% of
> its shares with cash and your own shares. You can be sure that Buffett
> believes BNI is a good buy - whether he's right or not is of course
> debatable.
>
> Also bear in mind that RRs transport over 40% of goods in the US,
> are more efficient than trucking/air, and are a primary mode of transportation
> in developed areas such as Europe, Japan, and the urban East Coast
> of the U.S. So we're not exactly talking Dr Quinn Medicine Woman
> stuff here.
I bought BNI in early 2005 in the 40's and got stopped out within a few months for a gain of about 12%. This is one case where stop loss risk control proved counter productive.
On Nov 03 01:27 PM John Lounsbury wrote:
> I think Buffet is making an energy play. He has been more and more
> an energy investor in recent years. Remember his 300% plus gain over
> a couple of years with Petro China? Utilities and pipelines are part
> of the energy investment picture. BNI is part of the same strategy,
> in this case he is buying a coal "pipeline".
>
> I bought BNI in early 2005 in the 40's and got stopped out within
> a few months for a gain of about 12%. This is one case where stop
> loss risk control proved counter productive.
It's as if Southwest Airlines decided to go buy pipelines and tank farms which bring jet fuel to the airports SW serves.
What if BH was looking to buy a coal producer?
On Nov 03 02:15 PM Socialism cannot compete! wrote:
> Only problem with this "energy play" -- the coal pipeline -- is that
> this Admarxistration does *not* like coal. Should be buying nuclear
> or something else instead. Unless...Buffett is doing this to create
> anti-Cap & Tax leverage against the neo-Coms??? Now *that* would
> be interesting!!! Last I checked, Warren was pretty liberal. Wonder
> if he's changing stripes...perhaps his capitalist self has woken
> to the realization that the liberals and their socialist policies
> are anti-freedom and anti-capitalism??? Things are getting very interesting
> indeed.
Actually, going back to BNI. Buffett knows that rails have no effective competition for high-volume commodity transport (coal, grain, chemicals), and that rails own their right of way 100% - and don't have to share it with anyone.
I also wonder how much BNI will get from taxpayers for new Amtrak leases and even high speed rail deals (land swaps, trackage rights, etc.) BNSF shares the rails with UP over Tehachapi Pass - where the Calif HSR wants to run. And BNSF also has tracks over Cajon Pass, the route between LA and Las Vegas.
Exchange of Berkshire and Fed paper for railroad assets and land.
Let's say the bad becomes worse based on Washington policies. People will still need to eat meaning rail assets become extremely valuable.
WB loses if the US government decides to throw the industrialists to the wolves as other Fascist or Communist governments did in the past. In that extreme case, we ALL lose. But if I am WB I sleep well at night on this deal.
On Nov 03 01:27 PM John Lounsbury wrote:
> I think Buffet is making an energy play. He has been more and more
> an energy investor in recent years. Remember his 300% plus gain over
> a couple of years with Petro China? Utilities and pipelines are part
> of the energy investment picture. BNI is part of the same strategy,
> in this case he is buying a coal "pipeline".
>
> I bought BNI in early 2005 in the 40's and got stopped out within
> a few months for a gain of about 12%. This is one case where stop
> loss risk control proved counter productive.
On Nov 03 02:15 PM Socialism cannot compete! wrote:
> Only problem with this "energy play" -- the coal pipeline -- is that
> this Admarxistration does *not* like coal. Should be buying nuclear
> or something else instead. Unless...Buffett is doing this to create
> anti-Cap & Tax leverage against the neo-Coms??? Now *that* would
> be interesting!!! Last I checked, Warren was pretty liberal. Wonder
> if he's changing stripes...perhaps his capitalist self has woken
> to the realization that the liberals and their socialist policies
> are anti-freedom and anti-capitalism??? Things are getting very interesting
> indeed.
I look at Buffet's "Bet on America" investment as a hedge against worldwide political instability that would cause us to rely on ourselves for production of products and energy for an extended period of time. Specifically, I see the increased likelihood of several events:
1) It's hard to say this, but a significant expansion of the domestic manufacturing base due to protectionist policies (e.g., major import taxes) that would reduce foreign inflow of goods from producer/creditor nations.
2) Political instability/collapse in BRIC nations. Such events can damage and reduce their production capacity.
3) High fuel prices for extended periods of time due to upcoming currency fluctuations and Middle East Crises.
On Nov 03 01:35 PM Klutz wrote:
> I hope this is the start of more Berkshire acquisitions in the industry.
> I don't know the rail business intimately but if I recall correctly
> the margins increase dramatically when you own all four.
I never thought I would ever see a Berkshire share of any kind selling for $67 a share. Hell they may let Warren in the S&P 500 now, wouldn't that be something?
Warren if you want to buy a better value energy play thats diversified internationally instead of domestic dependent like BNI why didn't you buy RIG????? Less money and a much better long-run energy play. What am I missing?
On Nov 03 01:27 PM John Lounsbury wrote:
> I think Buffet is making an energy play. He has been more and more
> an energy investor in recent years. Remember his 300% plus gain over
> a couple of years with Petro China? Utilities and pipelines are part
> of the energy investment picture. BNI is part of the same strategy,
> in this case he is buying a coal "pipeline".
>
> I bought BNI in early 2005 in the 40's and got stopped out within
> a few months for a gain of about 12%. This is one case where stop
> loss risk control proved counter productive.
Instead of getting our orders the next day we will have to wait until the next train comes to town.
This is a brilliant move by an old timer that sees the future but will not be around to live it.
I guess all of you can come down on rating agencies that may take his AAA rating away:
www.bloomberg.com/apps...
Remember, sacred cows make the best burger, and I don't mean Omaha Steaks.. In business, if you follow anyone or anything as though they are a deity or rock star, you'll get what's coming to you.
On Nov 04 02:36 PM bottoms-up wrote:
> I noticed that I got of thumbs down for coming down on the untouchable
> Sir Buffett of Omaha.
>
> I guess all of you can come down on rating agencies that may take
> his AAA rating away:
>
> www.bloomberg.com/apps...;sid=aTI6ak3w6s0Y
>
>
> Remember, sacred cows make the best burger, and I don't mean Omaha
> Steaks.. In business, if you follow anyone or anything as though
> they are a deity or rock star, you'll get what's coming to you.