Buffett Lets It Ride on the Railroad

Tuesday Warren Buffett announced his company, Berkshire Hathaway (BRK.A), would make its largest acquisition to date in Burlington Northern Sante Fe (BNI). When Warren makes a move, everyone takes notice. His affinity for this railroad operator has been no secret as he had steadily acquired a 24% stake in the company over the last few years, and now he is spending about $26 billion in cash and stock in order to buy up the rest of the company. In addition to the deal, valued at $100 per share Buffett will assume about $10 billion in debt, making the total value of the company in excess of $44 billion. This is a major move by any standard, and Buffett has said that this is essentially, “an all-in wager on the future of the U.S. economy.”

One of Buffett’s most famous sayings is, “the best time to sell as stock is never.” Clearly, Buffett sees a quality investment in the railroad industry and he sees rail as the way more goods will be transported throughout the U.S. in the future. He has believed in the power of rails for sometime as he acquired a railcar manufacturer and leaser last year in Union Tank Car.

Buffett has long been regarded by some as a leading indicator because of his proven ability to successfully act on a long term investment theses throughout his career. For those looking for the meaning below the surface in this deal, there is not much digging required. First, as Buffett himself said this is a play on U.S. economic recovery as economic growth will certainly lead to more demand for railways and transports more generally. A second corollary, which is a bit more of a stretch but not unfounded, would be that Buffett believes that rails will increase in attractiveness because they are a greener alternative to trucking. They burn less fuel per ton of cargo and are much cheaper for many bulk materials such as coal. Not to mention, the fact that rail traffic will undoubtedly increase if oil prices begin to spike again to the high levels seen in 2008 or beyond.

In addition to the acquisition, Buffett announced that Berkshire Hathaway will be splitting their B-shares 50-1. This will bring the stock down from over $3300 to the high-$60’s per share, and is a highly uncharacteristic move of Buffett’s company. However, the stated reason is so as to accommodate smaller holders of BNI stock that would prefer the stock swap instead of the cash payout. This should also increase liquidity in shares that have averaged only tens of thousands of shares traded per day. It also lowers the barrier to entry for small investors looking to hitch their fortune to the Oracle of Omaha, making this a win-win in our view for everyone involved.

With Tuesday’s announcement Buffett has followed through with the value investing style that has made him an investing legend. He saw an opportunity for long term growth in rail transportation and he believes he is paying an attractive price. Our methodology places a Fairly Valued rating on BNI as of this week’s report, and a price of $100 would be near the high end of where we would expect shares to trade. As for Berkshire Hathaway, we have it rated as Overvalued after cash earnings have been weakened during the recession. With that being said, the 50-1 split is already generating a substantial amount of interest and could provide some upside potential.

Comments

[Gadz:]

Buffett is THE most compelling investor ever. If Buffett is bullish on America and the railroads there must be something to it. Short of Alzheimers, this man is in control.

Nov 03 02:00 PM

[Mad Hedge F...:]

cvn You’ve got to hand it to Warren Buffett, who never does anything half heartedly. The stunning news that he is paying $44 billion for the 73.4% of Burlington Northern Sante Fe (BNI) he doesn’t already own, a 30% premium, had punch drunk traders picking themselves off of the floor. The other rails rocketed, like Union Pacific (UNP), CSX (CSX), and Kansas City Southern (KCSR). The deal is the Oracle of Omaha’s largest in his career, and took the BNI board all of 15 minutes to approve. For me this deal speaks volumes about the long term trends in the US economy as seen by its greatest investor. It screams Commodities! Commodities! Commodities! Rails can only prosper moving bulk freight from the heartland to ports on the three coasts, which foreigners are buying in ever larger quantities at ever higher prices. It also says the coal industry isn’t going anywhere soon, as it accounts for 70% of all rail traffic. Buffet let loose of some fascinating statistics about the enormous productivity increases the industry has accomplished. In the last 25 years, it cut employment from 500,000 to 175,000, while increasing freight by 60% and reducing track by 40%, and now accounts for 40% of the total goods moved in the country. Railroads are the greenest transportation out there, a ton of freight requiring only a gallon of fuel to move 470 miles. When I was growing up, my big goal in life was to become a train engineer. Maybe it’s time for me to revisit that aspiration. And I promise not to text while driving!

Nov 03 07:52 PM