Skeptical About Buffett's Big Bet

The amusing part of Berkshire buying BNI (Burlington Northern) isn't that he's doing it at what looks to be a ridiculous premium to the current stock price (although below the historic high) - it is that he's splitting Berkshire's "B" shares in doing it.

Remember, this is the guy who has maintained forever that stock splits are inherently wrong, in that they're nothing other than a game.

Well, yes. But under the cover of the claim that he wants BNI shareholders to "enjoy" a tax-free exchange, suddenly Berkshire "gets religion" and splits the "B" shares 50:1?

Uh, Warren. This is a stock and cash deal, right? What prevented you from issuing a "C" share? Nothing, other than dilution, which you could handle with an immediate buyback of the outstanding amount necessary to balance it.

Here's my view, for what it's worth - BNI at yesterday's closing price was reasonably valued at a P/E of 14. At the deal price it's about 20. That's too high, unless you believe that manufacturing is coming home in massive numbers, and that "indefinite growth" is coming back.

I think Warren's wrong on valuation. I also think he should have bought BNI back in March, when the stock price was under $51, and paid $70, which would have been an even bigger premium in percentage terms and been a better deal for Berkshire shareholders:

Here's Berkshire's "B" share chart (the "A" is the same, just bigger numbers):

If you're a BNI shareholder, I'd be taking the money - this morning. You're no longer the owner of a big industrial mover; you're now the owner of stock in what amounts to a financial conglomerate trading with a P/E of 52 (as of this morning), where you had a P/E of 14 last night. Worse, Berkshire's market cap is being "invaded" tremendously by this acquisition, turning Berkshire from a financial company (in the main; banking and insurance) into a multi-line conglomerate with a HUGE transportation component.

Mean reversion is going to suck WHEN it occurs, and this much is certain - you didn't own BNI expecting it to have a P/E of 52, but suddenly it does, and anyone who believes that a conglomerate with 25% of it's total market cap comprised of "railroad" should trade at anywhere near a P/E of 52 has rocks in their head.

Buffett's comment: "This is a bet on the future of the country, 5, 10, 20 years from now."

That's Berkshire's and Buffett's mantra, and in addition this is a bet that rails will be the big winner over time in terms of moving products in a world that is increasingly hamstrung by both energy constraints and (in my view insane) "global warming" nonsense.

I think Warren is right on who wins in the transportation matrix in the future, but he doesn't care about multiples.

I, as an investor, do.

If I owned either of these firms (I don't) I'd be a seller this morning into the ramp job, especially if I held BNI. Nobody in their right mind trades a P/E of 14 for a P/E of 52.

Disclosure: No position.

Comments

[obsoma:]

a
AGREE COMPLETELY;DENNINGER HAS NO CLUE ABOUT WHAT BRK REALLY IS AND WHAT WARREN IS ALL ABOUT.

...observer and stockholder in Omaha


On Nov 03 03:57 PM User 174536 wrote:

> This article is senseless. Do you think BNI management would have
> sold the company for $70 back in March? If they have any intelligence,
> the answer is "no".
>
> Second, there's more to valuation than P/E. What's BRK's cash flow?
> How's it compare to its GAAP earnings?
>
> Thanks for wasting 2 minutes of my life with this nonsense.

Nov 03 04:50 PM

[Munzmchn:]

Realize that Warren is in cahoots with the rest of the financial establishment as they try desperately to do everything possible to give any positive indication to the masses that nothing is amiss. This whole thing reminds me of his damn Goldman deal. Do you really think he had no inside knowledge of the golden bailout our government spoon fed them.

Nov 03 05:01 PM

[Roger Knights:]

Why pay a premium and put all your eggs in one basket? Why not buy a basket of RRs at market prices?

There's a considerable long-term risk in BNI: The port in Mexico's west coast that is being built, in conjunction with improvements to a railroad line from it to Kansas, that is intended to be a low-cost alternative to high-wage US west coast ports. This could divert a good deal of traffic.

I thought China had lots of coal.

Nov 03 05:13 PM

[Dave Wrixon:]

Well, it does kind of make sense to try to convert the US economy into a commodities supplier. It has no hope of competing with the Asian Tigers or the BRICs but should be able to hold its head up against third World Commodity suppliers, at least for now.

Nov 03 05:26 PM

[anon12345:]

This article is a mess and I wish I hadn't wasted the neurons to attempt to make sense of it or the energy to keep my computer on to read it. Do you have any idea why BRK.A is trading at a 52 multiple, i.e. the components of its earnings? I would argue that you have no clue: the derivative bet and mark to market has dragged down its normal operating earnings. There is no guarantee that these "bets" will rebound, but to make an assumption that BRK.A as a financial services company could justify a 52 multiple without an underlying story is absurd. Waste of time...

Nov 03 05:47 PM

[User 174536:]

Do you really think BRK could buy $34 billion of RRs in the market? Do you think Buffett amassed his fortune by buying "baskets" of stocks?


On Nov 03 05:13 PM Roger Knights wrote:

> Why pay a premium and put all your eggs in one basket? Why not buy
> a basket of RRs at market prices?
>
> There's a considerable long-term risk in BNI: The port in Mexico's
> west coast that is being built, in conjunction with improvements
> to a railroad line from it to Kansas, that is intended to be a low-cost
> alternative to high-wage US west coast ports. This could divert a
> good deal of traffic.
>
> I thought China had lots of coal.

Nov 03 07:48 PM

[Mad Hedge F...:]

xfi 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 07:51 PM

[Rolo:]

All of this P/E talk makes it sound like Warren is making a rookie mistake. The problem is that Warren is no rookie and I'm sure that he didn't make this decision over night.

Nov 03 07:53 PM

[The Geoffster:]

Is BNI O gauge or HO?

Nov 03 09:04 PM

[tinscale:]

Geoffster - Not O or HO -- it's tinscale!

I've been waiting to use that line for a long time :-)

Nov 03 10:32 PM

[Mark Anthony:]

I agree with Warren Buffet's big bet that the US economy will survive and thrive, and that the dollar is going to collapse, and that commodities are going to be HUGE.

What I can not understand is his timing, and his way over-paying for BNI. It's no secret at all that Warren Buffett loves railways. It's public knowledge for more than 2 years, maybe 3 years. He openly talked about his love of railways. So why now? Why not buy in march while the price was much better?

He definitely way over-paid for this thing. I am sure there are tons of other bullish assets way much cheaper to buy , at much better valuation than BNI. If he likes transportation and thinks America is going to export a lot of coal to China, then he should be buying coal mines and he should be buying dry bulk shipppers. Both are dirt cheap now, way much cheaper than railways.

Warren Buffett didn't lose on the big picture. He lost it completely in his valuation calculation and timing.

seekingalpha.com/autho...

Maybe Peter Schiff's comment on Warren Buffett's move is correct.

Nov 03 11:43 PM

[Cuse16:]

Who has the higher net worth? Who is the 2nd richest man in the World? This wanker officially lost his mind.

Nov 03 11:48 PM

[User 464776:]

You gentleman forget to make mention of the largest asset I would consider BNI to possess... their rail beds and right-of-ways. Guess where all the new power lines from all the "green energy" sources will be laid? Guess where all new fiber optic lines (most are already) for the increased broadband usage will be laid? Guess where potential high speed rail lines will be located? Guess who will be paying for all of this?

Nov 03 11:48 PM

[Cuse16:]

As Buffet as stated, "Beware of geeks with calculators".

Nov 03 11:54 PM

[Past Tense:]

Perhaps someone like Buffet has 'seen it all before' and without panic is picking his point of entry and in an industry he sees as having little down side risk.

1. He used to own newspapers but thinks they're at risk from the internet.

2. He is a volume discounter of furniture and has watched the looming threat of internet discounters combined with Chinese imports.

3. Financial services are likely to be at threat from increased government regulation.

If you looked at growing populations, increasing energy costs and globalization in unison, wouldn't you invest in one of the most efficient forms of transport?

Perhaps we should also stop and analyze how the world will look in 20 years, and then think 'what industries will take us there?'...Buffet's common sense is truly bewildering obvious, I just wish I would apply my own as he does his.

Nov 04 01:12 AM

[Karl Denninger:]

Any time a board takes 15 minutes to say "yes" to being bought out you paid too much.

Really, it's not much more simple than that. This is true of any negotiation - when it's that easy, you blew it.

Nov 04 08:20 AM

[londres:]

First of all, some of these comments show an almost religious faith in Buffet, that's risky. If it wasn't Buffet who made this deal, would it really seem sensible? An old economy stock at a P/E of 20 looks pricey.

Also I'm not sure how profitable exporting coal to China is, this would be quite a risky bet if coal is an underlying target, he could have bought ports operators instead. The Panama canal will be widened by 2015 and mayeb then coal would be more profitable, as larger 'capesize' ships could pass through. But will the world be using coal in 20 years? I hope not for environmental reasons.

Overall, I give WB the benefit of the doubt because, and only because, he's an insider, he owned a huge chunk already and knew the board very well. He knows something....

Nov 04 08:32 AM

[User 494952:]

MA agreeing with KD? Dogs sleeping with cats and the sun rising in the west? Who woulda thunk it?

Nov 04 09:19 AM

[artkarl:]

Well, you're right about everything except the "insane" global warming.
I hope you live long enough to see that play out.
It won't be pretty.
-Karl Krachenberg

Nov 04 11:59 AM

[Gadz:]

I've said it before and I will say it again, it's bad to bet against Buffett. Everyone here bad-mouthing the deal made by the BEST investor ever, with a proven track record of almost 50yrs, better know something the rest of us don't. Otherwise, given Buffett's astonishingly high success rate, I suggest you keep your own counsel and watch and learn. Sure, he's made mistakes, but his can be counted on one hand, can yours?

Nov 04 12:07 PM