Buffett's BNI Purchase: Bearish Bet on the Economy?

I apologize for how quiet it's been around here.

I wanted to hop on and discuss Warren Buffet's purchase of BNSF.

The world of course cheered the move. CNBC hyped this all day Tuesday claiming that the "animal spirits" in terms of M&A were now back on Wall St!

Ha! Yeah right....

After laughing at this headline, I spoke with a very wise bond trader following the news. His take was the same as mine: This is a huge bearish bet on both the US Economy and the US dollar versus the bullish spin you see on CNBC.

When you break it down, how could you interpret this move any other way if you had a brain in your head?

I personally think this was a brilliant move by Buffet (BRK.A) but it also scares the crap out of me. This is the LARGEST deal that Buffet has ever made with his money. He funneled a good portion of his cash holdings into this deal.

Question here:

Why would the smartest investor in the world put most of his cash into an antiquated railroad system in the 21st century?

IMO Buffet did it for a couple of reasons:

#1: Fear of inflation. As a veteran of selling commodities, I understand the cost of transportation. The cost of rail is a fraction of shipping via truck. Does Warren fear $200 oil? I sure think so after watching him place a multi billion dollar bet on the rails.

#2: Hedging against the US dollar: Warren obviously sees the same writing on the wall that the world does(as well as me). He realizes we will most likely will never pay back our $13+ trillion dollar deficit.

All you need to do is look at gold in terms of the lack of confidence in the US dollar or ANY world currencies for that matter.

The Bottom Line:

IMO, Buffet realized he needed to diversify his dollar holdings. I am sure he was scared ****less when gold rose close to $1100 this week. I am also sure every central bank feels the same way.

Treasuries are also rising as a result of the deficit lunacy. Who knows what the bond traders will do if gold continues to soar. Will yields rise in order to keep up with gold? I sure think so.

Warren Buffet basically found the perfect opportunity to diversify out of the US dollar via his rail purchase without losing face around his so called "confidence" in the US Economy.

The networks and Buffet can spin this purchase positive for the economy all they want. The reality here is this is much more of a bearish bet on the economy versus a bullish one.

Warren obviously sees higher fuel costs or a crashing dollar down the road. Why else would you spend $10's of billions on an "old school" technology that's been around since the 1800's?

Ironically, one of the worst depressions we saw in this country was the aftermath of a railroad speculative bubble in the 1870's.

How fitting is this! What comes around goes around!

I want to thank Warren Buffet for reinforcing my belief that the US economy is toast.

Author's Disclosure: No new positions but I agree with Buffet.

Comments

[brianr:]

I completely agree with your assessment. That's the best articulated view I have read on the subject. He is "all in" on the U.S. economy, just not the way most would think....Clever guy

Nov 05 09:33 AM

[Oneslip:]

Jeff,
Surprised he did not purchase a bulk shipper as this counrty will have to export commodities and manufactured goods in order to survive, a technology even older then the rails.

Nov 05 09:44 AM

[phil from E...:]

Aren't billions to be spent by government on high-speed rail, didn't Buffet just buy the best rail network in the country? Just a hunch.

Nov 05 09:45 AM

[Shaftsinker:]

Have the permabears really gotten so desperate?

This is the absolute most desperate reach of an argument I've ever seen on SA. I don't even know where to start.

"The cost of rail is a fraction of shipping via truck. Does Warren fear $200 oil? I sure think so after watching him place a multi billion dollar bet on the rails."

Yes, surely a multi-buillion bet on the rails means Buffet is expecting the shipping of goods to dwindle. You're saying that investing in rails is a smart move in the midst of a coming crash coupled with $200 oil? Do you have any idea what that would to to the entire transportation sector? Have you completely lost your mind or are you just a troll?

And Buffet is terrified of inflation because of a 13 trillion deficit (I thought that was the total US debt? Did Obama spend 11 trillion dollars while I overslept this morning?), wouldn't it make more sense to invest in a company whose revenues are not based purely in US dollars and who rely on the shipping of goods to Americans to meet their bottomline? What exactly will Americans be buying that needs to be shipped?

"Why else would you spend $10's of billions on an "old school" technology that's been around since the 1800's?"

Oh now I see the light. In a world where Americans purchase nothing and the American dollar is worth nothing, surely owning technology that ships goods to Americans and gets its revenues in USD is a great move.

Nov 05 09:48 AM

[Shocksink:]

It´s not only the railroad....think about the LAND he´s getting......

Nov 05 09:57 AM

[somecatchyp...:]

Buying a railroad is a great way to hedge against a falling dollar, inflation, and higher energy costs. I agree with your analysis 100%, but would add one more thing.

In making this buy, Buffet does his friends in power an enormous favor.

Buffet helps prop up the charade of recovery. It’s kind of like the PPT calling in backup. Headline: One of the world’s best known and influential investors is “bullish” on the US.

We all know that favors demand payback in some way, shape, or form.

Nov 05 09:58 AM

[bluesmoke:]

He also paid a 30% premium to the market price. That tells me he definitely sees the promise in commodities for the long term. Great move.

Nov 05 10:40 AM

[sorgmot:]

The question is not why did Buffet buy.

The question is why did the present owners sell.

This is a poor time to sell a railroad.. The price will be 2 or 3 times higher in 3 or 4 years. It was 30% higher 2 years ago. It will be 30% less as soon as the Fed puts an interest rate above zero on money

Are they broke?

Nov 05 10:53 AM

[Dzog:]

Something else to consider, as I see it, are the properties that Buffet has purchased (owned by this company), mineral rich - In particular precious metals?

Nov 05 11:04 AM

[HAA!:]

shaftsinker- this network includes oil sands, america's breadbasket and canadian mining, all commodities that don't depend on US consumers- but I don't believe Buffet's comment "all in on the US economy" this guy is a predator, look at his GS purchase, ultimately he could care less about the US. He's been eyeing trains for years, and I hope decentralization ruins this play, may he bed a pretty lady and wake up with an ugly one!

Nov 05 11:21 AM

[User 303490:]

Perferct. Here is a memo I wrote to myself yesterday to look back at later on:

Memo
To:
From: SBH
Date: November 4, 2009
Re: Why did Berkshire buy BNSF?
He gave up on finding a way to deplore US dollars as he had been able to do successfully in the past.
He knows time was running out and that instead of a slow, steady decline in the value of the US dollar, that it will collapse at a more rapid pace.
This was a very large hedge against the value of not just the US dollar, but against all currencies.
Gold isn’t an option, as there is no intrinsic earning power in it. A store of wealth isn’t attractive in and of itself unless it can generate some sort of revenue (whether it be US dollars, other currencies, commodities or bartered goods/services.
There are few options in multi-billion US dollar investments to hedge against the fall of the dollar. How many investments have (i) revenue, (ii) are simple to understand, (iii) have hard, real, revenue generating assets, (iv) are over $10 billion, (v) have little downside risk in future earnings, and (vi) can be purchased quickly and easily.
He was fine in assuming existing debt, taking on additional debt, and burning through a lot of cash in return in taking on huge amounts of additional assets as described above. The investment seems to make a lot more sense, if on day one, you assume the value of the dollar is what it actually represents (nothing. Other than a belief that it had value because so many people have confidence, and have believed it for so long that people think it will continue to have value). Unless we go back to living in caves, a railroad will be key in the future and able to generate revenue in whatever median of exchange is used going forward. So essentially, Berkshire gave away nearly worthless US dollars, borrowed nearly worthless US dollars that will be very easy to repay when they are worth considerably less. In exchange, he took control of 50,000 miles of track and other valuable, hard assets.

Nov 05 11:23 AM

[nvest80:]

I think Buffet is setting "himself" up for Federal Bailouts, Tax Credits, and other Fed Funding/Aid. The railroads will likely be improved (with the help of the govt) and insurance is the next industry to be bailed out. I wonder what Buffet's plan is, if there is a backup plan at all, once his preferred shares will get converted to common ones...that will make things a bit more interesting for BRK. Too bad there aren't any options, I would like to get some puts on them. - nvest80

Nov 05 11:41 AM

[Juliet:]

Leave us not also forget the very simple fact that they have been eyeing with jealousy Bill Gates' move into CNI--which has been, what, a five-bagger?

Nov 05 11:42 AM

[Mark in San...:]

The word of the day? COAL!!. . .BNSF is one of the largest shippers of coal, and China, etc. buys coal from USA. . .60% of US power is still from COAL. Agree that this is a commodity play as well as a shipping play.

Nov 05 12:11 PM

[WayneS:]

If our new government is commited to stopping global warming, they will have to stop all long distance trucking and force companies to use railroads. Railroads are at least three times more efficient than trucks.

Nov 05 01:29 PM

[epeon:]

I am a bit puzzled by Buffet's bet, too. He waited till BNI went up from March and then put on top of that another 30% premium. It seems to me, that the US economy has to come around big for him to make out well.

Buffet did this last year when he bought COP at the top. He also bought GE at 20. Of course, in the GE case he got a 10% preferred dividend to tide him over. With the Obama policies, I think we could see several years of low growth. It may take him some time for this to work out. Again, just like COP.

Nov 05 01:30 PM

[amused byst...:]

Buffett is long term bullish on the United States as am I

Nov 05 02:28 PM

[Ulysses Ben...:]

Going very overlooked I think is that Buffet said this investment is for 10,20 and 30 years out. In the short run, BNSF provides cash flow and an opportunity to make money on rising commodity prices due to supply and demand imbalances that will develop with any recovery however weak, and due to the likelihood we will continue to export coal, all without owning commodities, ala pipelines, over time.

As for permabears, they've been right for a decade, it's unlikely they will not be right awhile longer despite bear market rallies. JMHO.

Ben Dover
RealWisconsinNews.com

Nov 05 02:48 PM

[sethmcs:]

This is really a bet on increased Asian trade. Actually railroads do not fit in the Buffett investment criteria. Too capital intensive. I believe he owns UNP as well.

Nov 05 06:17 PM

[StockMaster...:]

I respectfully disagree with your premise that this is a bet on the demise of the USA economy, this is an American railroad company so if we are going down the tubes rail volume will go down because we will ship less coal etc. since we will use less power, consumer products, build less, etc. (all things BNI ships). A correct bet on the decline of the dollar would to bet on emerging economy stocks that make money in non-dollars.

Nov 05 08:44 PM

[aussiereader4:]

Unfortunately, i think you have missed the point. He is betting on a third world America exporting commodities to Asia while oil; goes to $200 barrel but at trhe same value in Euro as it is now. SA bloggers,stop talking in dollars and start talking in Euros, the new rerve currency.


On Nov 05 09:48 AM Shaftsinker wrote:

> Have the permabears really gotten so desperate?
>
> This is the absolute most desperate reach of an argument I've ever
> seen on SA. I don't even know where to start.
>
> "The cost of rail is a fraction of shipping via truck. Does Warren
> fear $200 oil? I sure think so after watching him place a multi billion
> dollar bet on the rails."
>
> Yes, surely a multi-buillion bet on the rails means Buffet is expecting
> the shipping of goods to dwindle. You're saying that investing in
> rails is a smart move in the midst of a coming crash coupled with
> $200 oil? Do you have any idea what that would to to the entire transportation
> sector? Have you completely lost your mind or are you just a troll?
>
>
> And Buffet is terrified of inflation because of a 13 trillion deficit
> (I thought that was the total US debt? Did Obama spend 11 trillion
> dollars while I overslept this morning?), wouldn't it make more sense
> to invest in a company whose revenues are not based purely in US
> dollars and who rely on the shipping of goods to Americans to meet
> their bottomline? What exactly will Americans be buying that needs
> to be shipped?
>
> "Why else would you spend $10's of billions on an "old school" technology
> that's been around since the 1800's?"
>
> Oh now I see the light. In a world where Americans purchase nothing
> and the American dollar is worth nothing, surely owning technology
> that ships goods to Americans and gets its revenues in USD is a great
> move.

Nov 06 02:03 AM

[dingding:]

As I posted in reponse to another article on this deal:

Buffer trades Berkshire and FED paper for railroad assets and land.

Nov 06 03:22 AM

[TinyTim:]

BNI has good routes and is well managed, as Buffett obviously knows thru his past purchases. They have the opportunity to haul coal if needed.

I think Buffett is thinking more along the lines of cheap transportation during high oil price periods.
There are fewer more capital intensive industries in the US these days.
This is also a play on hard assets, considering the rolling stock, track and land that goes along with the purchase.

Nov 06 01:12 PM

[Robert H. H...:]

How does an investment in a purely domestic railroad provide " the perfect opportunity to diversify out of the US dollar?"

I'm scratching my head over this one.

Nov 06 06:32 PM

[The Housing...:]

Robert

It's simple. Buffet allocated around 50% of his cash for BNI.

This is a hard asset that has value versus the hollow value of a paper dollar.

The points made above around other reasons to make this deal are very valid.

IMO, Buffet wanted to set himself up for a poor economy that needs cheap transportation.

Best of luck to all.

Nov 07 03:39 AM

[Niels Petersen:]

The notion that was being tossed around by the media that the BNI purchase was a bullish bet on the US economy has not been sitting well with me either. It seems to me that Buffett was looking for an investment with good cash generation attributes and a wide moat. Right of ways for rail systems are gold, no competitor will be able to afford to develop new routes in urban areas even with federal funding to develop high-speed rail routes. It may even be that it would be more cost effective to purchase existing right of ways from rail systems at substantial premiums to current values to set up these networks.

The commodity play is not bullish for the US economy either. Selling off our natural resources at discounts because we have gotten ourselves in a fix with our monetary policy may benefit resource holders and transporters but this type of activity does not create more economic value than manufacturing, information technology and service industries have. The US has fueled its growth in the past with two phases. The first growth phase was fueled by the investment of citizen's savings in the economy. This lasted for 50 years till the effective savings rate for the US citizen hit 0%. The next growth phase was fueled by the availability of cheap credit. This phase lasted 15 years and saw the effective savings rate of the US citizen turn negative, and went extremely negative when assets deflated in 2008-2009. So this begs the question, where is the next bank account that can be used to sustain our economy? There are two possibilities that I can see. Selling off our assets (commodities & real estate) and improving efficiency. The second possibility requires a high amount of investment with a long-term payoff. Given where we are today with trillions of $ in investments having gone up in smoke, a $13 trillion in public debt burden ill-spent on poorly performing investments and the lack of leadership in the public and private sectors in long term thinking my belief is that first possibility is the one that we will see happen.

Buffet is not making a bet on an improvement in the US economy. He is protecting his investments while the rest of the US goes to the pawn shop.

Nov 12 02:09 PM