What Buffett's Burlington Northern Buy Really Means

With Warren Buffett plunking down 44 billion to buy Burlington Northern (BNI), many folks are examining the tea leaves and looking for the hidden meaning of the Oracle's latest move. Economic cheerleaders (mostly in the MSM) were quick to call this a big vote of confidence in the economic recovery. They are wrong.

On the other hand, the gloom-and-doomers see a Buffett that is desperate to buy hard assets before a tidal wave of inflation wipes out the value of his cash hoard. I doubt it.

With a little back of the envelope number crunching, I think it's quite clear that this latest purchase by Buffett (and the largest of his career) is just another example of buying boring, productive assets at pennies on the dollar of their replacement cost. While it is true that economic recovery will help his return on investment, as long as the economy as we know it does not come to an end he will do just fine.

Let's see, for 44 billion Buffett just bought 32,000 miles of rail. (he also gets 220,000 rail cars, buildings and land but that's just icing on the cake). That comes to just 1.375 million dollars a mile. How much would it cost to replace these assets? Well, China just announced that they plan to build a bunch of new rail lines at a cost of over 20 million dollars a mile. And that's in China -- you can bet the cost would be quite a bit higher here.

Picking up assets far below the cost of replacement wouldn't mean anything if they didn't have any pricing power (real estate in Detroit, anyone?), but with rails that is not much of a worry. As long as we need to move large amounts of goods, rails will continue to be by far the cheapest way to do it. Even if oil went to $20 a barrel tomorrow, no one is going to start shipping grains or coal long distance by truck.

The bottom line is Buffett saw the chance to buy irreplaceable productive assets at five cents on the dollar, and he pounced. Simple. Safe. Vintage Buffett.

Disclosure: no positions, but I am salivating over the prospect of finally having options on Berkshire (BRK.A) stock after the 50:1 split.

Comments

[CaptainJJack:]

I agree with this analysis. I own BRK, and, fortuitously, I own BNI, as well, so I am biased.

While the deal was valued at $44 Billion, Buffet's cost was less than $100/share. He already owned a substantial block of BNI. I am guessing his cost basis in the mid $80s.

I think this is a bet on the West, including Mexico, more than a bet on the US, and it is clearly a bet on efficiency

I like it when someone with Warren's skill set owns the whole company. He runs his companies for the benefit of the shareholder, and he is especially careful when it comes to capital expenditures, requiring managements to show how they make sense in light of future CASH earnings.

And, he never allows them to take on inordinate debt when times are good.

Nov 08 08:16 AM

[CaptainJJack:]

I picked up the wrong numbers in calculating Warren's cost basis.

He owned 22,5% ( thought he owned a lot more), before the bid.

So, I am now guessing his basis is in the mid 90/share.

Nov 08 09:03 AM

[Jack Wx:]

In China, it is high-speed, high-tech railroad, allowing trains running above 100 miles per hour, totally different from what BNI owns.

Nov 08 11:20 PM

[Egg:]

The book value for BNI is $36.

So your "pennies on the dollar" quote is a tad off...unless you meant 300 pennies on the dollar.

Nov 09 02:15 AM

[Richard Glenn:]

Your point about China's rail is well taken, but I would still ask you -- how much do you think it would take to build BNI's rail system from scratch today? If you think you could do it for under 200 Billion I say you are crazy. (and that's ignoring the permiting nightmare that would await a prospective railroad baron.)
As for book value, that's an accounting fiction. In many cases it bears no resemblance to the value of assets owned, and I think this is one of those cases. The capital costs of building out the rail network were likely long ago written down to zero.

Nov 09 02:36 PM