In the article Berkshire + Burlington, I argued that Berkshire's (BRK.A) purchase of Burlington (BNI) was out of character and had little to do with value. It also seems clear that Burlington will raise Berkshire's risk profile. Some people took offense on the assumption that Buffett can do no wrong.
Sadly, I'm old enough to remember Berkshire's US Airways and Solomon investments. NetJets has been a money pit, and let's not talk about GeneralRe. Nonetheless, I count myself among the legions of Buffett fans. Still admiration can turn to idol worship if we can't acknowledge that Buffett is human, and thus subject to error.
In a Charlie Rose interview, Buffett said BNI's results over the "next 100 years" would justify the purchase price! How's that for a payback period? He also said that it was an "all-in bet" and furthermore that Burlington was "not a bargain". Personally, I preferred the Goldman (GS) and General Electric (GE) investments. We didn't have to wait 100 years for those to prove their worth.
As for Burlington, I rest my case. But if Buffett's own words aren't enough, Columbia professor Bruce Greenwald, value investor and author of "Value Investing: From Graham to Buffett and Beyond", went one step further.
In a recent interview, he was asked:
You own Berkshire Hathaway, so (what do) you think about Buffett’s purchase of Burlington Northern?
Greenwald's response:
It’s a crazy deal. It’s an insane deal. We looked at Burlington Northern at $75 and I’ll give you the exact calculation we did. You don’t have a high earnings return. They are paying 18 times earnings, but it’s really much worse than that. They report maintenance cap-ex very carefully. They report depreciation and amortization, and they report only about 70% of the maintenance cap-ex. So they are under-depreciating, and their profit numbers are lower than the true profit numbers – and in a bad way, because the tax shield for the depreciation is undergone too. Their profitability is much lower than it looks.
Buffett’s paying 18-times [at $100/share] and at $75 he was paying 16-times. Our calculation is he was paying 21-times.
Secondly, there are two kinds of assets. There are the rights-of-way, which you can’t get rid of. So there’s no issue about having to earn a return on them because you have to keep it in the business, and because there’s nothing they can do with those rights-of-way. If you look at the asset value of the non-right-of-way equipment, and you write it up because it’s more expensive than it was originally, you get an asset value that’s very close to the earnings power value. We didn’t see a lot franchise value or hidden asset value.
The other thing is that if you try to calculate sustainable earnings, you have to cope with the fact that earnings are up enormously since 2003, when oil went up. There is a simple calculation you can do, which compares the cost-per-ton-mile for freight for a truck versus a railroad. If you build the increase in the price of diesel fuel into the post-2003 experience, when revenues suddenly start to grow, what you see is that the entire growth of the revenue is accounted for by the energy advantage that the railroads have and therefore how much business they can capture from the truckers, and how much pricing they can get because the competition is now more expensive.
There is nothing special about the railroads. It’s entirely an energy play.
If you look at what their margins should have gone up by, given the energy efficiency, the margins go up by only about half of that. So you don’t have a good aggressive management over these five years producing outsized returns.
We looked back at when they did the merger with Santa Fe, because then they did increase margins. But they got bored with it, and margins started to come down. The same thing happened recently. We don’t see a lot of hidden profitability in the culture of the company.
It looked to us like an oil play. He has a history of making bad oil play decisions. And that was at $75/share, we thought there were better oil plays. At $100/share we think he has lost his mind.
A crazy, insanely bad decision.
Don't hold back, Bruce.
Author's Disclosure: No positions.
