MarketWatch recently reported that Berkshire Hathaway (BRK.A) will buy back some of its Class A and Class B shares. The article also mentioned that “the plan also essentially provides for ‘an unlimited and perpetual program.’” This suggests that the shares of Berkshire Hathaway will continuously be bought under specific conditions.
We’re in perfect agreement that the current plan to repurchase Berkshire Hathaway (BRK-B) stock along with the introduction of a select team of managers is part of the strategy to phase out Warren Buffett’s involvement in the company. However, we think that the most overlooked part of Buffett’s departure plan was the purchase of Burlington Northern Santa Fe.
For a long time, Warren Buffett has been outspoken against the ownership of airline shares because an airline requires “…significant capital to engender the growth, and then earns little or no money.” Therefore, it would seem out of character to purchase a company in an industry known for many of the same attributes. However, the purchase of a railroad company has two significant advantages that most corporations in the United States lack.
First, a quirk in the rules for railroads allows them to avoid liquidation in the event of bankruptcy. After Buffett is gone, whoever is in charge could bumble with some derivative instruments that, for unforeseen reasons, blow up. If the blow-up were large enough, it could trigger the need to file bankruptcy to get Berkshire Hathaway’s house in order. The clause in the Interstate Commerce Commission and Bankruptcy Act would protects Berkshire Hathaway from having to sell off valuable assets while the company emerges from bankruptcy.
The second significant succession strategy of a railroad has to do with what is called “compulsory mergers.” This requirement allows the ICC and a railroad that has gone bankrupt to merge with another company on terms drawn up by the ICC, the bankrupt company and the acquiring company.
Since the railroad industry, like the airline industry, is infamous for bankruptcy, BRK gets to take advantage of the "compulsory" mergers rule under section 77 of the Bankruptcy Act, which gives the ICC "...control over formulating a plan for the reorganization of an insolvent railroad."
Knowing that bankruptcy is only just around the corner in the next economic purge, Berkshire Hathaway can absorb other rails with absolute impunity. Even better, "...Section 5 of the Commerce Act, which governs mergers of solvent railroads, give the merging carriers primary control over the formulation of a merger plan." Could you imagine structuring your own deal of a merging rail that is going bankrupt?
There is a lot of precedent for these laws in the structuring of many railroads. In fact, Chicago, Burlington and Quincy Railroad and Northern Pacific Railway (independent companies before their merger) have had their days with aspects of these rules before merging. Because railroads go bankrupt often, there are many examples of how this works. In one merger, an acquiring railroad bought $1.9 million of claims against the state of Florida at a cost of $5,000 from another railroad facing bankruptcy. In our examination of the topic, we have seen assets worth even more being given away for absolutely nothing as part of a compulsory merger.
Because Buffett has been outspoken against the ownership of airline shares due to the general lack of profitability and high propensity to go bankrupt, it seems out of character to purchase a company in an industry known for the same attributes. We believe that Buffett’s purchase of Burlington Northern Santa Fe was a critical piece of the succession strategy laid down for the benefit of current and future shareholders of Berkshire Hathaway.
- Berkshire Hathaway 2007 Annual Report. Page 8.
- Altman, Edward I. Predicting Railroad Bankruptcies in America. The Bell Journal of Economics and Management Science. Vol. 4, No. 1 (Spring, 1973), pp. 184-211.
- The Yale Law Journal. "'Compulsory' Mergers under Section 77 of the Bankruptcy Act". Vol. 64, No. 2 (December 1954). page 282-292
- Bedingfield, Robert, “Top Officer Quits at Penn Central in Cash Squeeze”, New York Times, June 9, 1970. page 1.
- Schroeder, Alice. The Snowball. Bantam Books, New York. 2008.