Wednesday, November 04, 2009

Buffett's Berkshire Buys Burlington Northern

Yesterday's business news was all about Warren Buffett's Berkshire Hathaway buying the 78% of Burlington Northern railroad that it did not already own.

On CNBC, they interrupted regular programming for a long telephone interview with the investor. He said, clearly, that buying the remainder of BNI was a 'long term bet on the US economy.'


Additionally, he cited some statistic involving the ton/miles delivered per single gallon of locomotive diesel fuel, to illustrate that a bet on railroads is a bet on energy efficiency. Several CNBC on-air staffers "oohed" and "aaahed" at the number, as if Buffett were the first to discover this.

Actually, CSX has been using the number for about six months in its very effective television ads against long haul trucking competition.

This morning's Wall Street Journal contained an article noting that Buffett typically doesn't pay premiums in the range of the 30% he offered for BNI. Nearby are price charts for Berkshire-B, BNI, and the S&P500 Index for the past 5 and 29 years.

BNI has outperformed both for the past 5 years, and equalled Berkshire over the longer timeframe.

Wilbur Ross opined on CNBC yesterday that Buffett's move for BNI means it has, and/or promises, performance that will be better than Berkshire, or else he wouldn't be buying it.

As I discussed this last night over coffee with a business colleague, I noted that, once again, as with his purchase of Goldman Sachs and GE convertible instruments, Buffett received treatment about which other investors can only dream.
First, because Berkshire already owned 22% of BNI, Buffett was able to secure a private screening of the recent board presentation. As an effective insider, then, Buffett had special knowledge that you or I don't about the company's recent and prospective performance.

I don't believe such knowledge made the ultimate difference in Buffett's offer, but it does show how and why Buffett can get deals you cannot. And won't be hauled into court, either, for doing them. Like, oh, say a recent Sri Lankan-born hedge fund manager?

More likely, what Buffett achieved for and with his 30% premium was the avoidance of an even higher premium, due to a bidding war for BNI.

Here's why.

As my old mentor from Chase Manhattan Bank taught me, when an asset is a scarce item, with few replacements, it can easily realize a large premium from a bidding war. Back in the day, we saw US Leasing go for a large premium, because it was a rare type of financial company.

BNI has only one similar competitor, Union Pacific. Two smaller ones are CSX and KSU. The four, with the S&P500 Index, appear on the nearby 29-year price chart.
CSX and BNI have outperformed the other two railroads, and the S&P, handsomely. That explains why Buffett isn't buying UP.
It also explains why Buffett doesn't want competition in this bid. If he had approached the BNI management publicly, and/or with an investment bank, he may have had one or more hedge funds quickly raise the price through arbitrage.
But right now is a good time to buy. While liquidity is high, M&A activity hasn't re-ignited yet on a large scale. There probably isn't a single business competitor who is positioned to take BNI without anti-trust issues. And it would take some time for even a few private equity groups to collaborate on a bid for BNI. Plus, they tend to want quicker returns than Buffett will accept.
Again, here is where Buffett gets opportunities others do not. How many investors would sit still for being told that a $44B acquisition is carrying a 30% premium and may not pay off for a decade? Most would redeem at the next quarterly window.
That said, the acquisition makes a lot of sense. BNI is well-positioned to grow via transporting imported goods from the US west coast. It will benefit from increased focus, whether the entire green agenda is ever passed in Congress, on fuel efficiency. Rail beats over the road long haul trucking hands down, and can do inter-modal, too.
Railroads have high barriers to entry. It's unlikely anyone will ever, again, build a freight rail line from scratch in this country. Even with regulatory oversight, rails have good pricing power, and it will probably improve over time, again, due to a bias for mass transportation versus highway usage in the US.
Finally, while Buffett isn't buying BNI at the absolute trough of this past January, it's still way below the trend line of the past few decades. Chances are, as Wilbur Ross noted, BNI's assets will realize a much heftier return with eventual economic growth than will the bulk of Berkshire's other portfolio assets.
Put it all together, and it's a good move by someone who gets opportunities and benefits available to few other investors.
In that sense, it's really less newsworthy, because it's just a one-off deal by someone who gets special favors.

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