Instant analysis: Why Buffett spent $34 billion to buy a railroad
UPDATED at 1:05 p.m.:
As I've written before, super-investor and world's second-richest man Warren Buffett invests like an 8-year-old boy in the 1950s: He either owns outright or has big stakes in Coca-Cola, Dairy Queen and candy and chewing gum giant Wrigley, which bought M&M-maker Mars last year.
Today, Buffett completed his train set, offering a big premium of $100 per share to buy the remaining 78 percent of Burlington Northern Santa Fe railway that he didn't already own. It's a $34 billion deal -- Buffett's biggest ever.
It was Buffett's big investment in Burlington Northern early last year that alerted me to the pre-recession boom in the U.S. freight railway industry. This is an industry that had grown so moribund in the 1970s and '80s that it was actually tearing up tracks, as companies switched their shipping away from railroads and onto 18-wheelers.
But as fuel prices soared and demand for U.S. goods and raw materials surged in China, the railroads experienced a rebirth here. Companies were scrambling to add new tracks and even increase the height of tunnels to allow for double-stacked railroad cars to pass. You can read about that in a piece I wrote in April 2008 by clicking here.
Since then, however, U.S. railroads have struggled, as the Great Recession has reduced the amount of goods being shipped and oil is trading at half its peak of summer 2008. When oil prices drop, manufacturers switch their shipping from trains to trucks, which can take their goods directly from Point A to Point B without the transfers required in rail travel. UPDATE: The federal government set aside $48 billion of the $787 billion stimulus for infrastructure improvement, some of which goes to railroads. I'm checking to see exactly what cut of the stimulus Burlington Northern gets.
But when oil prices go up, rail is king. The railroad industry also has spent a lot of time and money touting its greeness, compared to trucks, and likes to say that one rail car can carry as much freight as four 18-wheelers.
So why did Buffett go all-in with his railroad?
This morning on CNBC, Buffett said his purchase is a "bet on the country, basically."
"I basically believe this country will prosper and more people will be moving more goods 10, 20, 30 years from now and the rails will benefit," Buffett told CNBC.
It's also a bet on the future of another country -- China.
China craves the coal and other raw materials that the U.S. produces. Those commodities fuel the great economic engine that is China, which is the factory to the world. U.S. coal and goods are shipped via rail to Pacific ports and then shipped to China. With his round-out purchase of Burlington Northern, Buffett thinks China will continue to be strong.
I shot an e-mail to Art Hogan, managing director at Jefferies, to get his take. Here's what he wrote back:
"Buffett is making an elephant-sized bet on three things here and all are related. He thinks the economy in the U.S. is getting better and will continue. He believes that energy prices will continue rise and that trains will be more productive then trucks in that environment and third and most important he sees Burlington Northern as cheap with a longer-term investment time horizon (three years vs. three months)," Hogan wrote.
The final point is a good one: Shares of Burlington Northern are trading well up off their March bottom -- they've popped up to nearly $100 per share today on the Buffett news (up 28 percent) after bottoming at nearly half that in March.
However, compared to their all-time high of more than $110 per share last summer, Buffett gets the remainder of his railroad at a relative bargain. And if the stock continues to grow, he'll be in the tall green in a decade.
The purchase is also a strategic one for Buffett who, I need to say in full disclosure, is a director of The Washington Post Co.
Burlington Northern has tracks in the western U.S. that run through states where Buffett controls power companies through his MidAmerican Energy Holdings. The Burlington Northern lines are major supply lines for coal traffic.
UPDATE: That's another element of this purchase: In a very direct way, Buffett is almost betting on energy stocks and coal. Railroads make a great profit from hauling coal and Buffett clearly believes that coal has a long future in producing energy, despite the pushback from some environmentalists. And it's worth noting that eco-pressure is higher in the U.S. than in most other countries, such as China, which can pretty much burn as much coal as it wants.
I e-mailed Peter Boockvar, equity strategist at Miller Tabak, to get his quick take on Buffett's purchase. Here's what he e-mailed back:
"He's betting on global population growth and global wealth increasing thus raising the world's purchasing power to buy stuff that the U.S. makes and also a bet that we will still import stuff that the rest of the world makes. It's also a bet on this particular mode of transportation that has proven to be most efficient and thus creates a defensible business model that Buffett so covets," Boockvar wrote.
As a bookkeeping note, I write here that Buffett purchased Burlington Northern, when in fact his company, Berkshire Hathaway is the actual investor. The two are inseparable -- Buffett is Berkshire -- so it's just a short-hand way of describing the deal.
However, in this case, Buffett did something that Berkshire usually does not: execute a cash-and-stock deal and split his stock. Because this is Berkshire's biggest purchase ever, it was too big for just a cash deal, so he had to add stock.
On the stock-split side, Buffett has famously opposed the practice. But in this case, he did it, he told CNBC, to give small Burlington Northern investors the same tax break that large holders would get.
This is an interesting deal for us whale-watchers -- those of us who like to follow what big investors do. Buffett likes to own simple companies that he understands. Today, he completed his train set.
-- Frank Ahrens
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November 3, 2009; 1:05 PM ET
Categories: The Ticker | Tags: Burlington Northern, Coca-Cola, Dairy Queen, Warren Buffett
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