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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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By Frank Ahrens  |  November 3, 2009; 1:05 PM ET
Categories:  The Ticker  | Tags: Burlington Northern, Coca-Cola, Dairy Queen, Warren Buffett  
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This man continues to amaze me. He almost always seems to be ahead of the curve.

Posted by: mortified469 | November 3, 2009 11:40 AM | Report abuse

I am jealous, the boy with the most toys wins...

Posted by: truthhurts | November 3, 2009 11:59 AM | Report abuse


Some leadership from somewhere finally.

Posted by: tmit | November 3, 2009 12:04 PM | Report abuse

Ah, I think you are just looking at a typical coal mine - railway - power utility deal. Obviously, Buffet thinks that coal use is going to expand.

Coal is the most profitable product for the rails to haul - in fact, more of the cost that a utility power plant pays for coal goes to rail than to the coal mine, depending on distance hauled. It's certainly true for the Powder River Basin.

Buffet's holdings in major coal-fired utilities are extensive, i.e. Constellation. He also has huge interests in Canadian tar sands, which his pipeline company (MidAmerican) has been involved with for years - and there's also the large bet on Conoco.

Thus, Buffet is a diehard fossil fuel booster, by all accounts - a kind of modern JD Rockefeller and Samuel Insull rolled into one - and he has the President's ear.

This is probably why Obama is stalling on climate change legislation that would limit coal combustion and ban Canadian tar sand imports - Daddy Buffet doesn't like it.

Of course, Obama is also from a coal state and has been a lifelong booster of coal-to-gasoline schemes for Southern Illinois - something the press conveniently forgets at the drop of a hat.

Yes, he gave a nice speech at a solar project the other day, and it is appreciated - Bush would never have done that.

However, his State Department also signed off on a Canadian tar sand import pipeline, he refused to ban mountaintop removal mining in the Appalachians, and his Minerals Management Service just delivered new oil leases to Shell for the Alaskan offshore - the same MMS that was recently busted for cocaine and prositution? Likewise, his DOE has given billions to clean coal, including backing the "FutureGen" project - which even the Bush Administration passed on, due to high costs and unproven technology.

I think we're being taken for a ride by one of Buffet's boys, personally.

Posted by: cargocult | November 3, 2009 12:10 PM | Report abuse

Re: mountaintop removal coal mining,
The courts have been throwing out attempts to ban it. There was a ruling very recently in West Virginia on the subject.

Posted by: cabterp | November 3, 2009 1:04 PM | Report abuse

Wrigley didn't buy--Mars bought Wrigley, which is now a fully-owned subsidiary of Mars.

Posted by: johns43 | November 3, 2009 1:17 PM | Report abuse

OK folks we stand united we have a voice, we ignore whats going on around us and we fall HARD. Now that the BNSF Railway is owned by Birkshire/Buffet put the TYE employees back to work. When are the employees who help build the company get back to work. My house, credit and bills are so far behind even after we were told that the railroad TYE employees make a good living (you average 67k a year, well we started at 80% thanks alot BNSF). Well the BNSF Railway treats its employees like crap I am here to tell you. Lets lay off the TYE employees while we make our big bonuses and lets cut there medical, dental and vision benefits so there familys have to starve the (UP Railroad pays their TYE employees benefits). This makes no sense to me.

I am U.S.Army veteran of 6 years including a peace keeping mission to Kosovo year 2000 (6 month tour). I have always had a pay check with the U.S. Army and was taken care of. BNSF does not care about its employees, oh yeah I was given a pin for my hat or shirt from Matt Rose stating he was appreciative for my service to this that doesn't pay the bills KEEP US WORKING and cut your (VP) pay or your bonus money for the year (and give back to the TYE worker).

Big companies LETS SEE WHAT WE CAN DO FOR OURSELF $#ck everyone else. Just do whats right morally and ethically, we are starving out here but no one seems to care thanks to all who have shipped their companies overseas thanks alot.

Posted by: templegrd | November 3, 2009 2:00 PM | Report abuse

Is that the road that after a big merger, fired about half of the employees and immediately collapsed? Farmers had millions of tons of grain rotting because of the dumb SOBs and they had to promise to hire the dumped workers back in order to save their rear ends.

Is that the one Jimmy is buying?

Monte Haun

Posted by: mchaun | November 3, 2009 2:08 PM | Report abuse

Are you sure you didn't get one statement
backwards? As I heard, M & M Mars bought Wrigley.

Posted by: fushin53 | November 3, 2009 2:35 PM | Report abuse

If Buffett's plans hinge on coal he's making a big mistake. The world's energy future does not include coal for very much longer. The burning of coal on a large scale will be effectively illegal in about 20 years, even in China and India (because they like us have a lot to lose if they let climate change wreck their agriculture and sea level rise drown their coastal cities).

Posted by: raschumacher | November 3, 2009 2:52 PM | Report abuse

I would point out that the wholesale abandonments and route reductions in the 1970s and 1980s were less the railroad industry going into turmoil than long-overdue reductions finally catching up, or being permitted. Onerous regulation by the ICC combined with outdated work regulations and union demands dating back to steam locomotive days (diesel locomotives still needed a "fireman" until the 1980s on most lines) hamstrung railroads trying to make business adjustments such as abandoning passenger service that had long since lost its passengers. It took the bankruptcy of most Northeastern railroads, the formation of Amtrak, and the collapse of the Rock Island and mass retreat of the Milwaukee Road from the West to the Midwest to wake up most legislators, and the result was deregulation in October 1980. Today's railroad industry bears small resemblance to old-time carload railroading glamorized in children's books of old; trainloads of containers, coal, grain, minerals, ethanol, and automobiles are the norm today.

Posted by: LNER4472 | November 3, 2009 3:43 PM | Report abuse

Ahrens has a poor understanding of railroad economics. Prior to deregulation in 1980, it was very difficult for railroads to abandon little used lines or to merge into more efficient operations. The industry was forced to maintain a balkanized, retail infrastructure. With passage of the Staggers Act, the roads could shrink into an efficient wholesale operation. Coal, grain and intermodal traffic could now move in unit trains. The energy crisis spurred coal. At the same time, containerization came on in a big way and stack train technology permitted shorter trains to haul twice the cargo.

Ahrens does not quite understand how the decision is made to go truck or rail or the Panama Canal (otherwise known as All Water Service). It is not so much fuel driven as inventory driven. Sophisticated supply chains were built in the 90's that better match supply and demand to drop the inventory-to-sales ratio. If sales are hot, a full container load of big screens can go directly to that big box store. No need for intermediate handling. But, when consumers cut back, you need to mix things up in that truck before it hits the back door.

Also, look at the map. You have people in the east, people in the west and a big gap in between. Intermodal still beats out truckers when plying the gap.

Currently, the railroads, airlines and containership lines face a major challenge: they built/bought all of this capacity for lots of customers. Now that business is down, they can park those trains, planes and ships, but they still have to pay for them. Rates can't fall as much as they should because of (let's call it) FIXED COST PUSH INFLATION.

Buffett is making a sound bet on the basis of integrated coal operations alone. The low-sulfur product strip mined in the Powder River Basin is the 'cleanest' around. In fact, eastern coal is supposed to be banned as 'non-compliant'. That western coal can go to the eastern US.

Incidentally, it was the UP buying the SP that led to a major clusterXX@@ck.

Posted by: twstroud | November 3, 2009 3:47 PM | Report abuse

Check your facts - Wrigley did not buy Mars. Mars bought Wrigley. Relevant given the subject of this article.

Posted by: johninva1 | November 3, 2009 3:55 PM | Report abuse

OK, I give up.

What is TYE?

Posted by: Guvernor | November 3, 2009 4:58 PM | Report abuse

Gee, is there anything, any little thing that the Christians don't own?

Posted by: Farnaz1Mansouri1 | November 3, 2009 6:24 PM | Report abuse


TYE = Train, Yard and Enginemen - those people who operate the trains - aka Engineers, Brakemen, Conductors, etc.

Posted by: nip4 | November 3, 2009 8:05 PM | Report abuse

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