After years of searching for his next elephant, Berkshire Hathaway (BRK-B) Chairman Warren Buffett found it today in railroad company Burlington Northern Santa Fe (BNI). Berkshire had already owned 22% of Burlington, and today announced that it will be acquiring the remainder of the railroad company for a mix of cash and stock that values Burlington at $100 per share, or $34 billion in total.
This deal is significant for a number of reasons. Burlington is the biggest deal that Berkshire has done in a few years, and as such, it will put a lot of the conglomerate’s capital to work at rates better than cash is earning right now. Furthermore, Burlington will continue to diversify Berkshire’s stream of earnings, and add yet another business to its stable of firms with decent competitive strengths.
After decades of under-investment and brutal competition, the railroad industry has improved dramatically over the last several years. Some consolidation has reduced some of the competitive pressures that had afflicted the industry. In addition, railroads have become more efficient, using double-decker rail cars, as well as having the ability to load containers directly from ships onto railcars. And finally, with relatively higher fuel prices, railroads have gained a cost advantage over trucking, potentially making it cheaper to ship via rail.
These improvements were not lost on Buffett or Berkshire Vice-Chairman Charlie Munger, who have commented on these factors at the last couple Berkshire Hathaway Annual Meetings. More than simply observing, though, Berkshire put its money where its mouth was and began amassing stakes in several railroads including Norfolk Southern (NSC), Union-Pacific (UNP), and the aforementioned 22% stake in Burlington. What’s more Berkshire was so interested in Burlington that it even wrote puts on Burlington’s stock in the last couple years.
In my opinion, this deal can be summed up as the purchase of a decent business at a fair price—at trough earnings, perhaps. Furthermore, I think Burlington will benefit from being under the Berkshire umbrella. For example, as Burlington continues to make investments in its business, including upgrading its infrastructure—perhaps with the help of government funding—it will likely be able to make more longer term investments than some of the other publicly traded railroads, that are often subject to more short-term pressures from Wall Street. What’s more, it’s possible that over time Burlington will also benefit from Berkshire’s funding advantage, thereby being able to borrow money at rates cheaper than competitors. Should this eventuate it would give Burlington another leg up on its peers.
There is one other component to this deal that is interesting. In order to promote liquidity for Burlington shareholders, to potentially sell portions of their Berkshire stake should they decide to take stock in the deal, Berkshire announced that it has effected a 1 for 50 stock split on its class-B shares. While stock splits are by definition un-economic events, this split could aid in increasing the liquidity of Berkshire’s stock. If one also considers that Buffett is slowly gifting his stock to the Gates Foundation, and that he has also stipulated that these gifts be sold fairly quickly, the stock split could hasten an even greater trading volume and liquidity in Berkshire’s stock. This could allow Berkshire to eventually be included in the S&P 500 stock index, which would force legions of index funds to buy the stock, potentially creating a huge demand for the shares.
You also might be interested to know that this blog was mentioned in an Associated Press article that I have linked here, a Marketwatch article that I have linked here, and a Reuters article that I have linked here.
As always, I enjoy dialogue with my readers, so please do email my any questions or comments you may have.
Justin
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The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business. This content is intended solely for the entertainment of the reader, and the author.
