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A Few thoughts on the Burlington acquisition

Vitaliy Katsenelson's picture




 

I have tremendous respect for Mr. Buffett.  But every word that comes out of his mouth should not be looked upon as prophecy, or the gospel truth.  I get a feeling that Buffett has been canonized into a value investor saint  – investors and the media worship the ground he walks on and the air he breathes.  The media are unable to get any critical quotes from his investors, and nobody wants to be caught disagreeing with the Oracle of Omaha – after all he’s been right more often than wrong – and so we only get positive puff pieces.  On the rare occasion when Berkshire Hathaway stock declines more than the market, you see an article asserting that “Buffett has lost his magic touch,” but these articles are usually followed by stellar performance by Berkshire.  Though Buffett deserves admiration – he is brilliant and likable and he has achieved incredible returns for his investors over the last half-century – he should not be canonized, and not everything he does or says is the ultimate truth.  

 Most investors agree with Buffett’s criticism of Kraft’s decision to buy a fairly valued (or overvalued) Cadbury at 22 times earnings (over the past 15 years, its average price-to-earnings ratio has been 21), using Kraft’s undervalued stock.  Cadbury runs a global, noncyclical confectionary business that, if properly managed, should have a very high return on capital.  Buffett, a shareholder of Kraft, was very public about his dismay – he said he felt poorer when Cadbury accepted Kraft’s increased offer.  

 But though many agree with Mr. Buffett’s assessment of the Kraft/Cadbury deal, investors and media are completely ignoring Berkshire’s own, $30-billion-plus acquisition of a very cyclical, capital-intensive, not terrifically high-return-on-capital business – Burlington Northern.  A railroad for which Mr. Buffett’s Berkshire will lay out 18 times earnings (over last 15 years its average P/E was 15); and to make it even worse, part of the deal will be financed by issuing what Buffett recently called “cheap” Berkshire stock.  Burlington stock is not cheap, it is fairly priced at best, and likely overpriced.  Also, Buffett owning Burlington Northern will not make the railroad business any more valuable.  There is little value to be unlocked in this business, and Buffett will practice his usual hands-off approach. 

 Though Mr. Buffett said all the right words – “I am betting on the recovery of the US economy” – there are some rays of hypocrisy shining through Buffett’s statements about other companies (e.g., Kraft) and his own actions.   He felt “poorer” when Kraft made the acquisition – well, BRK’s shareholders should feel poorer, too. 

 Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo. He is the author of “Active Value Investing: Making Money in Range-Bound Markets” (Wiley 2007).  To receive Vitaliy’s future articles my email, click here.

 

 

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Mon, 02/01/2010 - 09:14 | 213139 10044
10044's picture

Why do you have respect for a fcking crook who ALWAYS trades on inside information?? Fyi, he was fined 100m last week for something you and I would do 10yrs for. The man is a fraud and a fcking crook

Mon, 02/01/2010 - 08:56 | 213131 Ben Graham Redux
Ben Graham Redux's picture

I agree its an energy/inflation bet.  I expect Buffett to fail on this one because if we get a continuation of our global depression, those rail assets are going to kill him.  Also, placing a bet on a weak vessel like Obama may end up being a big mistake.  You pay a high price for a cheery consensus and Buffett is paying an uber-high price. 

Considering his status as the ultimate insider, this suggests he understands something of what the administration/fed expects to do about our overhang of debt - ie. print money.  The problem stems from both the high price he's paying, the debt he's assuming, and the prospects for a huge decline in demand for rail services that I envision.  He bet the ranch and this one could destroy his legacy. 

Mon, 02/01/2010 - 13:11 | 213340 Mad Max
Mad Max's picture

I think BNSF will be a good bet regardless of the actions of the current or next administration.  Would have been equally good under McCain, maybe even better.

You can place your own bet on BRK-B for under $100.

Mon, 02/01/2010 - 14:32 | 213454 Ben Graham Redux
Ben Graham Redux's picture

Coal usage is down 11% year over year according to the EIA.  Rail is a high fixed cost business that's dependent on volume and volume can get much weaker.  Given that railroads don't pitch off much cash flow, they have historically gotten into a lot of trouble during economic downturns.  I personally expect this present downturn to get much worse from here which is why I would not be a buyer of rail assets.

Mon, 02/01/2010 - 08:52 | 213128 Anonymous
Anonymous's picture

Buffet said he would not have bought his own stock when it was selling at around $100K.

Now that it has risen in 9 months since he made that statement, to $115K, he is likely even more opposed to buying it.

It appears that his recommendations are to be viewed as contrarian if you want to make money from what he says.

What he DOES may be a different story. And I doubt he says that is until its done. At least to the great unwashed.

Mon, 02/01/2010 - 07:03 | 213087 Anonymous
Anonymous's picture

Fuck you Janice. Warren Buffet's scum. The only reason he bought BNI is because he needs some real assets to make up for his worthless insurance assets before this giant ponzi unravels.

Mon, 02/01/2010 - 04:29 | 213051 Handle with care
Handle with care's picture

Buffet has said that the ideal business is to own the only bridge across a river.  He has also said that he looks at a business and asks if he could build it from scratch using the market cap.

 

So for $30 billion could you build that rail network today?  

 

And while road does constitute another bridge across the river, I agree with other posters that rising energy costs effectively allow him to raise the tolls on his bridge as fuel costs raise the costs on road transport.

Mon, 02/01/2010 - 01:56 | 212982 Augustus
Augustus's picture

the folks down in Panama are changing the shipping game with the rebuilding of the canal. When finished it will allow much more cargo to go to the east coast by ship, reducing the need for the long haul intercontinental long haul rails. They can beat the rail charges.

A better toll taker bet would have been to acquire one of the gas pipes. It has been clear for a couple of years that the gas supply situation has been solved. With his man Obama killing the coal industry, the remaining choices are NG or energy efficient flying carpets. I'd bet on the NG and collect the increasing transport tolls.

BNI is a good operator in a bad business with mediocre returns and dominated by union labor. It has very limited upside at best. Maybe the BRK stock is not as cheap as Uncle Warren claims that it is?

Mon, 02/01/2010 - 13:12 | 213341 Mad Max
Mad Max's picture

BNSF doesn't depend on import/export trade to stay afloat.  It's a great area for them, but the railroad would be quite solid without it.  Nearly all the coal we use is mined here.  Likewise, most of our grain is grown 1000-2000 miles away from its consumers.

Mon, 02/01/2010 - 01:34 | 212961 Anonymous
Anonymous's picture

The wily sage wins by any means necessary. He rarely makes mistakes, but when he does he doesn't like to pay for them. He also usually knows a little more about the prospects of the deal than some shmuck of the street. Never fuck with the sage.

Mon, 02/01/2010 - 00:29 | 212905 Anonymous
Anonymous's picture

It's a fast way to get the hell out of US dollars and into "hard assets."

Sun, 01/31/2010 - 23:47 | 212862 Anonymous
Anonymous's picture

A devaluation of the US dollar leaves BN handling exports at world prices (and Buffet owning the toll bridge on exporters).

Sun, 01/31/2010 - 23:35 | 212853 Amanda Pumper
Amanda Pumper's picture

You may be missing the elephant in the room.  Burlington Northern will be receiving a nice chunk of that $8 billion in Obama rail grant money.  Buffett, the insider's insider, knew this was coming before he bought BN.

Sun, 01/31/2010 - 23:15 | 212836 Anonymous
Anonymous's picture

You missed the elephant in the room. Burlington Northern is getting a large chunk of Obama's $8 billion rail grant.

Sun, 01/31/2010 - 23:13 | 212835 Anonymous
Anonymous's picture

I think BN was a brilliant purchase. There is going to be federal spending on high speed rail and basic rail infrastructure. High speed rail will likely utilize existing rail lines and corridors.

Berkshire also owns MidAmerican Energy, a utility which owns many coal-fired power plants. Warren knows coal.

He also had the foresight to befriend then candidate Obama.

Sun, 01/31/2010 - 23:07 | 212831 Turnstile
Turnstile's picture

There are many things this article over looks in the Burlington deal.

(1) If energy, primarily oil, prices spike, this will make transportation of goods by trucking more costly and make railroad transportation much more competitive.

(2) Burlington is a major transporter of grain and coal with connections to the West coast, thus being able to ship to Asia, which will have huge demand for grain, and coal if oil should spike higher in price.

(3) Burlington may even be able to compete against shipping by sea. If goods coming from the East need to reach the West coast and vice versa, then instead of the ships sailing through Panama or around S. America (as they’re currently beginning to do), then they will drop the goods off at their perspective ports and ship by train.

(4) Also, as the US infrastructure is upgraded, Burlington will no doubt get heavy government subsidies to upgrade; and as passenger trains are upgraded into bullet trains, I suspect Mr. Buffet will move into this area as well (assuming he is still alive to do so, but no doubt he has worked out these long terms plans and vision with his successor).

(5) I also suspect that Mr. Buffet will lobby to have inter-State tariffs for goods transporting either removed or reduced, specifically for railroads, thus making trucking more costly—this will probably take place under some environmental plan. Further, owning Burlington allows Mr. Buffet to transfer much of his capital out of financial instruments and into real assets—one that is tied to energy, agriculture, goods transportation, and increased industrial capacity.

Mr. Buffet’s purchase of Burlington is not a bet on the US economy as it is more of a bet on higher energy costs (namely oil, or refined oil), grain demand in Asia, and real assets outperforming financial instruments.

An unseen problem with Cadbury is that if oil prices spike, this in turn will cause an increase buying of sugar for ethanol, thus spiking the price of sugar, and this in turn will spike the price of confectionaries, and confectionaries are discretionary (one can see with their own eyes at their local supermarket that the cost of candy bars has increased significantly in the last year and a half).

I would judge Mr. Buffet correct on his assessment of the Cadbury deal and on his decision to buy Burlington—however, what I highly agree with the point in the above article is that any assessment, regardless of origin, should always be viewed with skepticism and critically analyzed.

Sun, 01/31/2010 - 23:20 | 212841 Anonymous
Anonymous's picture

You are missing the elephant in the room. Burlington
Northern is getting a nice chunk of that Obama $8
million rail grant money.

Sun, 01/31/2010 - 23:20 | 212840 Anonymous
Anonymous's picture

You are missing the elephant in the room. Burlington
Northern is getting a nice chunk of that Obama $8
million rail grant money.

Sun, 01/31/2010 - 23:03 | 212829 Anonymous
Anonymous's picture

Mad Max is right on RRs will replace trucks

Sun, 01/31/2010 - 23:03 | 212828 Janice
Janice's picture

Just spoke to Warren....You will be hunted down like an animal for your degradation of the master.  Take it all back.

Sun, 01/31/2010 - 23:01 | 212827 Mad Max
Mad Max's picture

I was hoping for some analysis and discussion here.  I see none in the post.

BNSF is one of the best run US railroads (admittedly not a large club) with a very good geographic coverage.  Most importantly, it is perhaps THE most important railroad for hauling low-sulfur coal to the eastern 1/2 of the US.  Whatever you may think of global warming, coal isn't leaving our electric grid any time soon, and BNSF owns that transportation business.

On a related but equally important note, the purchase is a bet on higher oil prices likely killing off long-distance trucking for all manner of food, consumer goods and light industrial uses.  Railroads use a tiny fraction of the oil per ton/mile that trucking does, so if you bet on higher oil prices (short of my eponym's reality), railroads make sense.  Union Pacific compares well for this but is not quite as central for coal and for whatever reason was not Buffet's focus.

Mon, 02/01/2010 - 01:55 | 212979 George Orwell
George Orwell's picture

Agree with Mad Max 100%.   I think the people who are critical of Buffett's BNI acquisition should state their opinion on peak oil first.  How about it Vitaliy?  Do you believe that the world oil production has reached its peak or will reach its peak in the next 5 years?

 

Your answer to this question will form the framework to which we can understand the basis of your analysis.  For example, if you think peak oil is pure garbage and that oil is going down to the good old days of $40 a barrel, then this BNI acquisition will look bad.

 

But if you think peak oil is here or will be here in the next 5 year then the BNI acquisition make sense.  In a world of $200 a barrel oil, the only form of transportation that makes sense will be railroads. 

 

George Orwell

Sun, 01/31/2010 - 22:32 | 212817 Anonymous
Anonymous's picture

Warren is owned by GS, what else to say

Sun, 01/31/2010 - 22:11 | 212803 Anonymous
Anonymous's picture

Is Burlington a long term play on oil? Is it possible Buffet has negative info on Saudi oil production?

Sun, 01/31/2010 - 21:45 | 212781 Seal
Seal's picture

WB’s main object is to saddle his successors like Ajit with this offal of acquisitions so they have no room – or cash – to do much of anything except “carry on.”

Sun, 01/31/2010 - 22:22 | 212813 Anonymous
Anonymous's picture

The only problem with your comment is that BRK has about as much cash as of the last 10Q as they had at the close of business 3 years ago, roughly 24 billion. Nice fairy tale that is easily dismissed after spending the better part of 20 seconds looking at Balance Sheets.

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