Saturday, November 7, 2009 3 comments ++[ CLICK TO COMMENT ]++

Warren Buffett CNBC interview...and my thoughts on his BNSF buyout

My primary goal these days is develop an investment technique similar to Buffett-Prime, which I define as paying up for quality assets and buying them for the long-term (possibly for the full lifespan of the asset.) Basically, I view this as being the strategy utilized by Warren Buffett during his prime in the 70's and 80's. Buffett's proposed buyout of Burlington Northern Santa Fe is a good example of this so I have been trying to figure out why Warren Buffett did what he did.

I also believe that BNSF buyout, if it is successfully completed, appears to make more sense than some of Buffett's other investments in the last decade, such as Wal-mart, Kraft, or ConocoPhillips (I am not fan of those three buys.)

I ran across a couple of bloggers' preliminary, quick, estimates of BNSF's intrinsic value. Old School Value pegs BNSF at $80 to $140. A classic value investor, Modern Graham, figures BNSF to be worth $177. Morningstar, which is as close to value investing as mainstream analysts get, estimated BNSF's fair value as $90 before the buyout.

The BNSF buyout price isn't cheap but it's reasonable. After all, keep in mind that this strategy involves paying up for quality assets. It's generally impossible to buy these assets at low valuations unless they were distressed (BNSF is definitely not distressed.) The big question to me isn't the price paid but the lack of attractiveness of railroads. Why invest $40 billion (including owned stake) in an industry that has historically earned very low returns on equity? That is the most important question about this deal for someone like me. Because you are willing to pay up, such a buyout means that Buffett views BNSF as being more attractive than, say, P&G, ExxonMobil, UPS, and other world-class companies with historically better ROE and who generally trade at above-market multiples.

The only possibility I can see for justifying such a purchase is if there has been an industry shift—something that made modern railroads behave completely differently from 20 years ago. Although I don't consider Warren Buffett as a very good macro investor, he is very good at capitalizing on trends.

The following interview with CNBC primarily covers the BNSF buyout (although it goes into Bufffett's opinions on taxes and a few other issues as well.) What struck me was Buffett's assertion that railroads changed significantly a decade ago. Although many analysts and others have presented views describing the efficiency of rails, this is the first time I have seen Warren Buffett say that the industy changed a decade or so ago. Scroll to 8:34 in the interview (after the commercial plays) and notice the following points made by Warren Buffett:

  • "...situation changed dramatically a decade or so ago..."
  • railroads are far more efficient now
  • 90% more ton-miles moving than 25 or 30 years ago on 40% less track
  • costs have gone down
  • overall, more productive than before

So, it appears that Buffett may be trying to capitalize on a major shift in the business environment of railroads. The risk with investing in rails is that they appear so sensitive to primary resource commodity shipments and global trade. However, based on what Warren Buffett is saying, it seems that the railroad profits have risen in the last decade mainly from increasing productivity. If so, this may mean that rails will perform well even if commodity shipments or gobal trade slows.

(Thanks to Dah Hui Lau's blog for linking to the following CNBC interview with Warren Buffett.)

If you want a brief run-down of various railroads in USA and Canada, here is a Globe & Mail recap. I looked at rails about 3 or 4 years ago and my favourite at that time was Canadian National. But it tends to trade at a premium most of the time.


3 Response to Warren Buffett CNBC interview...and my thoughts on his BNSF buyout

November 8, 2009 at 5:08 AM

Would railroads benefit from a protectionist regime? Does anyone know?

Sivaram Velauthapillai
November 8, 2009 at 1:22 PM

I doubt it. Rails benefit from increasing trade (they ship a lot of natural resources, foreign manufactured goods, and so on) so they will probably be hurt by protectionism. However, if oil prices skyrocket because of protectionism then rails will benefit and become more competitive against airlines and trucking.

Overall, I doubt Buffett's bet is much of a bet on protectionism (but someone who is short to medium term oriented can make or lose money off it.) Buffett is buying BNSF outright, which means he will hold on to it for 50 to 70 years (or until railroads become obsolete.) So, even if there is rising protectionism in the next 10 or 15 years, it doesn't mean that it will continue for the next 50+ years.

November 9, 2009 at 10:51 AM

The biggest question that's been hanging over Berkshire is what happens after Buffett?

Based on its price (including debt assumed), BNI will be about 1/4 of Berkshire.  BNI's management won't be making the top-level capital allocation decisions, but they will be running 1/4 of the company.  It seems to me that this can in some sense be considered a partial decision on Buffett's successor.

Their CEO is only 49, and can be expected to stick around and run the railroad for quite some time after Buffett is gone.

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