Friday, November 6, 2009

Why Warren Buffett Acquires Burlington Northern?

Why Warren Buffett Acquires Burlington Northern? (my 3cents)

The price is right. Buffett think he can earn meaningful return from the investment over the long term. I think Burlington is worth more than $200 if it is still listed. (Buy with wide margin of safety, or return of at least 100%)

Management is the key to business success. Buffett is very very good at evaluating management. Passion, honesty, integrity are some of the important traits in a great leader.

The business itself. Even though railroad businesses were not popular investment in the past, things changes over time.(something 2 ponder: railroad businesses are of high capex, why Buffett still buy? It can make higher return on assets?)As oil prices increase due to diminishing oil resources, demand for transportation through railroads will increase due to competitive pricing. As Buffett knows it best, rail transportation consumes significantly less fuel than other types of transportation. Read the pieces below to know more. Last but not least, it is a boring but great business.


Buffett’s Buy Includes CEO Who Engineered Railroad (Update2)

Nov. 5 (Bloomberg) -- Warren Buffett didn’t just buy a railroad when he announced his purchase of Burlington Northern Santa Fe Corp. He hired the engineer, too.

“It’s a bet not only on the company but on talent,” said Gary Bradshaw, portfolio manager at Hodges Capital Management Inc. in Dallas, which owns 150,000 Burlington Northern shares. “I can’t imagine anything changing. That’s Buffett’s style. He’s always bet on management and let those guys run it.”

Chief Executive Officer Matthew Rose has led Fort Worth, Texas-based Burlington Northern to the top of the U.S. industry in sales. Revenue almost doubled through 2008 from 2001, his first full year at the helm. That growth outpaced the 50 percent rise at Union Pacific Corp., his biggest competitor. Becoming a part of Buffett’s Berkshire Hathaway Inc., with its AAA credit rating from Standard & Poor’s, may make Rose’s job easier by lowering his company’s borrowing costs.

Berkshire has been building its stake since 2006, giving Buffett a glimpse of Rose, 50, a 16-year employee who has been CEO since December 2000. In a Nov. 3 statement, the Berkshire chairman and chief executive said the deal was an investment in the railroad, “Matt Rose and his team.”

Buffett didn’t return a message left with his assistant Carrie Kizer.

Berkshire’s largest purchase will cost the company $26 billion, or $100 a share in cash and stock, for the 77.4 percent of the railroad it doesn’t already own. Including the previous investment and debt assumption, the deal is valued at $44 billion, Omaha, Nebraska-based Berkshire said.

Expanded Capacity

What may have attracted Buffett to Burlington Northern is the company’s reduction of expenses as it expanded capacity, said Anthony Hatch, an independent railroad analyst based in New York.

“One of the ways they’ve improved is taking a high percentage of their variable costs down,” including by using longer and fewer trains, which has increased average velocity across its system, Hatch said.

Hatch also cited Burlington Northern’s development of its intermodal business, beginning in 1989 under Rose’s predecessor Robert Krebs. Intermodal refers to containers that move by a combination of rail, road and sea. Krebs, now a director of General Motors Co., set up a partnership with Lowell, Arkansas- based J.B. Hunt Transport Services Inc., now the third-largest U.S. trucking company.

Since taking over as CEO, Rose has continued the strategy, Hatch said.

New Tracks

“In my nine years we’ve probably laid out $25 billion worth of capital for our railroad,” said Rose, who earned $15.6 million in total compensation last year, according to a Securities and Exchange Commission filing.

Those investments include new locomotives and adding tracks alongside existing ones, he said. Operating parallel tracks boosts train speeds. On the single-track lines that are the most prevalent in the industry, a train heading in one direction must pull off on a siding to let oncoming traffic pass.

During a quarterly earnings call on Oct. 22, Chief Financial Officer Thomas Hund said spending on tracks, equipment and other improvements would remain at $2.6 billion for 2009. Being owned by Berkshire probably won’t change those plans, said Jason Seidl, analyst at New York-based Dahlman Rose & Co.

“If he was buying a railroad that was small and capital- constrained, there would be a big change if you’re with Berkshire,” Seidl said of Buffett’s deal. “But Burlington generates an enormous amount of free cash flow.”

‘Hands-Off’ Shareholder

The railroad will probably have lower borrowing costs as a unit of Berkshire, even if Standard & Poor’s strips Buffett’s company of its AAA rating, said B. Craig Hutson, a Chicago-based railroad debt analyst at Gimme Credit LLC. S&P said yesterday Berkshire’s rating may be cut to as low as AA because of the acquisition. That’s still six levels higher than Burlington Northern’s BBB.

“It would be safe to assume that Burlington will have a broader access to capital and a lower cost of capital than they would have had on a stand-alone basis,” Hutson said. “They haven’t really held back per se on spending on growth opportunities recently. It gives them the ability to invest for the long-term without being asked every quarter how those investments in their infrastructure are doing.”

Burlington Northern has $10 billion of long-term debt and paid $462 million in interest expense this year through Sept. 30, according to its most recent 10-Q regulatory filing.

‘Very Friendly’

Rose said Buffett has been a “hands-off” shareholder who phones “fairly infrequently.” The two met before Berkshire began buying Burlington Northern shares, Rose said.

“We have a large operation in Omaha, so I had a chance to meet him through some charity events,” Rose said in an interview yesterday. “It’s been very friendly, and he’s always told me he wouldn’t do anything hostile that we weren’t aware of (see how Buffett changed his behavior compared with the past!). The biggest change is that instead of having quarterly analyst meetings, I’ll go to Omaha every once in a while. Warren told me one requirement is I have to go to his annual meeting.” :D

Buffett, 79, while not immersed in industry intricacies, understands that railroads stand to benefit from rising diesel fuel prices because they can transport goods more efficiently than trucks, Rose said.

“I wouldn’t call him a detail guy on the railroads,” Rose said. “But he clearly understands the U.S. economy very well.”

Burlington Northern fell 12 cents to $96.98 at 4:15 p.m. in New York Stock Exchange composite trading. The stock climbed 28 percent this year before today and has jumped almost fourfold since December 2000, when Rose was promoted to CEO.

Berkshire’s Class A shares increased $370 to $101,900.

Rose, who lives with his wife in the Fort Worth suburb of Westlake, is the father of two children, a trustee of Texas Christian University in Fort Worth and serves on the board of Fort Worth-based AMR Corp., parent of American Airlines.

Berkshire Buys Burlington in Buffett’s Biggest Deal
Nov. 3 (Bloomberg) -- Warren Buffett’sBerkshire Hathaway Inc. agreed to buy railroad Burlington Northern Santa Fe Corp. in what he described as an “all-in wager on the economic future of the United States.”

The purchase, the largest ever for Berkshire, will cost the company $26 billion, or $100 a share in cash and stock, for the 77.4 percent of the railroad it doesn’t already own. Including his previous investment and debt assumption, the deal is valued at $44 billion, Omaha, Nebraska-based Berkshire said today in a statement. The railroad’s stock closed yesterday at $76.07.

Berkshire has been building a stake in the Fort Worth, Texas-based railroad since 2006 as Buffett looked for what he called an “elephant”-sized acquisition allowing him to deploy his company’s cash hoard, which was more than $24 billion at the end of June. Trains stand to become more competitive against trucks with fuel prices high, he has said.

“It is Warren being Warren, taking advantage of a market that is soft at a time when the possibility for competitive bids is relatively low,” said Tom Russo, a partner at Gardner Russo & Gardner, which holds Berkshire shares. “He looks at this as a business that has advantages against other forms of transportation.”

At $100 a share, Buffett is paying 18.2 times Burlington Northern’s estimated 2010 earnings of $5.51, according to the average analyst projection in a Bloomberg survey. That compares with the 13.4 multiple for the Standard & Poor’s 500 Index as of yesterday’s close. Shares of Burlington Northern, the largest U.S. railroad, dropped 13 percent in the 12 months through yesterday.

Union Pacific, CSX

Competing railroad Union Pacific Corp.’s ratio was 13, while Jacksonville, Florida-based CSX Corp.’s was 13.1, Bloomberg data show.

Union Pacific rose $4.35, or 7.9 percent, to $59.41 at 4 p.m. in New York Stock Exchange composite trading. CSX climbed 7.3 percent. Burlington Northern surged to $97. Berkshire Class A shares rose $1,700, or 1.7 percent, to $100,450.

The deal culminates a search by Buffett, 79, that sent him to Europe looking for possible acquisitions and lamenting in letters to shareholders that he and Vice Chairman Charles Munger couldn’t find companies they considered large enough to meaningfully add to annual earnings.

Buffett needs “elephants in order for us to use Berkshire’s flood of incoming cash,” he said in his annual letter to shareholders in 2007. “Charlie and I must therefore ignore the pursuit of mice and focus our acquisition efforts on much bigger game.”

Trains, Trucks

Burlington Northern, with pretax income of $3.37 billion on revenue of $18 billion last year, would be Berkshire’s second- largest operating unit by sales. The McLane unit, which delivers food to grocery stores and restaurants by truck, earned $276 million on revenue of $29.9 billion in 2008.

Berkshire’s largest business is insurance, with units including auto specialist Geico Corp. Buffett, who is the company’s chairman and chief executive officer, has said he likes insurance because he gets to invest the premiums paid by customers until the cash is needed to pay claims. The insurance businesses last year collectively earned $7.51 billion on revenue of $30.3 billion.

Buffett will use $16 billion in cash for the deal, half of which is being borrowed from banks and will be paid back in three annual installments, he told CNBC. Berkshire will have more than $20 billion in consolidated cash after the purchase, he said.

Cash Hoard

“It doesn’t mean we’re out of business, but it does mean that we won’t be making any huge deals for a while,” Buffett told the network today. He said earlier this year the company needs at least $10 billion in cash to be ready for unforeseen events such as catastrophe claims at its insurance units.

Berkshire would get $264 million from Burlington Northern if the railroad’s board accepts a higher bid, according to a regulatory filing today.

Buffett built Berkshire into a $150 billion company buying firms that he deems to have durable competitive advantages. His largest purchases include the 1998 deal for General Reinsurance Corp. for more than $17 billion. Buffett expanded into power production with the purchase of MidAmerican Energy Holdings Co., and last year bought Marmon Holdings Inc., the collection of more than 100 businesses, from the Pritzker family. Marmon’s Union Tank Car unit manufactures and leases railroad cars.

He expects the economy to recover, he said in an interview in September with his company’s Business Wire unit.

“We are still tossing out 14 trillion worth of product a year,” he said. “It will return. It’s already returned with most people in most ways, but it’s not back 100 percent. It’ll get there.”

‘Simple Bet’

The U.S. economy returned to growth in the third quarter after a yearlong contraction as government incentives spurred consumers to spend more on homes and cars. The world’s largest economy expanded at a 3.5 percent pace from July through September, Commerce Department figures showed last week.

“It’s a pretty simple bet,” said Mario Gabelli, CEO of Gamco Investors Inc., which has holdings in Berkshire and Burlington Northern. “Warren knows the assets. He’s been involved in basic businesses like this for years.”

Buffett is increasing his stake in an industry that doesn’t have any competitors for certain types of freight. Federal law requires some chemicals to be moved only by rail.

Railroads burn less diesel fuel than trucks for each ton of cargo carried, giving companies such as Burlington Northern and Omaha-based Union Pacific a grip on bulk commodities such as coal. That fuel-efficiency advantage also gives railroads a share of the profits from moving goods such as Asian imports of cars and other consumer goods sent to U.S. West Coast ports.

Fuel Prices

From ships, containers are loaded onto railcars to be hauled to so-called intermodal terminals, where they’re transferred to trucks for the final leg of their journey.

Buffett said in 2007 that railroads may prosper at the expense of trucks. “As oil prices go up, higher diesel fuel raises costs for rails, but it raises costs for its competitors, truckers, roughly by a factor of four,” Buffett told shareholders in 2007 at his company’s annual meeting. “There could be a lot more business there than there was in the past.”

Berkshire’s board approved a 50-to-1 split of its Class B shares as part of the acquisition plan, the company said in a second statement. Berkshire will schedule a shareholder meeting to vote on an amendment to the company’s certificate of incorporation that’s needed to split the stock. B share typically trade for about a thirtieth of the price of A shares.

Stock Split

Most of the shares exchanged for Burlington Northern stock will be Class A shares, Berkshire said. Splitting the B shares is designed to accommodate the smallest holders who elect for a tax-free swap of the railroad’s stock, it said.

Goldman Sachs Group Inc., Evercore Partners Inc., and Cravath Swaine & Moore LLP are advising Burlington. Berkshire didn’t disclose a financial adviser and said Munger Tolles & Olson LLP furnished legal advice.

Matthew Rose, the chief executive officer of Burlington Northern, said he struck the deal with Buffett after the two met in Texas. Buffett, named by Forbes as the second-richest American, was visiting because he has other business interests in the state, Rose said.

“We spent a couple hours talking about the economy and the business,” Rose told Bloomberg Television. “The next day I got a call. He asked me to meet on a Friday night down in downtown Fort Worth. It was a relatively short conversation; he told me what he wanted to do. The next day we fired up the process.”

Antitrust Review

Burlington Northern operates 32,000 miles of track, with 6,700 locomotives, according to its Web site. Most of the carrier’s network is west of the Mississippi, where it competes with Union Pacific.

The U.S. Department of Justice will conduct an antitrust review, which Burlington expects to be completed by the first quarter of next year, the company said today in a conference call with analysts and investors.

Burlington Northern said two-thirds of the shares that aren’t held by Berkshire must vote in favor of the transaction for it to proceed under Delaware law. The railroad said it anticipates a shareholder meeting in the first quarter of 2010 and the completion of the transaction “very shortly thereafter.”


Transcript: Warren Buffett on FOX Business Network today with Liz Claman
But I -- you know, I like the business very much. I think the management is the best there is, and, like I say, when I didn't get thrown out of the office, I made it specific, and it was a good offer from their standpoint. And they decided to accept it. And now we're going to own a railroad. And we never fool around on things, Liz. I mean, I tell the lawyers, get this thing done, you know.

Well, the rails move a freight at a much more environmentally friendly (the future way) way than the truckers do. And they also only use about a third of the fuel. So, it's helping -- it helps our trade balance in the long run. It helps in terms of the atmosphere. It is a very, very efficient, effective, environmentally friendly way of moving freight. And, you know, our rail system is a huge asset to the country.

Well, they haul a lot of coal and coal from the Powder River Basin in the West -- is more competitive, it's lower-sulfur coal than in the East. So, it will be around a long time. But coal, over the long run, coal will diminish in relative importance.

BUFFETT: It's true. I didn't have to listen to that, but it's true any company that has long-life assets is replacing assets that they bought many years ago with things that cost more money now. That's true of our utility business, that's true of any business. It's true -- if you build a plant that 30 years ago had a 30-year life. When you go to replace that same plant, it's going to cost you more money. That's a fact of life in an inflationary economy.

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