Showing posts with label Burlington Northern Santa Fe Corp. Show all posts
Showing posts with label Burlington Northern Santa Fe Corp. Show all posts

Tuesday 2 March 2010

Buffett Overpaid, and It Made Sense


Buffett Overpaid, and It Made Sense


That quote, pulled from a news article, is a common attitude when it comes toBerkshire Hathaway's (NYSE: BRK-A)(NYSE: BRK-B) November purchase of railroad giant Burlington Northern.
The $100-per-share buyout represented a 30% premium on Burlington's stock price -- a stock that had already gained 50% over the previous eight months. By any valuation metric, Buffett was coughing up top dollar for Burlington. Coming from the guy who coined the phrase, "price is what you pay, value is what you get," and who built his reputation buying companies like Coca-Cola (NYSE:KO) and American Express (NYSE: AXP) at fire-sale prices, this was a puzzle. Berkshire suddenly looked more like Blackstone (NYSE: BX).
Buffett also partially financed the deal with Berkshire's common stock, a rare move for him, and one he often later regretted. And since he was willing to use Berkshire's stock as currency, he was sending a clear signal to the market: Either Berkshire shares were fully valued (if not overvalued), or he was using an undervalued stock to buy Burlington, making the deal even more expensive than it looked.
Please don't tell me he's lost his marbles
On Saturday, Berkshire released its 2009 letter to shareholders. Within, Buffett went into detail on the mechanics and valuation of the Burlington acquisition. In short, yes, Berkshire paid a full price. Yes, Berkshire shares were probably undervalued at the time. And yes, that means the full price could turn into a dear price.
But the decision nonetheless made sense. Here's exactly what Buffett had to say:
In our [Burlington] acquisition, the selling shareholders quite properly evaluated our offer at $100 per share. The cost to us, however, was somewhat higher since 40% of the $100 was delivered in our shares, which Charlie and I believed to be worth more than their market value ...
In the end, Charlie [Munger] and I decided that the disadvantage of paying 30% of the price through stock was offset by the opportunity the acquisition gave us to deploy $22 billion of cash in a business we understood and liked for the long term. It has the additional virtue of being run by Matt Rose, whom we trust and admire. We also like the prospect of investing additional billions over the years at reasonable rates of return. But the final decision was a close one. If we had needed to use more stock to make the acquisition, it would in fact have made no sense. We would have then been giving up more than we were getting.
The price of being huge
One of the unfortunate rules of finance is that returns wither with size. As individual investors, we can meaningfully buy any stock in the market universe, since the few thousand bucks we'll invest probably won't contort the company's stock price. Our tiny investments mean nothing to the market, but they can mean big bucks for our humble portfolios. The world is our oyster.
Not so for big investors like Berkshire. Heck, Berkshire makes more than $1,000 a minute in dividends on its stakes in General Electric (NYSE: GE) and Goldman Sachs (NYSE: GS) -- and that's a fairly small portion of the overall portfolio. When cash piles up that fast, you have to be able to deploy it in massive chunks -- billions at a time -- to make a dent in the portfolio. That purges most small investment opportunities, forcing investors like Berkshire to settle for lower returns.
That's exactly what happened with Burlington. Paying an overvalued price made sense because it provided the opportunity to deploy tens of billions of cash at reasonable, but not great, returns.
For decades, Buffett has repeated a similar line in Berkshire's annual letters: "[O]ur performance advantage has shrunk dramatically as our size has grown, an unpleasant trend that is certain to continue ... huge sums forge their own anchor and our future advantage, if any, will be a small fraction of our historical edge."
After the Burlington deal, it's clear he isn't kidding.

Why Buffett bought Burlington Northern Santa Fe Corp

In earlier days, Charlie and I shunned capital-intensive businesses such as public utilities. Indeed, the best businesses by far for owners continue to be those that have high returns on capital and that require little incremental investment to grow. We are fortunate to own a number of such businesses, and we would love to buy more. Anticipating, however, that Berkshire will generate ever-increasing amounts of cash, we are today quite willing to enter businesses that regularly require large capital expenditures. We expect only that these businesses have reasonable expectations of earning decent returns on the incremental sums they invest. If our expectations are met – and we believe that they will be – Berkshire’s ever-growing collection of good to great businesses should produce above-average, though certainly not spectacular, returns in the decades ahead.


Our BNSF operation, it should be noted, has certain important economic characteristics that resemble those of our electric utilities.
  • In both cases we provide fundamental services that are, and will remain, essential to the economic well-being of our customers, the communities we serve, and indeed the nation. 
  • Both will require heavy investment that greatly exceeds depreciation allowances for decades to come. 
  • Both must also plan far ahead to satisfy demand that is expected to outstrip the needs of the past. 
  • Finally, both require wise regulators who will provide certainty about allowable returns so that we can confidently make the huge investments required to maintain, replace and expand the plant.

We see a “social compact” existing between the public and our railroad business, just as is the case with our utilities. If either side shirks its obligations, both sides will inevitably suffer. Therefore, both parties to the compact should – and we believe will – understand the benefit of behaving in a way that encourages good
behavior by the other. It is inconceivable that our country will realize anything close to its full economic potential without its possessing first-class electricity and railroad systems. We will do our part to see that they exist.

In the future, BNSF results will be included in this “regulated utility” section. Aside from the two businesses having similar underlying economic characteristics, both are logical users of substantial amounts of debt that is not* guaranteed by Berkshire. Both will retain most of their earnings. Both will earn and invest large sums in good times or bad, though the railroad will display the greater cyclicality. Overall, we expect this regulated sector to deliver significantly increased earnings over time, albeit at the cost of our investing many tens – yes, tens – of billions of dollars of incremental equity capital.

http://www.berkshirehathaway.com/letters/2009ltr.pdf

Comment:

-  The best business are those that generate high return on capital with need for little incremental re-investments to grow, that is, those that generate large FCF.  It is increasingly difficult to find such companies to invest into due to the size of Berkshire generating ever increasing amounts of cash.

-  Berkshire is willing to invest into companies that require large capital expenditure to grow provided that these businesses have reasonable expectations of earning decent returns on the incremental sums they invest.  These businesses are expected to produce above-average, though certainly not spectacular, returns in the decades ahead.


-  *The major problem for Berkshire last year was NetJets, an aviation operation that offers fractional ownership of jets. Over the years, it has been enormously successful in establishing itself as the premier company in its industry, with the value of its fleet far exceeding that of its three major competitors combined. Overall, our dominance in the field remains unchallenged.


NetJets’ business operation, however, has been another story. In the eleven years that we have owned the company, it has recorded an aggregate pre-tax loss of $157 million. Moreover, the company’s debt has soared from $102 million at the time of purchase to $1.9 billion in April of last year. Without Berkshire’s guarantee of this debt, NetJets would have been out of business. It’s clear that I failed you in letting NetJets descend into this condition. But, luckily, I have been bailed out.


Dave Sokol, the enormously talented builder and operator of MidAmerican Energy, became CEO of NetJets in August. His leadership has been transforming: Debt has already been reduced to $1.4 billion, and, after suffering a staggering loss of $711 million in 2009, the company is now solidly profitable.

Monday 30 November 2009

Future expectations can be approached in two different ways: Qualitative or Quantitative approach

According to Benjamin Graham, the current price reflects both
  • known facts and
  • future expectations
was intended to emphasize the double basis for market valuations.

Corresponding with these two kinds of value elements are two basically different approaches to stock analysis. 

Every competent analyst looks forward to the future rather than backward to the past, and realizes that their work will prove good or bad depending on what will happen and not on what has happened.

The future expectation itself can be approached in two different ways, which may be called:

  • 1.  the way of prediction (or projection) and
  • 2.  the way of protection.

-----

1. The way of prediction (or projection)



Those who emphasize prediction will try to anticipate fairly accurately just what the company will accomplish in future years - in particular whether earnings will grow rapidly and consistently.  These conclusions may be based on a very careful study of such factors as
  • supply and demand in the industry-
  • or volume, price and costs -
  • or else they may be derived from a rather naive extrapolation from past growth into the future. 
If these authorities are convinced that the fairly long-term prospects are unusually favourable, they will almost always recommend the stock for purchase without paying too much attention to its current price.

This first, or predictive approach, could also be called the qualitative approach, since it emphasizes prospects, management and other nonmeasurable, abeit highly important factors that go under the heading of quality.

--

2. The way of protection.

By contrast, those analyst who emphasize protection are always especially concerned with the price of the stocks at the time of study.  Their main effort is to assure themselves of a substantial margin of present value above the market price - a margin large enough to absorb any unfavourable developments in the future.  Generally speaking, therefore, it is not so necessary for them to be enthusiastic over the company's long-run prospects as it is to be reasonably confident that the enterprise will get along.

The second or protective approach may be called the quantitative or statistical approach, since it emphasizes the measurable relationships between selling price and earnings, assets, dividends and so forth. 

Incidentally, the quantitative method is really an extention into the field of common stocks of the viewpoint that security analysis has found to be sound in the selection of bonds and preferred stocks for investment.

----

Choosing the "best" stocks is a controversial one.

In Benjamin Graham's own attitude and professional work was always committed to the quantitative approach. 
  • From the first he wanted to make sure that he was getting ample value for his money in concrete, demonstrable terms. 
  • He was not willing to accept the prospects and promises of the future as compensation for a lack of sufficient value in hand.

This has by no means been the standard viewpoint among investment authorities; in fact, the majority would probably subscribe to the view that prospects, the quality of management, other tangibles, and the "human factor" far outweigh the past performance records, the balance sheet and all other cold figures.

Thus this matter of choosing the "best" stocks is a controversial one.

Buffett gambles £27bn on rail to get back on track

Buffett gambles £27bn on rail to get back on track
Warren Buffett has placed the largest single wager of his investing career, gambling on "the economic future of the United States" by taking control of the American rail giant Burlington Northern Santa Fe in a $44bn (£27bn) deal.


By James Quinn
Published: 8:53PM GMT 03 Nov 2009

Warren Buffett has bought Burlington Northern Santa Fe, the rail operator, in a $44bn deal. Burlington is America's largest railway by revenue, operating freight across large swathes of the west and mid-west. Its tracks are also used by a variety of passenger services.

Mr Buffett believes that Burlington will benefit as the US economy recovers.

The septuagenarian billionaire argues that railway operators cannot do well unless the businesses and consumers who use the products they transport are beginning to spend again. "It's an all-in wager on the economic future of the United States," said Mr Buffett. "I love these bets."

In typical Buffett style, the cash-and-shares deal was struck in a 15-minute conversation with Matthew Rose, Burlington's chief executive.

It is the largest single investment Mr Buffett has made since taking control of Berkshire Hathaway, the investment conglomerate he has run since 1965.

It contrasts with his more recent deals, which have been big bets on the financial services sector including multi-billion dollar gambles on the recovery of shares in General Electric and Goldman Sachs, both of which have repaid him handsomely.

However, not all of his financial gambles have paid off, with 2008 going down as Berkshire's worst financial year since Mr Buffett took the helm, following a 62pc fall in profits and a drop in net worth of 9.6pc.

Berkshire is offering $26bn for the 77.4pc of Burlington it did not already own, 40pc in shares and the balance – $16bn – in cash, drawn equally from existing reserves and a bank syndicate. Berkshire will still have $20bn of cash.

Including Berkshire's previous investment and the assumption of $10bn of debt, the deal is worth $44bn.


http://www.telegraph.co.uk/finance/businesslatestnews/6496667/Buffett-gambles-27bn-on-rail-to-get-back-on-track.html

Sunday 8 November 2009

Good fundamental reasoning is important. Guts too!

Forty-four billion reasons to support the bull market
Warren Buffett has just made his biggest investment ever in buying Burlington Northern Railroad Company in the US.

By Alan Steel
Published: 1:21PM GMT 06 Nov 2009


Alan Steel The two big differences between Warren Buffett and the thousands of pessimists predicting our financial demise is that he puts his hard earned cash on the line, and he is usually right.

Warren Buffett, in buying Burlington Northern Railroad Company in the US has just made his biggest investment ever. All said and done the business came with a $44 billion price tag.

He said he’s betting on an out and out recovery in the US economy and he is focusing, as all good investors should, on the medium to long term.

Meanwhile, pessimists are pulling their money out of equity funds and piling into fixed interest bonds.

So no doubt they will not only be dismayed by Warren Buffett’s move, but also by Cisco CEO’s statement on Thursday which ignited US stockmarkets. He stands alongside his counterparts at Apple, Amazon and Intel by stating “the quarter was very strong and the recovery is gaining momentum”.

Further good news comes from the US Institute for Supply and Management who reckon the US GDP is likely now growing at an annualised rate of 4.5pc. Workers’ productivity also offers a guide.

This week the US Labour Department said output per hour of non farm workers rose at an annual rate of 9.5pc in the quarter, more than four times the average productivity growth rate of the last 25 years. Taking that together with the previous quarter’s 6.9pc, it’s the strongest productivity growth rate over any six month period since 1961.

All of this, plus the continued scepticism among experts and ordinary investors, tells us to expect a continuing worldwide stockmarket recovery.

Alan Steel is chairman of Alan Steel Asset Management

http://www.telegraph.co.uk/finance/personalfinance/investing/6514334/Forty-four-billion-reasons-to-support-the-bull-market.html

Thursday 5 November 2009

Does Buffett's Big Acquisition Signal a Market Bottom?

Does Buffett's Big Acquisition Signal a Market Bottom?
By Ron DeLegge, Editor
On 5:32 pm EST, Tuesday November 3, 2009

Warren Buffett is finally spending some of Berkshire Hathaway's cash hoard. And he's buying a railroad company. As the greatest investor of our generation, does his latest acquisition signal a market bottom?

Dissecting the Deal



Buffett's firm, Berkshire Hathaway (NYSE: BRK-A - News), agreed to buy Burlington Northern Santa Fe Corp. (NYSE: BNI - News) for $100 a share valuing the deal at $44 billion.

Over the past year, Burlington's stock price has lagged the performance of its peer benchmark, the Dow Jones Transportation Average (NYSEArca: IYT - News).

How much did Buffett pay?

The analysts surveyed by Bloomberg, say he paid 18.2 times Burlington's 2010 estimated earnings, which is higher than the S&P 500's multiple according to the same analysts. Not very Buffett like, especially considering he rarely pays a premium when putting new capital to work. The only other plausible explanation is that Buffett sees hidden value in Burlington.

A Consummate Contrarian

As a contrarian to the bone, Buffett decided to pull the trigger on a company within an ailing industry sector. Through the November 2nd market close, transportation stocks have lagged the entire U.S. stock market (NYSEArca: VTI - News) by a substantial margin of 15.94%.

The recent activity of rail traffic is depressed. This is a key barometer of economic health.

The Association of American Railroads reported that for the week ending October 10th, 2009, rail traffic declined 17.2% compared to the same week in 2008. The report also shows weak demand for the transportation of goods throughout the entire U.S. On the East coast, carloads were down by 19.7% and in the West they were off by 15.4%.

Interpreting the Deal

As an insurance executive, Buffett knows a thing or two about betting. And over the years most of his bets (at least the important ones) have paid off handsomely. Some, however, did not.

In the early 1990s, Buffett's $358 million investment in U.S. Airways was virtually wiped out. In a letter to shareholders he quipped, 'How do you become a millionaire? First, you become a billionaire then you invest in an airlines company.'

With this latest deal, even Buffett himself admits that the Burlington deal is a gamble.

'It's an all-in wager on the economic future of the United States,' he said.

Conclusion

No doubt, analysts, fund managers and others with a bullish bias have already begun misinterpreting Buffett's $44 billion gamble as a sure sign the worst is over. It's time to break out the champagne!

A bedazzling 80% of economists now believe the worst economic recession of our generation is over. And around 100% of them never saw the recession coming.

Even though Warren Buffett's latest buy may be viewed as an act of genius, it may not necessarily signal that a market bottom has been reached. This was recently covered in 'What's Next- Minor Correction or Major Collapse.'

Regardless, the belief that Warren Buffett can do no wrong is an investment myth that won't die soon. His billions prove that he's always right, right?

It calls to mind the wonderful lyrics in a song from Fiddler on the Roof.

'When you're rich, they think you really know.'

http://finance.yahoo.com/news/Does-Buffetts-Big-Acquisition-etfguide-2790244804.html;_ylt=AjJvqpl4d2AWWb6ET8y2luy7YWsA;_ylu=X3oDMTFhZnVrbWZwBHBvcwMxBHNlYwNzcGVjaWFsRmVhdHVyZXMEc2xrA2RvZXNidWZmZXR0cw--?x=0

Wednesday 4 November 2009

Warren Buffett’s takeover of Burlington Northern Santa Fe Corp.

Buffett Takeover Reduces Successor’s Need for ‘Amazing Insight’
Share Business ExchangeTwitterFacebook| Email | Print | A A A By Andrew Frye

Nov. 3 (Bloomberg) -- Warren Buffett’s takeover of Burlington Northern Santa Fe Corp. may reduce his successor’s need for “amazing insight” to lead Berkshire Hathaway Inc.

The deal for the largest U.S. railroad gives Buffett the “elephant”-sized acquisition he’s been looking for to deploy accumulated earnings from Berkshire’s insurance units and investments. Buffett who is vetting candidates for CEO of the company he built over four decades, called his biggest purchase “an all-in wager” on the future of the U.S. economy.

“He knew long ago that his time was limited,” said David Carr, chief investment officer at Oak Value Capital Management Inc. in Chapel Hill, North Carolina. Buffett, 79, has been structuring the company so that it doesn’t have to rely on the next leader for “making deals that require amazing insight.”

Buffett, the world’s most celebrated investor, adds a business in Burlington that was profitable every quarter for at least a decade and remains shielded from competition by its rail network. The purchase marks a shift from Buffett’s strategy in the recession of drawing down Omaha, Nebraska-based Berkshire’s cash hoard, valued at more than $24 billion at the end of June, to finance firms including Goldman Sachs Group Inc.

Berkshire agreed to pay $26 billion for the stake in Fort Worth, Texas-based Burlington it didn’t already own and assume $10 billion in net debt.

‘Opportunities Have Changed’

“It’s kind of like dumbing down the asset base,” said Jeff Matthews, author of “Pilgrimage to Warren Buffett’s Omaha” and founder of the hedge fund Ram Partners LP in Greenwich, Connecticut. “It suggests that the long-term opportunities have changed, and going forward Berkshire is not much more than a general call on the American economy, whereas in the past it was a call on Buffett’s investment acumen.”

The deal culminates a search by Buffett 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 didn’t return a message seeking comment left with his assistant Carrie Kizer.

Burlington, with pretax income of $3.37 billion on revenue of $18 billion last year, would be Berkshire’s second-largest operating unit by sales. Berkshire’s McLane unit, which delivers food to stores and restaurants by truck, earned $276 million on revenue of $29.9 billion in 2008. Berkshire’s largest business overall is insurance, including the Geico Corp. unit.

Sokol, Jain

By expanding operations outside of finance, Berkshire’s operations more closely match the expertise of David Sokol, chairman of Berkshire’s energy business, said Alice Schroeder, the author of “The Snowball,” an authorized biography of Buffett, and a Bloomberg News columnist. Buffett added to Sokol’s duties this year by naming him to head Berkshire’s money-losing plane-leasing unit.

Sokol and Buffett’s reinsurance lieutenant Ajit Jain are among Berkshire executives included on media lists of potential successors. Buffett hasn’t publicly said who will replace him.

Buffett has joked that he built Berkshire so it could be run by a cardboard cutout or the bust of Benjamin Franklin that Munger keeps in his office, Schroeder wrote in the book.

Berkshire will continue to generate cash, giving Buffett the chance to make additional deals in years to come, said Gerald Martin, a finance professor at American University’s Kogod School of Business in Washington.

“I don’t think he’s ready to give up control,” Martin said. The Burlington deal is “classic Buffett, I think he’s found a good buy at a good time with a company that has good earnings prospects.”

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.

To contact the reporters on this story: Andrew Frye in New York at afrye@bloomberg.net;

Last Updated: November 3, 2009 14:56 EST

http://www.bloomberg.com/apps/news?pid=20601170&sid=auTdgkJ6zurk

http://www.bloomberg.com/apps/news?pid=specialreport&srnum=2

http://www.bloomberg.com/apps/news?pid=20601170&sid=acCmNIfVFMZc
Buffett Takes 10 Days to Seal Biggest Deal in Career