[Why does the WSJ call this a $26.3B deal while Buffett and BNI say the deal size is $44B (#msg-43212244)? Two reasons: the WSJ figure excludes $10B of BNI debt that Buffett’s Berkshire is assuming and it excludes the 23% of BNI’s shares outstanding that Berkshire already owns.]
›Berkshire to Buy Burlington Northern for $26.3 Billion, in Long-Term Bullish Signal
NOVEMBER 4, 2009 By SCOTT PATTERSON AND DOUGLAS A. BLACKMON
Warren Buffett made the biggest bet of his career, agreeing to buy Burlington Northern Santa Fe Corp. in a $26.3 billion deal that reflects his long-term optimism about the U.S. economy.
The deal for the nation's largest railroad operator by revenue will speed the transition of Mr. Buffett's Berkshire Hathaway Corp. into a mega-operator of industrial firms, moving the Omaha, Neb., conglomerate further from its roots as a nimble investment outfit.
Berkshire agreed to purchase the 77% of the Fort Worth, Texas, railroad that it doesn't already own for $100 a share, a 31% premium to the railroad's Monday closing price.
Mr. Buffett is betting that in an era of high fuel costs, railroads will perform better than the trucking industry. More broadly, the investment is a wager on the long-term strength of the U.S. economy as it emerges from a prolonged recession. As U.S. commerce recovers, so too will demand to move goods around the country.
Mr. Buffett has been a pessimist on the economy over the near-term. He said on Tuesday that the deal is "not a bet on next month or next year. We're going to own it forever."
In addition, Mr. Buffett noted, he likes U.S. railroads because their businesses are relatively immune to competitive pressures from low-wage overseas economies, which in recent years have battered U.S. auto makers and other industries.[Moreover, US railroads, especially BNI and UNP, fit right in with The Global Demographic Tailwind (#msg-39888049).]
While large, heavily regulated railroad operators provide little in the way of risk, they don't generally offer the double-digit returns Mr. Buffett has scored through his long career.
Given the large premium Mr. Buffett is paying, some analysts contend it could take years for the investment to pay off for Berkshire. If the economic recovery is gradual, it could be a long time before Burlington Northern hits profit levels that justify Mr. Buffett's acquisition price, they say.
'Slow Crawl'
"We're going to have a slow crawl in terms of recovery," says Citigroup Inc. analyst Matthew Troy. "But the reason Warren Buffett is buying BNSF is a 10- to 20-year trend. For us near-term investors, it may seem curious. For him, the trajectory of the recovery over the next one or two years is irrelevant."
Morningstar Inc., the Chicago research firm, says it valued Burlington shares at $90, below the deal's price of $100. If Mr. Buffett offered the same 31% premium when Burlington's stock was at its low in March, he would have paid roughly $67 a share, although Berkshire's stock has also risen from its lows.
Mr. Buffett said $100 was his first and best offer. "You do what you can when you can," he said[LOL].
The deal, under which Berkshire will assume $10 billion of debt, values all of Burlington Northern at $34 billion. Burlington Northern executives say the deal's valuation will be justified even if it takes years to fully recover from the recession.
"We don't have to be back to the golden era next year," said Matthew Rose, Burlington Northern's chairman and chief executive, in an interview. "We just need to see continual recovery in terms of more units coming back to the railroad. Our model will work quite nicely."
Stock Split
Berkshire will pay about 60% cash and 40% stock for the railroad. Burlington Northern shareholders will have the option to receive either cash or Berkshire shares. To enable small Burlington Northern shareholders to participate in the share swap, Mr. Buffett agreed to a 50-to-1 split of Berkshire's high-priced Class B shares. The company's Class B shares closed Tuesday at $3,325.35. Berkshire's Class A shares, which closed Tuesday at $100,450, up 1.7%, won't be affected. The deal marks the first time Berkshire has split its famously pricey stock.
On the New York Stock Exchange, shares of Burlington rose 28% to $97.
Analysts who follow Berkshire say buying a highly regulated, relatively predictable business could help smooth the transition for a successor to Mr. Buffett, who is 79 years old. "He's trying to acquire these companies that can just chug along with or without him," says Paul Howard, an analyst at Janney Montgomery Scott.
The deal suggests how challenging it has become for Berkshire to find deals big enough to be meaningful, given its size. "We do need to deploy cash, but we can't put many billions to work every year in spectacular businesses," Mr. Buffett said. "To move the needle at Berkshire, they have to be big transactions."
Mr. Buffett said he proposed the deal to Mr. Rose on Oct. 22, when Mr. Buffett was in Fort Worth for a Berkshire board meeting. A day later, the two companies started to hammer out terms.
The investment is in many ways a classic move by Mr. Buffett, who prefers companies with a strong competitive edge over rivals. It would be almost impossible for a new competitor to emerge in the railroad industry, which has consolidated over the years into four major carriers[BNI and UNP operate from Chicago to the West Coast; NSC and CSX operate from Chicago to the Atlantic].
Burlington is considered one of the best-managed U.S. railroads, but last month it cut its fourth-quarter forecast. The company's $18.02 billion in revenue last year made it the No. 1 rail company in the U.S., slightly ahead of Union Pacific Corp.
Railroads have enjoyed a resurgence over the past several years, following decades of decline due to the boom in trucking that followed the expansion of the interstate highway system.
During the past decade, as rising fuel prices, congestion on the roadways and price wars staggered trucking, railroads re-emerged as a fuel- and cost-efficient means of moving goods -- especially commodities such as coal, wheat and lumber, and imported finished goods arriving at major ports.
Pricing Power
The advantages have given railroads the ability to maintain solid pricing power through the recession.
Mr. Buffett said he expects Berkshire to have about $20 billion in cash left in its coffers when the deal is completed. The deal is expected to close early next year and is subject to Burlington Northern shareholder approval.
The deal is the fourth-largest announced this year in the U.S., and comes amid a moribund period for mergers and acquisitions. Global deal making so far this year is down about 34% from 2008, and more than 54% from 2007.
The deal highlights Mr. Buffett's growing interest in companies that stand to benefit as energy becomes more costly.
Berkshire began accumulating stock in Burlington in 2006 as energy prices surged. Another big Berkshire holding, MidAmerican Energy Holdings Co., an Iowa utility operator, has been making a big push into wind power.
For much of his career, Mr. Buffett avoided capital-intensive industries such as railroads and utilities, focusing instead on businesses like retailing and insurance. Berkshire's second biggest deal ever, completed in December 1998, was the $22 billion buyout of General Re, the reinsurance giant.
But Mr. Buffett has been wading recently into more industrialized sectors. In December 2007, he agreed to pay $4.5 billion for the majority of Marmon Holdings Inc., which makes industrial products, from Chicago's Pritzker family. At the time, it was Berkshire's largest deal outside of insurance.
Berkshire posted its worst year ever in 2008 when it lost 9.6% in book value per share, a common metric Mr. Buffett uses to track performance. While the company's fortunes have rebounded this year, along with the rest of the market, its shares remain more than 20% below where they stood in mid-2008.‹
Buffett’s Burlington Buyout Is a Good Deal, Says Barron’s
[Barron’s is perhaps the most consistently bearish of the major investment publications, so take the macroeconomic advice in this article with a grain of salt. I do, however, agree with the contention that BNI shareholders are getting a good deal.]
A pessimistic business forecast by the management of Burlington Northern Santa Fe as the railroad considered Berkshire Hathaway's merger proposal in late October may mean U.S. industrial activity will be less robust in 2010 than many on Wall Street anticipate.
Railroads, which transport more than 40% of the country's freight, are an excellent gauge of economic activity. If Burlington's (ticker: BNI) outlook proves accurate, the nation's other major railroads -- CSX (CSX), Norfolk Southern (NSC) and Union Pacific (UNP) -- also could see subpar results. Shares of all three have rallied since Burlington's Nov. 3 announcement of its acceptance of Berkshire's (BRKA) $34 billion proposal.
After Berkshire CEO Warren Buffett made what proved to be a successful $100-a-share bid to Burlington CEO Matthew Rose, Burlington management sent the railroad's board four potential financial scenarios to consider as it weighed Buffett's proposal. The most optimistic -- that Burlington could earn $5.06 a share if the economy and the company's business recover in 2010 -- was at odds with Wall Street's far more upbeat 2010 consensus earnings estimate of $5.50 a share, according to the preliminary proxy for the merger.
Management thought it more likely the economy wouldn't start to recover until 2011 and that the railroad would earn a depressed $4.40 a share in 2010. The other two scenarios were even more bearish: Either there would be no recovery and unit growth would be flat for five years, or the economy would enter a "deeper recession."
These forecasts suggest Berkshire overpaid for Burlington. Wall Street thinks Buffett paid a full but not excessive price, especially as 40% of the deal price will be paid in Berkshire shares.
At 99,000 each, Berkshire's Class A shares are little changed since the merger was announced Oct. 23. The stock is up 2% this year and trades for 1.2 times our estimate of year-end 2009 book value of $84,000 a share, below an average multiple of 1.6 times book in the past decade.
Berkshire looks attractive, given its low valuation and the company's enhanced earnings power, which stems from several well-timed investments Buffett made during the financial crisis, including stakes in preferred stock and warrants of Goldman Sachs and General Electric.
If Berkshire is undervalued, Burlington holders are getting a particularly good deal. The Burlington board's quick approval of the transaction suggests it believed Buffett is paying a full price. Besides, the board determined it had few other options; a merger with another big railroad would have raised antitrust issues. It was told private-equity buyers were unlikely to bid because of the difficulty of financing such as a large purchase.
Burlington is an atypical Berkshire acquisition because it doesn't generate a lot of free cash flow, owing to the costs associated with maintaining its large rail network. The company spent $3 billion last year on locomotives and other capital equipment, more than double its depreciation expense. Burlington shares now trade at 98.40, a slight discount to Berkshire's purchase price. The acquisition is expected to close in the first quarter of 2010.
Buffett takes a long view and he called the Burlington deal an "all-in wager on the economic future of the United States." It also bespeaks his confidence in the American West. Burlington and Union Pacific are the dominant rail carriers west of the Mississippi, with Burlington a major hauler of coal from the Powder River basin of Wyoming and Montana. It's also a big carrier of agricultural commodities.
Wall Street is playing down the importance of Burlington management's bearish 2010 forecast.
"We believe the Burlington board is probably conservative in its approach and economic outlook, which would encourage management to provide scenarios that are also somewhat muted," wrote JPMorgan railroad analyst Thomas Wadewitz in a report titled "Thoughts on BNI's proxy: Were 2010 Scenarios Conservative or Cause for Concern?" Wadewitz thinks Burlington's forecasts "may not provide a good read for other railroads."
Burlington and other major railroads report weekly car loadings, and Burlington's performance has been the worst of the bunch in recent months. Its shipment volume is down 14% in the fourth quarter, against a 7% drop for Union Pacific. Coal traffic, which accounts for about a quarter of Burlington's revenue, has been weak because utilities, the major coal consumers, recently were sitting with 77 days of supply, compared with a normal level of 45 days at this time of year.
"There is no V-shaped recovery at this point. The recovery is shallow," Dan Keen, the assistant vice president of policy analysis with the Association of American Railroads, said in our D.C. Current column last week.
At a time when major market indexes are at or near 2009 highs and valuations on many industrial stocks are signaling a significant recovery, the cautious view of Burlington's management is worth heeding. It could mean 2010 will be tougher for the markets and the economy than Wall Street expects.‹
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