Tuesday, November 3, 2009

On the Berkshire buyout of BNI

A few things came to mind on the Berkshire buyout of BNI (note that I haven't read any public statements on the deal by either party, so if I'm missing something, that's my bad).
I am not Warren Buffett, and I'm sure Mr. Buffett has a number of intelligent reasons that are not these ones. But here are things I'm guessing Warren Buffett believes:
1) Warren Buffett believes oil prices, and thus gas prices, are going up a lot. Trains benefit substantially by higher gas prices because it causes people to substitute over from trucking. They expand margins. I can't remember the time Mr. Buffett paid a premium this substantial for a company - 28% at midday today, which still incorporates a large margin of safety for him. He must think we're all seriously underestimating this factor or factor 2.
2) Warren Buffett believes that some combination of coal demand, agriculture demand and US industrial metals demand are going to be substantial. These are the products most often shipped via railroad. By corollary, I'm guessing he doesn't see the natural gas glut keeping up with energy demand; if he did, coal demand wouldn't increase much because natural gas reactors (and, in a few years, natural gas auto engines) would be the first to be brought online.
3) Warren Buffett rightly acknowledges the fact that while commodity supply and demand can adjust (oil output, coal output, etc) and foreign governments can nationalize oil assets of big oil companies, US railroads have an impenetrable barrier to entry (nobody can build railroads in good places easily anymore because of problems with eminent domain in populated areas) and the US government, no matter how socialist it seems to be getting, will not nationalize rail assets.
4) This quote I've seen in headlines - Warren Buffett believes that the US can remain a world economic and industrial superpower. Rail demand is directly related to the level of industrial and agricultural activity in a country.
5) Most interestingly, Warren Buffett believes Berkshire Hathaway stock is overvalued. He doesn't issue stock lightly - he's long lamented when companies issue stock to dilute shareholders in order to raise capital at low per-share rates, and he has plenty of assets he can sell. Less than a year ago, he sold a bunch of JnJ stock in order to participate in opportunities he thought were attractive. Although Mr. Buffett has noted that he doesn't like financial leverage, he has plenty of equity he could have sold to facilitate this as well as additional capacity for debt beyond the $8 billion (to be repaid over only three years). Obviously he used some excess cash first, but he'll have $20B in cash on the balance sheet at the close of the deal. The fact that he thought that his shareholders would benefit most by Berkshire issuing stock instead of selling holdings, using more cash or issuing more debt means that he believes Berkshire stock is overvalued relative to the equities held by Berkshire, the return on cash he can get and the cost of debt Berkshire could receive. In other words, the move implies that you're better off buying Coke or Wells Fargo, or even holding cash than you are buying Berkshire stock. Is it partially old-school conservatism, and is it partially confidence in his ability to pick stocks that will outperform Berkshire? Sure, but it seems unlikely that this is all it is.

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