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December 2009

Rail News: BNSF Railway

Buffett's secular bet on BNSF & the 'Rail Renaissance'

By Tony Hatch

The "Sage of Omaha" placed more of his chips on Fort Worth, offering $100 per share for the 77 percent of Burlington Northern Santa Fe Corp. that he didn't own, or a solid 30 percent premium to the pre-announcement price, valuing the enterprise at $44 billion.

The price might seem rich if you're looking at the economy through a near-term prism, but the actual forward (2010 consensus) multiple compares well with past deals — including the recent short-line offerings. Warren's elephant deal follows his $4.5 billion purchase of Marmon Holdings Inc. in late 2007, so he already was moving toward rail industry ownership. This obviously reflects well on the industry as a whole, and on the tempering fears of over-aggressive re-regulation. A few additional thoughts:

  • This should face no real regulatory or congressional scrutiny — it's a change in stock ownership, not competitive position, and Buffett long has been a friend of government. The last comparable event was the Chicago & North Western leveraged buyout back in the '80s. But this deal also can be viewed as a positive bet on "re-regulation" by a well-connected and driven performer of due-diligence. Buffett will be selling his other rail holdings: Union Pacific Corp. and Norfolk Southern Corp.
  • The case for private ownership of railroads is compelling: The tension between short-term outlook (and quarterly performance) and long-term capex (assets that last 50 years or more) means that a privately held company might be able to act strategically more often, although the rails have been moving in that direction (see their capex in this recession).
  • Many major private-equity firms analyzed and even approached rails during the last boom (circa 2006); rails rebuffed their advances, and some of those P.E. firms are in difficult straits today. Although couched in the guise of a "patriotic investment" in the U.S. economy (it is that), it is also a shrewd bet on a rail-renaissance leader at a cyclical low point — and when rival bidders able to outspend Mr. Buffett are few and far between and/or nonexistent. BNSF actually is the most global of the U.S. rails, with one-third of its business coming from intermodal, and half of that in international boxes from Asia (which might not be seen as patriotic by some).
  • BNSF could can gain a competitive advantage, presuming it's able to better plan its capital cycle. It certainly wouldn't hurt to have a connected owner. Another presumption: that Mr. Buffett will let management do its thing, which he's typically done, post-acquisition. How might the industry benefit? It already has: A perceived heroic/patriotic investor owns a Class I railroad, rather than "greedy Wall Street types." And whatever the irony, changing the paradigm in D.C. would benefit the industry — and the nation.
  • It's also an interesting bet by Buffett on federal government actions — not just on "re-reg" but on coal, from someone accustomed to help fashion the debate in D.C.

Again, this is only partially "an all-in bet on the American economy" — it is a secular bet on rail and on BNSF, and purchased rather cheaply. So, to answer the question we've been asked so often: I know why Warren is buying.

Tony Hatch is an independent transportation industry analyst and consultant.


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