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Warren Buffett's Berkshire Hathaway buying Burlington Northern

The company will pay $34 billion for the railroad giant in what the billionaire investor calls 'an all-in wager on the economic future of the United States.'

November 04, 2009|W.J. Hennigan and Alana Semuels

Billionaire investor Warren Buffett's $34-billion acquisition of railroad giant Burlington Northern Santa Fe Corp. is the biggest bet yet on a U.S. economic recovery, one that could resonate from the international sea lanes to the railroads crisscrossing the country.

Burlington Northern is the nation's largest rail transporter of coal and grain and provides a vital link for consumer goods from Asia to the Midwest, many of them flowing through the ports of Long Beach and Los Angeles.

"It's an all-in wager on the economic future of the United States," Buffett said in a statement announcing the deal Tuesday. "I love these bets."

The purchase stunned Wall Street, but it was vintage Buffett. The 79-year-old investor, through his Berkshire Hathaway Inc., is known as the Oracle of Omaha for making shrewd investments, including Coca-Cola Co. when it was being challenged by PepsiCo Inc. and Goldman Sachs Group Inc. when financial stocks were considered toxic during the economic collapse.

Buffett's interest in railroads puzzled some investors because the once mighty industry that fueled the industrial revolution a century ago has been fading for decades. But Buffett is buying into what Anthony Hatch, an independent transportation analyst, called a "rail renaissance."

Railroads lost significant market share after the interstate highway system launched in the 1950s during the Eisenhower administration made it easier to ship cargo by truck. Now, however, the 21st century focus on fuel efficiency is helping rail companies chug their way back.

Globalization is adding to rail's comeback, since much of the cargo coming into ports such as Los Angeles and Long Beach is freighted across the country by rail.

"People now view rail as a part of our efficiency infrastructure and carbon solution," Hatch said. "Just a few years ago, rail was thought to be a waste of time."

Burlington Northern carries a variety of goods, including food, clothing and electronics. Its largest business segment last quarter -- more than 30% -- was moving consumer goods including televisions, refrigerators and clothing from the West Coast to Midwestern cities such as Chicago and St. Louis. Burlington Northern also hauls imported cars from manufacturers including Toyota and Honda.

Buffett believes that by carrying such an assortment of goods, Burlington Northern is a gauge for the health of the U.S. economy.

"Our country's future prosperity depends on its having an efficient and well-maintained rail system," Buffett said. "Conversely, America must grow and prosper for railroads to do well."

Keith Schoonmaker, an equity analyst with Chicago-based Morningstar, said the acquisition -- which is subject to regulatory approval -- showed Buffett's confidence that the U.S. economy would bounce back in the long term.

"It's an investment that looks toward the next decade. Not the next quarter," Schoonmaker said.

Burlington Northern is also Buffett's kind of business. A model-train aficionado, the nation's second-richest citizen (after Microsoft's Corp.'s Bill Gates) has often espoused a simple axiom that investors should invest in what they know well.

Berkshire Hathaway already holds stock in railroad companies Union Pacific Corp. and Norfolk Southern Corp. Also, Burlington Northern has a significant presence in Omaha, Buffett's hometown.

But rail companies have been hit by the economic downturn as cash-strapped consumers rein in their spending. Total volume on U.S. railroads for the third week in October was down 13.4% from the same period last year. In the West, carloads were down 14.8% from the same time the previous year, and 15.8% from 2007, according to the Assn. of American Railroads.

The downturn was clearly evident this summer at Burlington Northern's facility in the sprawling Hobart Railyard south of downtown Los Angeles, where cranes sat silent and several of the loading areas were idle.

Burlington Northern, whose revenue fell 27% in the third quarter compared with a year earlier, is an undervalued asset for Buffett, said Lee Klaskow, senior transportation and logistics analyst at Longbow Research.

His purchase of Burlington Northern is a bet on its "long-term growth potential," Klaskow said.

It is also a costly wager for an investor who has typically bought shares at the low end. Berkshire Hathaway agreed to pay $100 a share in cash and stock, a hefty 31.5% premium over Burlington Northern's closing price Monday and 18 times its estimated earnings for 2010.

Analysts cautioned that it could take years for the purchase to pay off, but investors were giddy at the news Tuesday, bidding Burlington Northern shares up $20.93, or 28%, to $97. At the market bottom in March, the shares were trading around $50.

In addition to cash and stock, Berkshire Hathaway would assume $10 billion in Burlington Northern's debt, increasing the total value of the deal to $44 billion. It already owned about 23% of the company.

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