Wednesday, November 4, 2009

Buffett's Biggest Bet!!

Yesterday, Warren Buffett stormed back into the headlines with the largest deal in his 44-year career at the helm of Berkshire Hathaway. The “Oracle of Omaha” announced that he was buying the 77.4 percent of Burlington Northern Santa Fe that he didn’t already own – paying $26 billion or $100 per share of the railroad (a 30 percent premium over the previous day’s closing price), and assuming roughly $10 billion in Burlington debt. Including his previous holding in Burlington, this is a $44 billion investment for Mr. Buffett, and is quite a bet for the investment icon.

The acquisition accounts for virtually all of Berkshire’s available cash, and combined with the assumed debt, the company could face credit rating downgrades from the major agencies that could affect other parts of the insurance giant’s operations (Berkshire’s debt was already on negative watch by Standard & Poor’s). And when arguably the world’s best investor puts this much on the line, it’s certainly worthwhile to stop and take notice in order to determine the scenario in which Mr. Buffet sees this bet paying off.
Warren Buffett has been calling the acquisition an “all-in wager on the economic future of the United States.” Of course, this is a tremendous endorsement of the U.S. economy as Burlington Northern plays a very large (and growing) role in it. Just look at the map of the railroads and you’ll see what Buffett means – Burlington’s routes move goods to and from Canada, to and from China-linked ports, to and from ports that trade with Europe – and, of course, they crisscross a big part of the U.S., moving goods across the country.

We will, however, take it one step further. From our standpoint, we see the acquisition as a play on higher commodity prices and tremendous future inflation. Rails see higher demand as oil prices rise and the costs of the alternative form of transportation, trucking, move higher. Because railcars don’t run on oil products, but rather coal, they have a clear competitive advantage; Coal also is a commodity which, relative to oil, is more plentiful, as well as domestically available.

Oil prices are dictated by worldwide demand. Regardless of continued economic weakness at home, energy prices have shot up from their lows as international/developing economies demand has returned. Burlington is not only protected from these price increases, but benefits from them as well with increased business. As the economy eventually improves, and shipping rates increase – railroad companies, Burlington included, will benefit. With higher demand, the rails also gain pricing power – and can increase their rates to compensate for rail maintenance and expansion.

Of course, the purchase is also shrewd because the replacement value of Burlington Northern’s assets has been estimated as high as $180 a share. To help pay for the acquisition, the board of Berkshire Hathaway has decided to split the B shares – a move that will make them more accessible to the retail investor. This is another timely move by the Oracle.

This purchase also jives with Buffett’s investment in the Brazilian real – a currency which, courtesy of a resource-based economy, has one of the brightest futures around. The investment also provides a counterbalance to Berkshire’s fixed income investments (a must for insurance companies who need to keep less-volatile investments on hand to meet claims), which protect against a deflationary event. All in all, we applaud the choice and continue to recommend Buffett’s vehicle, Berkshire Hathaway (Growth Portfolio), as a good stock for the long haul.

Courtesy: Stephen Leeb

No comments: