Buffett makes his biggest investment yet, a cool $44bn on a few railway lines.
"We are looking for big deals. The way I refer to it is that we are hunting the elephant. But we have got an elephant gun and it's loaded."
-- Warren Buffett, September 2002
Mission completed. Berkshire Hathaway shot and killed a massive, $44 billion elephant with its acquisition of rail giant Burlington Northern.
And not really killed, of course, because Burlington Northern shareholders are getting $100 a share, about a 30% premium to where the shares were previously trading. Shareholders can opt for either cash or Berkshire shares.
Berkshire's buying the remaining $26 billion it doesn't already own, plus $10 billion in debt. That makes it the largest acquisition in its history, trouncing its former elephant, the $22 billion purchase of General Re back in 1998. It also makes Berkshire's big investments last autumn in Goldman Sachs and General Electric look like peanuts.
Buffett's been loading up on railroads for years now. It really started in 2007 with big purchases of Burlington, Norfolk Southern, and Union Pacific. Who knows what he's thinking now, but the allure originally sounded something like this:
- Rail freight's main competitors are lorries.
- As the price of diesel soared and innovation took hold, rails gained a competitive advantage, mainly since railroads are markedly more efficient per gallon of fuel burned than trucks.
Too Stupid
This advantage gets cemented in stone when you consider how tough it is to build a railroad. It's a unique position where their advantage over competitors (lorries) is growing, but the ability of new entrants to enter the industry is held down by massive capital needs. Berkshire co-Chairman Charlie Munger commented on this a few years ago, saying:
Railroads -- now that's an example of changing our minds. Warren and I have hated railroads our entire life. They're capital-intensive, heavily unionised, with some make-work rules, heavily regulated, and long competed with a comparative disadvantage vs. the trucking industry, which has a very efficient method of propulsion (diesel engines) and uses free public roads. Railroads have long been a terrible business and have been lousy for investors.
We did finally change our minds and invested. We threw out our paradigms, but did it too late. We should have done it two years ago, but we were too stupid to do it at the most ideal time.
There's a German saying: Man is too soon old and too late smart. We were too late smart. We finally realized that railroads now have a huge competitive advantage, with double stacked railcars, guided by computers, moving more and more production from China, etc. They have a big advantage over truckers in huge classes of business.
Generous Valuation
Buffett is often thought of as a pure value investor, buying companies and shares only when they are dirt cheap. He does some of that, and his investments in Goldman and GE last year were an example.
But far and away Buffett's investing style is to buy great companies at reasonable prices. His simple definition of a great company is one which has a sustainable competitive advantage, like a railway, for example.
Price wise, he is not getting Burlington on the cheap. The Financial Times calls Burlinton's valuation "generous", but also says "Buffett is not a man to quibble (on price) when he sees something he likes".
Only One Warren Buffett
Buffett imitators often try to buy shares in a company because they are cheap. Buffett himself concentrates on buying great businesses. The difference is chalk and cheese, and it's the reason why there's only one Warren Buffett.
And that's where I'll turn it over to you. What do you think about this deal? Fire away in the comments section below.
More on the economy and the markets:
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> A version of this article was originally published on Fool.com. It has been updated by Bruce Jackson, who has an interest in Berkshire Hathaway shares.
