Tuesday, November 3, 2009

Warren - What Are You Doing?

So the blockbuster news today is that Warren Buffett is buying Burlington Northern for $44 Billion. That is a huge move for Warren on multiple fronts. He is using debt to buy it, he never does that. He is splitting his B shares, he never does that. He is using stock to purchase the company, he very very rarely ever does that. What is going on?

All the headlines are quoting Warren that is he is going all in on the economy. On the future of America. That has to be the long term bet (railroads are the most economic senstive things you can buy) but is that what he is doing in the short term? Is there something more going on?

I honestly don't know what is going on but here are some thoughts.

He is using I think $8 billion in debt to buy the company. Why? Yields are really low and he is essentially betting it makes sense to finance through debt because later yields are going to blow out? Similar to a Julian Robertson play? Sounds good in theory but I think the debt is only a three year note so the duration is short and the overall debt level at $8 billion is small.

He is using stock!!! I can think off the top of my head him only using stock twice in his life to buy something and both times he said later he regretted it. The first tme I think was in the late 60s / 70s and he purchased a small company with stock. He did the math years later showing how much of a mistake it was. He also used stock to buy Gen Re 5 to 10 years ago. The first case, if I remember correctly, the company wouldn't do the deal without stock. The second case, he thought Berkshire was selling at a very rich price. So the question must be asked (the deal is 40% stock, that is big), does Buffett think Berkshire stock is trading at a very high premium? Does he think his stock is overvalued?

Why now? Is it possible all his economic strength mumbo jumbo is a front? This transaction is actually occurring because this is the quickest way to get out of dollars? Is he worried about large amounts of inflation down the road? It would be easy to argue yes but I am not totally sure. On the plus side, transportation typically takes a percentage of the value of the freight moved. If prices double and the railroads take the same percentage, the amount of money on the revenue side doubles. It is essentially like an inflation protected TIP. However, one of the biggest inputs is energy. If we had serious inflation, my guess is the volume would drop and profits would be squeezed from the big boost in energy costs. Also, railroads are very capital intensive businesses. In the 70s he wrote an article (I think it was Forbes) describing why you would rather not own heavy cap ex companies in periods of high inflation. It is better to own companies with alot of intangible value. So that from an inflation standpoint, it doesn't make sense.

These are all just thoughts off the cuff. I may have more later. The deal doesn't make sense to me. I put this one in the General Electric deal he did (though that one was small). The Goldman Sachs deal I thought was genius. The General Electric deal did not makes sense and to me, neither does this. (I have that posted in old blog posts from last October)

I love studying Buffett but to be honest he is not gotten this economic downturn right. This smacks of a USG 2006 purchase except a much bigger bet.

Here is a 30 minute interview with Buffett on CNBC this morning.

If you have thoughts, feel free to email them. I would be interested in others thoughts.

1 comment:

Anonymous said...

It may be that future government polices will favor railroads as a weapon against climate change. Right now, rental car taxes are very high to support new commuter rail projects.

To me, his use of uncharacteristic financing means he is either particularly confident of this decision or has lost his edge. I suppose it could be both as well.