I had a feeling there was an energy component to the Berkshire Hathaway decision to buy Burlington Northern Santa Fe. And now comes the evidence via coal, a major freight on BNSF’s tracks. But, there is a lot more to this acquisition than just hauling coal.
Warren Buffett has been increasing his energy plays in recent years, both in the U.S. and abroad. he has said repeatedly that he likes energy and power. His chief asset in the U.S. is Mid-American Energy, a major utility company whose CEO is often touted as one of the eventual successors to Buffett at the helm of Berkshire.
On the other hand, Berkshire was on record as hating the railroad business. When I was a panellist on BNN TV in Canada at noon today, fellow panellist Brian Milner, business columnist at the Globe & Mail in Toronto, mentioned that Charlie Munger, Buffett’s right-hand man at Berkshire, said two years ago he and Buffett hated the fundamentals of the railroad business. Rolfe Winkler has a good post showing that the BNSF acquisition is fully priced. So, what gives – why is Berkshire paying top dollar for a company in an industry with what it used to describe as poor fundamentals?
The answer is coal.
This comes via MarketWatch (hat tip PapaSwamp):
Berkshire Hathaway Inc.’s $44 billion deal to buy Burlington Northern Santa Fe Corp. is basically a huge bet on coal, a fuel that powers Warren Buffett’s power plants at his MidAmerican Energy utility and plays a major role in the railroad business.
While regulatory delays and uncertainty over climate-change legislation has slowed the addition of new U.S. coal plants, plenty of new facilities are expected to come on line in the United States, becoming prospects for future growth for the railroads.
Nine new coal plants have been permitted in the United States and 25 are under construction for a combined generation capacity of nearly 15,000 megawatts, according to an Oct. 9 report by the National Energy Technology Laboratory.
Moves by the Obama administration to curb emissions in proposed climate-change legislation are also anticipated to push the generation industry toward wider use of carbon-capture and storage technology at coal plants, which still supply nearly half of America’s electricity.
With the U.S. economy poised for a rebound, both the coal-fired electricity industry and the railroads that haul the black rock are primed for growth, leading Buffett to describe his huge purchase as "an all-in wager on the economic future of the United States."
Moreover, Munger’s comments regarding coal were more to the effect ‘we hated railroads for decades. But we love them now because the industry has consolidated, affording the remaining players monopoly-like rents.’ Given the fact that BNSF gets a quarter of revenues from hauling coal and this is a major feedstock for MidAmerican, there are a lot of synergies.
The Motley Fool talks about Munger’s change regarding railroads in a December 2007 post on Charlie Munger’s 10 Rules for Investment Success:
9. Be ready for change
Accept unremovable complexity.Investing success requires us to accept inevitable changes. Munger and Buffett hated railroads for decades, but as the times changed, they threw their old thoughts out the door and invested billions. The world around us won’t always conform to our preferences and prejudices, and sometimes our best ideas will prove incorrect. If you aren’t willing to roll with a changing market, you may find yourself fighting a lost cause.
The Wall Street Journal’s Matt Phillips also believes Buffett has waited until the turn to buy these assets as freight traffic is off its lows earlier this year – something Buffett tracks as a proxy for aggregate demand. But, this is not a market call alone. When Berkshire buys a business outright, they are making a long-term investment .
Let’s see how this call turns out because Buffett’s record over the last few years has been less stellar than in the past as ‘largeness’ makes earning high returns more difficult. If you look at the timing of his Conoco Phillips and General Electric calls last year, there is ample room for doubt (Berkshire has since rotated out of COP). On the other hand, his Goldman preferreds are looking quite nice.
Note: Goldman Sachs was also BNSF’s advisor on this deal.
Other sources
Catching up: Buffett bought railroads, J&J, Comcast – USA Today, May 2007
Buffett’s Berkshire buys more shares in railroad – USA Today, Jan 2008