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Buffett's All-In Bet

Jeremy Glaser

Jeremy Glaser: I'm Jeremy Glaser with Morningstar.com. This morning Warren Buffett took an all-in bet on the U.S. economy by making a $100 per share offer for BNSF, a company that he already owned a substantial stake in. Here to discuss it with me is Berkshire analyst Bill Bergman and BNI analyst Keith Schoonmaker. Thanks for joining me, guys.

Keith Schoonmaker: Our pleasure.

Bill Bergman: Nice to be here, Jeremy.

Glaser: Why do you think that Buffett decided to go ahead and make this purchase today?

Bergman: Well, as you said, Jeremy, and as he said, it's an all-in bet on the economic future of the United States. Berkshire had built up a great deal of cash prior to the crisis, and has been employing the cash in a variety of different investments as the crisis developed, in the financial crisis and the economy, and the slowdown in the economy in recent years.

He's looking forward and he's putting his chips where his mouth has been. He's betting on the future of the United States. This is the biggest deal in Berkshire's history. It's bigger than GenRe, and it's a bet on the fundamental infrastructure of the economy in the United States, and a company that we like as well.

Glaser: So, Keith, do you think he paid a fair price?

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Schoonmaker: I do think the price was fair. It's a slight premium to our fair value estimate, but he may have a little bit more optimistic view of the near-term future than what we had when we set our fair value. He paid about an 11% premium to our fair value estimate, and about a 30% premium to the current market price.

I think, though, broader, as we talk about what he liked about the company, I think there are four things about railroads that he really likes.

I think he likes the fact that it's the most economically efficient way to ship things in the United States. So in reference to what he and Bill said, as far as capturing exposure to a portion of the United States economy, it's most efficient by fuel, by use of manpower, and by us of public assets like roads as well, since the railroad tracks are private.

So he likes the economic efficiency, he likes the strong free cash flow.

He likes the fact that it's got really insurmountable barriers to entry, so it's got a strong economic moat.

And he also likes that it's a predictable business model. So the railroad is going to stay a railroad. It's not going to spin itself into some other type of business. You know what it is when you buy it; it's a railroad.

Bergman: Coke will always be Coke and railroads will always be built on rails. This is an infrastructure bet, and infrastructure is something that stays around. It's something that's part of the economy, it's an integral part of it.

And as Keith mentioned and as Warren Buffett mentioned, he finds the railroad business as being very attractive economically right now with oil prices. We peaked at oil prices at a $133 a barrel in the early stages of the recession. They've come down a lot, but they haven't come down as significantly as they could have.

And at current prices in oil prices--oil prices are a tough thing to predict. But at current prices the relative value of rail transportation to truck transportation is something that they've been interested in.

Schoonmaker: It's a great point. To ship a ton of freight a mile, it's four times the efficiency to use rail versus trucking. So it's got quadruple the fuel efficiency.

When we think about manpower, too, it takes generally two men to run a locomotive. A train can haul approximately, let's say, 250 to 300 containers. It would require either one man or two for each one of those. We're talking 100 times more efficiency when we're talking about container shipping from across the United States.

I should mention that when I mentioned containers, Burlington has a couple of franchises that really set it apart from others. Now all rails are involved in all of these commodity shippings, but Burlington has very high exposure to both intermodal shipping and also to coal.

It's the only railroad that has access to shipping both out of the north and the south of the Powder River Basin, really the richest coal mine in the United States. So these are really tremendously valuable franchises, coal and intermodal. They're the standard of excellence for intermodal shipping, with L.A. to Chicago almost double-track the whole way. It's almost a two-lane superhighway at this point.

Glaser: So he didn't just randomly pick a railroad, there are specific reasons that he liked BNSF over other opportunities that he might have had to invest in the rail sector.

Schoonmaker: I believe that's true. Burlington is a high performer. Canadian National has superior operating margins, but it's a much smaller entity. This was the highest performing large railroad. It's the largest railroad; last year it passed Union Pacific as far as revenue, a little over $18 billion. So there's a greater economic value in the larger enterprise.

We think all the railroads have improved themselves tremendously, but Burlington is one that has proven they can do it for several years now, whereas some of the other have improved more recently.

Glaser: So thinking of Berkshire's cash position, this is a pretty big outlay for them. Do you think that this impairs their overall financial security in any way, or do you think they'll still have a big enough buffer?

Bergman: I think they have a big enough buffer. They had a huge buffer going into the crisis; they developed it in a timely way. And they've been employing it at advantageous prices, and one that we think here is a fair price for the Burlington Northern acquisition.

More fundamentally, I think, from Berkshire's perspective--there's an interesting way to think about Berkshire Hathaway. It's easy to think about the enterprise's conglomerate, a little too quickly perhaps, as an insurance and financial services investment machine.

But the operating subsidiaries within Berkshire, there's a wide variety of very interesting moat-y, economically sensitive companies within this Berkshire enterprise, and a lot of companies that move stuff from A to B. The insurance enterprises are almost the financial heartbeat of the overall organization, but in a sense now we're getting a high-quality transportation services heartbeat within the overall organization as well. So I think that's part of the attractiveness to the deal.

Glaser: One of the things about making this huge bet is, in a way, Buffett is saying to all naysayers who think we're going to be in a new normal and there's going to be much slower economic growth going forward and that we're going to be in for a very, very long, sluggish recovery--do you think this is him rebutting that by making a huge bet? Or do you think he still sees that slower growth?

Bergman: I believe what he sees is a fair price or an advantageous price from a long-term perspective. This is a long-term investment. We may not get an economic recovery this year. I think we will, I think we're getting a strong one developing. But that's just my own opinion.

Having said that, we're going to have an economic recovery. The fundamental economic strength of the United States is something that we can overcome the problems we've had in our financial services sector. And the fundamental productivity of our competitive enterprises is going to prove out in the long run.

This is infrastructure feeding those enterprises, and it's going to prove out to be a valuable part of the Berkshire enterprise.

Glaser: Based on this purchase, what do you think Buffett's outlook is for the economy over the next five years, let's say?

Bergman: I think he's consistently said that the time to buy American is now, and I think he sees the future as a positive one to be betting on right now. It's consistent with what he's been saying; he's putting his chips where his mouth is.

Glaser: OK. Bill, Keith, thanks for joining me today.

Schoonmaker: Our pleasure.

Bergman: Thanks.

Glaser: For Morningstar.com, I'm Jeremy Glaser.