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Warren Buffett's Defining Play
Friday November 6, 08:08 AM
Warren Buffett did it again this week, launching his biggest ever takeover which defines his optimism in America's future and makes an emphatic statement about the financial strength of his Berkshire Hathaway company.
And, I suppose, there's the added bonus of showing up all the naysayers who were whispering a year ago that he was 'under pressure' and could be badly damaged by the financial crunch and recession.
There may be a financial cost: a ratings agency has warned that it may downgrade the credit standing of Berkshire Hathaway, his master company and the one that launched this week's $US44 billion (total value) deal for the Burlington and Northern Santa Fe Railroad.
That's because the takeover will chew up a large chunk of the $US20 or billion so dollars left in his cash pile after he's spent around $US20 billion in the past year making some very smart investments.
Anyway, we will get an updated view of Berkshire's financial health tonight when it reports third quarter earnings in the US.
But already the takeover offer for Burlington reveals the thinking that has made Buffett an investment legend and his long term view of the attractiveness of the US economy.
And the long term means well after the 78 year old has gone from this world.
A year ago and in the early months of 2009, many in the markets were wondering if Buffett has met his match.
Berkshire shares were down sharply (but not as much as the market was down, it must be said) and some had concerns about the potential damage a series of financial derivatives (bets against the US stockmarket) might do to his reputation and the financial strength of the group.
Well he was so badly damaged that he has emerged as the biggest winner so far from the crunch.
He and Berkshire offered vital financial support to, and potentially helped to save Goldman Sachs and General Electric in the depths of the crunch. He also bought debt from Harley Davidson and Tiffany's.
Interestingly, he has sold down his large holding in Moody's, the credit rating group, in recent months. Berkshire remains Moody's biggest shareholder at the moment.
But it's the Burlington deal that seems to have restored him to the top of the smart money tree.
Berkshire is spending $US26.6 billion to buy the 77%-78% it doesn't own of Burlington, America's second biggest railroad.
It's a deal that is an out and out bet on the future of coal as America's major source of electrical power for decades to come and a bet that the American economy will recover to something approaching its pre-crunch glory. It values the total rail group, including debt at $US44 billion.
"It's an all-in wager on the economic future of the United States," Buffett said in a statement, adding railroads will benefit in a recovery. "I love these bets."
"Our country's future prosperity depends on its having an efficient and well-maintained rail system," Buffett said in a statement.
The Financial Times Lex column was a bit more restrained, saying.
"Taking a long-term view on an industry, company and management is Mr Buffett's classic strategy.
"The capex-heavy rail sector enjoys the kind of defensive, competitive advantages - or, in his parlance, "moats" - that Mr Buffett seeks out.
"In spite of weaker operating trends this year, it has recently thrown off cash over the cycle.
"The rate at which Burlington converts its profits into cash has fallen from a peak of more than 80 per cent to 55 per cent this year, estimates Davenport & Company.
"But the company should still generate $870m in free cash flow this year, after capital expenditure of more than $2.5bn."
So, cash heavy, a strategic position, and some added benefits of huge property holdings and part of what will become a more vital piece of infrastructure in the US as it slowly becomes greener and more carbon conscious.
It could be one of those deals that helps lift America's flagging confidence because of Buffett's wide appeal to Americans of all types as a great American hero. (He's not a banker).
It is also a bet that Australia will find encouraging, with our heavy dependence on carbon in our exports and economy.
Some US commentators have claimed it is also a punt on new clean coal technologies coming to the fore in the next decade (Buffett may not be around to see that). It also gives defacto support for some sort of emissions/carbon trading and control system.
For a country the size of the US, it is also a punt on rail becoming a dominant mode of transport when compared to road which has a higher carbon use and footprint.
It is also a bet that, whatever system of carbon control and reduction America adopts, the cost of carbon will rise, making trucking more and more expensive, and in turn helping rail to become more attractive as a transport mode, especially over shorter distances.
So even if coal carriage falls as less is consumed, more general cargo, grain etc, will be carried on Burlington.
But Burlington will still be carrying lots of coal every year for years to come, plus some oil and other products.
It is also a huge grain carrier (food), as well as cars and other consumer and industrial goods.
More than a quarter of its $US10.7 billion in revenues in the first nine months of this year comes from coal transported from the huge Powder River Basin coal mining complex in Wyoming and Montana to power stations across the middle, south and west of the country.
And with coal powering for just over half America's electricity, it is not going to go away quickly, no matter what the greens and others think or claim.
According to Burlington's Web site, the coal it hauls generates more than 10% of America's electricity, with 50 of the most efficient and lowest polluting stations on top of that list.
And Burlington has other assets: its track networks and rights of way are positioned to benefit from any expansion of US coal-fired electricity generation in the next 20 years, coupled with clean coal technology to help curb CO2-dioxide emissions.
Power stations could be built next to its rail networks, so long as multi-state distribution systems can be built, which has been a big restriction in recent years.
That might be all well and good, but for greens and others, it's coal, full stop. But it is the reality in the US.
The deal is Buffett's biggest ever takeover and involves cash and shares in Berkshire Hathaway worth $US100 for each Burlington share
It's the first time in a decade Buffett has offered shares in a takeover; his many other deals have been all cash, so he will have more shareholders to accommodate in Omaha at next May's annual meeting.
It is also the latest in a string of deals done during the current recession and crisis that has seen him lock up some enormous gains:
He owns billions of dollars of debt (paying 10% or more) and shares in some of the following groups, Wrigley, Dow Chemical, Goldman Sachs, General Electric, Harley Davidson and Tiffany's the luxury jewellery group (Buffet's Berkshire is actually America's biggest jewellers).
In some respects Buffett was a lender of first and last resort for these companies who needed to money to make a deal work (Dow and Wrigley), or just needed the money and his name when times were tough (GE and Goldman Sachs).
Unlike those deals, where Buffett was sought out by the companies involves, this was an approach from Buffett himself to Burlington management, so it's an aggressive move from that respect, not reactive.
The deal makes Berkshire an industrial giant, adding to the existing interest in power generation, manufacturing, building materials, housing and real estate, besides the huge insurance businesses based on General Re and Geico.
Plus his huge investment portfolio where Burlington first appeared around two years ago.
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