Buffett Bets Big on Railroad

Berkshire to Buy Burlington Northern for $26.3 Billion, in Long-Term Bullish Signal By SCOTT PATTERSON AND DOUGLAS A. BLACKMON Warren Buffett made the biggest bet of his career, agreeing to buy Burlington Northern Santa Fe Corp. in a $26.3 billion deal that reflects his long-term optimism about the U.S. economy. The deal for the nation's largest railroad operator by revenue will speed the transition of Mr. Buffett's Berkshire Hathaway Corp. into a megaoperator of industrial firms, moving the Omaha, Neb., conglomerate further from its roots as a nimble investment outfit. Mr. Buffett is betting that in an era of high fuel costs, railroads will perform better than the trucking industry. More broadly, the investment is a wager on the long-term strength of the U.S. economy as it emerges from a prolonged recession. As U.S. commerce recovers, so too will demand to move goods around the country. Mr. Buffett has been a pessimist on the economy over the near-term. He said on Tuesday that the deal is "not a bet on next month or next year. We're going to own it forever." In addition, Mr. Buffett noted, he likes U.S. railroads because their businesses are relatively immune to competitive pressures from low-wage overseas economies, which in recent years have battered U.S. auto makers and other industries. While large, heavily regulated railroad operators provide little in the way of risk, they don't generally offer the double-digit returns Mr. Buffett has scored through his long career. Given the large premium Mr. Buffett is paying, some analysts contend it could take years for the investment to pay off for Berkshire. If the economic recovery is gradual, it could be a long time before Burlington Northern hits profit levels that justify Mr. Buffett's acquisition price, they say. Berkshire Hathaway agrees to buy the portion of Burlington Northern railroad it doesn't already own for $26 billion in cash and stock. The News Hub asks whether the deal makes sense. Plus, turnout is key to today's off-year elections and gold hits another high. 'Slow Crawl' "We're going to have a slow crawl in terms of recovery," says Citigroup Inc. analyst Matthew Troy. "But the reason Warren Buffett is buying BNSF is a 10- to 20-year trend. For us near-term investors, it may seem curious. For him, the trajectory of the recovery over the next one or two years is irrelevant." Morningstar Inc., the Chicago research firm, says it valued Burlington shares at $90, below the deal's price of $100. If Mr. Buffett offered the same 31% premium when Burlington's stock was at its low in March, he would have paid roughly $67 a share, although Berkshire's stock has also risen from its lows. Mr. Buffett said $100 was his first and best offer. "You do what you can when you can," he said. The deal, under which Berkshire will assume $10 billion of debt, values all of Burlington Northern at $34 billion. Burlington Northern executives say the deal's valuation will be justified even if it takes years to fully recover from the recession. "We don't have to be back to the golden era next year," said Matthew Rose, Burlington Northern's chairman and chief executive, in an interview. "We just need to see continual recovery in terms of more units coming back to the railroad. Our model will work quite nicely." Journal Community“Look for all rail shares to start to rise and other buyouts in the future. There is an entire school of investors that do what Warren does.” —Daniel Westerbeck Stock Split Berkshire will pay about 60% cash and 40% stock for the railroad. Burlington Northern shareholders will have the option to receive either cash or Berkshire shares. To enable small Burlington Northern shareholders to participate in the share swap, Mr. Buffett agreed to a 50-to-1 split of Berkshire's high-priced Class B shares. The company's Class B shares closed Tuesday at $3,325.35. Berkshire's Class A shares, which closed Tuesday at $100,450, up 1.7%, won't be affected. The deal marks the first time Berkshire has split its famously pricey stock. On the New York Stock Exchange, shares of Burlington rose 28% to $97. Analysts who follow Berkshire say buying a highly regulated, relatively predictable business could help smooth the transition for a successor to Mr. Buffett, who is 79 years old. "He's trying to acquire these companies that can just chug along with or without him," says Paul Howard, an analyst at Janney Montgomery Scott. The deal suggests how challenging it has become for Berkshire to find deals big enough to be meaningful, given its size. "We do need to deploy cash, but we can't put many billions to work every year in spectacular businesses," Mr. Buffett said. "To move the needle at Berkshire, they have to be big transactions." Mr. Buffett said he proposed the deal to Mr. Rose on Oct. 22, when Mr. Buffett was in Fort Worth for a Berkshire board meeting. A day later, the two companies started to hammer out terms. The investment is in many ways a classic move by Mr. Buffett, who prefers companies with a strong competitive edge over rivals. It would be almost impossible for a new competitor to emerge in the railroad industry, which has consolidated over the years into four major carriers. Burlington is considered one of the best-managed U.S. railroads, but last month it cut its fourth-quarter forecast. The company's $18.02 billion in revenue last year made it the No. 1 rail company in the U.S., slightly ahead of Union Pacific Corp. Railroads have enjoyed a resurgence over the past several years, following decades of decline due to the boom in trucking that followed the expansion of the interstate highway system. During the past decade, as rising fuel prices, congestion on the roadways and price wars staggered trucking, railroads re-emerged as a fuel- and cost-efficient means of moving goods -- especially commodities such as coal, wheat and lumber, and imported finished goods arriving at major ports. The advantages have given railroads the ability to maintain solid pricing power through the recession. Mr. Buffett said he expects Berkshire to have about $20 billion in cash left in its coffers when the deal is completed. The deal is expected to close early next year and is subject to Burlington Northern shareholder approval. The deal is the fourth-largest announced this year in the U.S., and comes amid a moribund period for mergers and acquisitions. Global deal making so far this year is down about 34% from 2008, and more than 54% from 2007. The deal highlights Mr. Buffett's growing interest in companies that stand to benefit as energy becomes more costly. Berkshire began accumulating stock in Burlington in 2006 as energy prices surged. Another big Berkshire holding, MidAmerican Energy Holdings Co., an Iowa utility operator, has been making a big push into wind power. For much of his career, Mr. Buffett avoided capital-intensive industries such as railroads and utilities, focusing instead on businesses like retailing and insurance. Berkshire's second biggest deal ever, completed in December 1998, was the $22 billion buyout of General Re, the reinsurance giant. But Mr. Buffett has been wading recently into more industrialized sectors. In December 2007, he agreed to pay $4.5 billion for the majority of Marmon Holdings Inc., which makes industrial products, from Chicago's Pritzker family. At the time, it was Berkshire's largest deal outside of insurance. Berkshire posted its worst year ever in 2008 when it lost 9.6% in book value per share, a common metric Mr. Buffett uses to track performance. While the company's fortunes have rebounded this year, along with the rest of the market, its shares remain more than 20% below where they stood in mid-2008. —-Jeffrey McCracken contributed to this article.