Buffett’s train ride is on a one-way track
By Agnes T. Crane and Rolfe Winkler
(Corrects the size of Berkshire’s bid to $26 billion from $34 billion. The $34 billion figure included Burlington shares already owned by Berkshire.)
It’s somehow fitting that Berkshire Hathaway’s largest deal ever would look backward to two industries that helped the United States become a world power: railroads and coal. Warren Buffett even dressed the deal up as a patriotic bet on America’s economic future.
Berkshire’s $26 billion cash and stock bid for Burlington Northern Santa Fe represents a significant premium over the company’s closing share price on Monday. Yet it’s a bet that will pay off only if the economic recovery stays on track and Burlington can keep raising prices.
For decades, rails were a losing proposition as falling prices made it difficult to eke out returns on investment. That changed in 2004, once new investments in the railroad industry began to pay off.
And Burlington is best in class. Robert W. Baird analysts note that Burlington’s return on capital has averaged 11.2 percent over the past five years — the best showing of any U.S. rail.
Its tracks and rights of way near Powder River Basin coal mines are a crown jewel. Not only is coal forecast to play a larger role in our energy future, but cleaner coal is expected to dominate. PRB coal has lower sulfur content than Appalachian coal. More than 90 percent of Burlington’s coal shipments originate in the PRB.
And measured in ton-miles, coal-related revenue accounted for nearly half Burlington’s total in the first nine months of the year.
Renegotiating legacy coal contracts helped give Burlington an edge over its competitors, and another round in 2011 should keep coal shipment prices ahead of inflation, according to Deutsche Bank.
There’s also the rail company’s strong intermodal operation — seamless shipping via containers. Burlington is the largest intermodal carrier, and its Western presence means it’s well positioned for a rebound if consumers stay attached to cheap imports.
But to get Burlington, Buffett is paying up. The deal values the company at 28 times next year’s free cash flow, a hearty multiple that leaves little margin of safety if the economy stalls.
And given the high price, it’s unlikely that Burlington will generate better than mediocre returns for Berkshire shareholders.
Buffett may be willing to pay up because he doesn’t like holding cash. According to its recent quarterly filing, Berkshire has nearly $25 billion on its balance sheet. Given the paltry returns available on cash, Buffett may have no choice but to chase risk along with everyone else.
(Reuters columnist Rolfe Winkler contributed to this article.)