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Sizing Up Buffett's Biggest Bet


Berkshire Hathaway (BRKA) CEO and value investing demigod Warren Buffett has been hinting for some time that he was looking for a large company to buy with Berkshire's huge cash hoard, which stood at about $21 billion at the end of the second quarter. Last year he described his likely targets as "big ones, elephants." On Nov. 3, Buffett bagged a good-sized pachyderm, paying $34 billion—$44 billion, including debt—for sole ownership of Fort Worth (Tex.)-based Burlington Northern Santa Fe Corp. (BNI), the second-largest U.S. railroad. The deal is the biggest acquisition in Berkshire's history and, in Buffett's words, "an all-in wager on the economic future of the United States." In a statement, Burlington Northern CEO Matthew Rose added: "We admire Warren's leadership philosophy supporting long-term investment that will allow BNSF to focus on the future needs of our railroad." Pending an antitrust review by the Justice Dept. because Berkshire has smaller stakes in other railroads, the deal is expected to close early next year. Berkshire has been eyeing freight trains for some time. In 2006, the company bought a 10.9% stake in Burlington Northern, later increasing its holding to 22%. On Tuesday Berkshire bought the rest of the company for $100 a share in cash and newly issued Berkshire Hathaway stock. About $16 billion of the purchase price is in cash, half of it coming from Berkshire's coffers and the other half borrowed from banks. The price represents a roughly 30% premium over Burlington Northern's New York Stock Exchange closing price on Monday. Berkshire also agreed to assume $10 billion in outstanding Burlington Northern debt. Buffett holdings: "a tick better?"As with every Buffett move, the deal is being examined for signs and portents about the U.S. economy. Is Buffett calling a bottom in the recession? Is Buffett firing the starting gun for a mergers-and-acquisitions resurgence? The simplest interpretation is that if Buffett—the most ardent devotee of the "intrinsic value" school of equity analysis propounded by his late mentor Ben Graham—thinks Burlington Northern is worth buying now, he simply thinks it's a good business at a cheap price. Burlington Northern's results for the third quarter, which it reported on Oct. 22, showed an earnings decline of roughly 30%—$1.42 per share, compared with $1.99 for the same period in 2008. While the company said it had improved productivity and cut costs, it also noted that this year's third-quarter revenues from carrying freight had dropped $1.28 billion, or 27%, compared with last year. The question is when might the economy start to perk up and fire demand for goods hauled by rail? Buffett has always been far too canny to publicly make that kind of short-term forecast. He told CNBC on Tuesday that he was confident the U.S. economy would recover, although he had no idea whether it would be this month, this year, or next year. He also said that he had seen no big bounce at any of Berkshire's portfolio companies, although he said "they might be doing just a tick better" than they were six months ago. Berkshire's purchase has also widely been interpreted as a bet on coal. About a quarter of Burlington Northern's revenues come from hauling coal along its routes throughout the U.S., Canada, and Mexico. There are currently 25 coal-fired power plants under construction in the U.S. Berkshire owns coal plants through its portfolio company MidAmerican Energy, which is not only Iowa's largest utility, but also serves other midwestern states. The company's CEO, David Sokol, has frequently been mentioned as possible successor to Buffett, 79. Is Buffett really just diversifying?There's another way to look at the Burlington Northern deal, says hedge fund manager Doug Kass of Palm Beach (Fla.)-based Seabreeze Partners Management. Kass, who earlier this year shorted Berkshire Hathaway stock—he says he has no position in the stock now—doesn't think the Burlington Northern purchase was a Ben Graham-style value purchase. Berkshire, after all, bought Burlington Northern at a premium to its stock price, not a discount. Kass thinks the purchase represents a move by Buffett to rebalance a portfolio that has become overweighted in stocks with heavy exposure to the financial sector, among them General Electric (GE), Swiss Re, and Goldman Sachs (GS). Berkshire Hathaway has also recently been shrinking its holdings in ratings agency Moody's. Says Kass: "I think the real headline here is 'Buffett Diversifies.'" Kass, a confirmed bear, also thinks the market's muted reaction to the deal—the Dow Jones industrial average finished down 17.53, or 0.2%, to 9,771.91—is more proof that the economy remains weak.
Carbonara is a senior writer for BusinessWeek.

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