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Bruce Berkowitz Weighs in Against BNSF Deal


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http://www.advisorperspectives.com/newsletters10/pdfs/Bruce_Berkowitz_on_the_Keys_to_Success_for_the_Fairholme_Fund.pdf

We interviewed Bruce Greenwald, the Director of the Heilbrunn Center for Graham & Dodd Investing at Columbia University in November. He was less than impressed with Berkshire Hathaway’s decision to buy the balance of Burlington Northern they do not already own. You own a good deal of

Berkshire Hathaway, what is the value investor’s case for using Berkshire

Hathaway stock to buy this company?

 

Last year I sold all my Berkshire and then I bought back what we now own.

Last year I said that you have to take Warren Buffett at his word that he will

do a couple of points better than the S&P going forward. And he did. That’s

not bad at all. But I believe that we are still of the size where we could do a

bit better. But that is absent some type of cataclysmic event – and then we

faced this cataclysmic event, which allowed Berkshire to put tens of billions of

money that was earning less than 1% to work, to earn 10%.

 

I can’t see how Burlington Northern was a great deal. The greatness of

Berkshire is its deployment of float and profit. They are deploying other

people’s money in terms of float - premiums on insurance policies that don’t

have to be paid out for years and years. If you are going to use part of that

float to pay for an investment, you have to make sure the investment is going

to make good money. With Burlington Northern, if you adjust for a buyer with

cash and don’t think much more about it, then it was not a great deal. But if

you bought it using cheap debt and good chunk of other people’s money and

you were highly confident that the company would give you a cost-plus return

over a decade, then it’s a good investment.

 

Borrowing money is a sure way to die. But if you are buying toll booths and

roads and regulated industries – pipelines or railroads or electric utilities,

where you know you are going to end up with some type of cost-plus pricing –

you are going to do very well, given that the actual equity you have in it is low.

 

It’s like buying a house with a low down payment. If you judge the return after

expenses, after taxes, and on the profits on shareholder equity, the return can

be two to three times what it looks like to an all-cash buyer.

Surprised that this one has been missed.
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Guest dealraker

Reading the entire interveiw I came away with the feeling Berkowitz thought that buying BNI was a good decison.  Funny how 2 people can read the very same thing and come up with a opposite impression.  Great title though.  Mine would read: Berkowitz Says

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Reading the entire interveiw I came away with the feeling Berkowitz thought that buying BNI was a good decison.   Funny how 2 people can read the very same thing and come up with a opposite impression.  Great title though.  Mine would read: Berkowitz Says

 

 

I agree with your assessment, dealraker, of what Bruce actually said and your assessment of the deal.  Currently,  Web is mostly using BRK's cash, earning a negligible return, to buy a coupon that is now @ 6%, but is reasonably projected by BNSF to nearly double over the next 4 years.  Interestingly, if we should move into a hyperinflationary environment during the years ahead, the coupon could well go to 20%+ with BNSF's extraordinary pricing power.  The only downside is the % of the deal paid for in BRK stock, but this is a wash because BRK will still have cash on hand to do other good deals in the future.:)

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These are Bruce Berkowitz's comments from his interview on Wealthtrack:

 

BRUCE BERKOWITZ: Berkshire has a tremendous amount of flow from the premiums received from long-term insurance policies. That flow has to be invested in very secure, sound financial instruments: electric utilities cost plus or a railroad business which has the stability unlike many businesses. So here he’s taking money that’s actually got a zero cost to it and then investing it at a reasonable, not at an egregious yield, but at a reasonable investment yield. But when the cost is zero, the returns are phenomenal. He’s brilliant. Warren Buffett is being Warren Buffett in that he’s married another great big business to Berkshire Hathaway that’s going to make a sizeable difference overtime.

 

 

 

Read more: http://advisoranalyst.com/glablog/2009/11/23/bruce-berkowitz-wealthtrack-interview-transcript/#ixzz0cbGGA0mW

 

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I think Berkowitz thinks the BNI purchase is a great deal.  The confusion is stemming from what I think is probably a typo in the article:

 

I can’t see how Burlington Northern was a great deal. The greatness of Berkshire is its deployment of float and profit. They are deploying other people’s money in terms of float - premiums on insurance policies that don’t have to be paid out for years and years. If you are going to use part of that float to pay for an investment, you have to make sure the investment is going to make good money. With Burlington Northern, if you adjust for a buyer with cash and don’t think much more about it, then it was not a great deal. But if you bought it using cheap debt and good chunk of other people’s money and you were highly confident that the company would give you a cost-plus return over a decade, then it’s a good investment.

 

This paragraph is odd because everything after the first sentence indicates that Berkowitz thinks this is a good investment.  The "can't" has to be a typo in light of the rest of the interview and the other interviews that Berkowitz has given where he has approved of the BNI deal.

 

Berkowitz's point is the one that I was making a couple of weeks ago.  You have to understand that the BNI deal is being financed with very low cost money.  It might seem like BRK is paying all cash, but they're really not because the cash and newly issued stock paid to current BNI shareholders will be replaced with low cost float over the coming years.  Why do you think the private equity guys are so envious of Buffett?  He has permanent capital by having BRK as a public company and by having one of the largest and most well run insurance businesses in the world. 

 

What's so ironic about the criticisms of the BNI deal is that for a number of years, almost all the "smart money" was using a ton of debt to finance their investing activities in order to juice their returns on equity.  Think about the real estate bubble.  Think about the LBO guys levering up acquisition entities to buy public companies in order to flip them after a couple of years.  Think about GS and the other prop traders levering up to make trades.  But only a few criticisms came out against those folks during the bubble years. 

 

It seems the pendulum has swinged such that people are completely ignoring the fundamentals of the BNI deal. 

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