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*BNSF Hidden Assets


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Professor Bruce Corman Norbert Greenwald at Columbia University's Graduate School of Business needs to reassess his analysis of railroads. When asked, what do you think about Buffett’s purchase of Burlington Northern his reply was, "It’s a crazy deal. It’s an insane deal."

 

http://www.gurufocus.com/news/120147/bruce-greenwald--what-say-you-now-about-buffetts-crazy-burlington-deal-

 

I, Ben Graham, say that is blasphemy! Please give thought to the hidden asset component of a business. Among one of the hidden assets with railroads, is the buried fiber optic high speed railroad of broadband bits carrying content to all the eyeballs fixated on devices with screens.

 

Level 3 Communications Signs Right of Way Agreement With Burlington Northern and Santa Fe Railway Company in 1998,which allowed the fiber optic company to build the majority of that network  utilizing railway rights of way.

 

http://www.thefreelibrary.com/Level+3+Communications+Signs+Right+of+Way+Agreement+With+Burlington...-a020821075

 

I think Warren Buffett has the insight fulness of how valuable those hidden assets are.

 

Uses other than rail transport:

 

Railroad rights-of-way need not exclusively be for railroad tracks and related equipment. Easements are frequently given to permit the laying of communication cables (such as optical fiber) or natural gas pipelines, or to run electric power transmission lines overhead.

 

An easement is a certain right to use the real property of another without possessing it.

 

Ever seen a train lay its own track? Watch this amazing video: http://www.wimp.com/traintrack/

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Isn't income from this "hidden asset" already reflected in the earnings of the company?  If so, why should it be characterized as a "hidden asset".  That term seems to imply - to me at least - that there is a extra source of future income that is not known about or reflected in the business's current income stream.

 

As an aside - I think there was a consensus by board members that posters shouldn't take user names of someone they are not.  "Ben Graham is awesome" is preferred over "Ben Graham".  And saying in your post, "I, Ben Graham..." takes it one step further in what i believe to be the wrong direction.

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It really is as simple as deploying large amounts of capital at >= 10% initial pretax earnings yields in businesses that will look essentially the same in 50 years.  He also liked Rose a lot.

 

Greenwald just didn't understand how quickly the earnings power would return from the trough.  If I remember correctly, Buffett paid less than $34 Billion for a business with a huge moat, no threat of obsolescence, run by able and honest management and which is already earning $1 Billion pretax a quarter with further recovery to come.

 

 

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It really is as simple as deploying large amounts of capital at >= 10% initial pretax earnings yields in businesses that will look essentially the same in 50 years.  He also liked Rose a lot.

 

Greenwald just didn't understand how quickly the earnings power would return from the trough.  If I remember correctly, Buffett paid less than $34 Billion for a business with a huge moat, no threat of obsolescence, run by able and honest management and which is already earning $1 Billion pretax a quarter with further recovery to come.

 

 

 

Thumbs up.

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It really is as simple as deploying large amounts of capital at >= 10% initial pretax earnings yields in businesses that will look essentially the same in 50 years.  He also liked Rose a lot.

 

Greenwald just didn't understand how quickly the earnings power would return from the trough.  If I remember correctly, Buffett paid less than $34 Billion for a business with a huge moat, no threat of obsolescence, run by able and honest management and which is already earning $1 Billion pretax a quarter with further recovery to come.

 

 

And let's not forget that he only put in $24 billion of equity, some of which can be considered float.

 

From the annual letter, discussing the equity puts that he's going to make an underwriting profit on:

 

What is sure is that we will have the use of our remaining “float” of $4.2 billion for an average of about

10 more years. (Neither this float nor that arising from the high-yield contracts is included in the insurance float

figure of $66 billion.) Since money is fungible, think of a portion of these funds as contributing to the purchase

of BNSF.

 

Assuming earnings approximate FCF over the next 50 to 100 years, he's getting a pretty darn good ROE.

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I think he put in more than $24 Billion.

 

Berkshire paid $5.85 Billion cash for the first 22.5% they bought in the open market and through options.

 

Then they paid something around $26.5 Billion for the rest of the equity, with $8 Billion of the cash portion financed at 1.6%.

 

Total price was something like 32.4 Billion and 2/3 was cash, 1/3 Berkshire shares.

 

The biggest coup was getting the deal done, which is why he was willing to issue the shares.

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For some reason, I was under the impression that the $34 billion figure included the assumption of $10 billion in debt, but I think you might be right.

 

So he basically paid out $34 billion minus the float from the derivatives in equity, some of which was made up of BRK stock.

 

Still not bad.

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Professor Bruce Corman Norbert Greenwald at Columbia University's Graduate School of Business needs to reassess his analysis of railroads. When asked, what do you think about Buffett’s purchase of Burlington Northern his reply was, "It’s a crazy deal. It’s an insane deal."

 

http://www.gurufocus.com/news/120147/bruce-greenwald--what-say-you-now-about-buffetts-crazy-burlington-deal-

 

Well Greenwald was probably right...about monetizing the rights of way, at least that is essentially what Buffett said himself.  The interesting thing to do is to go through Greenwald's analysis and see what he did wrong--since he lays it out for you (see the gurufocus article)--and try and see what Buffett saw.

 

To tease out part of the deal, was it an oil play?  Well at least partially.  But I would maintain that Buffett deployed huge amount of capital safely on a cheap utility type play.  And most important, he bought at the bottom of the cycle--oil, equity and economy were all bumping along at lows, which Greenwald could not see.  I have not gone through the Annuals to see what the margin issues he was talking about, but I'm not interested enough in railroads to try.

 

 

 

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It really was a great deal - as close as you're going to see Buffett get to an LBO.  He borrowed $8 Billion at 1.6% and has already taken $3.25 Billion in dividends out of Burlington to pay it down.  He's been pulling cash out at a Billion a quarter this year so far.

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Based on the 2nd paragraph Berkshire's 2010 letter (talking about BNSF increasing Berkshire's normal pretax earning power by 40% to about $17 billion) I think you can calculate that BNSF's normal earning power is $4.85 billion. I think Buffett paid an enterprise value of $44 billion ($34 + 10 billion of debt), implying 9x pretax earnings. Critics, including Greenwald, have focused on the fact that maintenance capex is far in excess of depreciation, so looking at the numbers on a GAAP basis doesn't make sense. I think the reason it does make sense (and the reason Buffett looks at it that way) has to do with the way the rails are regulated. The "rate base" used to calculate revenue adequacy is historical cost, rather than replacement cost. Replacement cost is much higher (in some cases 2x) historical cost, which is why depreciation so understates real economic depreciation. If the rails were allowed to earn adequate returns and this was calculated on replacement cost, much higher rates would immediately be justified. The flip side, though, is that any capex spent in excess of accounting depreciation (even if it's called "maintenance") serves to increase a railroad's earning power, because it increases the historical cost of its assets. So in all it looks like Buffett paid 9x pretax...probably not bad at all.

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Guest ValueCarl

Ben Graham, I am a simple man with a simple mind and simple means sometimes being accused of practicing psycho babble, wearing tin foil hats, and other less complimentary depictions by those who refuse to acknowledge conspiracies, as either being good or bad.

 

ROW's must be a very interesting complex topic for any would be buyer of a railroad including various tricky factors like Eminent Domain at its origin, the ability to transfer those rights with or without legal liability for other uses like you point out, as well as the "charges" a railroad may levy against third parties along their tracks inclusive of whether they need to share those charges with their government whose citizens have overtime, granted them such privileges for the good of the whole.

 

In attempting to make the COMPLEX SIMPLE though, let me try to summarize what you are implying with those broadband pipes that are buried next to BSNF's tracks.

 

Warren Buffett is protecting his friend, one who he describes as "a great builder," Walter Scott's "broadband moat" from future USURPERS who want to destroy his castle? Or, Warren Buffett is protecting a friend's moat to a castle leading to CLOUDS in the SKY which he intends on participating in again as an equity owner one day?  ;)  

 

There is something to be said about KISS, or Keep It Simple, Stupid.      

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