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Bruce Greenwald – What Say You Now About Buffett’s Crazy Burlington Deal ?

January 23, 2011 | About:

I recall very clearly late in 2008 when my admiration for Warren Buffett as an investor reached even higher levels than ever before. For 2005, 2006 and 2007 I watched as Buffett sat with tens of billions of dollars on the Berkshire Hathaway balance sheet earning virtually nothing. Then all through 2008 Buffett was able to invest that cash at progressively higher rates of return.

Make no mistake, Buffett was not like Michael Burry or Steve Eisman and saw the huge financial collapse coming. I remember very vividly watching him on CNBC in mid 2007 where he said he thought a recession was unlikely. But he was waiting for a big opportunity, not sure when, why or how that opportunity would arrive.

It takes incredible discipline to sit and wait. I’m sure there were plenty of decent opportunities that Buffett passed on while waiting, but having cash when nobody else does is the best way to amplify your returns.

Given my level of admiration for Buffett I was somewhat annoyed when I read this from Bruce Greenwald immediately after Buffett completed the $26 billion acquisition of Burlington Northern:

“I know you own Berkshire Hathaway, so I have to ask you what you think about Buffett’s purchase of Burlington Northern.


It’s a crazy deal. It’s an insane deal. We looked at Burlington Northern at $75 and I’ll give you the exact calculation we did. You don’t have a high earnings return. They are paying 18 times earnings, but it’s really much worse than that. They report maintenance cap-ex very carefully. They report depreciation and amortization, and they report only about 70% of the maintenance cap-ex. So they are under-depreciating, and their profit numbers are lower than the true profit numbers – and in a bad way, because the tax shield for the depreciation is undergone too. Their profitability is much lower than it looks.

Buffett’s paying 18-times [at $100/share] and at $75 he was paying 16-times. Our calculation is he was paying 21-times.

Secondly, there are two kinds of assets. There are the rights-of-way, which you can’t get rid of. So there’s no issue about having to earn a return on them because you have to keep it in the business, and because there’s nothing they can do with those rights-of-way. If you look at the asset value of the non-right-of-way equipment, and you write it up because it’s more expensive than it was originally, you get an asset value that’s very close to the earnings power value. We didn’t see a lot franchise value or hidden asset value.

The other thing is that if you try to calculate sustainable earnings, you have to cope with the fact that earnings are up enormously since 2003, when oil went up. There is a simple calculation you can do, which compares the cost-per-ton-mile for freight for a truck versus a railroad. If you build the increase in the price of diesel fuel into the post-2003 experience, when revenues suddenly start to grow, what you see is that the entire growth of the revenue is accounted for by the energy advantage that the railroads have and therefore how much business they can capture from the truckers, and how much pricing they can get because the competition is now more expensive.

There is nothing special about the railroads. It’s entirely an energy play.

If you look at what their margins should have gone up by, given the energy efficiency, the margins go up by only about half of that. So you don’t have a good aggressive management over these five years producing outsized returns.

We looked back at when they did the merger with Santa Fe, because then they did increase margins. But they got bored with it, and margins started to come down. The same thing happened recently. We don’t see a lot of hidden profitability in the culture of the company.

It looked to us like an oil play. He has a history of making bad oil play decisions. And that was at $75/share, we thought there were better oil plays. At $100/share we think he has lost his mind.

When I read to myself I thought the following:

- Buffett has likely been reading Burlington Northern annual reports and railroad trade publications for 50 years

- Buffett is the greatest investor of all time

- Buffett has been sitting on this $30 billion for the better part of a decade looking for an elephant and this is what he thinks an elephant looks like

- Given that Buffett is the greatest investor and likely knows Burlington better than anyone on the planet is the likely conclusion to be drawn here that

1) Buffett has lost his mind ?

2) Or maybe Greenwald isn’t able to see what Buffett sees ?

That was actually a rhetorical question. I was pretty sure that number 2 was the correct answer.

So I thought it was interesting this weekend when Barron’s provided an update on the Burlington acquisition:

“The Burlington deal looks like one of Buffett's best, done in November 2009, when the economy was just starting to recover and there was little competition from private-equity or other buyers. Berkshire offered a 33% premium, paying $26.4 billion for the 77.4% of the company that it didn't already own. That initially looked overly generous, at about 20 times then-current estimates of 2010 profits. Yet Burlington's earnings -- and those of the rest of the railroad industry -- surged in 2010 and are expected to increase another 15% or so this year. Burlington could earn $3 billion after taxes in 2011 -- it netted $706 million in the third quarter. So, Berkshire paid only about 11 times projected 2011 profits for Burlington. Burlington probably is worth $40 billion to $45 billion now.”

With oil now at $90 and potentially heading higher the competitive advantage Burlington has over trucking transport of goods is likely to lead to continued earnings growth for many years into the future.

So what do you think Bruce ? Did Warren go crazy with this acquisition ? Or were you just not able to see what Buffett was seeing ?

About the author:


Rating: 4.4/5 (37 votes)


Batalha - 6 years ago    Report SPAM
CanadianValue, I believe a one-year time frame is way to short to judge an investment decision. Also, I remember someone quote WB saying that this deal was by no means a bargain and that he was betting on the future and success of America. Needless to say WB has bought this for Berkshire to own it forever even after he's gone.
Energywonk - 6 years ago    Report SPAM
yeh i wouldnt count your chickens either. this is a bet on US recovering strongly and the worlds needs for coal continuing to increase. neither of which is likely in my opinion (US will continue its long term decline and gas is the marginal fuel of choice, so unless BNSF has lots of LNG trains i am not sure--it does have some LNG engines, not sure about carriage capacity), i love warren, hes the best ever, but i too question this deal. i think more than anything it dilutes the percentage of insurance businesses and allows nice stable returns. this allows him to hand over the reigns to someone who might not be as familiar with insurance as he is. it remains to be seen what this business might be like in 20 years?
Bmichaud758 - 6 years ago    Report SPAM

I do not have an opinion one way or the other on the deal to be honest, other than I think Buffett likes the pricing power and utility-like nature of the business. However, regarding the price paid, I think Berkowitz makes a great point (sorry, it's late and I do not feel like searching for the link) - if Berkshire was able to issue low-cost debt to fund a large portion of the deal, then the ROE goes up tremendously. It's a utility-like business, and given the financial strength of BRK, Buffett was probably able to lever up this deal.

Dealraker - 6 years ago    Report SPAM
It was very easy to see that Greenwad was out of his league from the very beginning. The guy just couldn't keep his mouth shut on something where he was near certain to embarras himself.
LwC - 6 years ago    Report SPAM

I wondered how long it would take for dealwanker to crawl out from under his rock to dis Greenwald (That's GREENWALD, not greenwad). And yes, dealwanker isn't the only one who can creatively mangle a name, or alias in this case.

Sciomako - 6 years ago    Report SPAM
Someone please correct me if I'm wrong.

I have reservation about Greenwald. He is not portrayed positively in Roger Lowenstein's The Making of American Capitalist. He doesn't (didn't?) make his money as a value investor himself. Besides, I read his Value Investing book. While it's not a bad book, many of his modifications to Graham-Dodd's traditional approach give me the feeling he is trying to add (unproven) academic elegance into Graham's (proven) approach.

Batalha - 6 years ago    Report SPAM
Greenwald was positively portrayed by Buffett himself on a number of occasions. He was the only teacher ever reccomended by him on the Annual Shareholder meeting in either 2000 or 2001. Does that change your mind?
Yswolinsky - 6 years ago    Report SPAM
Everyone makes wrong calls. We all know Irving Fisher's famous call in 1929 literally right before the crash-"Stock prices have reached what looks like a permanently high plateau.". He still is held in high regard. However, you can tell an honest economist/investor or anything by how they react when they are proven wrong. I think Bruce Greenwald should state he was wrong in this case.

FYI If anyone wants to see my interview with Greenwald where he discussed the acquisition here is the link_http://www.valuewalk.com/interviews/jacob-wolinsky-interviews-bruce-greenwald-discusses-the-future-of-value-investing-buffetts-purchase-of-bni-and-more/
Dealraker - 6 years ago    Report SPAM


Greenwald dissed himself by opening his mouth precisely at the wrong time about the wrong subject. Many Buffett doubters have preceeded the professor and nearly all go down the hall of shame.

It was an easy call from the very beginning. There are very few easy calls but this one was a sure thing: Buffett vs. Greenwald.

Sciomako - 6 years ago    Report SPAM
@Batalha: Thanks. I didn't know that. You're absolutely right. I dug up a 2001 BRK shareholder meeting transcript and Buffett did recommend Greenwald.

This makes it hard to reconcile Buffett's opinion vs what Greenwald himself said on record,

"At investing I'm a complete idiot... I'm sympathetic to the Graham-Dodd of view but I'm not really a Graham-Dodder." (Quoted in Lowenstein's book. I assume this was from a face-to-face interview.)

And you are absolutely right that 1 year doesn't mean much.

By the way, what's your opinion on Greenwald's (economic) goodwill adjustment on NACV, which in Graham's tradition is treated as a liquidation value, he describes in his book?

Batalha - 6 years ago    Report SPAM

First, I believe Greenwald`s opinion in regards to the aquisition is related to the fact that the 1st Eagle fund, of which he is director of research, is a shareholder of BNSF. I dont think its personal at all.

As far as the NAV adjustments I believe there are two important points:

1) some companies will be easier to estimate (capitalize) R&D and SG&A on the replacement value calculation. For instance, if you take Bombardier and you want to compete with them you will have to spend a decent amout of money to develop similar products. PP&E is usually not hard to estimate also, especially if a company breaks down whats land, buildings etc. However, whenever I do this I tend to be very conservative.

2) What I like most about the framework is that it combines both valution and strategic assessment, which the DCF method doesnt. You will only pay above NAV if the company possesses some kind of competitive advantage and operates in an industry with barriers.

Dealraker - 6 years ago    Report SPAM
Oh well.

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