Reading Buffet's mind.....

Sum evaluates what are the key “take away” from Berkshire Hathaway buy of Burlington Northern Santa Fe Railway?

He bought a rail road company spending USD 45 billion coz he says his father didn’t bought him a toy rail when he was a kid. Buffet’s biggest Private Equity deal involving buying the remaining 78% stake in Burlington Northern Santa Fe Railway (BNSF) is being read by market watchers for signals on how the smartest and richest American Investor assess and evaluate America’s prospects going forward. After window shopping in Asia and Western Europe for nearly a year he chose to invest back home in capital intensive transport sector which traditional he and his company avoided. Buffet’s Berkshire Hathway thought PE investments in capital intensive businesses had fewer opportunities for generating value and making profitable exists. If his timing and foresight is anything to go by, his investment in Goldman Sachs is up 20 %. Goldman turned to

He remained invested with a minority stake in BNSF all through the recessionary times and waited for clear skies to invest even though BNSF share hit a bottom of around USD 51. The deal price of USD 100 per share aggregating USD 45 billion for a 78% stake is undervalued as per Buffet and he believes he can make a profitable exit. A striking thing about this takeover is that Buffet closed the deal very neatly in less than ten days and without the help of any investment banker. No valuation done, no due diligence process, it’s a firm decision swiftly executed.

So why it is that a Private Equity investor like Buffet can add value to a company while the present management is unable to do so. And more so Private Equity funds are able to buy distressed and underperforming assets at dirty cheap prices, turn them around and sell them at a premium making a neat return of a couple of hundred basis points. The answer lies in better management of these assets/ companies by integrating the interests of senior managers with the long term valuation of the companies. In a normal company with a public float there is increased pressure on managers to maintain a company’s stable or growing dividend policy or maintain the company’s share price and report quarterly figures (all short and medium term goals). The company’s performance is dissected by numerous markets participants like analysts, brokers, market makers for search or undervalued or overvalued securities and there is a lot of pressure on meeting analyst expectation. Focus is on achieving long term goals and incentives to achieve them by senior managers of the company are very strong in a PE set up. Secondly PE replaces the high cost debt of the company by repaying it and leveraging the company’s capital structure by borrowing at low cost. PE funds are able to borrow at low cost because of their excellent debt repayment reputation. As the company is turned around the operating cash flow and EBIDTA generated is used to deleverage the capital structure. There is restriction on payment of dividend till the debt is repaid and all funds generated are used to deleverage the company to normal acceptable levels.

So coming back to our basic question, what signal can we read out of this big ticket investment? First take away for many would be Buffet’s confidence in American economy and an expectation of a medium to fast recovery. This dispels doubts of a prolonged slowdown. Clearly he is investing in a company which will weather the oil price spike better than trucking companies or the airlines. He expects oil to spike in the near term and business to shift to rail road from trucking and airlines. Second with all the climate change and environment talk in the town he is expecting subsidy and tax credits for green companies from the congress. If you give any weight to his proximity to law makers, cap and trade and environment regulation is a take away and expects some movement on this from the congress going forward. He is also betting big on increased trade between China and America particularly through the opening of Panama Canal for trade. Walmart has already set up a big warehouse to transport exports from China through Panama Canal to mainland US. Thirdly he is expecting American to get realistic and mend their spending patterns particularly when it comes to travel. He has put all his money on a cheaper mode of transport so all those who trust his trading skills can short stocks of airlines and trucking companies.

For me the biggest take away is that going forward he has recognized and realized that America will no longer be as flamboyant as it used to be. It has just survived a major stroke and now America is expected to return to cheaper ways of life. All said and done I am very excited to see how Buffet profits from this investment for this is one investment I really do not agree with him.