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November 27, 2009

Buffett bets on BNSF in $US 34 billion buyout

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Last month one of the world’s most successful entrepreneurs made his biggest ever acquisition by purchasing all remaining shares in North America’s second-largest railway. Keith Barrow looks at how Warren Buffett’s high-stakes wager on BNSF has sent ripples through Wall Street.
 

THE world's second richest man Mr Warren Buffett has sealed the biggest deal in his distinguished career after his investment company, Berkshire Hathaway, reached an agreement to acquire the remaining 77.4% of US Class I railway BNSF for around $US 26.6 billion. This takes his total investment in BNSF to $US 34 billion.

The transaction, which includes BNSF's $US 10 billion outstanding debt, means Berkshire Hathaway will become the sole shareholder in North America's second largest railway. "Our country's future prosperity depends on an efficient and well-maintained rail system," said Buffett. "Conversely, America must grow and prosper for railroads to do well. Berkshire's $US 34 billion investment in BNSF is a huge bet on that company, CEO Mr Matt Rose and his team, and the rail industry. But, most important of all, it's an all-in wager on the economic future of the United States. I love these bets."
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Berkshire Hathaway has consistently increased its stake in BNSF since it first bought into the company in 2007. Over the last two years it has also sold its modest holdings in two other US Class Is, Norfolk Southern and BNSF's principal competitor Union Pacific.

At a recent BNSF board meeting, Buffett suggested to Rose that he would like to acquire the rest of the company, and within just 10 days, Berkshire Hathaway reached an agreement with BNSF on the takeover. Regulatory approval of the deal is expected in the first quarter of next year.

"This is a very positive transaction," Ms Karen Rae, deputy director of the Federal Railroad Administration told IRJ. "Buffett is known for his keen sense of where the economy is going, and his decision to make such a strategic move is a very strong indicator of the future potential for rail in this country."

Berkshire Hathaway paid $US 100 per share in stock and cash for the company, a 31.5% premium on BNSF's closing price on the New York Stock Exchange on November 2. The following day Wall Street responded enthusiastically to news of the sale, with BNSF's share price soaring more than 28% to almost $US 100, the highest level for 12 months.

Share prices also rose 6.8% on Union Pacific, 6% on CSX and 2.4% on Norfolk Southern, while the news also sparked a rally on Chinese railway stocks, with Daqin Railway Company, China Railway Tielong Container Logistics, and Guangshen Railway, among the beneficiaries. Railway construction companies such as China Railway Construction Corporation (CRCC) and China Railway Group have also seen their stock prices rise.

However, analysts believe few other investors will have the resources to buy major stakes in other US Class Is, particularly under the current economic conditions.

Like all other US Class I railways, BNSF has been hit hard by the economic downturn. Third quarter freight revenues were down 27% to $US 3.49 billion compared with the same period in 2008, although operating income was down only 25.3% to $US 901 million.

Despite the impact of the recession on the company's finances and its share price, Buffett has refuted any suggestion that BNSF was a bargain. Speaking on PBS television last month, he said: "It's a good asset for Berkshire Hathaway to own over the next century, but you don't get bargains like that. It's not cheap. It was an opportunity to buy a business that's going to be around for 100 or 200 years, that's interwoven into the American economy. If the American economy prospers, the business will prosper."

Prior to the downturn, BNSF enjoyed a period of sustained growth - in the first seven years after Rose became CEO in 2001, revenues almost doubled, while Union Pacific achieved only a 50% increase.

Announcing the third quarter results in October, chief financial officer Mr Thomas Hund said capital investment for 2009 is likely to remain at $US 2.6 billion. In an interview with the Financial Times, Buffett acknowledged railways require a high level of compulsory capital investment, but added he believes that investment will generate a decent return.

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