Deals

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

President-elect Donald Trump has vowed to Make America Great Again. But one investor, Warren Buffett, has invested billions under the assumption that it already is. 

It's been seven years since Buffett's Berkshire Hathaway Inc. announced its biggest deal to date -- the $35 billion-plus purchase of Burlington Northern Santa Fe Corp. The Oracle of Omaha had the foresight to place his "all-in wager on the economic future of the United States" just as the nation emerged from a recession, and has reaped the benefits. After analyzing the transaction, Gadfly gives it a slam dunk.

Deals that coalesce as rapidly as this one did (it went from being an idea to announced in just 12 days) can turn out to be disastrous, but that hasn't been the case for BNSF. Through the acquisition, Berkshire gained a network stretching 32,500 miles (52,300 kilometers) across 28 U.S. States and Canada, immediate diversification benefits, access to a steady stream of dividends and control of a company that demands regular, substantial reinvestment -- a welcome sponge for at least some of the conglomerate's cash.

BNSF Scorecard
BNSF's net income has more than doubled since 2009, which has in turn driven Berkshire Hathaway's earnings higher.
Source: Bloomberg
The "before" and "after" revenue and net income figures reflect full-year 2009 and the 12 months to Sept 30., 2016. The implied valuation of BNSF is calculated using the EV/Revenue multiple of its closest rival Union Pacific. It would be $90.2 billion based on Union Pacific's EV/Ebitda multiple.

Berkshire has already earned more than $22 billion in dividends from BNSF. In other words, it has already recouped basically all the cash used to finance the deal, which is a rare feat in itself. The relatively steady stream of dividends is likely part of the reason Buffett views the business as a long-term investment he could "hold forever," despite its cyclical nature.

Precious Cargo
BNSF's profits have supported more than $22 billion in dividend payments to Berkshire Hathaway since the conglomerate completed its acquisition in early 2010
Source: Bloomberg, company filings
*2009 figure based on Berkshire's minority stake

While there were a fair share of skeptics when the deal was announced, hindsight shows that Buffett picked his timing right. Since the purchase, railroad valuations have improved. (And they may improve further under a Trump administration, given the president-elect's commitment to aid a key constituency: the coal industry.) Berkshire paid a multiple of 8.7 times BNSF's trailing 12-month Ebitda, a decent discount to the current industry average, which is roughly 10.3 and below a peak reached in 2014. Considering that the conglomerate had already been buying shares and owned 22.6 percent of the company at the time of its takeover, its average entry multiple was actually lower than 8.7.

Berkshire had also taken stakes in Norfolk Southern Corp. and Union Pacific Corp. around the same time. As it turns out, Union Pacific also would have made a great target, as evidenced by the more than doubling of its market value to $80 billion from $28 billion.  But Bekshire should be happy with its selection: Even though both railroads' revenues are about the same, BNSF has a slight edge when it comes to profit margins.

Aboard for the Long Haul
BNSF's revenue has tracked that of peers and moved lower recently amid lower coal volumes. Ups and downs aside, Buffett regards the railroad as a "very good business to hold forever."
Source: Bloomberg

The conglomerate's shareholders should be grateful that Buffett -- against his own hesitations -- agreed to issue stock, and agreed to a stock split for its Class B shares , as means to fund the BNSF purchase. (He famously once said he feels the same about colonoscopy preparation as he does about issuing stock.) While the new shares slightly diluted existing holders, failing to structure the transaction that way may have resulted in a worse outcome: no deal at all. Now at least, the conglomerate has the opportunity to put billions more to work -- a position that puts Berkshire in somewhat of a foolproof position for Buffett's eventual successors. 

Already, the company has spent $27.2 billion on capital expenditures since the beginning of 2010, outpacing its closest rival, Union Pacific, which has spent $24.5 billion through Sept. 30. If in the future its peers are forced to pull back on spending, Berkshire shouldn't encounter any roadblocks. As Buffett has said: "However slow the economy, or chaotic the markets, our checks will clear." 

Billion Dollar Baby
Railways are a capital-intensive business, the type that previously weren't among Berkshire Hathaway's favored investments. Since its acquisition, BNSF has outspent even its closest rival, Union Pacific:
Source: Bloomberg

On the topic of diversification, BNSF's contribution to Berkshire's earnings has fluctuated between 18 percent to 29 percent since it was brought into the fold. Check out the transformation:

Diversified
Buying BNSF immediately transformed's Berkshire Hathaway earnings composition
Source: Company filings
*2016 figure as at Sept. 30

Equity investors aren't the only beneficiaries of the BNSF deal. It's been a smooth ride so far for lenders who are on the other side of BNSF's relatively inexpensive borrowings.  Notes maturing anywhere from 2019 to 2046 are all trading above par, even without Berkshire's guarantee, which is a sign of confidence in the railroad's creditworthiness.

Easy Borrowings
Berkshire Hathaway doesn't have to guarantee any of BNSF's more than $20 billion debt pile
Source: Company filings

So, what's next? Another large railroad takeover appears to be out of the question due to regulatory hurdles, so it's likely Berkshire will have to hunt elsewhere for its next big deal. With a cash pile of almost $85 billion, another supersized transaction is a matter of when, not if. Chances are good that it, too, will be in America.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. In assessing the performance of the BNSF deal, we took into account the stream of dividends following the deal's close; the rise in BNSF's implied valuation as a result of the lift in its profits and the fact that the company's demanding capex spend provides an outlet for Berkshire to put additional cash to work.

  2. Norfolk Southern would've had a smaller impact: its market value has swelled to $29 billion from $19.3 billion.

  3. Buffett is pleased enough: he's admitted the deal was struck at an attractive price and that he'd do it all again, if he could

  4. Berkshire agreed to a 50-1 stock split specifically to help finance the BNSF deal and issued new stock that boosted the amount of shares outstanding by around 6.1 percent. Buffett has previously said he feels the same about colonoscopy preparation as he does about issuing stock.

  5. BNSF's borrowings are at a relatively inexpensive weighted average interest rate of 4.8 percent

To contact the author of this story:
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net