Yesterday’s announcement that Warren Buffett, the oracle from Omaha, was buying the balance of the shares of Burlington Northern, the second largest rail carrier in the country, illustrated his philosophy of buying into an industry that he can understand. Investors in the stock of the holding company that he runs, Berkshire Hathaway, should be pleased to see Buffett make a big move with the mounds of cash at his disposal. The $44 billion price tag is the largest deal ever done by Buffett.
The railroad business in the U.S. has suffered with the general economy. However, the Burlington's share price has been trending up as the impact of the recession lessened this year. Buffett is paying a premium for the stock, but obviously feels that the future of the railroad business is good. He knows that it’s a big bet regardless. Buffett in announcing the deal said “It’s an all-in wager on the economic future of the United States. I love these bets". Yet Buffett already knew firsthand about the state of and prospects for both Burlington Northern and the railroad industry through his prior ownership of a 22% stake in the Company.
The immediate reaction by the market to the deal has been favorable as Berkshire Hathaway’s share price has risen in the day since the announcement. Not all sentiment is positive, however, as Barron’s in an article featured today on its web site “Has Buffett Overplayed His Hand” points out that there are a lot of ifs that must turn out positive to achieve the large returns that long time Buffett investors have grown accustomed to. These include the growth of the economy and especially the sectors that use rail transportation to move products like coal and other commodities.
This deal is not his last. He is a money manager and needs to put his cash to work. He has been connected with the proposal by Goldman Sachs – which company he holds a $5 billion preferred stock investment in – to acquire tax credits from Fannie Mae. If they can buy these credits at a substantial discount, this will reduce both companies Federal corporate tax liability and lower their effective tax rate. This would result in a positive bump in earnings and a good use of cash. Since Fannie Mae is now Government controlled, the Fed will need to give the green light to this deal. This will be both a political and PR risk by the Obama administration as Goldman was one of the institutions that took the Federal bailout money and has been accused of being sheltered from losses by the Government’s $180 billion investment in AIG. Goldman had substantial risks in credit paper it bought from AIG that would have produced huge losses to Goldman if AIG could not honor its obligations.
With Buffet as a partner with Goldman, it is likely that the tax credit deal will be consummated. He has shown his support for Barrack Obama during his presidential campaign and Warren is no stranger to getting a return on a favor. When and if he calls the President or one of his chief advisors to get their approval for the deal, they will feel the Buffett touch.