Berkshire Hathaway’s recent acquisition of rail operator Burlington Northern Santa Fe Corp has generated a tremendous amount of dialogue within the investment community.  For one, the deal involves Warren Buffet, Berkshire’s iconic CEO and legendary value investor.  The 79 year-old sage, whose succession plan remains one of the most tightly bound secrets in the industry, invited the rail operator to join the ranks of such names as GEICO, Dairy Queen, Fruit of the Loom, and Brown Shoe Company which currently shine atop Berkshire Hathaway’s Omaha, Nebraska-based mantle.

In addition to Buffett’s obvious name recognition, the deal stands out due to its sheer enormity.  Berkshire Hathaway agreed to fork over all of $26 billion to acquire the 77% stake in BNSF it doesn’t already own.
That would value Berkshire’s total ownership stake at $34 billlion (not to mention the $10 billion in
BNSF debt payments the conglomerate now assumes).

In return, Berkshire gains control of the nation’s second largest freight railroad network.  In fact, BNSF is also the country’s most prolific mover of intermodal freight traffic, a practice characterized by moving freight between ship, truck, and rail within the same container.  Not only does this insure that a container’s contents remain considerably secure, but it also presents a much more cost-effective means of moving freight across multiple modes of transportation.

In the end, the deal’s cost was by no means cheap.  Buffett & Co. agreed to pay $100 per share for the operator, more than a 30% premium over the firm’s share price on Monday, November 3, when the deal was first announced.  With shares trading at 18.2X estimated 2010 earnings, the deal does not constitute the typical Buffet- esque value play.  In fact, the mere notion of ponying up a premium for any company is considered a rarity at Berkshire Hathaway, a firm who owes much of its previous success to purchasing companies at bargain-basement prices.  Buffett has even willingly admitted as much, commenting on the deal, “You don’t get bargains on things like that. It’s not cheap.”

Although the investment appears puzzling from a valuation standpoint, a number of issues stand out as potential motivations for the deal.  First, there is the concern over the future of the US dollar.  As many are now concluding, the dollar’s recent descent presents a legitimate, growing concern to investors and businesses,
alike.  In part, the Federal Reserve’s insistence upon keeping interest rates low is forcing investors to flee low-yielding bank deposits and short term investments, dumping dollars and chasing investment returns which are more likely to keep pace with inflation.  One way to hedge against the dollar’s demise is to invest in real assets, whether that be precious metals, commodities, real estate, or other businesses.  With that said, what better a place to make a long-term investment than in  one of America’s largest rail operators?  BNSF holds billions of dollars’ worth of real estate, offering the potential for long term value stability.  Meanwhile, by paying out roughly a billion dollars per year in dividends, it also provides Berkshire with a steady cash flow, joining the ranks of other cash flow-rich businesses such as insurers, newspapers, and utilities which have funded Berkshire Hathaway’s prolific growth throughout the years.

Despite the relatively quick execution of the deal, Berkshire Hathaway’s decision did not arise without precedent.  In recent years, Buffett’s firm had shown a propensity for rail operators, accumulating positions in Union Pacific and Norfolk Southern.  When BNSF CEO Matt Rose recently expressed a willingness to negotiate with Buffett, Berkshire pounced at the opportunity and made an offer.  However, even after completing the combined cash/stock purchase, Berkshire still holds roughly $20 billion in cash.  Buffett had plenty of motivation to put his cash to work. Hence, when the opportunity arose, he tossed his chips into the ring.

Stretching beyond concerns about the dollar,  the dealmaker for this transaction is, without a doubt, coal.  Coal, that dirty, filthy fossil fuel has increasingly become the target of global warming advocates and legislators.  However, by accounting for nearly one half of all of the electric generation in the US today, its presence is solidly entrenched in this country’s energy future.  Fortunate for Berkshire Hathaway, one half of all the tonnage BNSF’s trains have transported thus far this year is-you guessed it-coal.  In all, the total yearly tonnage of coal BNSF moves is enough to power one in every ten US homes.

According to the Energy Information Administration, a statistics office within the US Government, the US’s current recoverable coal reserves should meet a growing US demand for another 150 years.  Given coal’s cheapness, abundance, and relative efficiency, it presents an extremely cost effective and convenient form of energy.  Furthermore, with the largest recoverable reserves of any country buried in our own back yard, it presents a viable energy option, provided the US begins to ween itself off of its foreign oil dependency.

From a strategic standpoint, BNSF is well-positioned to benefit from our continued use of coal.  Its tracks spread across 28 states and 2 provinces, mainly west of the Mississippi River, at a combined length of 32,000 miles.  Its  network of rail lines is heavily concentrated in the upper Great Plains, particularly in the region of the Powder River Basin, an area of southeast Montana and northeast Wyoming which supplies roughly 40% of the nation’s coal. Of note, the region is rich in sub-butiminous coal, a cleaner-burning alternative to Appalachian coal.  This coal is known for being low in sulfur dioxide, a common contributor to acid rain.  Lastly, BNSF’s extensive lines throughout the Great Plains, Midwest, and Pacific Northwest will allow it to serve MidAmerican Energy, an energy producer also owned by Berkshire Hathaway which happens to operate several coal-fired power plants of its own.

Currently, BNSF transports the majority of its coal to population centers of the Great Plains, including Denver, Kansas City, Chicago, St. Louis, and Dallas.  However, with its wide reach, it could also feasibly provide significant amounts of coal to population centers in the Upper Northwest, Southern California, and South Texas as well.  The nation’s hunger for electricity is expected to increase 25% by 2030.  Factoring in our continued reluctance to build more nuclear power plants, the cost barriers to implementing green energy initiatives, and the highly variable cost of oil, our reliance on coal is likely to intensify for the foreseeable future.

In addition to this, coal exporters are also poised to benefit from the developing world’s mounting appetite for electricity, especially China and India.  China, which burns more coal than the US, Europe, and Japan combined, is scheduled to build 500 additional coal-fired powerplants over the next decade.  After first becoming a net importer of coal in 2007, the country’s appetite for coal will undoubtedly force it to increase its reliance on imports.  Given BNSF’s plentiful access to Pacific ports, it sits in a prime position to benefit should coal producers look to direct their coal shipments across the Pacific.

Mr. Buffett has never shied away from admitting his bullishness with regards to the US’s long term prospects.  In fact, following the deal’s announcement, Buffett told CNBC, “America’s best years lie ahead, there’s no question about that.”  If one assumes that Mr. Buffett’s remarks are correct, this deal should put Berkshire Hathaway in an enviable position to ride that wave of prosperity over the next 50-100 years.  BNSF gives Berkshire a brawny, strapping infrastructural presence, transporting carload-after carload of goods and resources cross-country.  The relative cost-effectiveness of rail transport (it takes only one gallon of diesel fuel to move one ton of goods 470 miles) gives it an obvious edge over the automobile.   In fact, should gas prices rise considerably, demand for rail freight will undoubtedly increase.

Berkshire Hathaway prefers to identify companies which hold a competitive advantage within their industries.  BNSF’s competitive advantage lies in its strong infrastructure base, some 32,000 miles of tracks.  Furthermore, its geographic footprint-primarily located between the population centers of the Great Plains and the West Coast-ensures that it holds a distinct advantage for moving not only processed goods and products, but more importantly, coal.  As US, and for that matter, global demand for goods and resources accelerates over the coming decades, Berkshire Hathaway and its shareholders could be rewarded handsomely.

Tags: Berkshire Hathaway, bnsf, brown shoe company, Burlington Northern, Burlington Northern Santa Fe, CEO, China, coal, dairy queen, debt payments, Federal Reserve, foreign oil dependency, fruit of the loom, geico, great plains, india, intermodal freight traffic, midamerican energy, U.S. Dollar, union pacific, Warren Buffett

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Stock Market Investing: The equity averages continue to languish, however, as anticipated, the relative strength of precious metals investments soars. The Dow, S&P500 and the NASD all sit at or near their respective lows of the last two weeks while Gold hits a new high for the year at $1,085.65 and Silver crosses $17.

I would like to spend some time today augmenting our precious metals investment thesis. To begin, please review the story below…

IMF Sells Gold to India, First Sale in Nine Years

Nov. 3 (Bloomberg) — The International Monetary Fund sold 200 metric tons of gold to the Reserve Bank of India for about $6.7 billion, its first such sale in nine years.

The transaction, equivalent to 8 percent of global annual mine production, involved daily sales from Oct. 19-30 at market prices and is in the process of being settled, the IMF said in a statement yesterday. The average price to India, the biggest consumer, was about $1,045 an ounce, an IMF official said on a conference call.

“The fall in the U.S. dollar seems to be pushing all the central banks to strengthen their portfolio with gold,” said N.R. Bhanumurthy, professor at the National Institute of Public Finance and Policy in New Delhi. “Gold is a safe store of value compared to the U.S. dollar.” Read More

…The key to this story: 200 metric tons were sold over 10 business days at an average price of $1,045. This sale price was only 2.7% below the recent high!

The key is to identify a basket of attractive takeover candidates now, place them into the portfolio and wait for the explosive takeover phase to begin. If our research capability is intelligent and we are patient, we are very likely to hit several 5-10 baggers.

Tags: China, gold, hyperinflation, india, investment strategy, precious metals, silver, stock market investing, US$

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Emerging markets have seen explosive growth over the past decade, but with the recent contraction in the global economy, investors have a chance to look at real growth in individual markets. There is no doubt in my mind that the boom over the past couple of years in some countries were due to insatiable

investors overbuying in whatever country the talking heads mentioned. However, as the global economy worsened over 2008 and the first part of 2009, investors switched from the greed mentality and into a fearful and defensive position. Investors began pulling capital out of the emerging markets around the world, and what is left in these economies is real growth in GDP.

Investors now have a chance to analyze the fundamentals of the emerging markets and look for real potential value. Some of the markets stood up, while others folded to the economic pressure. MSCI Barra provides country specific indices based on equities listed by a specific country. The MSCI China Standard Core and the MSCI Brazil Standard Core have already doubled from their lows in October and November respectively. China is up almost 10 percent for the past year, but Brazil is down 13 percent over the same period. The MSCI India Standard Core is up almost 100 percent since its low in March of this year but is down almost 10 percent since August of last year. India has made it difficult for individual foreign investors to invest in Indian equity. Russia is struggling to recover as the MSCI Russia Standard Core is down almost 50 percent from this time last year.

As the market has started recovering over the past couple of months, many of these emerging markets are recovering quickly. Most of the emerging markets listed by MSCI are up 30 to 60 percent year to date, but hopefully investors will be weary of overbuying into emerging market funds just because it’s trendy. Hopefully, as a global society, we can stop to get our breath and think about building the economy back based on innovation, ingenuity, and real growth.

Tags: Brazil, China, Emerging Market, etf, hedge fund, Index, india, Not Categorized, Russia

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Instead of wasting time arguing about the inevitable and fearing the fallout let’s position the portfolio to benefit: Short US Treasuries (Long TBT) as the spending increases make it impossible to keep rates under control. Short US$ (Long UDN) as the talk of a new settlement currency turns into reality, and long precious metals as currency devaluation drives asset prices higher. Repeat after me: inflation is a currency event not an economic event.

China officials call for displacing dollar, in time – Reuters
Reuters reports the financial crisis has laid bare defects in the dollar-led global economy and the world should look to displace the U.S. currency, even if that will take many years, Chinese officials said in comments published on Monday. The push for fundamental, if gradual, reform of the international financial system comes just before the Group of Eight summit in Italy, where China’s willingness to question the dollar’s role could fuel debate. The Special Drawing Right, a unit of account used by the International Monetary Fund, presents a viable alternative to the dollar as a global reserve currency, said Li Ruogu, chairman of the Export-Import Bank of China, a major state-run bank. “It is a feasible plan to reform the present SDR and make it into a real settlement currency, a universally accepted ‘currency basket’ that would replace the dollar at the heart of the monetary system,” Li was cited as saying in Financial News, a newspaper published by the central bank.

China begins pilot program to settle trade in Renminbi - NY Times
NY Times reports China has officially opened a pilot program to allow companies to settle imports and exports in renminbi in selected regions, marking a major step toward eventually internationalizing the Chinese currency. Three pairs of Shanghai companies with their Hong Kong and Indonesian counterparts signed contracts on Monday to be the first to settle business deals in the Chinese currency. Executives said the move would save costs and avoid exchange rate risks. Bank of China and Bank of Communications were the first lenders to clear transactions in renminbi, considered a lucrative business given China’s expanding economy and huge presence in international trade. Hong Kong also kicked off the long-awaited yuan settlement program on Monday. HSBC said it completed its first renminbi trade settlement with Shanghai and its first cross-border credit transaction.

India open to discussing dollar’s status as reserve - Reuters
Reuters reports India is willing to discuss proposals to replace the U.S. dollar as the global reserve currency, Foreign Secretary Shivshankar Menon said on Monday. “This would be one of the ideas which is on the table. There have been ideas expressed and we are ready to discuss all of them,” Menon told reporters when asked if India would consider replacing the dollar.

Calls grow to increase stimulus spending - WSJ
WSJ reports Vice President Joe Biden said the Obama administration “misread how bad the economy was” and didn’t foresee unemployment levels nearing double digits, in comments likely to intensify calls for the administration to do more to counter job losses… White House economists are discussing whether a second round of stimulus is needed, but a decision isn’t expected until at least the fall. “We remain focused on putting thousands of Americans back to work” through implementation of the February stimulus act, an administration official said Sunday. “Any discussion of a second stimulus is premature at this point.” That timetable isn’t fast enough for some economists, who say quick action is necessary to avoid a protracted period of joblessness. “A second stimulus should be the one they should have done the first time, something that is relatively fast and thoughtful,” said Phillip Swagel, a professor at Georgetown University’s McDonough School of Business. So far, though, politicians of both parties are showing little eagerness to tackle another stimulus bill. Republicans have attacked the current stimulus package as wasteful and ineffective, labeling it as government bloat at a time of record deficits. As the GOP seeks to reclaim the mantle of fiscal discipline, many are loath to support another round of government spending. Many Democrats, too, said they’re disappointed with the recovery program so far but, for now at least, are resisting calls for a second package.

Tags: China, india, renminbi, Special drawing rights, Stimulus spending

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