Monday, March 01, 2010

What I Learned, Part VI: No Brilliant Ideas, but a Dig at Kraft

The second-to-last question of the day is asked, and it’s about Burlington Northern.

“Are you also purchasing rights of ways and do they have other purposes?” a shareholder wants to know.

He is, no doubt, wondering whether the “Oracle” has divined an additional use for the rights-of-way on which the Burlington Northern track sits—one that takes such clever advantage of those long, uninterrupted stretches of railway beds that, years from now, other railroad operators will smack their foreheads and mutter “How did we miss that!”

Buffett knows
where the question is going, for there has been speculation that he has his eye on using those rights-of-way to expand his electrical distribution operations in some sort of grand scheme to both help fortify the tired, aging national grid while likewise making buckets of money for Berkshire.

So he gets right to the heart of the matter:

“ I think Phil Anschutz found a way to do this in the case of his railroad, but no, Burlington Northern does not have a lot of excess land, and I don’t have any brilliant ideas to use the right of way, the rolling stock, the tonnage, the bridges…”

Buffett knows his history: Phillip Anschutz was the genius, Kansas-born, land/farming/oil magnate who began installing digital fiber-optic cable along the tracks of the Southern Pacific Railroad in the 1990s, creating Qwest Communications out of thin air—or, rather, thick dirt.

Anschutz was copying the model created by Williams Companies, a pipeline operator that had been stringing decommissioned oil pipelines with fiber-optic cable since 1985.

Buffett, however, will not be copying Williams or Anschutz: he merely wants the railroad.

Having made this clear, he winds up the subject with a dig at Kraft—the food company whose shares Berkshire owns, which is buying Cadbury for what is, in Buffett’s mind, an offensively high price using offensively low priced stock:

“Unlike Kraft, we do NOT expect dramatic synergies.”

This gets a laugh from the sympathetic crowd, and Buffett continues by accentuating the positives, and also displaying more of his command of financial history—the kind of command he will put to greater effect at the annual shareholder meeting when he and Charlie Munger will answer these types of questions for more than five hours:

“Matt Rose does a wonderful job running it [Burlington Northern]... I do not see its utility elsewhere. The Burlington had lots of oil, real estate [years ago], and they spun those things off. The railroads have nothing like the surplus of assets they had 20-30 years ago. I looked at a map of the Union Pacific the other day, when they were chartered in the ‘60s I think they had 10% of the land in Nebraska.”

By “’60s” Buffett is, of course, referring to the 1860’s, but I wonder if the youthful side of today’s crowd makes that connection.

The final question of the day—at least the last question Buffett will answer—is about his partner, represented today by a color cut-out of a youthful Charlie Munger...“What is Charlie’s view on the split?"

Buffett says,

“We consult on anything important—like this. We’re paying a full price, and paying part of the price in stock is unpleasant.”

When a shareholder from La Jolla tries to sneak in a question on Buffett’s view on the price of oil, the Oracle seizes the chance to cut things off:

“We should really limit this,” he says, concluding the question-and-answer session. “Charlie, any last words?” he asks his cardboard partner.

Instead of Munger’s voice, we hear him snoring.

This draws laughter and makes for the sort of humorous coda with which Buffett likes to end his public appearances. He stands and shareholders start moving to the front of the concert hall, their cameras ready.

As the cameras start flashing, Buffett obliges. He stands next to the image of Charlie and makes a “V” with his fingers behind Munger’s head.

The flashes go off.

Then Buffett waves and walks quickly offstage.

To be concluded…

Jeff Matthews
I Am Not Making This Up

All images and Text © 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.


jb said...

Doug Kass's opinion is that "an interaction of several factors will lead investors to valuing Berkshire Hathaway more like a closed-end fund (which typically sells at a discount to its net asset value) and less like the premium and prized possession that it has been over the past 40-plus years."

Do you agree?

Jeff Matthews said...

JB: I understand Doug's point and agree the stock will be less highly valued than in the past...

...but I believe once Buffett is gone it will be run, and valued, as a conglomerate--not as a closed-end fund, because the value of the bulk of the assets can no longer be valued in real-time. These are operating businesses with a large equity and derivatives portfolio.

What Burlington does for Berkshire, in my view, is it completes the transformation to an operating company that can be managed by somebody who isn't famous for picking socks.

And nobody has ever valued BRK on a P/E basis!


BGM said...

Jeff -

To what extent is BNI's "hidden asset" the ability to invest capital with a long-term view? At the press conference shortly after the transaction was approved Rose seemed pleased to out from under the short time horizons shareholders and the sell side used to judge BNI's performance.

I suppose this question applies to Berkshire's diverse collection of businesses.

Thanks for your thoughts.

Anonymous said...

What bookstore will you be at in Raleigh on 3/18, I look forward to it.

Jeff Matthews said...

BGM: Yes, that's one of the keys to the Burlington deal--a lot of cash can and will be reinvested in the railroad (and the utilities).

Buffett could get 'hit by a truck' tomorrow and it would not greatly damage the Berkshire's potential investment opportunities.

That's very different from the Berkshire of ten years ago.

As for my appearance in Raleigh, it is actually with the local CFA chapter--please contact them for information!


Alex said...

Jeff, thanks very much for these transcriptions.

However, I disagree with the notion that BNI moves BRK towards a pure operating model. In a slowly recovering market, the company will generate north of $8 to $9 billion dollars, much of which will be unencumbered by capital requirements. These dollars will require skilled stewardship or risk the attention of activist yield pigs.

You have made the point that Berkshire has not historically been a favorable home for high growth companies. If Buffett truly wished to transition to an operating model, he would have, or should have, adjusted the culture amongst the management in place.

Jeff Matthews said...

Alex: yes, Berkshire will generate significant cash flow in future years, on the order of magnitude you suggest.

But unlike a decade ago when those cash flows were largely unencumbered by the need to (or desire to) reinvest in plant and equipment, Berkshire now owns a lot of plant and equipment, and that requires capital spending.

Just five years ago Berkshire had gross fixed assets of $11 billion; including Burlington that number exceeds $100 billion, even excluding non-cash write-ups, if any, related to the deal.

Consequently, five years ago Berkshire's capex was barely above $1 billion; in 2010, including the railroad, it will be closer to $10 billion.

So much of that cash flow is no longer "free." You can sell furniture from an old building but you can't run move a rail cars or power on old lines.

And, as Buffett himself has pointed out too many times to count over the last five decades, capital equipment must be upgraded in current--i.e. inflated dollars--so the capex bill just mentioned will grow even if Berkshire stands still.

That, of course, Berkshire will not do. Buffett will continue to acquire companies as they become available, and his successor will do likewise, given Berkshire's healthy insurance 'float', operating cash flows and balance sheet.

But I do believe the nature of the company has entirely changed--that's the bad news.

The good news is that company can now be managed by somebody other than the best investor we've ever seen in our lifetimes.


Anonymous said...

Jeff: Very interesting observations. So what does that leave us with for reasonable expectations for BRK returns? Is it akin to a (very good) utility stock? If that analogy works, should we expect to see a dividend post-Buffett? Put differently, how would you value BRK on a P/E basis?


CurmudgeonlyTroll said...

I think Southern Pacific Railroad started Sprint (hence SPRint), which led to today's Sprint/Nextel. Just wondering if there was also a Qwest connection.