Burlington Northern Santa Fe
A review of Berkshire Hathaway's twelve years of ownership
“Our country’s future prosperity depends on its having an efficient and well-maintained rail system. Conversely, America must grow and prosper for railroads to do well. Berkshire’s $34 billion investment in BNSF is a huge bet on that company, CEO Matt Rose and his team, and the railroad industry. Most important of all, however, it’s an all-in wager on the economic future of the United States. I love these bets.”
Nearly a decade into the twenty-first century, the economic future of the United States seemed anything but assured. Faith in the financial system had been shaken by the events of 2008, but the malaise extended far beyond Wall Street. Americans were facing high unemployment and the deflation of the housing bubble took a major toll on household balance sheets. The stock market bottomed in early 2009, but bearish pundits never failed to make comparisons to the abortive bear market rallies of the early 1930s. Widespread despair threatened to bring about a self-fulfilling prophesy.
In the days after the 1929 stock market crash, John D. Rockefeller Sr. bought stocks, including a million shares of Standard Oil of New Jersey, and issued a press release intended to boost the confidence of investors:
“These are days when many are discouraged. In the ninety years of my life, depressions have come and gone. Prosperity has always returned, and will again. Believing that the fundamental conditions of the country are sound, my son and I have been purchasing sound common stocks for some days.”
During the dark days of 2008 and into 2009, Warren Buffett assumed a similar role as a confidence builder. Starting with his Buy American. I Am. article in October 2008, Mr. Buffett made clear his confidence in the long-term health of the economy as well as the benefits of owning stock in American companies.1
Warren Buffett is not omniscient, and his “Buy American” article appeared several months before stocks hit bottom. Mr. Buffett is known for buying stocks when he sees opportunities regardless of macroeconomic prognostications.
Burlington Northern Santa Fe is a case in point. Mr. Buffett began accumulating shares in August 2006, long before the financial crisis, and Berkshire owned 22.5% of the railroad by early 2009.2 Much to the surprise of many observers, on November 3, 2009, Berkshire Hathaway and BNSF announced a definitive agreement for Berkshire to acquire the company, a transaction that was completed on February 12, 2010.
In the exhibit below, I have estimated the cost of the acquisition. At the close of the deal, Berkshire’s existing 22.5% interest in BNSF had a carrying value of $6.6 billion.3 To acquire the rest of the company, Berkshire paid $15.9 billion in cash and issued Berkshire Class A and Class B shares with market value of $10.6 billion.
It is important to put the size of this acquisition in the proper context. Prior to the issuance of the new shares, Berkshire Hathaway had 1,551,749 Class A equivalent shares outstanding as of December 31, 2009 and a market capitalization of approximately $173 billion as of February 12, 2010. Buying BNSF was not quite a “bet the company” move but it was certainly a transformative acquisition that sent a strong message regarding the future of the United States economy.
At the time of the acquisition, many observers were under the impression that BNSF would retain most of its earnings and that Berkshire might direct additional cash to the railroad. Instead, BNSF has paid distributions to Berkshire over the years. Since the acquisition, BNSF has paid Berkshire a cumulative total of $47.7 billion, a figure that far exceeds the value of the cash and stock that Berkshire paid to acquire BNSF. 4
In late 2009 and early 2010, I wrote several articles about BNSF, including on the day of the announcement as well as on the day the transaction was completed. In addition, I wrote about the merger proxy, Mr. Buffett’s discomfort with using Berkshire shares in the deal, the use of insurance float to fund part of the transaction, and BNSF’s performance and the potential for expansion.5
In 2013, I revisited the acquisition and I have followed the company ever since in Berkshire Hathaway’s quarterly and annual reports as well as the more detailed financial information that BNSF continues to release. The purpose of this article is to take a look at BNSF again over twelve years after the acquisition.
The article is divided into the following sections:
Operating History. BNSF has posted relatively slow revenue growth since the acquisition, but profitability has improved significantly due to more efficient operations and the corporate income tax cut that took effect in 2018.
Balance Sheet Review. BNSF’s asset base has grown since the acquisition with property and equipment accounting for the bulk of the increase. The enlarged asset base has been funded roughly equally with equity and long-term debt.
Cash Flow Generation. Since the acquisition, BNSF has generated cumulative cash flows from operations of $82.7 billion. Capital expenditures, including equipment, consumed $45.5 billion, leaving $37.2 billion of free cash flow.
Capital Allocation. Since the acquisition, BNSF has distributed $47.7 billion to Berkshire, accounting for all free cash flow plus the net proceeds of additional debt incurred since the acquisition. The narrative surrounding the acquisition when it was made does not quite match what has taken place in terms of internal reinvestment opportunities. BNSF has become a cash cow.
Conclusion. Was Berkshire Hathaway’s acquisition of BNSF a success? Among other things, we need to consider the fact that Berkshire shares were issued to fund part of the acquisition. Did Berkshire gain more than it gave up in dilution? Will BNSF be able to continue strong advances in net income without the twin tailwinds of a declining operating ratio and a lower tax rate?
BNSF is the product of 390 predecessor railroads dating back to 1849.6 The company provides critical infrastructure for the United States, covering 143 million miles and carrying 535 million tons of cargo in 2021.7 Over a network of 32,500 miles in twenty-eight states and three Canadian provinces, the company operates an average of 1,200 trains per day. BNSF's orange locomotives are ubiquitous sights in the western two-thirds of the country as they travel over 25,000 grade crossings, 13,000 bridges, and 89 tunnels. The railroad serves over forty ports and has twenty-six intermodal facilities. By any of these measures, the railroad is a massive operation.8
In most of the western two-thirds of the United States, BNSF and Union Pacific represent a duopoly with networks and systems that would be impossible to create from scratch today. Although railroads face competition from long-distance trucking, railroads have the advantage of being far more efficient in terms of how much cargo can be carried per gallon of fuel.9 One downside of concentration in the industry is that railroads are subject to political scrutiny and expected to provide reliable and cost-effective services for customers who have limited alternatives.
The freight railroad business model is relatively straight forward. The capital investments required to build and maintain the network makes it possible to carry freight for customers which represents the primary source of revenue. In the exhibit below, we can review BNSF’s freight revenue segmented by product type: