Wednesday, November 4, 2009

Buffett Revisits Hunting Ground for Survivors: Alice Schroeder

Warren Buffett called Berkshire Hathaway Inc.'s deal to buy the part of Burlington Northern Santa Fe Corp. that it doesn't already own an "all-in wager on the economic future of the United States."

If so, it's a survivalist bet. The railroad business is never going away, but it's not going to lead the economy out of recession, either. Buffett has spent a lot of time in the last year burnishing his legacy by tackling Franklin Roosevelt's role as the verbal antidepressant for this wretched economy. As I have said before, though, Buffett isn't as bullish as he sounds.

This deal has a feel about it of Berkshire's 1998 acquisition of General Re, the last monster acquisition, which was overpriced and done with stock for complex motives that reached far beyond the appeal of the underlying business. Like General Re, Burlington is an uncharacteristically expensive deal. Berkshire is paying more than 18 times Burlington's 2010 earnings, with 40 percent of the price in stock.

Fortunately, this time he's getting a less risky company. This deal is mostly about managing risk. One of the many motives is to soak up Berkshire's capital while Buffett is at the wheel. That lowers the danger of his successor doing something dumb. In that sense, it furthers a goal that Buffett once told me about: to create a company that will last a generation beyond his death. He can't ensure it but he is going to try.

Railroads as Survivors

Buffett likes companies that make bricks and boots and paint and electric utilities because they are survivors. So are railroads. Financial services have always been an exception -- the risky rocket fuel that leveraged the rest of Berkshire. Buffett acknowledged that he bought General Re during the Internet bubble partly to dilute Berkshire's equity holdings in stocks that couldn't easily be sold, such as Coca-Cola Co.

The combined effect of Berkshire's huge and leveraged financial business cost the company its AAA credit rating during the financial crisis. Buffett considered the top grading the company's "most precious asset," something he would never do anything to endanger. He has downplayed the loss of the rating in public, but a motive of the Burlington deal is that it allows Buffett to protect his legacy by diluting Berkshire's exposure to financial services. Who knows what it will take to manage risk in the markets 10 years from now?

Trial Balloon

Buffett has to be thinking about what that means for his successor, yet another motive. For some time, he has been floating the name of David Sokol, who runs his utility business and NetJets, as a trial balloon (meaning he can yank the string back at any time). I admire and respect Sokol, but my comfort with him as chief executive officer is in inverse proportion to Berkshire's exposure to financial services. Even brilliant CEOs often can't manage such companies. The Burlington acquisition makes me a lot happier with Buffett's choice of Sokol.

There are many other motives. Burlington is well-managed. Railroads are a bet against the U.S. dollar and in favor of higher energy costs. Railroads are a play on the trade deficit because this is how we haul all those containers of stuff imported from Asia. In recent years, they have become somewhat like electric utilities that earn a respectable return on capital. U.S. railroads, which have been around since the early 1800s, won't disappear any time soon. Berkshire is lobbying on energy policy, and this deal gives it more clout. There are some subtle synergies between the utility business and the railroad.

Stock Mincing

A final motive I am confident about is that Buffett finally has a plausible excuse to split Berkshire's B shares. He has spilled a lot of ink over the years decrying stock splits. A 50- to-1 ratio isn't a stock split, it is a mincing. Why do it? Buffett has just given Standard & Poor's the ticket it needs to add Berkshire to the S&P 500 Index at a time when S&P is desperate for large, solvent, high-quality companies to replace the casualties of last year's carnage. It is high time for Standard & Poor's to do this, but the stock's liquidity has always been the sticking point.

Buffett would never admit to wanting Berkshire to join the S&P, but becoming an acknowledged peer to other major companies is part of the path to his legacy. It isn't enough for him that Berkshire lives on profitably long after he does. Berkshire is his "didactic enterprise," his way of teaching the world how he thinks a business should be run.

Of course, this is about Buffett's ego, but then so are most great achievements. The business world would have been a lot better place in the past two years if more companies were run with survival and longevity in mind like Berkshire Hathaway.

It's safe to say, therefore, that as long as he is able, Buffett will keep an eye looking backward over his shoulder for possible acquisitions toward the companies such as railroads that he studied in his childhood. From the perspective of his almost 80 years, this is a hunting ground for more survivors.

(Alice Schroeder, author of "The Snowball: Warren Buffett and the Business of Life," is a Bloomberg News columnist and a Berkshire Hathaway shareholder. The opinions expressed are her own.)

Click on "Send Comment" in the sidebar display to send a letter to the editor.

To contact the writer of this column: Alice Schroeder at