Berkshire to Acquire Burlington Northern: A Closer LookPublished on November 3, 2009 at 9:45 am
As reported earlier today, Berkshire Hathaway has entered into a definitive agreement with Burlington Northern Santa Fe (BNSF) to acquire for $100 per share in cash and stock the remaining 77.4 percent of outstanding BNSF shares not currently owned by Berkshire. In addition, Berkshire Hathaway will split its B shares 50-for-1 in order to accommodate a share exchange for smaller owners of BNSF shares.
This transaction, which will bring Berkshire’s investment in BNSF to $44 billion including shares already owned, is the largest acquisition in Berkshire Hathaway history. What does this acquisition mean for Berkshire Hathaway shareholders?
Using Stock in Acquisitions
Much of the initial chatter on Twitter and elsewhere related to this transaction centers on Warren Buffett’s decision to use stock for part of the purchase. Does this mean that Mr. Buffett considers Berkshire Hathaway shares to be overvalued and suitable as currency for acquisitions? While it is possible that Mr. Buffett considers Berkshire shares to be fully valued or overvalued, this is not necessarily the case. Let’s look at what Mr. Buffett had to say about using stock in acquisitions over twenty five years ago when Berkshire acquired Blue Chip (from the 1982 Chairman’s letter):
Our share issuances follow a simple basic rule: we will not issue shares unless we receive as much intrinsic business value as we give. Such a policy might seem axiomatic. Why, you might ask, would anyone issue dollar bills in exchange for fifty-cent pieces? Unfortunately, many corporate managers have been willing to do just that.
I highly recommend reading the entire section of the 1982 Chairman’s letter entitled “Issuance of Equity” for more of Mr. Buffett’s thoughts on using stock in acquisitions. Berkshire’s use of stock, based on these principles, does not indicate that Berkshire shares are overvalued. Instead, it indicates that management believes that at least as much intrinsic value is being received as being given up through the new share issuance.
Terms of Agreement
The terms of the agreement provides BNSF shareholders with the right to receive either cash payment of $100 or a variable number of Berkshire Class A or Class B common stock. The mix of cash and stock will be subject to proration if the elections made by shareholders of BNSF do not equal approximately 60 percent in cash and 40 percent in stock.
If Berkshire Hathaway Class A shares trade in the range of $80,000 to $125,000 per share, the value of the share exchange for BNSF shareholders will be fixed at $100 per share. However, if Berkshire Hathaway Class A shares trade either below $80,000 or above $125,000 at the close of the transaction, BNSF shareholders will receive a fixed number of Class A shares (at either 0.001253489 per share below the “collar” range or 0.000802233 per share above the “collar” range). BNSF shareholders may elect to receive the economic equivalent in Class B shares as well.
The “collar” terms create a situation where BNSF shareholders who elect stock rather than cash could potentially receive less than $100 per share if the price of Berkshire Hathaway A shares are below $80,000 at the close of the transaction. BNSF shareholders could receive greater than $100 per share if the price of Berkshire Hathaway A shares are above $125,000 at the close. At any share price between $80,000 and $125,000, BNSF shareholders will receive enough Berkshire shares to result in a valuation of approximately $100 per share.
Bet on the United States Economy
There is no doubt that this transaction represents a bullish bet on the United States economy as Mr. Buffett stated in the press release:
“Most important of all, however, it’s an all-in wager on the economic future of the United States,” said Mr. Buffett. “I love these bets.”
We know that Mr. Buffett closely follows railroad statistics and has even said that he would choose railroad data as his only economic indicator if “stranded on a desert island“. Rail car loadings have been far below levels reached during the peak of the last expansion but have recently shown some signs of improvement. Mr. Buffett has been appearing on television frequently in recent months and has made bullish comments about prospects for the United States economy in the long run. The transaction is a massive bet on this bullish sentiment.
Stock Split: No, It’s Not April Fool’s Day
My initial reaction to the stock split announcement was total shock, but when one considers the terms of the BNSF transaction, it appears that Berkshire had no choice but to either split Class B shares or force small shareholders of BNSF to accept cash instead. With the post-split Class B shares likely to trade well below $100, it appears that even a small holder of BNSF shares will be able to elect Berkshire stock rather than cash. This is important for BNSF shareholders who wish to defer payment of capital gains taxes.
What is interesting about this stock split is the fact that it shows great concern for very small holders of BNSF shares. After all, any BNSF shareholder with more than 35 shares could elect to receive one pre-split Class B share of Berkshire based on current prices.
Make no mistake about it: The stock split has absolutely no impact on the actual intrinsic business value owned by Berkshire Hathaway shareholders. However, the split has some interesting implications in terms of potential inclusion in the S&P 500 index in the long run. It may also result in greater trading liquidity which could theoretically benefit shareholders who wish to enter into transactions.
The verdict is still out on whether this transaction will benefit Berkshire Hathaway shareholders in the long run, and much will depend on the trajectory of the economic recovery in the United States.
Berkshire Hathaway/Burlington Northern Santa Fe Press Release
Berkshire Hathaway Press Release on Class B Stock Split
Burlington Northern Santa Fe Investor Presentation Webcast
Burlington Northern Santa Fe Webcast Transcript
Burlington Northern Santa Fe Presentation Slides
Burlington Northern Santa Fe Transaction FAQ
Merger Agreement Form 8-K
Burlington Northern Letter to Customers
Disclosure: The author owns shares of Berkshire Hathaway