The Burlington Northern Santa Fe acquisition was the largest in Berkshire Hathaway’s history and many shareholders naturally assumed that Berkshire would create a new “Railroad” operating segment for financial reporting purposes. It came as somewhat of a surprise to learn that BNSF would be incorporated into Berkshire’s existing Regulated Utilities segment.
Certain followers of developments at Berkshire such as Alice Schroeder have criticized the decision due to concerns over reduced transparency. While there may be some overlap between the nature of business at a regulated utility and a railroad, does combining these two very different operations make sense?
Similar Economic Characteristics?
Warren Buffett makes the following comments in his letter to shareholders:
Our BNSF operation, it should be noted, has certain important economic characteristics that resemble those of our electric utilities. In both cases we provide fundamental services that are, and will remain, essential to the economic well-being of our customers, the communities we serve, and indeed the nation. Both will require heavy investment that greatly exceeds depreciation allowances for decades to come. Both must also plan far ahead to satisfy demand that is expected to outstrip the needs of the past. Finally, both require wise regulators who will provide certainty about allowable returns so that we can confidently make the huge investments required to maintain, replace and expand the plant.
Mr. Buffett also believes that the two businesses have similar characteristics in terms of debt use and retention of earnings:
In the future, BNSF results will be included in this “regulated utility” section. Aside from the two businesses having similar underlying economic characteristics, both are logical users of substantial amounts of debt that is not guaranteed by Berkshire. Both will retain most of their earnings. Both will earn and invest large sums in good times or bad, though the railroad will display the greater cyclicality. Overall, we expect this regulated sector to deliver significantly increased earnings over time, albeit at the cost of our investing many tens – yes, tens – of billions of dollars of incremental equity capital.
Both utilities and railroads have obvious similarities in terms of being highly capital intensive businesses that are subject to regulation and have major impacts on the communities and customers who are served. It also appears that Berkshire plans to operate both businesses with a similar philosophy in terms of taking a very long term view of capital investments and viewing both businesses as a destination for free cash flow generated by Berkshire’s diverse collection of businesses.
How Much Transparency is Reasonable?
From a shareholder perspective, many of us who follow Berkshire’s developments very closely would like to have much more transparency on a variety of business units. For example, it is not possible to get a full picture of Berkshire’s troubled NetJets business because it is included within the broad “Other Service” group within the “Manufacturing, Service, and Retailing” segment. From time to time, Mr. Buffett provides additional commentary regarding specific business units such as NetJets in his letters, but we cannot rely on granular information being made available on the business each year in a consistent manner.
It would be wonderful to see granular details of each and every business that Berkshire has ever purchased. See’s Candies was a separate segment until 1999 and is now a small part of a much larger segment. This is simply inevitable as Berkshire becomes much larger over time. Otherwise, quarterly reports might be 100 or 150 pages and the annual report would be a 400 to 500 page monster. Some of us would welcome the opportunity to go through the details but most shareholders would not and the result would be that even fewer shareholders and potential shareholders will bother to read the reports at all.
But BNSF Is Not See’s …
It is fair to note that BNSF is Berkshire’s largest acquisition and shareholders have a right to demand transparency. In particular, shareholders need to be able to determine whether the price paid for BNSF is justified after a period of three to five years passes. The question is what level of disclosure is required to make such a determination. Simply because BNSF will be included in the Regulated Utilities segment does not automatically mean that BNSF and MidAmerican’s results will be lumped together in a meaningless manner. We have examples of other subsidiaries within Berkshire such as Clayton Homes that are part of broader segments but still have sufficient granularity.
Those who are being critical about a lack of transparency should consider withholding judgment until Berkshire’s Q1 2010 report comes out in early May. The Q1 report will be the first to consolidate BNSF and we should be able to get a feel for how much disclosure is provided. Next year’s annual report will provide even more insight into how Berkshire plans to report on the business. Shareholders have a right to demand an appropriate level of transparency even if the CEO of the company is Warren Buffett. However, given that we have no idea exactly what we will get until May, it seems reasonable to wait until then to comment further.
The author owns shares of Berkshire Hathaway and is the author of The Rational Walk’s Berkshire Hathaway 2010 Briefing Book which provides a detailed analysis of the company along with estimates of intrinsic value.