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Tuesday, December 29, 2009

Warren Buffett Explains BNSF Deal; Hazardous/Solid Waste Companies Similar; In Search of See's Candy-Like Companies

Last week, Burlington Northern Santa Fe Corp. (BNI, $98.73) filed a transcript with the SEC of an interview with Berkshire Hathaway's (BRK-A, BRK-B) Warren Buffett regarding the proposed acquisition of BNSF by Berkshire. The transcript is worth a read and can be found here. A Reuters article also summarized the news here.

Like Berkshire Hathaway's investment in MidAmerican Energy Holdings and BYD (post here), BNSF falls outside of Mr. Buffett's "prototype of a dream business" -- the kind that generates significant, growing excess earnings without significant capital investment (e.g. See's Candy - please see Berkshire's 2007 Annual Report for Mr. Buffett's lucid, insightful discussion).

Energy and railroad businesses both require meaningful capital investment for maintenance and expansion. However, both provide necessary services and can establish/achieve durable competitive advantages (e.g. regulatory approvals/licenses and impossible-to-replicate right of ways and/or plant locations) that assure investors that the companies will be around in ten, twenty, thirty years. This seems to be Berkshire Hathaway's primary thesis in purchasing BNSF. From the transcript:
  • Question from BNSF's CEO: You said in the past, you’d rather buy a great business at a fair price than a fair business at a great price. What does BNSF meet the definition of a great business?
  • WB: Well, it’s a great business in that you know it’s going to be here forever, to start with. I mean, the hula-hoop business came and, you know, went, and then, you know, the pet rocks and all that kind of thing. And even television set manufacturers have, you know, moved over to Japan. All of that sort of thing. The rail business is not going to go anyplace. It’s going to be right here in the United States. There’s going to be four big railroads that are moving more and more goods. So it’s, it’s, it’s a good business. It, it can’t be, it can’t be something like Coca Cola or Google, because it’s, you know, it’s a public service type business, too, and it has, it has a fair amount of regulation that is part of the picture. But it’ll be a good business over time. It will make sense for this country to want railroads to continue to invest more and more money, in terms of expanding and becoming more efficient. So you’re on the side of society, and society will largely be on your side. Not every day, but most of the time.
Mr. Buffett goes on to say that, as with other investments, Berkshire Hathaway will sit in the back seat and let existing managers run BNSF, stating "We’ve got 20 people in Omaha, and there isn’t one of them that knows how to run a railroad." He also talks on the importance of owning businesses with passionate managers, among other things.

Although we looked at some railroad companies last spring, we didn't get comfortable with weak fundamentals and ongoing capital requirements. In addition, while we own some REITs and other asset-based companies, we retain a preference for asset-light, cash generating businesses such as eBay (EBAY - prior post here) and PetMed Express (PETS - prior post here) -- that is, we're in search of See's Candy-like companies.

For a brief comparison, look at BNSF's historical 2006-2008 annual operating cash flows and capital expenditures (in this case, consider free cash flow defined as OCF less capex) -- from Yahoo! Finance (YHOO):

And, that of eBay:

BNSF generates free cash flow, but not nearly as much as eBay. While the latter is a "new economy" company and the Internet will continue to evolve, we're fairly certain eBay will not only be around, but that excess cash will keep piling up on eBay's balance sheet over time, enabling share repurchases, additional acquisitions, and potential dividends.

However, we understand the case for owning well-positioned asset-heavy companies at the right price. In this regard, we think hazardous waste companies Clean Harbors (CLH) and American Ecology (ECOL) might fit the bill. Per our prior posts, we continue to watch these companies and did initiate a small position in Casella Waste Systems (CWST - solid waste services, not hazardous) in November.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long BRK-B, CWST, PETS, EBAY, YHOO.
© 2009 Jeffrey Walkenhorst
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