Buffett's Burlington Northern Buy: Not Such A Bargain?

warrenbuffett concerned tbi

Shockingly, investors are actually bidding up shares of Berkshire Hathaway (BRK) following the news that it’s spending $44 billion to buy Burlington Northern (BNI). We’re not suggesting it’s a bad deal, only that when you’re paying out such a monster counterparty, you’re usually going to get a selloff not this time.

That being said, some folks aren’t so impressed with the deal.

Reuters’ Rolfe Winkler runs some quick numbers:

So I thought I’d do a little number crunching on Buffett’s Burlington deal. What does that tell us? That Buffett is paying a full price for a business with mediocre returns on capital, that he’s betting on growth, not value.

Valuation (based on share prices of $100 for Burlington, $59 for Union Pacific, and $48 for Norfolk Southern):

  • Enterprise Value to 2010 unlevered free cash flow (think of this as a better alternative to P/E ratios): BNI = 29x UNP = 24x NSC = 18x
  • BNI = 29x
  • UNP = 24x
  • NSC = 18x
  • Return on capital employed (based on 2010 operating income and year-end ’10 balance sheet estimates. BNI = 11% UNP = 10% NSC = 10%
  • BNI = 11%
  • UNP = 10%
  • NSC = 10%

(I’m using Stifel Nicolaus estimates for 2010)

The cash flow characteristics of the business aren’t very good. From 1999 to 2009, BNI poured 68% of operating cash flow back into capital expenditures. That’s cash flow that doesn’t go to shareholders.

That corroborates what we said earlier: That Buffett’s bet is on future stimulus, not merely on the railroad spinning of a ton of cash in its current form. Suddenly, we’re guessing, a lot of Berkshire shareholders just got really, really liberal.

NOW WATCH: Money & Markets videos

Want to read a more in-depth view on the trends influencing Australian business and the global economy? BI / Research is designed to help executives and industry leaders understand the major challenges and opportunities for industry, technology, strategy and the economy in the future. Sign up for free at research.businessinsider.com.au.