Oak Value Fund Portfolio Managers Take Questions from Morningstar - January 22, 2010
1. What’s your take on Berkshire’s investment in Burlington Northern?
When it comes to the long-distance transportation of goods in the U.S., the lowest cost, most energy efficient mode of transportation is rail. Though the capital-intensive nature of the business contributes to significant barriers to entry, the industry has historically been characterized as a low return, cyclical business with poor customer service. Variations of the expression “what a way to run a railroad” are generally viewed as less-than-complimentary for good reason.
Perceptions aside, there are several reasons why the railroad business is evolving for the better. First, with the consolidation of the players over the past quarter century, the competitive dynamics within the industry have been gradually improving. Second, the industry has embraced the use of technology to improve customer service, operating efficiency and shareholder returns. From a broader value chain perspective, the railroad industry operates as a high fixed cost, low variable cost provider while the trucking industry generally functions in an environment that involves lower fixed costs and higher variable costs. In our view, these basic structural differences that allow the rails to move goods at less cost while consuming less energy are likely to advantage the rails in periods of inflation and rising variable costs.
We view Berkshire’s decision to purchase the country’s second largest railroad as a textbook example of Mr. Buffett’s longstanding view that it is better to pay a fair price for a good business than a good price for a fair business, particularly when one has the ability to source large amounts of inexpensive capital. Burlington’s geographic footprint in the West, where long-term growth prospects appear to be above average, could make it especially compelling. The Burlington network is positioned to benefit from increased volume of imports to the West Coast, increased transport of coal out of the Rockies and increased movement of grain out of America’s heartland. As one of the industry’s largest players, Burlington should benefit from structural and competitive advantages for many years.
Shares of Berkshire Hathaway have recently treaded water as the investment community has seemed preoccupied with the task of interpreting some “hidden message” in the timing and/or structure of the Burlington transaction. In our opinion, the most important message for observers to glean from this transaction is the sheer economic power of the Berkshire Hathaway business model to accomplish such a transaction at this point in time. As a long-term investor with significant capital and a diverse collection of businesses and investments, Berkshire may well be the ideal owner for a cyclical, capital-intensive business that benefits from the basic laws of physics and is positioned to be a toll bridge on economic growth.
