Buffett has bought a $34 billion seat on 'rail renaissance'

Billionaire investor Warren Buffett's acquisition of railroad giant Burlington Northern Santa Fe Corp. is the biggest bet yet on a U.S. economic recovery, one that could resonate from the international sea lanes to the railroads crisscrossing the country.

Burlington Northern is the nation's largest rail transporter of coal and grain, and it provides a vital link for consumer goods from Asia to the rest of the county, timber from the West, grain from the Midwest and imports arriving directly from Mexico and Canada, as well as through California ports.

"It's an all-in wager on the economic future of the United States," Buffett said in a statement announcing the deal last week. "I love these bets."

Agreeing to buy

the 131-year-old railroad might strike many as a bit old-fashioned -- more 19th century than 21st. But Buffett is wagering that the demand for goods transported by trains will grow as the economy recovers.

And railroads, Buffett contends, are transportation for a fossil fuel-challenged future, because trains are generally more efficient and greener than trucks.

But for Buffett, the deal is also the fulfillment of a dream denied in childhood. "This is all happening because my father didn't buy me a train set as a kid," Buffett joked in an interview.

His new toy will not come cheaply. Berkshire Hathaway Inc., the conglomerate he runs, will spend roughly $26 billion for the 77.4 percent of the railroad that it does

not already own, paying $100 a share in cash and stock. His investment is $34 billion, not counting assumed debt.

The purchase stunned Wall Street, but was vintage Buffett. The 79-year-old investor, through Berkshire Hathaway, is known as the "Oracle of Omaha" for making shrewd investments that include Coca-Cola Co. when it was being challenged by PepsiCo Inc. and Goldman Sachs Group Inc. when financial stocks were considered toxic during the economic collapse.

Buffett's interest in railroads puzzled some investors because the once mighty industry that fueled the industrial revolution a century ago has been fading for decades. But Buffett is buying into what Anthony Hatch, an independent transportation analyst, called a "rail renaissance."

Railroads lost significant market share after the interstate highway system launched in the 1950s during the Eisenhower administration made it easier to ship cargo by truck. Now, however, the 21st century focus on fuel efficiency is helping rail companies chug their way back.

Globalization is adding to rail's comeback, because much of the cargo coming into ports such as Los Angeles and Long Beach is freighted across the country by rail.

"People now view rail as a part of our efficiency infrastructure and carbon solution," Hatch said. "Just a few years ago, rail was thought to be a waste of time."

Burlington Northern carries a wide variety of goods including food, clothing and electronics. Its largest business segment last quarter -- more than 30 percent -- was moving consumer goods such as televisions, refrigerators and clothing from the West Coast to Midwestern cities such as Chicago and St. Louis. Burlington Northern also hauls imported cars from manufacturers including Toyota and Honda.

Buffett believes that by carrying such an assortment of goods, Burlington Northern is a gauge for the health of the U.S. economy.

"Our country's future prosperity depends on its having an efficient and well-maintained rail system," Buffett said. "Conversely, America must grow and prosper for railroads to do well."

Keith Schoonmaker, an equity analyst with Chicago-based Morningstar, said the acquisition -- which is subject to regulatory approval -- showed Buffett's confidence that the U.S. economy would bounce back in the long term.

"It's an investment that looks toward the next decade. Not the next quarter," Schoonmaker said.

Burlington Northern is also Buffett's kind of business. A model-train aficionado, the nation's second-richest citizen (after Microsoft's Corp.'s Bill Gates) has often espoused a simple axiom that investors should invest in what they know well.

Berkshire already holds stock in other railroad companies, Union Pacific Corp. and Norfolk Southern Corp. Also, Burlington Northern has a significant presence in Omaha, Buffett's hometown.

At the same time, rail companies have been hit by the economic downturn as cash-strapped consumers rein in their spending.

Total volume on U.S. railroads for the third week in October was down 13.4 percent from the same period last year. In the West, carloads were down 14.8 percent from the same time the previous year, and 15.8 percent from 2007, according to the Association of American Railroads.

The downturn was clearly evident this summer at Burlington Northern's facility in the sprawling Hobart Railyard south of downtown Los Angeles, where cranes sat silent and several of the loading areas were idle.

Burlington Northern, which saw revenues fall 27 percent in the third quarter from a year earlier, is an undervalued asset for Buffett, said Lee Klaskow, senior transportation and logistics analyst at Longbow Research.

His purchase of Burlington Northern is a bet on its "long-term growth potential," Klaskow said.

It is also a costly wager for an investor who has typically purchased shares at the low end. The company agreed to pay $100 a share in cash and stock, a hefty 31.5 percent premium over Monday's closing price and 18 times the estimated earnings for 2010.

Analysts cautioned that it could take years for the purchase to pay off, but investors were giddy at the news -- bidding Burlington Northern shares up 28 percent to $97 last week. At the market bottom last March, shares were trading around $50.

In addition to cash and stock, Buffett's Berkshire would also assume $10 billion in Burlington Northern's debt, increasing the total value of the deal to $44 billion.

The acquisition was approved by the boards of both companies. It now needs anti-trust clearance and two-thirds approval by Burlington Northern's shareholders. They hope to close the deal by the first quarter of 2010.

Part of Buffett's investment in the railroad company might not be related to freight at all. He could be looking at the $8 billion in stimulus money the federal government has set aside to boost the economy, said Steve Ditmeyer, an adjunct professor with Michigan State University's Railway Management Program.

Some of that money could go toward upgrading freight lines so that higher-speed trains can run on them, which would in term make the freight trains go faster, he said. And with 32,000 miles of track, Burlington Northern would likely benefit.

"It could be a win-win situation," he said.

With more focus on the environment, Buffett may also see the advantage of more energy-efficient freight trains that use less fuel than trucks.

During a 2007 Berkshire annual shareholder meeting, Buffett pointed out that as oil prices spiked, higher diesel fuel costs went up for rails as well. But truckers were affected four times as much, he said.

"There could be a lot more business there than there was in the past," Buffett said at the time.

The New York Times contributed to this story