Jan 11, 2010
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With Warren Buffett recently warning Kraft (NYSE:KFT) about issuing too many shares in pursuit of acquiring Cadbury, Andrew Bary over at Barron’s has an article regarding Berkshire Hathaway’s (NYSE:BRK.A) own share issuance related to its acquisition of Burlington Northern Santa Fe (NYSE:BNI). One of the areas that Bary touches on, is whether or not Berkshire itself is undervalued:
Based on earnings and book value, Berkshire fans consider the Class A very attractive now, at around $100,000 a share. After rising just 3% in 2009, the stock, which is way below its late 2007 peak of $149,000, fetches a mere 1.2 times our estimate of the company’s year-end 2009 book value of $84,500 a share — compared with an average 1.65 times in the past decade. The stock rarely has been cheaper, relative to book value, in 15 years…
Book value, moreover, understates what Buffett calls Berkshire’s intrinsic value: the discounted value of its cash flow. Buffett won’t estimate this, but has stated that it “significantly” exceeds book value, because auto insurer Geico and some other businesses are worth more than their carrying value on Berkshire’s balance sheet.
Berkshire’s book value could hit $92,000 to $95,000 a share this year if the financial markets stay strong. Thus, Berkshire may be trading below its 1.1 times forward book value. Why, then, is Buffett willing to issue equity for Burlington? He declined to comment last week, but he likes the railroad business, having accumulated a 22% stake in Burlington prior to the deal. In the past, he’s called the transaction “an all-in wager on the economic future of the United States.” And he’s said that, while he’s not enthusiastic about issuing more shares, the deal is too large to be all-cash and that he wants to give Burlington shareholders a tax-free option. Some think the 79-year-old investor wants to trim Berkshire’s $24 billion in cash to cut the pressure on his successor to make investments.
Still, Berkshire is paying a full price for Burlington — 18 times projected 2010 profits for a capital-intensive business. Other major rail companies are valued at about 15 times estimated 2010 earnings. One saving grace: Berkshire is using cash on its balance sheet and an estimated $8 billion in cheap financing for the deal, which uses a 60/40 mix of cash and stock.
The Buffett Paradox (Barron’s)
Bary goes on to note that it is interesting that Buffett is so willing to issue shares for Burlington as Berkshire trades around historically low price to book value multiples. He gives the General Re acquisition as a possible example where Buffett used his expensive stock as currency, at the time Berkshire traded at 3 times book value.
Berkshire Hathaway appears undervalued as it stands and I think that the decision to issue shares stems mainly from a need to acquire Burlington Northern. For Berkshire, the deal makes a lot of sense. Berkshire will get a large business to add to its other lines and help create a new cash flow stream and become less reliant on the company’s financial division. The long-term economics of the rail business seem positive enough to warrant buying the company without a discount and the $8B cheap financing is not very much when one considers the current dividend that Burlington Northern already pays out. Buffett always refers to Berkshire Hathaway as his masterpiece and this acquisition should ensure that the company is built to last through good and bad economic periods, without being so reliant on one key leader like himself.
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