By Jason Zweig (WSJ)
Warren Buffett’s purchase of Burlington Northern Santa Fe Corp. (BNI) is the newest chapter in the oldest story of his professional life.
Mr. Buffett’s mentor, the pioneering “value” investor Benjamin Graham, trafficked for decades in railroad stocks and bonds. In the early 1950s, at the outset of his career, Mr. Buffett read every page in Moody’s voluminous transportation manuals — twice, to make sure he didn’t miss anything. Working at Mr. Graham’s fund, Graham-Newman Corp., Mr. Buffett analyzed a portfolio with 21% to 36% of its assets in railroads.
But there is a more subtle side to the story. Mr. Graham taught Mr. Buffett that at the heart of the relationship between management and shareholders is a profound conflict of interest. Managers, Mr. Graham believed, will always want to pile up cash to protect themselves in case they make mistakes. But that cash belongs to the shareholders, who may be able to put it to better use than the company’s managers.
Graham also highlighted a painful paradox: The better the business and the more skilled its managers, the greater its profits, causing cash to pile up to unreasonable levels. And, to Mr. Buffett’s own chronic discomfort, he and Berkshire Hathaway are living proof of Mr. Graham’s paradox. Because of Mr. Buffett’s extraordinary skill at picking stocks and buying lucrative businesses, Berkshire consistently generates far more cash than even Mr. Buffett thinks he can put to productive use.
As long ago as 1998 — when Berkshire had $122 billion in assets and less than $14 billion in cash — Mr. Buffett worried his company was getting too big for its britches. “We have always known,” he wrote to a fellow investor, “that huge increases in managed funds would dramatically diminish our universe of investment choices.” That’s because investments of a few million dollars apiece could no longer make a material difference to Berkshire’s fortunes.
By 2006, when Berkshire’s cash mountain had risen to $37 billion, Mr. Buffett said, “We don’t like excess cash…We would be much happier if we had $10 billion.”
“Size is always a problem,” Mr. Buffett told me last month. “With tiny sums [to invest], it’s extraordinary what you can find. Most of the time, big sums are one hell of an anchor.”
Mr. Buffett would rather not resort to the simplest way of solving this problem — paying excess cash out to shareholders in the form of a dividend. Since he owns roughly 26% of Berkshire’s shares, a cash dividend would saddle Mr. Buffett with one of the largest personal-income tax bills in American history. That’s not the kind of thing at which he likes to excel. Mr. Buffett’s reluctance to pay a dividend leaves him with little choice but to buy big companies outright.
Mr. Buffett is paying for Burlington Northern partly with Berkshire shares — something he has long been loath to do. In 2007 he lamented buying Dexter Shoe in 1993 for $433 million in Berkshire stock — which would later have been worth at least $3.5 billion if Mr. Buffett had not exchanged them for Dexter, which ended up worthless. “He’s so sensitive to this issue that I can’t believe he would [pay in stock for Burlington Northern] unless he had absolute confidence that it will work out well over time,” says David Carr of Oak Value Fund, which owns $25 million in Berkshire shares.
At age 79, Mr. Buffett has no plans to retire, but he wants to ensure that Berkshire’s businesses will endure for decades after he is gone. He is betting that no new technology can make rail transportation obsolete. Mr. Buffett has sometimes been wrong about which businesses will prosper forever. Over the years, he’s invested in shoes, newspapers and printed encyclopedias. But Mr. Buffett’s approach underscores a key lesson for any investor: Before you buy any business, ask how vulnerable it is to new technology or price competition.
As a result of the Burlington Northern deal, Berkshire’s Class B shares will split 50-for-1, which would knock its share price down from $3,300 to $65. That puts the shares, for the first time in years, within psychological reach of most investors (who have long balked at Berkshire’s high per-share price).
Like Burlington Northern itself, Berkshire’s shares aren’t quite a steal. Mr. Buffett is putting tens of billions of dollars into a company that he thinks has only moderate growth prospects. That implies that the market as a whole isn’t a steal, or he would have put the money elsewhere. But Mr. Buffett has built an investing bulwark — and an industrial conglomerate. Berkshire is likely to survive any storm, but whether it can continue to beat the market by such wide margins is another story.