Berkshire's New Investment

It was announced earlier this week that Berkshire Hathaway made an offer to acquire Burlington Northern Santa Fe Corp. The offer consists of a cash and stock offering that values the company at $34 billion, which will cost Berkshire $26.3 billion for shares that it does not own. This deal would be the largest purchase in the history of Berkshire, and also includes an interesting component as it relates to the stock offering. Warren Buffett, Chairman and CEO of Berkshire Hathaway, has maintained a long-held belief that stock splits did not help to increase the value of the company. Berkshire Class A stock is by far the most expensive on any of the stock exchanges. It has a current price of more than $100,000 a share. As a result of this Burlington Northern offer, Berkshire has proposed 50 to 1 stock split for Class B stock. This will value the Class B at around $65 and will offer a tax-free option to the owners of Burlington Northern.

As unusual of a purchase as this would be for other companies, this is within the normal parameters for Berkshire. Warren Buffett is a value investor and only invests in companies that he understands. He stayed away from companies that were rapidly growing during the technology bubble. As a long-term investor, he is willing to forego short-term gains to have successful long-term investments. Buffett believes the acquisition of Burlington Northern is a big bet on the United States. As the country’s industrial business starts picking back up and the emphasis on “going green” continues, trains are a logical investment. They are the most fuel efficient way of transporting goods long distances.

After the announcement of the deal, S&P put Berkshire on CreditWatch for downgrade. Currently Berkshire is rated AAA from S&P and AA from Moody’s and Fitch. This credit watch is typical after the announcement of such a deal. Berkshire lost its AAA rating from Moody’s and Fitch earlier this year. This was due to the large exposure to the equity markets. The credit rating is based on the ability of a company to repay its debt. The highest rating is AAA and implies that there is a very small risk of default. Only four United States companies still have a AAA rating: Automated Data Processing, ExxonMobil, Johnson & Johnson, and Microsoft. The next highest rating of AA is still very good and represents a solid company with a low risk of defaulting on its debt. The credit rating affects the interest rate a company must pay for its debt. If Berkshire needs to issue additional debt, this lower rating would make it more expensive for them to borrow.

The factors that affect credit rating are the previous history of repayments and the current availability and liquidity of funds. It is estimated that the cash portion of the Burlington Northern deal will total around $15 billion. The money for acquisitions has traditionally come from the insurance portion of Berkshire’s portfolio. As a result, John Iten from S&P said, “We believe that this transaction will decrease the liquidity and capital adequacy of the insurance operations.” In an interview with CNBC, Buffett said that Berkshire will have $20 billion in consolidated cash after the acquisition is complete.

Since two of the credit rating agencies already have Berkshire at an AA, it will not be that significant if the third one does as well. On the opposite side of the deal, Burlington Northern was put on CreditWatch with positive implications. Their rating will most likely not increase more than one notch. While this deal has not officially happened, it is expected to by early next year. After this deal is completed, both Berkshire and Burlington Northern’s Credit rating will be re-examined. Since additional debt is being incurred, it seems likely that a downgrade will occur. On the other hand, Warren Buffett has a history of successful acquisitions, so this expected downgrade may be short-lived.