Tuesday, November 3, 2009

Merger Arbitrage Play on Berkshire Hathaway and Burlington Northern


Warren Buffett's surprise announcement that Berkshire Hathaway was buying the rest of Burlington Northern this morning shocked me quite a bit, especially since I'm a long time Berkshire shareholder and I follow the company closely.

So far, I don't like the deal.

I think BNI is a great company but just not at this price or these terms or for the effect it will have on Berkshire and its long standing unique shareholder culture.

But I also see a great profit opportunity here so I'll swallow some bitter medicine to feel healthy at the bank.

First objection, the price.

Berkshire is paying a 31.5% premium over yesterday's closing price. Why? Berkshire already owns 22% of BNI. Why not just keep buying shares quietly on the open market? Clearly management of BNI is happy with Warren's investments in the company and wouldn't object to him owning more. Why not save billions of dollars and just creep along buying at discount prices? Check out the chart above. Berkshire is buying BNI at nearly its all time high price---but at the bottom of an economic recession, not at the height of a boom.

Second objection, the structure of the deal.

Berkshire is paying 60% cash, 40% stock to do this deal. Warren has learned from the past about doing merger deals for stock. Remember Dexter Shoe? He's often wrote about what a mistake this was. Why do it now? Why trade a good chuck of the future of Berkshire and its tremendous earning capacity for a railroad company? It's a good one, no doubt, but a company with limited growth prospects and a voracious appetite for cash.

Third objection, the stock split.

Berkshire's B shares will be split 50-1. Again, why? The whole reason B shares exist at all is that Warren wanted to discourage speculation in Berkshire's stock. Now at $65.30 a share, Berkshire will be the focus of intense stock speculation. It's affordable for the first time since 1969.

And why make all these corporate altering decisions when a management transition is in the works? In every annual report and at every shareholder meeting Warren discusses what happens when he dies or is incapacitated by illness. So why change Berkshire so radically when a new team may take the field in the coming years?

I agree that Warren is buying BNI at the right time. Great timing, in fact. But he could be buying millions of shares today at $76. Instead he's buying hundreds of millions of them at $100 instead. And paying for those, in substantial part, with Berkshire equity and not cash.

So what is the profit play on all this for me?

I picked up some BNI today at $97.60. Basic merger arbitrage play of which Buffett himself has done many. Warren has promised to pay $100 per share. Easy profit. I'm very sure (and so is Warren, I bet) that the regulators won't stop this deal. Berkshire also owns millions of shares of other railroad stocks. I'll pick up some more Berkshire shares and a small cash profit for very low risk.

Robert J. Abalos, Esq.