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Warren Buffett is heading for retirement. Earlier this year, the Berkshire Hathaway (NYSE:BRK.B) CEO announced his intention to stand down at the end of the year.
I think, however, there’s still time for one last big deal before Buffett hands over to Greg Abel. And an ideal opportunity might just have presented itself.
Railroads
One of Berkshire’s largest subsidiaries is Burlington Northern Santa Fe (BNSF). It’s one of the four Class 1 railroads in the US and operates along the western side of the country.
Its competitor over there is Union Pacific, with CSX and Norfolk Southern over in the east. And those regional duopolies have led to some very attractive unit economics for the businesses.
Despite high capital requirements, the major railroads all have operating margins comparable to Microsoft. And they offer customers a much cheaper way of moving freight than trucking.
The competitive dynamic, however, is set to change. Union Pacific (in the west) has agreed to merge with Norfolk Southern (in the east) and that raises a question for Berkshire Hathaway.
Consolodation
Combining Union Pacific and Norfolk Southern could have some significant benefits. Most notably, it could improve efficiency for goods moving across the country.
At the moment, goods travelling from east to west (or the other way around) are usually handed off from one railroad company to another. But this creates waiting times and difficulties for operators who are picking up products.
A single network operating across the country could solve this problem. And it would still mean there are two Class 1 railroads on each side of the country, so antitrust concerns shouldn’t arise.
It would, however, put both the remaining railroads at a disadvantage. So the big question is whether Berkshire might respond by trying to acquire CSX to combine with BNSF.
Obstacles
The idea of Buffett doing one last big deal before stepping down is very tempting, but there are a couple of obstacles in the way. One is the differences in approach between BNSF and CSX.
Unlike all the other major railroads, Berkshire hasn’t gone in for precision scheduled railroading (PSR). In short, it has looked to focus on revenues and customer service, rather than margins.
Union Pacific, Norfolk Southern, and CSX have all implemented elements of PSR. As a result, joining BNSF with CSX is more complicated than combining Union Pacific and Norfolk Southern.
The other issue is price. Buffett is well-known for looking to be opportunistic and buying shares when they trade at unusual discounts. That isn’t obviously true of CSX a the moment.
One last big deal?
The proposed merger of Union Pacific and Norfolk Southern presents Buffett with a dilemma. It threatens to create a stronger competitor and the only way to prevent this is to buy CSX.
Berkshire has denied reports that it has contacted Goldman Sachs to explore a deal. I believe it hasn’t, but only because Buffett typically tries to avoid paying investment bankers for advice.
Whether or not we’ll see one last deal before Buffett retires remains to be seen. But one thing I’m sure of is that Berkshire has the cash to make it happen.
Whatever happens, I think any of the US railroad stocks are worth considering. Their long-term competitive advantages – together or separately – make them stand out to me as investments.
