Warren Buffett’s BNI Intrinsic Value Calculation

November 6th, 2009

I’ve been hearing a lot about Buffett’s purchase of BNI.

Whether the choice of a partial stock deal means that Buffett considers Berkshire shares to be overvalued, or whether Buffett is going “all in” in American stocks and commodities, or is he just making a last hurrah of asset allocation before retiring? Maybe he is simply bearish on the entire economy.

Whatever the reason, it will be easier to just wait until Buffett says something.

In the meantime, let’s take a look at whether Buffett is getting a good deal on BNI or paying a reasonable price.

Back in August as I went through each of Warren Buffett’s stock picks in the Berkshire portfolio, I posted the following on BNI.

Burlington Northern Santa Fe (BNI) Stock Value

Burlington Northern Santa Fe is a holding company and engaged primarily in the freight rail transportation business.

Impressive FCF growth previous 4 years and especially last year
High capex but latest annual result was extraordinary
lower sales and margins but improved efficiency in returns and turnover
CROIC is on the low side at 3%
Top line growth is also above average at 14%
Debt to equity ratio is above 200% which isn’t uncommon for capex heavy companies

I came to the conclusion that the intrinsic value of BNI was $80-$140.

When I first calculated the intrinsic value of BNI, I chose to be conservative and reduced the latest year FCF by a significant amount as it was just too good compared to previous years. Not knowing about the details of BNI, I just left it at that and concluded that the intrinsic value had been reached at $87.

If I now go back to the intrinsic value calculator and leave the FCF number as is with a default 11.6% growth rate and 9% discount rate, the stock price calculation shows the following:

DCF Intrinsic Value: $104.30

BNI Intrinsic Value

Benjamin Graham Value: $102.67

BNI Graham Formula

From these numbers I can conclude that

Buffett is either paying a small premium to the intrinsic value of $87. About 15% and not the 25-30% people are led to believe based on the closing date price of the announcement.
or Buffett is paying a fair price for a company that will generate future cash for Berkshire Hathaway.

Typical Old School Buffett

Whatever the reason for the purchase, one thing is clear. The purchase of BNI wasn’t a cheap one. But like his investment in See’s, it could turn out to be one of his best ideas. He didn’t overpay by too much so the margin of safety should still be there.

Price is what you pay, value is what you get. – Buffett

Disclosure

No holding

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- Luis

Been following your work for a while and think you are doing a great job!

I wanted to make a quick comment on your last paragraph. The concept of margin of safety implies that there is room to be wrong. If you pay a fair price (no discount) or a premium by definition you have no margin of error. That does not mean that your purchase will not work out, just that there is no margin for error.

If Buffett paid full price or a premium for the assets, he has no margin of safety on the valuation. I would say his only margin of safety is his and his managers talent/skills at running successful companies.

- Jim

Good article Jae.
.-= Jim´s last blog ..Gannett Co., Inc. – Undervalued =-.

- Sivaram Velauthapillai

Unless one expects sales (or profits) to grow at the rate it has in the last 5 years–highly questionable IMO–I don’t see why Buffett picked Burlington Northern Santa Fe. As you point out, it is traditionally a high capex industry with low returns on equity.

I’m not really arguing Warren Buffett overpaid for BNSF but why tie up $40 billion (total, including currently owned stake) in such a business?

An interesting thing to note is that this is a leveraged buyout. I’m not an expert on Buffett’s investment or Berkshire Hathaway but htis might be his first major buyout involving large amounts of debt (around $8 billion.) Buffett is financing around half of the stake with debt. I wonder if this may be a factor in the buyout. I wonder if he is boosting his return through financial leverage. The debt under consideration apparently has 3 year term so it’s not really long-term leverage but I wonder if Berkshire will re-finance in 3 years and maintain the debt level. If Berkshire maintains the debt level, returns to shareholders will be boosted slightly.

In any case, I, as well as most observers, are clearly missing the core reason for this purchase. It’s like his Coca-Cola purchase which turned out to be great but no one understood it at the time.
.-= Sivaram Velauthapillai´s last blog ..Articles for a Friday =-.

- Jae Jun

Hi Luis,
It’s been a while. Good point about the last paragraph. I don’t think I make sense at all. It was around 2am and I just wasn’t thinking straight. lol.

Sivaram,
It’s interesting to try and dissect his motives for the purchase but in the end, we’ll have to see whether it was worth it. Buffett could be making a macro call but time will tell.

- Tyler

Hi Jae,

I Really encourage you to take a look at Telstra on the ASX. I Bought some recently.
DCF = $5 with a discount rate of 11%

Warren Buffett’s BNI Intrinsic Value Calculation

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