November 3rd 2009
Source: Financial Post
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Shares in Canadian railways jumped Tuesday on
the news that Warren Buffet’s plans to acquire Burlington Northern
Santa Fe Railway. It also renewed speculation that a smaller player
in the sector, like Canadian Pacific Railway Ltd., might also be on
the radar of would-be buyers in the current market.
The US$44-billion Buffet bid Tuesday at once served as another
endorsement of the thesis that railways are a long-term investment
and as a boost of confidence that the economy is beginning to claw
its way out of the recession, said Fadi Chamoun, a UBS analyst.
“It’s really a play on the economy and a play on the rail business
model,” he said in an interview. “I don’t see a lot of M&A in this
sector. I think this is a unique situation with Berkshire
privatizing BNSF. I don’t think there are a lot of $40-billion guys
waiting to buy up railroads.”
But, he did acknowledge that CP, which is the smallest of the North
American Class 1 rails, might attract some attention based on its
While Mr. Buffet has expressed admiration for the railway’s larger
domestic rival, Canadian National Railway Co., investors are only
allowed to own 15% of the former Crown corporation. CP has none of
the same restrictions, making it the only real play in the Canadian
Two years ago, when the so-called rail renaissance was at its peak,
Toronto investment house Brookfield Asset Management Inc. was one of
a handful of private equity players kicking the tires at CP when its
stock was trading above $70 a share. A deal at the time was
estimated to be worth more than $15-billion.
CP’s management, however, rebuffed Brookfield and the other players,
and entered into an agreement in the ensuing months to use its
stockpile of cash to acquire Dakota, Minnesota, & Eastern Railroad
for nearly $1.5-billion in what was deemed at the time as a
defensive move against future offers.
Ironically, the DM&E acquisition might make CP even more attractive
this time around after Mr. Buffet’s bid for BNSF.
While the DM&E increased CP’s exposure to the ethanol trade, the
real gem in the deal was the rights the regional railway had to
build into the coal-rich region of the Powder River Basin, which
straddles the Montana and Wyoming border and is the fastest growing
region for thermal coal in North America used in the production of
electricity. Currently, the basin is only served by BNSF and Union
Mr. Buffet’s Berkshire Hathaway already owns MidAmerican Energy
Holdings Co., and the BNSF offer was veiwed by some analysts as a
way of vertically integrating the U.S. expansion into coal-fired
“Apart from a bet on the broad U.S. recovery, Berkshire may also be
looking for an indirect exposure to coal, specifically Powder River
Basin coal,” said David Newman, National Bank Financial analyst.
“While demand for thermal coal has moderated due to high stockpiles
and reduced electricity generation, longer term, the prospects
remain favourable.... The Powder River Basin coal is abundant,
relatively clean, and cheap.”
Roughly a quarter of BNSF’s sales last year were derived from
shipments of coal, of which 90% was pulled from the Powder River
CP has yet to decide whether it will push ahead with the development
of Powder River Basin rail line, but it does come with a substantial
price tag. Not only is the whole project expected to cost roughly
$4-billion, but CP would have to pay an additional $1-billion to the
former owners of the DM&E if it starts moving coal along those lines
before 2025 as set out in its purchase agreement.
Still, even without the Powder River Basin project, CP might prove a
shrewd acquisition at the 18 times projected 2010 earnings per share
Mr. Buffet offered for BNSF. With all indicators suggesting freight
volume declines are on the mend, that multiple paid may actually be
12 or 13 times actual earnings, Mr. Newman said.
“Who knows? This could serve as a catalyst for anybody that was
sitting on the sidelines,” he said. “I was frankly surprised the
last go around that ports were being taken over and other
infrastructure was being targeted and railroads were not. It’s just
a natural infrastructure target in my view, and a key one.