Found an article that BNSF paid Berkshire Hathaway a $1B dividend this year and $1.5B to BH after the buyout in 2010. Appears that this will be more than enough to pay for the carrying costs of the amount BH had to allocate for the purchase?
Not following your question.
I am not sure how BNSF/BH accounting is handled (if earnings are in the form of a dividend, etc). Where did you read the article?
Ed
Try railway age:
http://www.railwayage.com/breaking-news/berkshires-billion-dollar-bnsf-dividend.html
My question is does this mean that BH made a very good buy?
BNSF’s financial statements are consolidated into the Berkshire statements, so intercompany dividends have no effect on consolidated reported earnings. In addition, BH has a long term problem in finding sufficiently profitable enterprises in which to invest. Under those circumstances, it is entirely possible that they might decide retention of the cash in BNSF to fund additional capital projects is the best available investment.
Based on the $22 Billion that BH used to buy the rest of BNSF that it didn’t already own (per the lInked Railway Age article) - those are annual returns of 4.54 % and 6.82 %, respectively - considerably better than what’s available in money market funds, CDs, most bonds, and most stock investments. For comparison, to recover a borrowed amount over 30 years at 6.00 % interest requires an annual ‘payback’ of about 7.2 %, so they’re not too far off that as a ‘benchmark’.
Without a doubt it was a good buy - the RA article provides some more details.
- Paul North.
To expand a bit, I believe I saw somewhere on the UP website that for most of their capital projects, the “hurdle rate” (the threshold rate for return on invested capital below which a corporation will not undertake a capital investment) for their capital projects was something like 20 percent. In other words, if the projected annualized return for a given project is less than 20 percent, invest the funds elsewhere. Since before it got bought by Berkshire Hathaway, BNSF and UP were in the same risk class (same size, same business, roughly comparable sets of risks and opportunities), we can reasonably assume a similar 20 percent hurdle rate for BNSF holds., then pumping capital that is otherwise just sitting around into BNSF isn’t such a bad idea by the Buffett gang at Berkshire. A 20 percent return beats the pants off of 7.2 percent. Until the
Here is an article on Buffett’s planned acquisition of Lubrizol Corp for $9 Billion announced this morning. http://www.npr.org/templates/story/story.php?storyId=134527518
In other ages - such as the 1960’s - 1970’s, with different participants and reputations, and with the railroad in less great condition (physical and economic) than it is now, this would have been called “looting the railroad subsidiary to enrich the parent conglomerate corporation”. Many railroad “holding companies” back then were accused of that, not the least being Penn Central . . . . [:-^]
Without some objective reference as to the condition of the railroad and the amounts involved, it could be hard to tell the difference. In my view, an honest and profitable relationship would be a “2-way street” of money flows - into the railroad when it needs it for sensible investment that can yield a profit, and then a return on that investment back to the parent, together with the profits of the investment and other operations, etc. This appear to be of the latter kind.
- Paul North.
[quote user=“billio”]
Paul_D_North_Jr:
blue streak 1:
Found an article that BNSF paid Berkshire Hathaway a $1B dividend this year and $1.5B to BH after the buyout in 2010. Appears that this will be more than enough to pay for the carrying costs of the amount BH had to allocate for the purchase?Based on the $22 Billion that BH used to buy the rest of BNSF that it didn’t already own (per the lInked Railway Age article) - those are annual returns of 4.54 % and 6.82 %, respectively - considerably better than what’s available in money market funds, CDs, most bonds, and most stock investments. For comparison, to recover a borrowed amount over 30 years at 6.00 % interest requires an annual ‘payback’ of about 7.2 %, so they’re not too far off that as a ‘benchmark’.
Without a doubt it was a good buy - the RA article provides some more details.
- Paul North.
To expand a bit, I believe I saw somewhere on the UP website that for most of their capital projects, the “hurdle rate” (the threshold rate for return on invested capital below which a corporation will not undertake a capital investment) for their capital projects was something like 20 percent. In other words, if the projected annualized return for a given project is less than 20 percent, invest the funds elsewhere. Since before it got bought by Berkshire Hathaway, BNSF and UP were in the same risk class (same size, same business, roughly comparable sets of risks and opportunities), we can reasonably assume a similar 20 percent hurdle rate for BNSF holds., then pumping capital that is otherwise just sitting around into B
With respect - I too am under the impression that the ‘hurdle’ for capital projects that are “internally” financed by the railroad’s own internally-generated cash flow from operations - and perhaps for those financed from outside sources as well - is in the range of 20%, and was going to post to that effect as well. The rationale is that there are so many worthy projects - aside from those already mandated by law, regulation, contract, etc. - competing for the limited remaining capital available that in accordance with the theory, the Internal Rate of Return is calculated for each, and those with the highest IRR’s get the priority for funding, starting from the top down. As a matter of administrative practice and result, the informal rule of thumb is not to bother doing an extensive work-up and submitting a project if the IRR is much below 20%, because there will usually be enough other projects with higher IRR’s that will get funded and thereby use up all of the available capital funds.
I’m pretty sure we had a well-informed discussion of this within the last year or two, or another thread here. If I recall correctly, someone - pehaps dining car also ? - made the point that proposed projects which are funded and implemented ought to be audited after a year or two to make sure that the actual returns/ profits lived up to the expectations and promises of their sponsors.
More broadly, as a matter of policy and shareholder relations, the company may have decided that if the IRR for proposed projects is less than 20%, then it is better for the RR to keep the money as cash and do something else with it instead that supposedly has better IRR prospects - such as acquire another company - or other perhaps intangible benefits such as doing more to enhance shareholder value, such as either keep it as “retained earnings”, pay it out as dividends, or pay it out via a "sto
My railroad, CNI (Canadian National) has a 12 month return on investment of 18.7% and return on invested capital of 12%.
So, a hurdle rate of 20% is pretty reasonable.
I am not sure if I would want the company to in vest in 10% deals when they could be returning that $$$ to me either in the form of dividend payments or repurchased shares.
Ed
Thanks for that confirmation and additional “data points”. What is the “base” for each of those “return” figures ? Book value of stockholder’s equity ? Market capitalization ? Net asset value ? Something else ?
But I would - because even if they returned that $$$ to me either way, none of the investment opportunities available to me would yield anywhere near 10%. When the RR has exhausted those, they can then pay me whatever they’ve earned - and then maybe we’ll take about dividends or repurchased shares . . . [swg]
- Paul North.
The whole “cost of capital” is really an interesting subject which is a subject that is not one of expertise for me…but just enough to get me into trouble. Thus, any financial engineers or investment engineers out there, please take this over for me.
Return on investment (ROI) is:
net margin * asset turnover * financial leverage
Net margin is the net profit ratio based on revenue…sell $100 of stuff and net out $25 and your net margin is 25/100 or 25%. For CNI last year they had revenue of $8.3B and net of $2.1B…pretty darned impressive.
Asset turnover is the sales/assets. For CNI they use $25 Billion of assets to produce those $8.3 billion of sales. Railroads, as we know are very asset intensive. To realize how capital intensive, one should compare to other industries. Thus, their asset turnover is .33.
Financial leverage is assets/shareholder equity. CNI has shareholder equity of $11.2B for finacial leverage of 25/11.2 or 2.2x.
For CNI these numbers are - margin 25.36, asset turnover of .33, and financial leverage of 2.23
ROI = 25.36 x .33 x 2.23 or 18.7%
Or another way is net margin/shareholder equity. The neat thing about adding the asset turnover is that you see how critical assets are to a company. Think that is not important…check out the assets of CNI vs Microsoft. Or Coca Cola to Exxon Mobil.
So, by plugging in the investment required and the hurdle rate, you can see why companies have such a high platform for making an investment choice.
Paul, you should be looking for companies with returns well past 10%. Most good companies have ROI of 10-15%. Most really good companies are in teh 15-20% range. Great companies are well above 20%. Microsoft ROI is 44.34 and Coke is 42.3. AAPL is 37%.
Do not mix up the ROI (company return on investment) to your return on investment in a company. Your return on investment is bas
Yes, PDN, it was my thought that “post audits” should be used on any major capital project which uses specificially identified savings, or specifically projected revenue increases.This should determine the accuracy of the prognosticators and raise a question about their future prognostications, either good or bad.
Within corporations there are those who have perfected the art of “justifiying” their projects so that they get a larger share of capital projects approved. And they mave have been transferred and not on the scene by the time poat audits reveal the shortcomings of the justification projections. But if they are usually very close to being “right on” they should be recognized and appropriately rewarded.
When one looks at the “overall returns” as are illustrated with the preceeding posts the individual projects become lost. Sometimes the “wrong person” becomes too powerful and then the big picture begins to change.