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NEW YORK Warren Buffett defended his issuance of $10.6 billion of Berkshire Hathaway Inc (BRKa.N) (BRKb.N) stock as part of this month's acquisition of Burlington Northern Santa Fe Corp -- even as he admitted that issuing stock is as much fun as preparing for a colonoscopy.
Berkshire bought the second-largest U.S. railroad company two weeks ago, paying $26.5 billion for the roughly 77.5 percent it did not already own, in what Buffett has called an "all-in wager" on the U.S. economic future.
In his annual letter to Berkshire shareholders on Saturday, Buffett likened the railroad to Berkshire's electric utilities businesses, one of its largest operations, saying they both provide essential services to the country.
"It is inconceivable that our country will realize anything close to its full economic potential without its possessing first-class electricity and railroad systems," he wrote. "We will do our part to see that they exist."
Because an all-cash purchase would have exhausted too much of Berkshire's cash reserves, Buffett agreed to pay 40 percent of the price in stock, increasing Berkshire's share count by 6.1 percent.
He estimated that 30 percent of the overall cost was in Berkshire shares because the Omaha, Nebraska-based company had paid some $6 billion of cash for its earlier stake.
Yet Buffett has long maintained that Berkshire's stock is undervalued, and did so again on Saturday. So why issue more?
"The disadvantage of paying 30 percent of the price through stock was offset by the opportunity the acquisition gave us to deploy $22 billion of cash in a business we understood and liked for the long term," Buffett wrote.
"It has the additional virtue of being run by Matt Rose, whom we trust and admire. We also like the prospect of investing additional billions over the years at reasonable rates of return."
OTHER TAKEOVERS HAD PROBLEMS
Some of Buffett's prior acquisitions made with stock have proven problematic.
One was Berkshire's 1998 takeover of General Re Corp, its largest acquisition prior to Burlington Northern.
Though Buffett now calls General Re a "gleaming jewel in our insurance crown," the reinsurer struggled with years of bad underwriting decisions, and litigation over contracts with American International Group Inc (AIG.N) that included the convictions of four former General Re executives.
Another is NetJets, a plane leasing unit that has lost money pre-tax in the 11 years that Berkshire has owned it, while boosting its debt load to $1.9 billion from $102 million. Buffett last year replaced longtime chief executive Richard Santulli with David Sokol, often considered a candidate to run all of Berkshire, and Buffett said performance is improving.
And in 1993, Berkshire bought Dexter Shoe for $433 million in stock, only to fold it into another business eight years later. "The worst deal that I've made," Buffett said in 2008.
Vahan Janjigian, author of the book "Even Buffett Isn't Perfect," said he was concerned about the structure of the Burlington Northern takeover.
"He makes it very clear that when an acquirer uses stock to buy a company, it should do so only when the acquirer's stock is overvalued -- and he doesn't believe Berkshire is overvalued," he said. "However, the bulk of the transaction was made in cash, so it's not a huge concern."
Even for Buffett, who is not known for shying away from big bets, the price of being able to "hear that choo-choo," as he once put it, was almost too much to bear.
"Charlie and I enjoy issuing Berkshire stock about as much as we relish prepping for a colonoscopy," he wrote. "The final decision was a close one. If we had needed to use more stock to make the acquisition, it would in fact have made no sense. We would have then been giving up more than we were getting."
Buffett concluded his annual letter as he usually does, by exhorting shareholders to go to Omaha for Berkshire's annual meeting on May 1. This year, he added a postscript.
"Come by rail."
(Reporting by Jonathan Stempel; Editing by Xavier Briand)