Warren Buffett has referred to it as ‘hunting for elephants’ – the act of finding suitable companies to acquire with Berkshire Hathaway’s cash hoard.

For years, that pile of cash has continued to grow amidst a drought of attractive deals at the required size.

According to Morningstar’s Berkshire Hathaway (NYS: BRK.A) analyst Greg Warren, though, a credible and perhaps essential candidate has emerged.

Key subsidiary at risk of falling further behind?

The Burlington Northern Santa Fe railroad is one of Berkshire’s most important subsidiaries.

It is one of the “four jewels” that Buffett alluded to in his 2021 investor letter, and it is responsible for around 12% of Morningstar’s Fair Value estimate for the company.

BNSF is one of only a few Class I railroad operators in the US. These companies benefit from what Greg calls “colossal barriers to entry” as their huge interconnected rail networks and rights of way would be “practically impossible to replicate”.

Despite being a quality asset, BNSF’s operations have fallen behind those of many other railroads in the US. This is perhaps most notable when they are compared to those of its Western US peer Union Pacific (NYS:UNP).

One reason for this is that while other railroads have embraced versions of precision scheduled railroading, a system based on maximising a network’s efficiency and profitability, BNSF has not followed sway.

The smoking gun? Union Pacific’s average annual advantage on operating ratios (operating costs as a percentage of revenue) has increased from being 370 basis points lower than BNSF’s when it embraced PSR in 2018, to being 690 basis points lower between 2022 and 2024.

If this gap persists, Union Pacific could have room to be more aggressive on pricing in markets where it competes with BNSF. And, according to Greg, Union Pacific’s deal to buy Norfolk Southern (NYS: NSC) only raises the stakes.

Going transcontinental

If the merger gains regulatory approval, it would combine Union’s Pacific’s extensive network in the western and central US with Norfolk Southern’s assets in the country’s east. In other words, it would create the US’s first transcontinental freight railroad.

By doing so, Greg says this would remove current interchange bottlenecks between networks, shorten transit times, and potentially deliver even more of an efficiency edge to Union Pacific.

As a result, Greg thinks that Berkshire must look at creating a transcontinental network of its own. It could achieve this by buying the other major Eastern railroad network, CSX Corporation (NAS:CSX).

Will Berkshire finally put that cash pile to use?

Taking the terms of Union Pacific’s deal for Norfolk Southern as a guide, a deal to buy CSX could require an outlay of around $82 billion.

A deal of this size, Greg says, could easily covered by Berkshire’s infamous cash pile (over $300 billion at the last count). In my view, however, there are feasible reasons to question how likely Buffett and Berkshire are to want this deal.

For one, it would involve buying at a far higher multiple than Buffett usually likes buying companies at. Berkshire’s purchase of BNSF, for example, took place at a more opportune time and at 8.5 times EBITDA. Greg’s numbers point to at least 15 times for CSX.

Paying a premium valuation to acquire public companies outright hasn’t always worked for Berkshire. Precision Castparts, for example, was bought for $31 billion in 2016. It was subject to a $10 billion write-off during Covid as Berkshire conceded overpaying.

A deal for CSX is likely to be Berkshire’s biggest acquisition yet. Could experiences like the one with Precision deter Buffett from taking another big swing at a juicy valuation?

Another potential stumbling block is one of Buffett’s golden rules: Berkshire does not take part in bidding wars. And in a world of deep-pocketed investors high demand for high quality infrastructure assets, Berkshire is unlikely to be CSX’s only suitor.

Despite those caveats, Greg’s research note makes a convincing case that Buffett and BNSF may not have much of a choice.

It could be a case of paying what is required to own CSX, or running a very real risk of falling further behind its peers.

Why doesn’t Buffett join bidding wars?

I think it’s worth looking at why Buffett generally avoids bidding wars.

If several other suitors want an asset, the price you must pay to secure it is probably going to be higher. It’s like bidding for a property at auction when nobody else is interested versus being up against ten others. Buffett prefers to be the only bidder.

In the past, this has arisen when Berkshire is the only buyer that a company really wants to sell to. This is often due to Berkshire’s reputation for looking after its acquired assets rather than stripping them.

It has also transpired when market events left Berkshire as the only buyer standing.

Buffett revelled in this position during the GFC, where he was able to provide emergency funding in return for bargains like the famous preferred equity deal with Goldman Sachs.

This kind of situation may have emerged during the pandemic, too, had the US government not stepped in so quickly with stimulus. Buffett has said that he thinks Berkshire “came pretty close” to receiving phone calls of this kind in 2020 but no cigar.

Buffett takes a similar approach to equity market purchases.

He does not normally seek to buy shares in a company when everybody else wants to buy them and are bidding prices up. He usually steps in at times when people have severe doubts about the outlook and are far more interested in selling.

A fine example here is Berkshire building its big stake in Apple from early 2016. At this time Apple shares were heavily out of favour, trading at a multi-year low valuation on fears that iPhone sales had tapped out.

Situations like this have generally provided Buffett and Berkshire with the best investment opportunities. As opposed to cases where a company’s quality and future prospects are reflected by a full valuation.

Could fear of being left behind cause Berkshire to buy CSX anyway? I’ll certainly be keeping an eye on developments.

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