The following response was sent by Clifford Eby, former deputy and acting administrator of the Federal Railroad Administration from 2005 to 2009. He is currently a senior vice president at Parsons Brinckerhoff.

Inbound or Outbound?

Berkshire Hathaway is a patient investor. Low leverage, large cash reserves, and a reliance on fundamentals allow it to buy and hold investments for long periods. On its surface, Berkshire Hathaway appears to be the ideal landing place for a long-lived capital-intensive railroad, but for years, Berkshire Hathaway has avoided capital intensive railroad investments. Why now? Many have speculated on the rationale for Berkshire Hathaway investment in railroads. Is it a bet on the US economy, growth in China, energy/coal, or the fundamental efficiency of rail transportation? Others ponder the, “What about me?” question. Will Berkshire Hathaway’s Midwestern roots provide compassion for lower grain rates? Will labor benefit from now deeper pockets. Is the price too high or too low?

More provocative speculation ponders what if Carl Icahn, TCI, or a SWF had offered to buy BNSF? At a minimum, a Dubai Ports spectacle would have raged in Congress fearing that speculators or foreign investment objectives would be ruinous to US rail transportation -- contrast that expected over reaction with the welcoming that Berkshire Hathaway has earned in the marketplace. But as noted above, do we really know Berkshire Hathaway’s objectives and how it will run the railroad? BNSF is one of the best run railroads in the country, a trait that Berkshire Hathaway looks for in its acquisitions. So it is unlikely that Berkshire Hathaway has any plans to radically improve operating efficiency ala TCI and CSX. Even if Berkshire Hathaway is relying on the economy and rails’ natural advantages for earnings, how will we know if this “all-in bet” is paying off for investors and freight transportation?

Look for changes in railroad capital expenditures.

RR executives for years have rationed capital expenditures because Wall Street analysts/investors were critical of spending on long-lived assets that offered slow paybacks. The railroad industry reports that there are $39B in capital expenditures needed over the next 25 years that investors in publicly traded railroads are unwilling to fund. Berkshire Hathaway makes an apparent perfect fit for BNSF; and, in recent years BNSF has invested $2.2 billion per year in capital expenditures and has paid dividends of $500 million per year.

But will competition for capital within Berkshire Hathaway be any easier than on Wall Street? As a public company, BNSF had to only achieve risk-adjusted average returns and it did so routinely with Overweight” and “Buy” recommendations. Capital allocation within a firm of overachievers is likely to leave mere average performers behind. Stated another way, BNSF’s cost of equity capital has just increased and fewer projects now provide adequate returns. Combine this with the long-lived railroad assets and the need for Warren Buffett’s successor to show early performance, there’s a risk that railroad capital spending may not grow to meet these capital shortfalls. Ironically, private ownership may make tax and other incentives more necessary than ever to achieve our freight transportation goals.

How will Berkshire Hathaway run the railroad? Watch capital spending and how the $500 million per year in dividends is spent in the future.

Updated at 1:39 p.m. on Nov. 13.

Samuel Staley, the libertarian Reason Foundation's land use expert (we have Reason's transportation expert, Bob Poole, on this blog), has an interesting post on the BNSF sale on the foundation's Web site. Check it out:

http://reason.org/blog/show/atlas-shrugged-railroads-and-w

Freight railroads play an important role in our nation’s surface transportation mix and for the near future will likely remain the default mode for moving heavy bulk commodities like coal, scrap metal and grain over long distances. Mr. Buffett’s acquisition of BNSF appears to be a safe play, largely because of the projected growth in U.S. freight volume over the next 10 years.

Also, with only a handful of Class I railroads operating in the U.S., Buffett’s investment will benefit from the fact that existing railroads operate as monopolies, or duopolies. It is unlikely that this situation will change. Particularly in outlying regions of the country, a shipper may only have one rail option for moving their goods.

We cannot ignore the fact that any increase in rail freight also brings a greater need for trucks. Virtually all freight reaches its final destination by truck and 80 percent of communities rely solely on trucks for freight transportation. Generally, moving goods by railroad isn’t even a financially sensible option unless the destination is greater than 750 miles. Given their cost, speed and reliability, trucks are the moving force behind today’s supply chains and deliver nearly 70 percent of all U.S. freight tonnage.

Echoing the views of others, I think Warren Buffet's purchase of BNSF is an affirmation not only of the viability of the railroad industry but of an American economy that still needs us to make things and move things. It's also an opportunity for sound management and innovation to bring not only the railroad but the full scope of the transportation system into a new era. With the long-term Buffet view, I hope that BN"s management under Matt Rose's continuing leadership will be even more able to invest and innovate towards more efficent and effective customer service. It's also reassuring that Buffet indicated his expectation that BN will continue strong competition with an independent Union Pacific. It's that kind of competition that keeps the indsutrey in a mode of continuous improvement.

Matt Rose's contribution to the National Surface Transportation Policy and Revenue Study Commission is also worth noting. That landmark report put the railroad contribution to the movement on people and goods on the same agenda as our highway and transit investments, and paved the way toward a more intermodal view of the system as well as to the possiblity of public-private partnerships to leverage the capabilities of the rail system for multiple goals. That's something the BNSF has been doing well for many years and we can hope the direction continues.

While I cannot discuss the merits of the transaction, Berkshire Hathaway’s offer to purchase BNSF Railway is a solid endorsement of the railroad and the importance of our nation’s freight railroads to the global supply chain.

As Warren Buffett stated, “Our country’s future prosperity depends on its having an efficient and well-maintained rail system.” And we can accomplish a lot of our national policy objectives by realizing the strengths of freight rail.

Rail brings tremendous environmental and economic value to our society in terms of reducing highway congestion, fuel efficiency and reducing emissions. These efficiencies reduce supply chain costs, allowing American business to be more competitive in the global market.

Today, railroads provide significant value to our economy and society, and they will provide even more value in the future. As our nation’s demand for transportation continues to increase, rail is an obvious solution to meet the growing demand. For these reasons, BNSF and the rail industry are a safe bet for our future.

Warren Buffet's purchase of BNSF is a big vote of confidence not only in railroads but also in the expectation that the economy is on a rebound, and that the nation is becoming serious about energy independence and climate change, all of these factors contributing to a more prosperoyus rail industry.

Updated at 11:05 a.m. on Nov. 9.

CURE represents the class of rail customers that is dependent on railroad transportation because other transportation either isn't economically viable or doesn't exist. More specifically, the rail customers in our group, at least for some of their operations, are "captive" to a single railroad for their service. As such, they find themselves in a "take it or leave it" situation with their railroad carrier with regard to price and service. Our members are unhappy that the railroads are exempt from the antitrust law in the area where the Surface Transportation Board (Board) has regulatory jurisdiction. No other federally regulated industry has this exemption. Our members are also unhappy with the failure of the Board to protect captive rail customers effectively from monopoly abuse.

One of our complaints is that the Board consistently underestimates the financial health of the freight railroads, resulting in Board tolerance of extraordinarily high rail rates to captive customers - often at levels 5 or 6 times the direct cost to the railroad of moving the customer's freight. So, against this backdrop, what do we think of the proposed purchase of the Burlington Northern by Berkshire Hathaway?

First, we think this major investment undercuts stated railroad concerns about removing antitrust exemptions and reforming the practices of the Board. In opposing these bills, the railroads normally have stated that changes in current law will result in reduced investment in the railroad industry. Since we presume that Berkshire Hathaway made its investment on the worst case assumption that the legislation described above will be adopted, this major investment in the BN seems to undercut the railroad arguments against changes in current law.

Second, we note that this aggressive investment by Berkshire Hathaway came within a month after the Board found that the
BN is "revenue inadequate" meaning that the BN isn't earning enough to attract investors. Berkshire Hathaway not only seeks to increase its investment in BN, it proposes to buy all the outstanding stock of BN at a 30% premium. We believe this purchase proves our contention that the Board underestimates the earning power of the major railroads.

Third, unlike other regulatory bodies, the Board often has allowed in past railroad acquisitions the "acquisition premium", here at least 30%, to inflate the asset base of the railroad for future regulatory purposes, which increases the level of captive rates tolerated by the Board. This purchase brings this problem into focus; it needs to be addressed.

Fourth, we understand that, both despite and because of, the nature of this major acquisition of a railroad, the Board has no jurisdiction over the transaction. Thus, no public record will be made by the Board regarding a wide range of issues that should be of interest to the public and rail customers in particular. Perhaps there is a "gap" in law that should be addressed. Also, what if the acquiring entity in this situation were a government-dominated foreign corporation?

Finally, we are concerned that Berkshire Hathaway proposes to take BN private. We know of no precedent for a freight railroad of this size to be in private ownership. At a minimum, an opaque company is likely to become even more opaque. After purchase, BN may not be required to make the detailed SEC filings that it must make today. The full implications of a freight railroad of this size in private ownership need to be identified and understood.

At this point we have no concerns about reduced competition in the railroad industry or any anti-trust implications. We agree that this purchase is a major bet on the future of the domestic economy and the role of railroads in general, and the BN in particular, in that economy. Since many investors are followers, this major investment by Berkshire Hathaway may bring more investors into the freight railroad market, which rail customers agree is a very good development. Rail customers need robust, healthy freight railroads that compete for their business.

The announcement from Berkshire Hathaway last week signaled more than just the purchase of BNSF – it affirmed the importance of freight rail to the nation’s economy.
Record investments in infrastructure and advanced technologies have helped make railroads the most competitive form of freight transportation today. Since 1980, rail productivity is up 144 percent while inflation-adjusted rail rates have dropped by nearly half.

While traffic volumes currently are down in line with what is happening with the broader economy, freight railroads have leveraged what opportunities there are during this recession to improve efficiency and cost structure. We are retooling our networks, using the most fuel efficient locomotives and modern railcars – and yes, we continue to reinvest in our networks.

Railroads are the only mode of transportation that pays for its own infrastructure, while providing enormous public benefits. Despite the recession, 2009 looks to be another record year for capital investment – with railroads expecting to make more than $8.5 billion in investments back into improving our rail network infrastructure.

As an important part of our nation’s economic recovery, lawmakers should do everything they can to ensure that freight railroads can continue to make these investments in the nation’s rail network. Allowing railroads to operate in a balanced regulatory environment will ensure the industry can meet future demand to move more people and goods by rail.