Buffett Buys Options of Burlington Northern Santa Fe Corp

http://www.gurufocus.com/news.php?id=12857

Warren Buffett buys options of Burlington Northern Santa Fe Corp

It has been a long time for Buffett followers to see him buying options. Yesterday Warren Buffett's Berkshire Hathaway Inc said it has acquired options to boost its stake in Burlington Northern Santa Fe Corp, the No. 2 U.S. railroad, to 17.1 percent from 15 percent.

In a filing with the U.S. Securities and Exchange Commission late on Tuesday, Berkshire indicated that on August 30 and 31 its National Indemnity Co. unit acquired call options to buy 7.46 million Burlington Northern shares for $40 each. The shares have traded between $73.89 and $85.67 over the last month; today the shares closed at $ 82.19.

The options are exercisable on October 3, but Berkshire may extend this date to November 2 for an additional 21.5 cents per option, the filing shows.

Berkshire is now the largest shareholder of Burlington Northern, it already owns 52.98 million Burlington Northern shares. It informed Burlington Northern on August 28 that it might seek to boost its stake to 25 percent, according to an August 31 SEC filing.

Buffett is known for buying undervalued stocks of businesses with durable competitive advantage and holding them forever. It is interesting to see that Buffett is using options for shares of the company he wants to buy. We have not seen this during recent years. Buying options are rare among Gurus, however, Joel Greenblatt does use LEAP as his vehicles for the stocks he considers undervalued. He still owns large chunks of options on Wal-Mart (WMT) and American Express (AXP).

With too much money in hands, Warren Buffett’s universe of investment choice is shrunken to large companies only. That is one of the reasons why he has been buying companies like Wal-Mart (WMT), Wells Fargo (WFC), US Bank (USB) etc. "I've got an elephant gun, I just can't find the elephant.” He said during an interview. His purchases of railroad companies surprised a lot of his followers initially. During the Berkshire annual meeting in May, Buffett said that railroad business would never be "sensational," yet its prospects had improve. Charlie Munger, Vice Chairman of Berkshire Hathaway, commented during the annual meeting of Wesco Financial (WSC), Buffett and he himself “used to not like them because they needed large amounts of capital, had tough unions, and stiff competition from the trucking business. The paradigm had shifted. Now the railroad industry has a competitive advantage by double-stacking freight. With all of the imports from China , the U.S. has a huge amount of freight being sent across the county.”

In May Berkshire reported stakes in two other railroad companies: 6.36 million shares of Norfolk Southern Corp (NSC) and 10.51 million shares of Union Pacific Corp (UNP). Buying these railroad companies will help him to deploy some of his cash in hands.

 

Gotta love it! Buffet has slammed derivatives as the ultimate evil for years, but he's not above putting a few in his account when it serves his purposes. Classic!

 

Those do not appear to be traded options given the expiration dates, they look more OTC or specially negotiated.

And as far as Buffet on derivatives, many of the companies he buys knowingly use large derviative positions for hedging and his own 10Q reports list massive derivative positions owned by Berkshire as well as its wholly owned companies.

Do as I say, not as I do kind of approach. Why such outspoken talk on derivatives if he seems to use them a lot (check out the notional value of the derivatives he uses).

 

Warren is just a simple country boy.
To make a phone call... he has to walk 10 miles to the General Store.

 

he also likes to slam tax cuts for the 'rich' yet he structured his business early on as a insurance corporation so he could avoid paying income tax on his holdings(at the time they were high)

 

I think Warren's criticism of derivatives in the past has been directed more toward those who use them for purposes of excessive leverage, or toward those who deal in OTC swaps with substantial counterparty risk and no official mark-to-market pricing, making it easier to conceal losses.

In this case it appears he fully intends to call the railroad shares away at expiration by purchasing these deep in the money options. He appears to be using derivatives more as a tool for price improvement / slippage reduction over an open market purchase of the shares themselves.

 

Maybe it's a major sell-signal for the railroad sector.

 

Interesting point about those being OTC derivatives. I didn't check the contract specs on his options, but that's certainly possible. If that's the case, then it's even more damning, since OTC options carry clearing and counterparty risks that exchange-traded options do not. Those are exactly the type of inherent derivatives risks that Buffett has railed against for years.

This whole thing reminds me of a few years ago when Soros was railing against the dangers of currency speculators even though he was one of the biggest currency specs in the world.

Do as I say, not as I do....