Warren Buffett has made an offer to buy the Burlington Northern Santa Fe Railway for 34 billion dollars in cash and stock. The esteemed investor has stated on several occasions that good investment ideas are hard to come by. Fifteen years ago he stated that between him and his close colleague Charlie Munger, combined they were quite happy if they could come up with one good investment idea each year. Undoubtedly, BNSF is one of those ideas.

It is worth noting that there are several companies in which Buffet’s company, Berkshire Hathaway, has held close to 20% positions for many years. Breaching the 20% line is a big deal for Warren Buffett.

"Our country's future prosperity depends on its having an efficient and well-maintained rail system," Buffett said in a statement. "Conversely, America must grow and prosper for railroads to do well." He also added that "It's an all-in wager on the economic future of the United States. . . . I love these bets."

Speaking alongside fellow multi-billionaire, Bill Gates, at Columbia Business School in New York City last Thursday in a CNBC telecast, Buffett said: “I’m willing to bet a lot of money - $34 billion to be specific – on the fact that 10 years from now, 20 years from now, 50 years from now, there will be more and more goods being moved by rail and it will be better for the country and it will better for the shareholders of Burlington Northern.”

What is behind Buffet’s Strategy?

1. Railroads are consistent Profit Machines

This old-fashioned form of transportation has been modernized in recent years, with more-efficient trains, fewer employees and higher profit margins. BNSF has invested in its own infrastructure. They have made capital improvements (extending 2 lane tracks to 4 lane tracks) and are ready for growth.

2. Huge Barriers to Entry

The industry has consolidated with 2 Canadian railways, two west coast railways and two east coast class 1 rails. There are limited competitors in the rail sector of the market. The business is very capital intensive and expensive to run. Only a select few companies can compete in this arena.

3. Leadership

In Matt Rose as Chairman, CEO and President and John Lanigan as Chief Marketing Officer, BNSF has (along with Hunter Harrison at CN), two of the best leadership talents in the industry.

4. Rising Fuel Costs Favour Rail Transport over Truck Transport

Fuel costs are likely to spike again. Mr Buffet stated that “The Burlington Northern last year moved on average a ton of freight 470 miles on one gallon of diesel – that is far, far more efficient than what takes place over the highways. . . . You have a situation where overall they use a third less fuel, they put far fewer pollutants into the atmosphere than trucks will – one train will supplant 280 trucks or so on the road,” he said. In addition, BNSF has opportunities to make major reductions in its carbon footprint. Buffett likes the environmentally friendly aspects of rail.

5. BNSF primarily operates on the West Coast & Mid-West

The West coast is growth. Burlington Northern carries coal and timber from the West, grain from the Midwest and imports arriving directly from Mexico and Canada, as well as through California ports.

6. The Asia Connection

The West Coast has the key L.A. and Long Beach terminals that bring in goods from China/Asia. In the future the US will be doing more business with China/Asia (West Coast) and less business with Europe (East Coast).

7. Intermodal has great Growth Prospects

We are coming out of a recession. Railroads are a cyclical business. Intermodal has been hit but at some point it will bounce back. As fuel costs increase, the intermodal option becomes more rate competitive than truck. BNSF draws a third of its revenues from intermodal transportation, with half of it being Asia business. With its recently signed contract with JB Hunt, it has aligned itself with an industry leader and is well positioned to dominate in this sector.

8. Heavy involvement in the PRB

The PRB sells cheap coal... cheap energy that people need to heat and air condition their homes. Americans might be buying less flat screen TV's during the resetting economy, but they will need to heat their homes as winter arrives.

9. Potential to create a Privately Held National Railway

Buffet already has a large stake in Norfolk Southern, one of the two large eastern USA class 1 railway players. His long term plan may be to create a large truly national player that could dominate the U.S. transportation industry.

There is no doubt that the BNSF faces a few challenges. With the L.A. ports facing congestion issues in the past, some freight has been diverted to Mexican, Canadian (Prince Rupert) or east coast ports. As the U.S. dollar declines in value, this makes it more costly to import Asian goods. As fuel costs increase, we may see more goods produced in North America and less in Asia. However, the offset to these issues is that the L.A. ports are positioned to handle significant volume. A low U.S. dollar may spur more exports through these ports. The overall value proposition of rail transportation still remains strong. This looks like a winning move for the “Sage of Omaha.”