Why is Buffett paying $26bn cash for clunkers?

Why on earth is Warren Buffett forking out $26 billion in cash and assuming $10 billion in debt to assume control of the US railroad Burlington Northern Santa Fe?

This is the ultimate cash for clunkers deal. The railroad might have a replacement value of twice what its stock is selling for today, but then that is because nobody in their right mind would want to build a new one. A barrier to entry perhaps!

Painful cash piles

My friend Chris Mayer, editor of Capital & Crisis reports that the top 500 US companies are sitting on a $1.1 trillion in cash, up 28 per cent in the past year and the highest level of cash as a percentage of assets since 1960 at 11 per cent.

Is this cash just about to burn a hole in their pockets? Well it certainly would make acquisitions swift if the companies can spot value or see consolidation opportunities. But given the experience of the past 12 months these corporate chiefs are ultra cautious.

Does that mean Buffett is wise to rush out and buy? It is certainly a contrarian move. Those railroad trucks clunking along through the night earn a better return than cash sat in treasuries or on deposit. They are basic infrastructure and energy-efficient.

Buffett can clearly see cash in clunkers. But what does this say about the wider economy? Are tech companies and banks doomed? Would he not be buying into Wall Street again if this offered better prospects?

Value proposition

Many times in the past decades Buffett has explained that he looks for value independent of the share price, although he does like a cheap entry point whatever the theory. It seems he thinks US railroads are an undervalued utility.

That could still leave the rest of the US economy highly overvalued, and the proposition that Buffett is making a huge bet on America Inc. is preposterous. Moreover, he could still be buying at the wrong point in the stock market cycle, towards the top of a rally.

This does smack of a deal lined-up for an October market crash that never happened, and so it was decided to go ahead anyway. Such cash deals at market tops do not have a good track record. But Buffett is different of course! Others who get brave are likely fall guys.