Warren Buffett, The Modern-Day Railroad Tycoon?

GUY RAZ, host:

Berkshire Hathaway, the holding company run by Warren Buffett, announced on Friday that its third quarter profits tripled. The Oracle of Omaha has always bucked trends. While others put their money into junk bonds and banks, Buffett bought companies like See's Candies, GEICO Insurance and Fruit of the Loom.

And this week, Warren Buffett made a truly counterintuitive investment. Berkshire Hathaway paid $26 billion to take over one of America's largest rail networks, Burlington Northern. It's led to all kinds of comparisons between Buffett and the great railroad barons like Cornelius Vanderbilt and J.P. Morgan.

In a moment, we'll hear from Jean Strouse - she wrote a biography of Morgan.

But first, to the investment at hand. Curt Grimm is a professor at the University of Maryland's Business School, and he joins me here in the studio.

Welcome.

Professor CURT GRIMM (Robert H. Smith School of Business, University of Maryland): Happy to be here.

RAZ: This investment by Warren Buffett seems almost 19th rather than 21st century. Why would he do it?

Prof. GRIMM: I think this is a wonderful latest chapter in the amazing renaissance of the railroad industry. Of course, it was the king of the hill back in the 19th century, but it hit very hard times. And the U.S. railroad industry was given up for dead in the '60s, '70s. Nobody was making any money. It was thought that we're going to have to nationalize, like everybody else's railroad industry around the world.

But then with deregulation starting in 1980 and management, like the folks at Burlington Northern, cutting their costs, improving their operations, getting their profit bottom-line back on track, they've actually turned it around, done quite well. And now, this is a signal that Mr. Buffett expects the renaissance to continue into the future.

RAZ: And most goods in the United States still travel via rail?

Prof. GRIMM: Well, a certain set of goods: coal, grain, chemicals; especially over the longer distances, that's where they have an advantage over truck.

RAZ: So it's profitable.

Prof. GRIMM: Very profitable. And even in our tremendous economic downturn, railroads have continued to make money.

RAZ: It's amazing because when you think about innovative investors, you're thinking about people investing in Silicon Valley in high-tech. But this could be considered the original green investment.

Prof. GRIMM: They are more energy efficient than truck and they do a good bit less pollution than truck. As congestion increases over the highways, they have a great advantage of having their own infrastructure.

But I might also mention, when you say Silicon Valley, 20 years from now, Burlington Northern will still be with us and still be one of the top railroads in the United States. We cannot say the same about Microsoft or Google or any of the other companies. Those are very dynamic and subject to tremendous competitive pressures. The railroad industry is very insulated from entry, very insulated from competitive pressures.

RAZ: Well, if this is such a great investment, what's the downside?

Prof. GRIMM: The main downside is that the most important commodity that railroads carry is coal.

RAZ: Uh-huh.

Prof. GRIMM: And we know that coal - now, when we talk about green, the...

RAZ: It's controversial.

Prof. GRIMM: It's controversial. And to the extent we get ourselves away from coal with alternative energy sources, then we're going to use less coal. And the railroads are very dependent on transporting coals from coalmines' electric utilities for a good chunk of their revenue.

RAZ: Now, in the 19th century, Cornelius Vanderbilt faced competition from Jay Gould and others who wanted to get in on this industry, Warren Buffett didn't. If it's such a great investment, how was he able to do this, you know, relatively easily?

Prof. GRIMM: This is not an industry that's going to make a 20 percent, 30 percent return on investment. I mean, you kind of know what you're getting. But a lot of investors are looking for that quick hit, high rate of return on their investment - get in, get out. And if you're looking for that as your objective, then the railroads are not for you.

I think Mr. Buffett does invest for the long term. So, you know, his objectives are a little different than most investors. And of course, he has a little more cash on hand. Not a lot of investors can put $26 billion down and start talking with Burlington Northern, and a week later, having bought the company.

RAZ: That's Curt Grimm. He is a professor at the University of Maryland's Smith School of Business.

Curt Grimm, thanks so much.

Prof. GRIMM: My pleasure.

RAZ: So is Warren Buffett the modern-day version of Cornelius Vanderbilt or J.P. Morgan?

Well, Jean Strouse says there are some parallels. She's the author of the book "Morgan: American Financier." And she says that back in the beginning of the Industrial Revolution, the railroad was king.

Ms. JEAN STROUSE (Author, "Morgan: American Financier"): Railroads really were to the 19th century American economy what information technology has been for the late 20th century American economy and, in fact, world economy.

Railroads changed the way everything worked. They made it possible to ship grain and other farm produce from America's farm belt to both coasts and then on around the world. Manufactured goods could go from the East Coast manufacturing regions into the middle of the country.

There were communications changes that were very dramatic. The telegraphs blend in right alongside the railroad tracks, so suddenly, New York could communicate with California in a matter of minutes instead of weeks.

So changes in the way things worked were dramatic. And economically, the railroads cost an enormous amount of money and created an enormous amount of money.

RAZ: Hmm. Explain something to me, the Burlington Northern, a line that Buffett's company will control, is part of an actually larger system; a network that J.P. Morgan once owned.

Ms. STROUSE: Correct. Morgan put together a combination of railroads in 1902 that consisted of the Great Northern, the Northern Pacific, and the Chicago, Burlington and Quincy. That agglomeration of roads was called the Northern Securities Company. It existed for about two years and was broken up by Theodore Roosevelt's attorney general under the Antitrust Act. So it then went back into its constituent parts, and those parts are the ancestors of the Burlington Northern that Warren Buffett has just acquiring.

RAZ: There's been some talk that Warren Buffett overpaid for this rail line. But Morgan also faced a similar kind of skepticism.

Ms. STROUSE: Yes, he did. People are saying Buffett paid 30 percent more, I think, than what the stock should actually be worth. Morgan organized U.S. Steel in 1901, buying out Andrew Carnegie for $480 million, which was an enormous sum in those days, and then put together U.S. Steel, which was capitalized at $1.4 billion.

He bought many other companies in the process and people said he wildly overpaid. But within two years, he had made the stock fully worth what the company was capitalized at, so it was a very good investment. And we will see whether Buffett's is as good. It might well be.

RAZ: Jean Strouse is the author of the book, "Morgan: American Financier." She's also the director of the Cullman Center for Scholars and Writers at the New York Public Library.

Jean Strouse, thanks.

Ms. STROUSE: Thank you. Transcript provided by NPR, Copyright National Public Radio.