Railroad & Utility Segment
In an earlier post, one smart person responded that they're ok with MidAmerican and BNSF being combined because these companies file separate financials and they get the data on their own. I understand why you say this because as a diligent investor you are better off. But here's why I disagree with the principle.
> Financial statements filed with the SEC stand on their own. Segment data is supposed to provide meaningful information about businesses that operate in the same general line of business. Whether a business files separate financial statements elsewhere has no bearing and isn't mentioned in the criteria for segment reporting. In fact, it specifically contravenes the purpose of these rules for a company to force investors to go look elsewhere for the information.
> It gives, or could give, a misleading impression to combine these businesses. The #s reported in Berkshire's results will be picked up by the press, they're the ones that will be used by most analysts. Say something weird happens at BNSF and because the two are combined it's considered "immaterial" to disclose. When the annual report and 10-K are released, a flood of commentary comes out and no one will know about the event. Later, when you and three other people find it in a railroad filing, you're not going to write a blog post about it, or if you do, it isn't going to be picked up by CNBC's Warren Watch or the Omaha World-Herald and be read by a million people across the Internet. (In a sense, this is good for diligent investors -- in fact, you are better off with things as they are -- but it defeats the purpose of segment reporting).
Shaw has disappeared as have most of the other individual businesses. Some of this is inevitable, but I would cut Berkshire up something like this:
> Retail & consumer businesses
> Industrial & wholesale businesses
> Insurance & other financial services
> Energy
> Transportation
This would create some anomalies. But it's more logical to put BNSF with FlightSafety and NetJets than it is to put it with an electric company. Just because BNSF hauls coal does not make it an energy company. Just because it has regulated rates doesn't make its business similar to an electric utility. Also, in sheer size, lumping these two gigantic businesses together makes a mockery out of the segment disclosure process. NetJets and FlightSafety could go elsewhere and you can easily justify a separate segment for BNSF, given its size.
A degree of arbitrariness is a problem with all segment reporting (Shaw is not just a retail and consumer company, but that's the obvious place to put it). Still, there are alternatives that would be preferable to what we have now.
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Go to most basic and Obvious : Intregrity and ethic
If the smart CEO is likely cooked the book or letter, no matter how smart the analyst, they hardly detected it after the problem surface. These happen in all the past accounting/ human ethic issue lke ENRON, WorldCom, and recently those big bank off balance sheet by special invesment vehicle.
(if those CEO is honest, accountant & auditor is professional and analysts able to detect before the problem publish in paper, + lack of regulated etc).
Obviously, BRK's letter and financial statement is more true than those problematic company. Important is the CEO's intergrity and ethic, which I think Mr. Warren Buffett was influeced by his father and his mentor to be a good person. Furhter, I never see any greedy/no honest person donate almost all his money to charity (obvious and logical matter).
However, I do agree with Alice's suggestion for the segmentation which is clearer. But more important if the person's work can be trusted. Even with good segmentation in the bank's annual letter or financial statment, I doubt to follow it ;-). Suprisely in such well developed country and financial market, yet the accounting issue still not clear for reporting the value / earning either mark to Market or fair value that raised by FASB to banks (it seem back it after fire happen orientated.)
Makes Sense
Alice,
Thanks. Makes sense.
I'm just kidding, of course, but what hourly rate would you charge to sort out the complexities of my extended family? We have our own segmentation issues, and I think we need a skilled CPA/analyst/journalist/biographer to work them out. ;)
Alice, Your points make
Alice,
Your points make sense and it would be easier to evaluate Berkshire with more data in the company's financial statements. Perhaps management should present the data in summary form (at a high level) and then offer a supplementary package of data for those who would like to dig deeper.
One point is worth mentioning regarding the segment data and the manner in which it is presented. Warren Buffett's letters have often stated that he presents the data in a way that represents how management evaluates the business and in a format that he would want to see if he held a minority position in the business and was not involved in management. This could account for the combination of the rail and utility groups because apparently he does view these capital intensive businesses in a similar manner when making capital allocation decisions.
I have been keeping an eye of Burlington Northern primarily because I was one of those who didn't quite "get" the rationale behind the acquisition when it was announced. The way it was explained led me to believe that Berkshire views BNSF as an attractive *destination* for future capital commitments, not as a cash generator used to supply Berkshire with funds for investments in unrelated businesses.
The distinction is important since BNSF can only consume Berkshire's cash at an acceptable rate of return if the company ramps up on expansion capex. I've been waiting for BNSF to do so and this has not yet happened. In fact, BNSF paid a dividend to National Indemnity in Q2.
Since the question of BNSF capex is critical to understanding the rationale behind the acquisition, I think this should be spelled out in more detail by Berkshire in the future - a good place for more disclosure in my opinion.
BNSF capital management
"how management evaluates the business and in a format that he would want to see if he held a minority position in the business and was not involved in management"...
I guess one of my points is that there is no way that Warren would become a minority owner of a business if it were presented this way. He would be unable to analyze it sufficiently to the standards he requires. The way you allocate capital to these two businesses really isn't the same, even though they are both capital-intensive industries. Rail rates essentially aren't regulated (at least as of now) whereas utility rates are regulated by states and FERC (for wholesale transmission). Utility regulation is so complicated that I don't pretend to understand it, but it's pretty different from the more-or-less wide-open world of railroads (where customers claim they are gouged by a cartel). As I understand it, accounting for utility capex in particular is fairly complicated.
All this means is that I would prefer that Berkshire took a more conservative approach to defining its segments.
Re: BNSF, good point -- although I think the time horizon to judge BNSF capex may be too short as of now, at least in this extremely volatile economy we are living in. Meanwhile, Warren does not leave money sitting around....
Segmentation
Alice,
Did you ever bring your points on segmentation to Warren's or Charlie's attention? Do they offer any defense that a CPA would abide? Or is this simply a matter of (in so many words) "we do it because we can." Also, is there a journalist anywhere (besides you) that would take this matter up, i.e. the WSJ?
why they do it
Hi Lorax,
I didn't bring it to their attention directly, but Warren is tuned in to what is happening on this blog, so by writing about it here last spring, it was brought to his attention. By then, though, the decision was made. It's hard to unwind something like this after the fact; maybe impossible. The auditors already blessed it and they would have to admit it was a mistake. If Berkshire makes another big acquisition, or maybe even a medium one, they could do another reshuffle.
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