VALUE: After Hours (S07 E34): BNSF: Buffett’s Coup d’Œil Moment

During their recent episode, Jake Taylor and Tobias Carlisle discussed BNSF: Buffett’s Coup d’Œil Moment. Here’s an excerpt from the episode:

Jake: So, how about the second transaction?

Tobias: So, the second transaction that I wrote about was the BNSF, the railway deal. I think there’s a nice parallel to Graham. I introduced Graham a little bit, and I talk about Graham and I use that more as the mechanics of making an investment, which Sun Tzu also talks about–

Sun Tzu goes through how you conduct analysis. He doesn’t do it all in one place. It’s spread throughout the book. But I’ve put it all together into one place, so you can see that he has this quite systematic approach. So, he tells you how to analyze a situation for a strategy and what you should be looking at. He breaks down, basically, it’s the people and the territory and the conditions. He has nice, lyrical, so the conditions are heaven, the territory’s earth and then the commander. He goes through these things.

And then, he talks in a separate part about the way that you actually go. I mentioned that earlier, you do the measurement. You do the measurement quantity analysis and then balancing of chances. And then, when you have an overwhelming advantage, then you act.

Jake: If Sun Tzu was in the public markets right now, what strategy would he be running? Is he a quant guy? Is he running a pod shop? What do you think?

Tobias: I think he’s Buffett.

Jake: Okay.

Tobias: I think he could only be Buffett.

Jake: That’s too easy answer.

[laughter]

Tobias: Yeah, it is. That was obvious, wasn’t it?

Jake: Yeah, I stepped right into that one.

Tobias: But I like the BNSF deal for a number of reasons. One, is that I think it’s a geography story. It’s geographical, as well as it’s related to Graham. I think Graham is also very Sun Tzu.

Graham goes through and he has the same sort of, “You’ve got to conduct this. It’s a business-like operation. You go and undertake evaluation, you look at the quantitative stuff, you look at all of the factors that influence the outcome and then you come to a decision and you look for this margin of safety and then you assume even though you’ve done all these things, it’s still going to fail, so you don’t become too concentrated, you don’t over commit.”

All these ideas, I think are good ones. But BNSF is a particularly interesting transaction, again, because it was criticized at the time because it’s very unlike Buffett. He’s been talking about don’t–

Jake: Capital light compounders.

Tobias: Yeah, capital light compounders. Here, he’s investing in a railroad, which is the antithesis of a capital light compounder. It requires enormous amounts of capital.

Jake: Old’s man has lost the plot, huh?

Tobias: I think that was the criticism at the time. The opportunity set is just so barren. There’s so little to do. This is during a period of zero interest rates too. So, everything’s fully valued, there’s nothing to do. There’s nothing for a company the size of Berkshire Hathaway to deploy capital into and here he is, he’s taken BNSF, which is a railroad capital intensive. So, he’s panicked. He’s suffered from FOMO and he’s done this deal that looks terrible.

But he had understood lots of different things that were not obvious to people who didn’t follow that stuff as closely as he does. There’s a lot of elements to it which is this complexity. It shows the strategic genius of Buffett in doing this transaction. One of them is its geography is more to the Pacific, more to the West Coast. And so, he had perceived that America’s relationship was moving from Europe to Asia, doing more business across the Pacific. And so, BNSF is well positioned for that.

He also understood that there were some changes to the tax code that were going to allow them to accelerate depreciation on some of their investments. And so, they were going to require a lot of money going into this thing. But all of it would depreciate very quickly. And so, even though the after-tax earnings might not look that great, the after-tax cash flow was extraordinary on all of these investments. It was regulated. [crosstalk]

Jake: Right. You could take the pain early. That’s something that they’ve always been willing to do, is take the accounting pain for the cash flow tomorrow.

Tobias: Right. You can transport goods. As America starts transporting more and more goods around, because we’re all buying online and doing stuff like that, railways are still the cheapest way of moving stuff. It’s cheaper than moving it by truck on the road and cheaper in terms of carbon intensity too. I use it to illustrate the method, which is that process of doing the analysis and making the investment. But also, this idea of coup d’œil which is this– It’s not spelled that way. This is a very funny pronunciation of this thing.

Jake: It’s a French term, right? Yeah.

Tobias: It’s a French term that means stroke of the eye. They say that Napoleon talks about it. And von Clausewitz, who wrote Vom Kriege, which is On War, he was the Prussian general who wrote– He saw Napoleon fight against, I think, the Russians or the Prussians as a young officer. And then, when he was older, he wrote this book. And so, he talked about this a little bit.

But the idea was that these great commanders have this, what they call, the coup d’œil, which is the ability to take in all of these different ideas, like the geography and the changes in the tax code and the cheapness of moving it and the movement from Europe to Asia, all of these things and just filter it down into one single transaction, which was– And to identify BNSF as the right thing to do.

And so, I talk about coup d’œil as being something that I want to develop for myself. And so, I think it’s an interesting idea. Sun Tzu talks about a little bit too, when they get into the later parts of the book, which are a little bit more wu, a little bit– I still think they’re interesting ideas and– [crosstalk]

Jake: Wu or wu wei?

Tobias: Both.

Jake: Yeah. [laughs] Yeah. It sounds like that’s what Buffett’s talked about before of that apperceptive mass, which is you have all of this constellation of patterns and ideas in your head, and then something you see just makes it click into place.

Tobias: Yeah. Great term. I hadn’t heard him talk about that, but that’s a–

Jake: Toby, we did this whole veggie segment on apperceptive mass.

Tobias: I think we’ve done 400 of these now.

[laughter]

Jake: It’s hard to keep track.

Tobias: So, I used BNSF to illustrate those ideas. I think that does capture the method and analysis and the coup d’œil idea, which is– I think coup d’œil is the result of doing the method over and over and over again until you get to the point where it’s really second nature, and then you get the coup d’œil after you’ve done these analysis enough, you expect things to be where they are and then when you find them there, then the coup d’œil is functioning properly.

Jake: Back up the truck.

Tobias: Yeah.

Jake: Yeah. Maybe you can speak a little bit about the righteousness path that is– Maybe even the environmental impact of railroads being that– You can do, like, one ton can be transported– How far is it? Is it 500 miles one gallon of fuel?

Tobias: Yeah. So, it’s more efficient in terms of fuel. It’s more efficient in terms of carbon intensity than anything else. So, there’s a lot of good reasons why– It’s good for the environment. And it’s efficient. That’s one of Sun Tzu’s ideas as well, that you’re looking for efficiency, which– I could torture that into analogy for return on invested capital or something like that. [Jake chuckles] I didn’t do that, but I could have got there. But I think that the idea of the righteousness is really something that came in the third part of the book.

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