Yesterday vs. Tomorrow: The Value of BNI

By Joe Ponzio on August 13, 2007  |  10 comments

Take one of my old spreadsheets (found elsewhere on this site), plug in BNI's past performance, and you'll get a per share value of $60.15. Mike and I both did it, and we were both perplexed. Did Buffett pay upwards of a 30% premium for BNI? Let's pick it apart.

Problem 1: Negative Owner Earnings

Right off the bat, the valuation goes awry. In 1997, BNI had negative owner earnings to the tune of $368 million. Is that a problem?

Do not take yearly results too seriously. Instead, focus on four- or five-year averages.

Right. Thanks Mr. Buffett. Sometimes companies will have one or two erratic years out of ten, and it throws off our valuation. In the case of BNI, that one year—1997—throws off our owner earnings calculation and gives us a growth rate of 7%.

But let's fudge the numbers a bit. What did BNI do if we assume no growth from 1997 to 1998, and then look at the snapshot. If we set the 1997 owner earnings to $71 million—the same as 1998—we get a new picture: 25.4% growth in owner earnings. We just went from yawn to yowsers.

Can you do that?

Why not? There was a one-year monkey wrench in the company's past and it threw off our valuation. There is no law about using 9- or 11-year histories. There is nothing that says ten years is the magic number. Remember: Valuing a business is both art and science.

And what did I really do? I simply said, "Hey 1997, stop throwing off my valuation. Give me a 0% growth rate for 1997 to 1998, pretend that year never really happened, and let's see what we come up with."

The New Value

Take out the one bad year out of ten and you end up with a per share value of $126.83. But let's be rational—let's assume BNI can't keep owner earnings growing at 25.4% for ten years. I feel more comfortable saying it can do so for another three years. It has a heck of a competitor barrier to entry (are you going to start a railroad?) and moat (one of the largest railroad systems in America).

After year three, I'll assume its growth will slow by ten percent a year—that is, growth will be 20.5% in 2010, 18.5% in 2011, and so on to 10.9% in 2016. Then, 5% a year thereafter. If I'm wrong and BNI keeps owner earnings growing faster than I projected, I'll simply make more money.

The New New Value

Using the above tweaks in the numbers, I get a value of $96.05 a share. But I'm not done yet. Is your head spinning? Put BNI in your too hard pile and move on. Otherwise...

What do railroads have a ton of? Real estate. How do you account for real estate on a balance sheet and in net worth? Carry the property at the purchase price, depreciate it, and forget about it. You don't increase its value on the balance sheet just because the property is two, five, or fifteen years old.

BNI is real estate rich—riches that don't reflect in its balance sheet and net worth. How rich is it? I don't know—my valuation has to end here. Admittedly, Buffett is smarter than I when it comes to valuing a railroad. BNI is in my "too hard" pile.

Adding It Up

Based on the future owner earnings, BNI is at a 16% or so discount. Add in the hidden real estate gains, and you will likely find that it is trading at a much larger discount to its true value. How large? I don't know, so I have to move on.

Remember than valuing a business is both art and science. The science is easy—add up all the discounted cash that can be taken out of the business and you have a value. The art—projecting that cash—well, there are no hard, fast rules for it. Unfortunately, you can't use one spreadsheet to get a value for all companies.

All the more reason to stick with simple, understandable, predictable businesses.

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