Union Pacific (UNP) is a state-supported quasi-monopolist. Monopolies are great business to be in, and a few prominent investors (Buffett and Ackman, specifically) have profited from understanding fact this a few years ago.
If UNP was forced to compete with other businesses in a free market, we would discount its likely future cash flows at a rate of 10% (our reasoning is briefly explained in this post). At a normal 10% discount rate, UNP is overvalued. However, because it is an organ of governmental policy and its cash flows are implicitly maintained at high levels by bureaucratic fiat, it might reasonably be discounted at a lower rate.
We like to use a common yardstick to measure all companies, so we’re valuing UNP using a discount rate of 10%. If the regulatory climate was suddenly to move against UNP, we believe the stock would re-rate down to our fair value range.
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