Warren Buffett's Berkshire Hathaway Inc will pay $26 billion to buy out Burlington Northern Santa Fe Corp in a bet the nation's largest rail company will benefit from a recovering U.S. economy.

The deal, announced on Tuesday, is the billionaire investor's biggest-ever acquisition and may prompt him to sell some of his other investments, which include a wide range of companies from Coca-Cola Co to General Electric Co, some Buffett watchers said.

By betting on BNSF, Buffett -- the world's second-richest person and a long-time model train buff -- renewed interest in a storied, but highly cyclical American industry that has tried to reinvent itself by emphasizing its ability to move goods cheaply and efficiently.

It's an all-in wager on the economic future of the United States, Buffett, who has been building up his rail holdings for several years, said in a statement. I love these bets.

Buffett will pay a premium of 31.5 percent over BNSF's closing stock price on Monday, valuing the railroad at $34 billion, or 18 times estimated 2010 earnings. Most rail companies' P/E ratios are in the mid-teens.

BNSF shares jumped 27.51 percent and other U.S. and Canadian rail shares also rose, as analysts said the deal puts an oft-neglected industry in Wall Street's focus and could bring some fresh money into the sector. But they did not expect a wave of deals in the railroad sector, given regulatory concerns.

Buffett has always stated that he likes the longer-term viability of the rails ... but people really weren't paying attention, said Longbow Research analyst Lee Klaskow. This is shining a spotlight on this group, bringing more investors into the fold.

SHARE DEAL UNUSUAL FOR BUFFETT

Buffett, who has long preferred all-cash deals, is paying $100 per share in cash and stock for the 77.4 percent of BNSF shares that Berkshire does not already own.

Berkshire would also assume $10 billion of BNSF debt. It would pay about $16 billion in cash, of which $8 billion would be from its own funds and the rest from debt.

Smoothing the way for the share exchange, Buffett reversed his long-time opposition to stock splits, which has resulted in Berkshire having the highest per-share prices of any shares on the New York Stock Exchange. Buffett agreed to a 50-for-1 split of Berkshire Class B stock, which will make it much more accessible to retail investors.

The Class B shares trade at over $3,000, and the Class A shares at more than $100,000. The B shares were up about 1.9 percent and the A shares about 1.7 percent.

Berkshire could not do an all-stock deal because it would deplete its capital beyond what insurance regulators would allow, said Justin Fuller, an analyst at Midway Capital Research & Management in Chicago and author of the Buffettologist.com blog.

Buffett is not expected to shed any of Berkshire's biggest holdings, which include insurers such as Geico, analysts said. It has close to 80 units with products ranging from carpeting to natural gas, ice cream, paint and underwear.

They tend to accumulate capital faster than they know what to do with it and this is a really good deal for them, Fuller said. It will create a lot of value for Berkshire.

RECOVERING ECONOMY

Buffett, 79, is one of the world's most revered investors and is known for making big long-term bets. In October 2008, after the collapse of Lehman Brothers set off global selling, he wrote in The New York Times: Fears regarding the long-term prosperity of the nation's many sound companies make no sense.

The deal, expected to close in the first quarter of 2010, comes as the U.S. economy begins to recover from its worst downturn since World War Two.

BNSF, the No. 1 U.S. railroad by revenue, operates in the U.S. West and Midwest. It said in September that freight volumes were recovering and it was encouraged by an improvement in consumer-related markets.

The deal really marks a bet on the future of coal, said Jack Ablin, chief investment officer at Harris Private Bank in Chicago.

Buffett is trying to get into coal, but doing it in a cheaper way, Ablin said.

U.S. railroads have invested in technology and improved the efficiency of operations, while arguing that their method of transport is cheaper and cleaner than shipping goods by truck.

The deal came together quickly.

I made (BNSF Chief Executive Officer Matt Rose) an offer and he said he would take it to his board and it took about 15 minutes, Buffett told CNBC television. We won't be making any huge deals for a while.

With Berkshire's support, BNSF would be able to invest in its infrastructure and not have to worry about meeting quarterly expectations, said Thomas Russo, a partner with Gardner Russo & Gardner in Lancaster, Pennsylvania, which counts Berkshire as its second-largest holding.

RAILS RALLY

BNSF, with its Western presence, is a key shipper of Asian goods into the U.S. interior and the leading shipper of coal and agricultural commodities, according to Robert W. Baird.

About a third of BNSF's revenue comes from intermodal freight -- containers moved from ship to rail or truck -- with 23 percent from coal, and 19 percent from farm goods.

BNSF's 2008 revenue of $18 billion was about $1 billion ahead of that of its nearest rival, Union Pacific Corp.

BNSF shares closed up 27.51 percent at $97. Union Pacific gained 7.9 percent, Norfolk Southern Corp rose 5.4 percent and CSX Corp rose 7.3 percent. The Dow Transports index, which includes all these stocks, gained 5.3 percent and is up 75 percent from March lows, beating the Standard & Poor's 500 index.

Canadian National Railway Co rose 1.8 percent and Canadian Pacific Railway Ltd rose 3.2 percent.

Berkshire held a 1.9 percent stake in Union Pacific and a 0.5 percent stake in Norfolk Southern, according to Thomson Reuters data. The small size of those holdings was unlikely to attract regulatory scrutiny, said Bob Szabo, executive director of Consumers United for Rail Equity.

Buffett said he is not interested in buying Union Pacific.

Los Angeles-based money manager Capital Group Cos, which oversees the $780 billion American Funds mutual fund family, would be one of the big winners in the deal. Its fund unit held a 9.5 percent stake, making it the largest shareholder after Buffett, according to Thomson Reuters data.

Goldman Sachs and Evercore Partners Inc acted as financial advisers to BNSF, and the company's legal counsel is Cravath Swaine & Moore LLP. Berkshire did not have a financial adviser, but its transaction counsel is Munger, Tolles & Olson LLP.

(Reporting by Nick Zieminski; additional reporting by Angela Moon, Christopher Kaufman, Diane Bartz, Lilla Zuill, David Gaffen, Paritosh Bansal, Aaron Pressman, Ryan Vlastelica, Helen Chernikoff and Jonathan Stempel; editing by John Wallace, Gerald E. McCormick and Andre Grenon)

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