UTU News Digest - Tuesday, December 28, 1999

UTU
Daily News Digest

Information of interest to operating railroad and transportation employees

Tuesday, December 28, 1999

OHIO: Railroad mergers cutting ranks of players

TOLEDO -- For decades American railroads have played a merger mating game, growing ever larger as their numbers have dwindled, the Toledo Blade reported.

Famous names like the Baltimore & Ohio, the Atchison, Topeka & Santa Fe, and the Southern Pacific all have vanished, and recent mergers have swallowed up products of previous combinations, including Conrail and Burlington Northern.

Since 1980, the number of railroad companies meeting a federal revenue threshold for status as a "Class 1" railroad has shrunk from 26 to eight, largely because of mergers. And three of those eight are owned by Canadian National or Canadian Pacific, the two dominant railroads of Canada.

The announcement last Monday that Canadian National and Burlington Northern Santa Fe plan to merge within two years could well mark the start of the last big round of railroad consolidations, ending with the establishment of two, or maybe three, huge transcontinental systems.

But the proposal's ride toward regulatory approval portends to be a bumpy one - if it gets there at all.

"Everyone is pretty well mergered out,'' said David Eden, a spokesman for the United Transportation Union, who noted that railroad labor, shippers, regulators, and investors all viewed the BNSF-CN announcement with skepticism.

Linda Morgan, chairman of the federal Surface Transportation Board, publicly questioned the proposal's timing soon after the announcement. Her board now has the power to approve or reject railroad mergers, although its authority is up for congressional renewal this year. And congressmen leery of repeating recent railroad problems may lean on the board to proceed more cautiously with future combinations.

"I'm not sure that they're going to rubber-stamp this one,'' said Ed Rastatter, director of policy for the National Industrial Transportation League, which represents hundreds of railroad shippers.

But if the BNSF-CN merger is approved, observers agree, it is unlikely to be the last railroad combination.

"Everybody's watching what Union Pacific will do,'' said Michael Lloyd, an analyst with Merrill Lynch. "They're the ones that would be damaged the most by traffic diversions."

While railroad mergers of the 1960s and 1970s were mostly the products of economic duress in a declining industry, more recent combinations have involved mostly healthy companies that argued that consolidation would result in better and more efficient service. The railroads aimed to eliminate delays in exchanging shipments from one line to another, a common shipper complaint.

But two of the most recent mergers, Union Pacific's 1996 acquisition of Southern Pacific and, especially, this year's division of Conrail between CSX and Norfolk Southern, led to massive railroad congestion resulting from computer problems, personnel redeployment, and, to varying degrees, questionable planning and decision-making.

On the other hand, Mr. Lloyd noted, Canadian National bought and merged Illinois Central into its system last year with relatively little fanfare or controversy. The difference, he said, was that Canadian National and Illinois Central was an "end-to-end" merger (there were no overlapping facilities) and thus was much less complicated than the others.

BNSF-CN also would be an end-to-end merger, Mr. Lloyd said, so there is "good reason to believe" it will work if it passes regulatory muster.

And once CSX and Norfolk Southern straighten out their post-Conrail malaise, he said, they too could well be in play for mergers.

"You just don't want to mess with the East for now,'' Mr. Lloyd said. "But in a year or two, CSX and NS could merge end-to-end with the western roads."

The Union Pacific-Southern Pacific combination and the Conrail transaction left just two big railroads in the west (Union Pacific and Burlington Northern Santa Fe), and two in the east (CSX and NS), prompting widespread speculation that those railroads eventually would pair up to create two huge networks spanning the United States.

Canadian National, which bought Illinois Central last year and already owned Grand Trunk Western, and Canadian Pacific, which has long owned the Soo Line Railroad in the United States, also were forces to be reckoned with. And Kansas City Southern, which, with several subsidiaries, operates a network of lines running south from Missouri to the Gulf Coast and Mexico, was a wild card, particularly since it has marketing agreements with CN-IC.

That BNSF's first move was toward one of the Canadian lines, instead of an eastern railroad, caught Mr. Rastatter by surprise.

"We never in our wildest dreams imagined that a western railroad would merge with one of the Canadian railroads,'' said Mr. Rastatter, a former U.S. Department of Transportation staff member. Citing past remarks by BNSF chief executive Robert Krebs, Mr. Rastatter said the CN proposal may well be "a first step" and that a future merger with Norfolk Southern remains possible.

He and Mr. Lloyd said that by itself, a BNSF-CN combination likely would have minimal effects on rail service in the Toledo area unless it too causes service glitches that snarl the rail network. The long-term effect, they said, depends on how the merger dance lines up.

Jim Hildreth, a Union Pacific spokesman, said his company is "looking over the situation" but has months to decide how it will respond.

"We're not looking to race out the door here and do anything. We're having one of our best years,'' he said, remarking that UP has recently signed major long-term contracts with Chrysler and General Motors.

But Mr. Rastatter said a response is inevitable, and he thinks it may come sooner, not later.

NEW YORK: What's beyond the tunnel for rail stocks?

A little more than a century ago, railroads were the equivalent of today's Internet stocks, the New York Times reported.

These days, the $40 billion North American railroad industry remains a core component of the economic and transportation infrastructure. But no one will confuse Burlington Northern Santa Fe or Canadian National Railway -- which last week announced a $6 billion deal to form the biggest railroad on the continent -- with Yahoo.

The merger is the latest of many over the last few years. But consolidation and good economic times have yet to do much to raise the bottom line. And investors are really turned off: for the last three years, the group has badly underperformed the Standard & Poor's 500-stock index.

Gary Yablon, a managing director and transportation analyst at Credit Suisse First Boston, took some time last week to talk about the merger, the railroads and their competitors. Following are excerpts from the conversation:

Q. Wall Street was not immediately impressed with the Burlington-Canadian deal. Do you think this is a good marriage?

A. It makes sense longer term. Both companies will achieve more together than they would separately.

A big part of the reason it makes sense is that these two roads are leveraging themselves to north-south trade, be it Canada-U.S. trade or Mexico-U.S. trade. The volume of this NAFTA trade, if you like, is growing two to three times faster than the volume of domestic trade flowing from east to west, or vice versa.

But when investors see the results they have seen over the last couple of years, they tend to be skeptical.

Q. There is also some doubt about whether it will be approved by regulators. Will it?

A. I suspect it will get approved. There is not much overlap between the two roads. The things I understand the Surface Transportation Board looks at are public harms and public benefits, and how much one offsets the other. And I don't think the other railroads feel this is such an intrusive merger that they will need to fight it.

Q. The strong economy and the cost-cutting that comes as an industry consolidates are conditions that Wall Street usually loves. But the railroads haven't yet seen much benefit. Why not?

A. To begin with, we are in an economy that has been driven more by service improvements than by rising production of things like chemicals, coal, grain and lumber. And hauling those sorts of things is what the railroads do.

Also, the strong economy masks some things. Because the dollar has been strong, coal traffic, which is a lucrative market for railroads, has been declining due to more attractively priced coal from other countries. Similarly, grain traffic bound for Asia has been anemic because of the crisis in that region. That has hurt and put a cloud over revenues.

And there have been integration issues stemming from these mergers, particularly in the East, where Norfolk Southern and CSX split up Conrail. Whatever revenue stream you have seen from these mergers has been masked by integration costs.

Railroads realize they must get service up to satisfy their shippers before they can turn to looking out for their shareholders. That is one of the reasons the stocks have not done so well.

Q. Can you make an investment case for owning railroads right now?

A. I am not making the investment case for railroads right now.

Historically, we have been quite bullish on the group. But over the last couple of years, that has not been the case. I think the industry needs to improve service levels and show that congestion-related issues are falling by the wayside. Improvement in those areas will raise investor confidence and the valuation of these stocks. Broadly speaking, that is not happening on a steady-enough basis at the moment.

Still, at the moment, we are recommending Union Pacific and Burlington Northern.

Q. Of the freight transportation groups you follow -- air transport, railroads and trucks -- which one has the best investment potential over the next year?

A. Over the course of the next year, truckers have the best potential, followed by rails and then air freight, with the exception of United Parcel Service.

Trucking share prices are trading at almost recession-like levels and shippers are using fewer and fewer truckers.

Right now, the only stock that is working and has worked is USFreightways.

Two others are Swift Transportation and Covenant Transport. Both companies are 20 percent growers whose stocks are trading at historically low valuations. Both are non-union organizations with enormous, enormous potential. They do have the risk of rising gasoline prices, but they can pass that through to customers in the form of higher prices.

OHIO: Taft wants railroads to help pay for overpasses

HURON - The state plans to spend more money next year to pay for more railroad overpasses, and Gov. Bob Taft wants the railroads to help, the Associated Press reported.

Counties and cities in northern Ohio are urging the state to upgrade rail crossings now that train traffic has increased greatly following the takeover of former Conrail lines.

Since CSX Corp. and Norfolk Southern Corp. acquired the lines in June, traffic has tripled in some areas. Because of that congestion, trains are sitting on crossings and blocking cars, trucks and emergency vehicles.

"This is a high priority," Taft said this week. "This is a serious problem and a problem that affects a great many communities across the state of Ohio in adverse ways."

Train traffic has long been a source of frustration in northern Ohio, because the busy tracks connect the East Coast with industrial centers in the Midwest. But building new crossings has taken on urgency in the last six months.

The Ohio Rail Development Commission is studying where to build new overpasses and underpasses and how much it will all cost.

It's too early to say how much the railroads will be asked to contribute, Taft said.

"We'll be talking with them about being partners together with state and local governments in a program to fund underpasses and overpasses," he said.

Taft sent letters last week to the chairmen of CSX and Norfolk Southern, saying that he expected the rail commission's report to recommend a major commitment of state and railroad resources.

The overpasses and underpasses, though, won't be a quick fix.

There probably isn't enough money to build enough for each major crossing - each one carries a price from $1 million to $10 million.

And it takes at least two years to design and build each crossing.

Some money also may come from fines leveled against the railroads. One bill introduced in the legislature would increase fines for blocked crossings and direct that money toward railroad crossing improvements.

Most politicians, though, have been careful to point out that the railroads contribute greatly to the state's economy.

"Transportation is important to our economy," Taft said. "We need a strong rail system in Ohio to serve businesses, to preserve jobs, to create jobs. That's important."

Without the railroads, there would be no auto plants or steel mills. Much of the state's corn and wheat is transported by rail.

That is why legislators are reluctant to greatly increase fines against the railroads.

"Fines alone aren't the answer," said Rep. John Bender, an Elyria Democrat. "We don't want to inhibit commerce."

"We've got to be fair," said Sen. Jeffrey Armbruster, a North Ridgeville Republican. His bill would increase the fine for blocking a crossing to $1,000.

Neal Zimmers, a former state senator who is now a lobbyist for CSX, said few people realize just how much the Conrail takeover will help Ohio's economy.

"The benefits down the line can be very extensive," he said. "It will help businesses reach new markets."

The railroads say they are about halfway into integrating Conrail's lines into their own systems. Zimmers said CSX miscalculated just how much new business the takeover would bring the railroad.

"We found out we got a lot more," Zimmers said.