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The Railroad Week in Review 1/11/97
featuring: The Battle for Conrail

Ready reference: homepages for Conrail | CSX | Norfolk Southern

First, merger news. Of the top ten mergers announced in '96, AP lists at number seven the Norfolk Southern-Conrail $10.32 billion hostile bid and at number eight is the CSX-Conrail $9.76 billion friendly deal, which last week it moved another step closer to the CSX goal of amassing another 20% of Conrail's stock.

Thursday US District Court Judge Donald VanArtsdalen gave Norfolk Southern a very bad day. The Judge refused to rule against the CSX/Conrail two-year lockout, saying it was unprecedented, but, hey, it's their company. He also saw no evil in the inadvertent collection of a tad more than 20% of CR's stock between various factions in the deal, especially when they sold off the 85,000 excess shares (at a $million loss) when they discovered the error.

The Surface Transportation Board was another story. In a six-page decision, the STB acknowledged that the two-year lock-out period "appears excessive on its face" and would not preclude it from approving Norfolk Southern's proposal to acquire Conrail or keep Norfolk Southern from consummating the merger if approved. The Board also said that federal law would void the lock-out provision if the Board approves a Norfolk Southern/Conrail combination. In language applicable to CSX and Conrail, the Board held that "A person cannot effectively preclude our approval of a transaction from going forward simply by entering into a contract that purports to prevent all alternatives to its own preferred outcome."

In plain language, regardless of the battle for shareholders, the STB is the court of last resort, and any merger plan will need its blessing to be consummated. That's why it's important to see how the various shipper and governmental constituencies react to the competing proposals as they are fleshed out.

Continuing our 1996/1997 Review & Outlook, here are some reader observations:

"Outlook for 1997: Emergence of a "NAFTA Railroad, Mexico-KC & Chicago -Canada (KanCity Sou/TMM); more sell-off of rails to the short line holding companies; new life for coast to coast, port to port transcontinental rail business (BNI unclogging trains Washington state rails, Long Beach building overpasses for harbor rails, and new ports vying for port/rail traffic by building new facilities w/ rail connections,(as opposed to Boston's port which requires truck connection), that is, US Railroading as not quite the sunset industry it was."

"These opinions and two-bits will get you a cup of bad coffee in Cleveland, but here's some prognostications for 1997 and beyond in rails..............

  1. Obviously continued merger...once the indigestion of UP/SP and NS-CSX-CRR wears off. Perhaps the merger tone will shift from the "scorched-earth" policy of UP/SP to a more favorable rationalization and spin-off attitude that may characterize NS-CSX-CRR.

  2. Merger activity will lead to greater "structured dependence" upon pro-active, entrepreneurial-minded shortline and regional railroad operators. Best analogy here would be the type of relationship that the "TWA Express" and "United Express" [and Conrail Express] airlines share with their larger airline brethren.

  3. Consolidation in the short-line/regional railroad world as economies of scale and just plain economics force a lot of under-capitalized or under-managed railroad properties to be consolidated into larger regional systems in order to survive.

  4. Emergence of a new wave of cooperative transportation partnerships between different modes of transportation utilizing the best strengths of each mode to provide an even higher level of customer services. I believe the entrepreneurial regionals will take the lead in this regard."

The infamous "bottleneck case" was heard by the STB. In it, certain utilities had asked the Board what rails with exclusive access to power plants can charge for short haul runs when other rails have the long haul. The STB ruled in favor of the rails and against the utilities, triggering angry outcry from the NIT league and others saying the ruling would "intensify concerns" about future mergers. Reuters reported, "The railroads successfully argued that they would lose as much as $2.4 billion annually if the board limited short-haul rates to encourage competition on the long-haul portion of shipments. Shipper groups have indicated that they will, in response to the coal-rate decision, press harder for competitive service following any merger involving Conrail." And since one of the shippers bringing suit was Conrail customer Pennsylvania Power & Light, the shipper remarks carry a lot of weight in the current battle.

Over the past few weeks we've had an active thread comparing Norfolk Southern and Illinois Central on such things as operating ratio and return on equity. The nub of the argument was which was the better investment. Veteran rail-watcher and investor Tim Eklund in Chicago contributes this very accurate summation of IC's strengths. Says Eklund, "I think a number of things contribute to IC's very low Operating Ratio.

  1. Horsepower-per-ton averages .60 hp/ton thanks to basically flat terrain. [This lets the] operating department maximize horsepower on hand without spending the high costs for new stuff, plus keeps a handle on fuel costs. IC's motive power stable is full of lots of first-and-second generation EMD products...rebuilt GP 7's and 9's, GP 40's, SD 40's, SD 40-2's. Newest in the stable is no-frills SD 70's.

  2. They are very progressive in management of the railroad and have instituted an "out-and-back" philosophy so that road crews can begin and end their runs at home terminals the majority of the time.

  3. There are strategic relationships with other carriers (BNSF and WCLX) to maximize IC's straight-to-the-Gulf system; IC knows its niche and sticks to it. And once they begin to realize the synergies of their recent CC & P purchase, they ought to be able to get debt-to-equity back down below 70."

Another active thread has to do with debt load and ROE. Reader Arnold Komisar of NY writes, " My fear is that we are beginning to see inflated prices for these assets and the debt load may take years to enter the positive cash flow column. What aggressive short -lines and regionals are your current favorites? RailTex has not been doing well in this market."

Again, Tim Eklund: "In my opinion, RailTex has not done well because of the isolation of their various railroad properties. Having many small, stand-alone systems may not be as viable in the coming years. To me, the regionals that will gain dominance will be those that first of all can tie their systems together to form larger regional systems with multiple class 1 connections and broader diversity of traffic. They must also encourage entrepreneurial management -- individuals who may not necessarily come from the railroad industry yet who have the vision to see that the customer is going to require a seamless transportation solution which requires the railroad operator to work cooperatively with other transportation modes.

"Finally, there has to be a desire to work cooperatively with the remaining class 1s to handle secondary and tertiary non-priority traffic. Then the class 1s can utilize their infra-structure for those rail moves that it's tailored for intermodal, high-density, high-speed, etc. Some of these companies may not even exist today...but they will...soon." Amen to that.

--Roy Blanchard

Ready reference: homepages for Conrail | CSX | Norfolk Southern

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