THE BLANCHARD COMPANY

The Railroad Week in Review:
Week Ending December 25, 1999


Our Merry Christmas gift in the M&A department was Monday's announcement (leaked over the weekend) that BNSF and Canadian National are about to tie the knot. The press release carried the usual about customer service and operating synergies, but by Wednesday it became evident the investing community wasn't buying any of it. You've got to admit, though, a single line haul from Halifax to LA or Monterrey is kinda mind-blowing. By now, you've probably read the mechanics of the deal, so there's no sense boring you with them here. However the fallout is excellent reading.

Stock exchange disapproval was quick in coming. By week's end BNSF had dropped from a Monday high of $27 13/16 all the way to $23 15/16, a loss of 14%, the sort of change you'd expect of something like trendy Linux software-maker Corel, not a big NYSE-traded railroad. CN was hit upside the head just as hard, falling from a week's high of $31 9/16 down 16% to $26 5/8, having recovered slightly from Thursday's intraday low of $25 . As Larry Kaufman put it in the JOC, "Wall Street trashed BNSF's stock. A Senator said Congress would have to take a close look at the transaction, while a key regulator [Linda Morgan] expressed surprise."

How do the numbers stack up, actually? A pro forma combined third quarter results and balance sheets is revealing. Combined revenues were $3.6 bn, with BNSF contributing 65% on 59.4% of the combined asset base. Combined net income of $524 mm was 62% BNSF. Elsewhere in the financials, BNSF sports a slightly better debt/equity ratio, does a better job of managing cash as measured by payables vs. receivables, and has a 14 basis point advantage in ROA.

Washington-watcher Frank Wilner opines that if Congress shifts merger authority to Justice from the STB it could be tough sledding. Just coincidentally DOJ failed to show up in court as usual on the side of the STB in arguing an appeal in the CP Dispatcher case. Wilner writes that the court observed, "The STB essentially deferred to the Executive Department of which it is a part. Doing so is directly contrary to the statute that created the STB." Why would one suppose the DOJ stayed home?

A union-member friend who toils at BNSF is a regular correspondent on matters relating to stock performance and labor issues, generally finding helpful links between the two. His latest: "This is a long way from a done deal. BNSF is in trouble with their unions anyway. This will all but kill SACP (Safety Assurance and Compliance Program with reps from BNSF management, labor unions and the FRA) as dead as a coffin nail and the fight will be on. At the very least it will complicate everything and if the workers fear that the railroad will cut jobs to save money for merger costs then their congressmen and senators are but an e-mail away.

"The STB has been under a lot of pressure to make sure any mergers go together a lot smoother or not to grant them. While little has been said about out west of the problems faced back east there is still a lot of bad taste left over from the debacle of the UP-SP merger. If this merger is to go through, I believe they are going to have to show some real benefits for everybody involved and I just don't see that yet! The stockholders meeting just got a whole lot more interesting!"

CSX had stock troubles of its own this week. On Tuesday it was among the Most Actives with 3.5 mm shares changing hands, down $5.25 to close at $29 even, off 15%. Triggering the move was a Monday press release saying that earnings would be in the range of 18 to 24 cents a share before one-time items. CSX had opened the week on a 4Q99 consensus estimate of 60 cents a share.

Both the railroad side and steamship side took major hits. Rail (CSX Transportation) earnings got hammered as demand outstripped supply, particularly on the former Conrail lines, with higher than expected locomotive, equipment and crew costs. Sea-Land sold its international container business to Mearsk this month and saw global container shipping revenues decline sharply during the quarter. Moreover, operating costs rose in anticipation of the transition to Maersk.

Rail performance still needs sharpening. Terminal dwell time averages above 40 hours and cars on line remain in the 265,000 range. Of that number, 53,000 are "foreign" cars subject to car hire. Another 124,000 are private leased equipment that somebody is paying upwards of $13 a day in rental charges. CSX has to pay foreign car owners something like $12 a day, and though the private cars are "free" to CSX (no daily rentals), slowing them down irritates the customers who have them on lease.

That being said, taking just one day out of the yard dwell time is worth $600,000 in car hire if every one of those foreign cars goes through a yard just once. Doing the same saves leased car customers twice that much. But help is on the way. The Local Area Management (LAM) system now being implemented by CSX incents the yard managers to increase velocity and cut dwell time. Let's see how cars on line, yard dwell times, and equipment rental expense change in 1Q00.

The stakes are high, too. With the Maersk deal done CSXT will account for about 80% of total sales and earnings brought in by the "new" CSX. So the combined effect of these events on 4Q99 results has been substantial. What we ought to see once the dust settles is a leaner, meaner CSX ready to deliver on its promise to make its operation "smarter, faster, and closer to the customer" (WIR 12/11/99).

Not to be outdone, Norfolk Southern saw fit to drop below the $20 threshold for the first time, closing at $19 11/16, off 13%. Union Pacific shed 9% of its per share value, closing down at $41.1/8. Canadian Pacific continues to hew closely to its 200-day moving average, which has hovered in the low 20s for three years now. For the week shares lost but one dollar, closing at $21 and small change, off just 5%. Not what you call a good week for rail stocks.

Feedback Department. A reader writes, "I read your WIR and the quoted comments from somebody in the railroad industry with considerable interest. Here's the way I see the railroad industry. Collectively, the big railroads have spent about $17 billion to buy each other over the last four years. This debt carries interest payments (as most debt does). The collective result of all these mergers is that traffic is flat or down, revenues are down, costs are up, and operating ratios have suffered accordingly. How is the debt to be repaid?

"The industry has decided to put repayment of debt ahead of investments in new capacity (which, given declining yields, is justifiable). With the poor service now being offered, yields are not likely to improve any time soon. Conclusion: the Class I railroads of North America are having a 'going out of business' sale. And this week's merger activity confirms this." He has a point. Further comment is most welcome.

Lastly, the world of e-commerce continues to burgeon. Traffic World reports that Roadway Express has reorganized its information technology department in anticipation of a tidal wave of demand from here out. TW quotes a Roadway spokesman as saying the company is making "proactive changes to prepare ourselves for the e-commerce explosion, which has already started."

The web world is full of companies marketing business-to-business (B2B) services, expected by some industry observers to be worth more than the entire retail business by several orders of magnitude. If our industry could get just one aspect of its service -- car supply and management -- under control, untold new business opportunities could be captured.

My November 1999 column in Railway Age was on car supply for just this reason. In researching the article, I found more than 11,000 owned or leased freight cars spread among just six AAR Class 3 properties. Moreover this Gang of Six shortly will be adding to their fleets to accommodate new business. The bad news is that all of these roads are limited in the number of vendors they can call by the depth of their Rolodex lists. The good news is that is about to change, and, you guessed it, that change is on the Internet.

Watch this space for an imminent further announcement.

--Roy Blanchard


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