(The Omaha World-Herald posted the following article by Steve Jordan on its website on April 21.)
SALT LAKE CITY, Utah — Generations of railroaders have envisioned a true U.S. transcontinental rail system, with a few giant companies capable of carrying carloads of goods from Long Island, Calif., to Long Island, N.Y., and back.
For decades, the industry has moved in that direction, posting $20 billion worth of mergers since 1994 alone and compressing the number of large U.S. and Canadian railroads to six. Three years ago, the big railroads seemed to be headed for a Final Four.
Then a government agency stepped in, imposing a moratorium on mergers and setting higher barriers for the next big one. Since then, mergers have been missing from the railroads’ agendas.
And now Dick Davidson, chairman and chief executive of Union Pacific Corp., the nation’s largest railroad in terms of track and revenue, says North America may keep the current lineup indefinitely – two big railroads in the West, two in the East and two in Canada, connecting with Mexico’s two smaller lines.
Now is not the time for Union Pacific, based in Omaha, to consider merging with any of the five other big railroads, Davidson said in an interview here, where he hosted U.P.’s annual stockholders meeting last week.
“I don’t know that it will ever be the time,” he said. “It really doesn’t make economic sense for us.”
The reasons, he said, include the railroads’ recent success in operating cooperatively to cut costs and improve delivery times for customers without going through the expense and trouble of acquiring one another.
The traditional “merger game” among Class I railroads (those with annual revenues of $250 million or more) has worked like a Chinese restaurant menu.
To get a complete U.S.-Canada rail company:
— Start with one from Column A:
Western powerhouses Union Pacific and Burlington Northern Santa Fe Corp. These are the two most likely acquirers, given their financial strength and operating prowess.
— Pick one from Column B:
Eastern competitors CSX Corp. and Norfolk Southern Corp. They connect the East’s major cities from Chicago to New Orleans, Boston to Miami. Their finances were stretched in 1999 when they split up the assets of Conrail Inc. Today, Norfolk Southern has the financial and operating edge that makes it the most attractive takeover target.
— And choose one from Column C:
Canadian counterparts Canadian National Railway Co. and Canadian Pacific Railway Co. They reach from Pacific to Atlantic and dip deep into the central and eastern U.S. markets. Canadian National’s revenue and customer base make it the more attractive candidate.
Many railroad-watchers still think a scenario merging the six railroads into two huge networks may yet take place, said railroad analyst Donald Broughton of A.G. Edwards & Sons in St. Louis.
What about those operating agreements that Davidson says are saving money already, without mergers?
Someday, railroads may declare mergers necessary by saying that they have achieved all possible nonmerger savings and need to find further efficiencies, said Broughton, who does not own Union Pacific stock.
“I’d be one of those who argue that it’s a dating process,” he said. “‘We’ll see how well we work together. We enjoyed dating, but now it’s time to get serious.'”
He wouldn’t be surprised to see future mergers, though who would acquire whom is unclear.
“These guys are all poker players,” he said. “There are many ways to play this.”
For example, if Burlington Northern were to sign a deal to acquire Canadian National, Union Pacific could make an offer for Norfolk Southern rather than trying to duplicate B.N.’s Canadian strategy by buying Canadian Pacific.
So far, U.P.’s Davidson is playing the game close to his vest.
He says that’s because of U.P.’s strong cooperating agreements with CSX, Norfolk Southern and Canadian Pacific. U.P. also is starting to work more closely with Canadian National.
That cooperation was sparked by Burlington Northern’s attempt to acquire Canadian National in 2000. The four other railroads objected, and the federal Surface Transportation Board imposed its moratorium. The board’s new rules require that mergers not only preserve competition – the earlier standard – but that they also enhance it.
Davidson said Union Pacific also would make considerable sacrifices if it tried to acquire CSX or Norfolk Southern. U.P. does about $1 billion worth of business with each of the two eastern railroads every year. Acquiring one of those two competitors probably would cause the other to drop its U.P. dealings.
“We already look like a merged railroad to the customer,” he said, because the four are handing off cargo quickly at the points where they intersect, cutting red tape and saving shipping time and money.
Union Pacific, for example, now moves fruits and vegetables from the West Coast to New York City in eight days by seamlessly shifting cars to CSX’s lines. And it can haul goods from western Canada to California in six days through improved connections with Canadian Pacific.
One of the smaller U.S. railroads, the Kansas City Southern Railway, may be an acquisition target in the future, Davidson said. That’s a regional carrier, and the Surface Transportation Board set up separate rules that would make its acquisition easier for the large railroads.
If Burlington Northern were to seek another acquisition, would Union Pacific respond in kind?
Davidson said he’s not sure because it would be difficult for Burlington Northern to meet new federal merger rules on competitiveness.
Besides, he said, the remaining merger possibilities among big railroads are “end-to-end,” meaning their lines cover different geographic areas.
The big savings in past mergers was the elimination of duplicate rail lines, shipping yards and repair shops, Davidson said. A merger of an eastern and a western railroad would save only administrative costs, which are small, one-time efficiencies.
Then there’s the possibility of mergers not going smoothly.
Union Pacific struggled after its last acquisition, the 1996 purchase of Southern Pacific Corp. It took nearly two years to correct the resulting rail congestion and delayed shipments and to soothe outraged customers. Stockholders even felt the pain when the company cut its dividend for the first time in years.
Since then, Davidson’s crew has ironed out those problems, winning customers back and posting four straight years of improved profits. Dividends went back up last November.
Another strong argument against mergers, according to Davidson: “None of our customers are advocating it. I’ve never had a single customer tell me that. In fact, I’ve heard just the opposite. They think the railroads are big enough.”
Railroad merger history
— 1980 Chessie System + Seaboard System = CSX Corp.
— 1982 Norfolk & Western + Southern = Norfolk Southern Corp.
— 1995 Burlington Northern + Santa Fe = Burlington Northern Santa Fe Corp.
— 1996 Union Pacific + Southern Pacific = Union Pacific Corp.
— 1999 Norfolk Southern and CSX acquire Conrail Inc.