(The following article by Randolph Heaster was posted on the Kansas City Star website on March 1.)
KANSAS CITY — Proxies go out this week to shareholders of Kansas City Southern to approve its bid to buy control of TFM, Mexico’s largest railroad.
The nearly $700 million acquisition essentially will double Kansas City Southern’s size and create a single, 1,300-mile railroad between the Midwest, central Mexico and Mexico’s developing Pacific ports.
When the U.S. economy slowed earlier this decade, Kansas City Southern derived much of its profits from the 37 percent of TFM it already owns, because the Mexican economy continued to grow. Although its domestic business has since recovered, Kansas City Southern still expects future earnings growth to be driven mostly by TFM.
In the eight years since Kansas City Southern made its initial bid for control of TFM, the railroad will have gone from one some predicted would fail in the shadow of much larger rivals to one that some now believe could be a buyout target.
“It’s a fabulous deal for Kansas City Southern,” said S. Scott Nicholls, analyst with Gilford Securities. “We knew it would take a while, but it finally got done.”
Southern comfort
The railroad mergers of the mid-1990s left Kansas City Southern isolated in the middle of the country, a shrinking company surrounded by mega carriers that were taking away its customers, particularly in the West.
With bigger competitors looming to the east, north and west, Kansas City Southern looked south for growth possibilities. In partnership with Grupo TMM, a Mexican transportation company, Kansas City Southern made a bid to run TFM, a carrier that operates in the heart of Mexico, which that country was looking to privatize. That was in 1997.
Over the next month or so, Kansas City Southern hopes to buy out TMM’s interest in TFM and begin operating that railroad, the Kansas City Southern Railway and a shortline railroad, the Texas Mexican Railway, under common control.
It will be the culmination of a vision that Kansas City Southern chairman and chief executive Mike Haverty has had since coming aboard in 1995, a railroad created to take advantage of the 1994 North American Free Trade Agreement. It will stretch from Springfield, Ill., and Kansas City to Mexico City and ports beyond. The two railroads will maintain separate operations but derive great benefits by a single ownership, Haverty contends.
“We’ll have different cultures, different pay scales and different languages,” Haverty told analysts at a conference in Florida two weeks ago. “We will operate as a single system but keep them as separate companies. The railroads will connect from end to end, and we will move traffic between the U.S. and Mexico as though it’s a single line.”
Census Bureau statistics illustrate how much trade there is to tap into. Exports to Mexico have grown 55.2 percent to $110.8 billion since 1997. Imports have grown 44.8 percent to $155.8 billion in those eight years.
It has taken time to create what was once going to be called Nafta Rail. Originally, Kansas City Southern and TMM announced a deal for Kansas City Southern to take control of TFM in April 2003 after more than a year of negotiations. Four months later, TMM’s biggest shareholder, chairman Jose Serrano, rejected the deal.
It was not until last December, after months of arbitration hearings and negotiations, that the two sides reached an amended agreement in a cash and stock deal valued at $672 million.
Since the announcement, Kansas City Southern’s stock price has risen sharply. TMM is slated to receive 18 million shares of Kansas City Southern in the proposed deal. With Kansas City Southern’s share price currently hovering around $19, the deal’s value could rise to about $717 million.
Under the current schedule, barring any hurdles from regulators, Kansas City Southern expects to hold its shareholder approval meeting on March 29, with the sale closing days later.
Even after the purchase is completed, Kansas City Southern will own only 76 percent of TFM. The remainder is owned by the Mexican government, which has an option to sell the rest of the railroad to Kansas City Southern. However, a dispute over a tax refund owed Kansas City Southern and TMM has kept the option from being exercised for now.
Tracking changes
While Kansas City Southern will take control of a railroad running from the Midwest to Mexico, some of the benefits of the deal will come from Wall Street, Haverty contends.
“We believed the ultimate value for the shareholders was to put the three companies under single ownership in the U.S.,” Haverty said. “Trading on the New York Stock Exchange is where you get the greatest value for shareholders.”
In addition, Kansas City Southern’s sole ownership will give TFM a chance to refinance its high-interest debt.
“Even with the issuance of new shares (to TMM), this transaction is accretive to our shareholders only through the refinancing of $443 million in TFM debt,” Haverty said. “Because now it’s a U.S.-based company with access to U.S. markets with more favorable interest rates.”
Thomas R. Wadewitz, an analyst with Bear Stearns, agreed.
“With no overlap in operations and little opportunity for overhead cost reduction (both KCSR and TFM are being maintained as separate companies), we believe refinancing provides the most notable cost (savings) opportunity,” he wrote following the deal’s announcement in December.
As for operations changes, Haverty said Kansas City Southern will approach those with the delicacy that a cross-cultural deal requires. Kansas City Southern and TFM are about the same size as railroads, but TFM has about 800 more employees. Wages in Mexico, however, are significantly lower than in the United States.
“We want to respect the cultural differences and the nationalist pride that Mexico has in their railroads,” Haverty said. “And I think we’ve done so as a corporate citizen there since 1997.”
One change coming to TFM during the second half of 2005 will be the installation of a Spanish version of a computer operating system used by Kansas City Southern Railway. After some early troubles with the system, Kansas City Southern Railway has improved its operational efficiencies, reflected recently in increased train speeds and rail cars spending less time at terminals.
Another advantage once the acquisition is completed will be the ability to move locomotives and rail cars across the border to where they need to go.
TFM in recent years bought 150 new highly efficient locomotives.
“Those locomotives pretty much stayed in Mexico,” Haverty said. “We kept our assets here, and they kept their assets there. Now, we’ll be able to manage the asset flow where the company can get the best return on it. We didn’t always do that in the past.”
Asian influence
Kansas City Southern also is taking control of TFM at a time when companies moving goods from Asia are looking for alternatives to sending container ships to ports in Los Angeles and Long Beach, Calif., where congestion is becoming an annual problem.
A west coast Mexican port in Manzanillo has begun to pick up business. Those involved in the movement of freight think a city south of there called Lazaro Cardenas may have even more potential for growth. Hutchison Whampoa Ltd. of Hong Kong, the world’s biggest operator of ports, and Maersk Sealand, the world’s biggest ocean-shipping company, recently began operating there.
“Lazaro Cardenas has naturally deep water that the ocean liners need,” said Chris Gutierrez, president of Kansas City SmartPort Inc., an organization devoted to promoting international trade. “It’s an industrial city and has tons of land available. The KCS-TFM rail line goes right to the port.”
Gutierrez is part of a delegation of Kansas City officials seeking to establish a business relationship with Lazaro Cardenas. A similar pact has been signed with officials from Manzanillo.
Gutierrez said a delegation from Lazaro Cardenas, including its mayor, are scheduled to be in Kansas City later this month.
With such pacts in the works along with the first Mexican customs office on U.S. soil being proposed for Kansas City, trade and logistics experts think an era of Asian goods moving through Mexico into the central U.S. corridor is imminent.
“The move Kansas City Southern is making will help accelerate that process,” said Chris Kuehl, managing director of Armada Corporate Intelligence, a Kansas City consulting firm. Kuehl said the city of Prince Rupert in British Columbia also is working to become an alternative to U.S. West Coast ports.
“It’s a race between Mexico and Canada right now, but it’s the sort of thing that can flip pretty quickly,” Kuehl said. “Whoever can build the infrastructure-like warehouse capability will get the advantage.”
David Burdick, one of the owners of Priority Logistics of Kansas City, has spent much of his time in recent months in Mexico, researching customs issues, security and cargo tracking.
“To be honest, I can’t find any negatives,” said Burdick, whose firm last year signed an agreement with the biggest Mexican freight broker operating in Manzanillo. “Kansas City is the second-largest rail hub. This region is a natural fit for moving freight from Mexico to the North and Northeast U.S.”
It’s the corridor that Kansas City Southern has worked to establish for nearly 10 years.
But it also may look good to Kansas City Southern’s bigger competitors. Having done the heavy lifting to create a nearly borderless railroad into Mexico, Kansas City Southern could become a potential acquisition target.
Union Pacific Railroad bid for TFM in 1997 and lost to Kansas City Southern, said Gilford Securities’ Nicholls.
“If they were interested then, they’re probably interested now,” Nicholls said in December. “All the major problems with the infrastructure are now resolved. I think Canadian National and Norfolk Southern might also be interested.”
Kansas City Southern’s Haverty said the company would have a fiduciary responsibility to consider any reasonable proposal but it is management’s intention to remain independent.