Mergers and acquisitions could happen among the Class I railroads within the next decade if regulatory and economic factors drive railroads to see mergers as a path to greater efficiency and expanded capacity, according to industry observers.
“I just feel it’s inevitable at some point. It’s a natural evolution if capacity is going to be limited. And it is. It’s limited when you have two separate networks,” said Canadian Pacific (NYSE: CP) CEO Keith Creel at the Barclays investor conference Feb. 19. “When you create one bigger network, you create more capacity. And for the railroads to handle the growth that’s going to come…we have to have more capacity.”
One driving factor for a merger among the Class Is could be regulations that would compel the railroads to join forces as a means to make up for lost efficiencies, said Todd Tranausky, vice president of rail and intermodal services for FTR, a consulting firm. This would be the case if railroads feel the Surface Transportation Board is mandating open access, or allowing freight rail companies to operate over tracks normally restricted to service only by a competing carrier.
“I could see the carriers going ahead with mergers as a way to make up the efficiencies they would lose from an open-access regime,” Tranausky said. “Essentially if the carriers feel like the regulatory efficiency drag is too great, they could use mergers as a way to try and generate additional efficiency.”
He continued, “That said, I don’t think there is any political will on the part of the carriers or the board to undertake the next round of mergers if the status quo is maintained. It would take a shock to the system like open access to kick that off.”
Another impetus for a merger is if the Class I railroads feel their companies would be better served if they expanded their network footprint. Because the existing rail network is finite, one way to create more rail capacity is by joining resources.
“Eventually, you get to a place [where] to create … capacity without an ability to build more railroads … you got to have a better-running network,” Creel said.
While the adoption of precision scheduled railroading (PSR) by all the Class I railroads except BNSF has expanded the rail capacity of individual railroads, according to company officials, the adoption of a similar operating model among all the companies might make for a smoother transition post-merger.
But discussions about mergers might happen in the next five to 10 years rather than within the next five years because of the adoption of PSR, Creel said.
A merger “will depend on chemistry” and timing, said Canadian National (NYSE: CNI) CEO JJ Ruest at the Citi investor conference Feb. 20. Ruest also said the advantage of a merger with an Eastern U.S. railroad is access to major population centers, whereas a Western U.S. railroad has a geographic advantage because of the longer distances and a lack of competition from the rivers and the barge market.
However, despite talk of expanded capacity, some question whether the railroads’ intentions for mergers are more about gaining market share.
“There is nothing technical about a Class I merger that would help grow capacity. Capital investment to grow capacity is a choice by railroad management and their investors,” a transportation consultant said.
The consultant continued, “It is to the railroads’ advantage to keep capacity constrained. Careful control over capital investment to expand capacity reduces the chance that they will really compete with each other for market share to fill the capacity — the last thing that investors want. The game for 25 years has been cut costs and increase prices above inflation. Volume hasn’t grown much in that time. I think they are running up against the limitations of that strategy. All a merger would accomplish would be to improve the merging carriers’ market power, which would let them raise prices more rapidly above inflation and keep the current game going for a while longer.”
Whatever the railroads’ true motivation, the current environment doesn’t appear to support a merger and acquisition anytime soon, Tranausky said.
“Let’s also remember that there has never been a well-executed rail merger. Whether it is UP-SP [Union Pacific-Southern Pacific], the Conrail split between [Norfolk Southern] and CSX, or even CP’s acquisition of the Rapid City, Pierre and Eastern [short line]. So, I think it is a decision that would not be undertaken lightly and is probably off the table unless something drastic changes in the economic regulatory landscape,” Tranausky said.
R.D.
Mergers you say, market share value only.
PSR implementation, car volumes were lost due to RR dictating to customers how they were gg to be worked, definitely not for customer advantage. The current customers were hit with an increase of shipping charges to help offset car loss value. All dollars and cents. Business is out there to be had, especially in east coast intermodal.
Steven Peterson
The CP did not buy the RCPE. They bought the DME in a play to try and extend the western line into Montana to tap coal. When coal volumes went south, CP threw in the towel and sold the DME off to Genessee & Wyoming who turned it into the RCPE. CP kept the eastern portion of the DME, the portion that was operated as the Iowa Central & Eastern (ICE).
Allen Graetz
a) They were angling to tap the Powder River Basin in Wyoming.
b) Extending into the Power River Basin was DME’s child, not CP’s. CP dropped the project long before coal volumes went south.
C) CP kept much of the old DME, not just the old ICE. ICE did not own nor operate on CNW’s old SD-line that formed the DME.
Marc1943
Mergers are over as many of the management teams cannot operate what they have. I see breakups into smaller and more manageable railroads with marketing departments and sales personnel generating new business and growth opportunities for their employers.
Braden D Kayganich
We should’ve had true transcon RR’s decades ago.. The ability to avoid Chicago and other gateways makes sense for merger.. Intermodal cost would deptess as well by resucing dray moves, and building more IM terminals closer to production/consumption areas. Denver-Atlanta, Minneapolis-Atlanta, Detroit-Mexico, Sarnia, ON-Houston TX, Los Angeles-Harrisburg … I can go on and on for the pairs where freight lanes are heavy and ripe for the picking off the highway..