If a stalled attempted acquisition of Norfolk Southern by the owner of Canadian Pacific eventually proceeds, it would run smack into a Surface Transportation Board (STB) freshly reformed by Congress and could provoke other American railroads to jump on the merger bandwagon.
The board of NS has spurned two purchase offers worth more than $28 billion made by CP. Bill Ackman, CP’s majority owner who announced plans to merge the two railroads, has asserted that NS stockholders are being punished by the rail company’s low earnings.
Ackman has promised to slash costs and improve profitability, which he also said he would do with CP before acquiring it three years ago. He has been credited with having accomplished this at CP, although a recent survey shows shippers are not happy with the railroad’s leadership.
Although it is based in Canada and has extensive operations there, CP in 2009 acquired the Dakota, Minnesota and Eastern Railroad and the Iowa, Chicago and Eastern Railroad in the United States.
Last week the NS board said CP’s offers were too low, and cited antitrust and other regulatory roadblocks that would most likely derail the merger of two of the remaining handful of large freight railroads in North America.
“There is a high probability that, after years of disruption and expense, the proposed combination would be rejected by the Surface Transportation Board,” says James A. Squires, CEO of NS. The company has publicized a white paper written by two former STB commissioners, Francis Mulvey and Charles Nottingham, who agree with this view.
Squires pulls no punches in his opinion of CP’s leadership. “We believe that Canadian Pacific’s short-term, cut-to-the-bone strategy could cause Norfolk Southern to lose substantial revenues from our service-sensitive customer base,” he says, pointing to extensive changes the railroad is making to improve its profitability.
“We also believe the proposed transaction risks harm to vital transportation infrastructure and the communities we serve,” Squires adds. “Any strategy that hurts our customers and the broader community is highly unlikely to receive regulatory approval and is inconsistent with the delivery of shareholder value over the long-term.”
Responding to press inquiries, Union Pacific publicly restated its position that combinations like CP and NS will disrupt nationwide rail operations. “We oppose rail industry mergers in the current environment and believe the regulatory hurdles for future consolidation would be significant,” UP spokesman Aaron Hunt says.
“If there is consolidation to be had, we would participate as well,” BNSF executive chairman Matt Rose told Bloomberg News. He said that BNSF, which is owned by Warren Buffett’s Berkshire Hathaway, might choose to make its own offer to acquire NS and if the CP-NS merger proceeds, BNSF could switch gears and make a bid to purchase CSX.
The Wall Street Journal reports that a survey of rail shippers conducted by Cowen & Co. found that 71% of them oppose the CP-NS merger, and about half say they would communicate their unhappiness to the STB.
“We’ve long passed the point where merger-generated service improvements have the potential to outweigh the anti-competitive impacts resulting from fewer routing options,” comments one survey respondent. Another shipper observes that CP’s CEO Hunter Harrison “does not know how to run a railroad, but it is his way or the highway."
Facing a Reformed STB
Major rail mergers would get much more scrutiny from the government today because there are fewer big rail companies. Most rail customers can access only one major railroad, which gives rail companies unique pricing power that you don’t find in more competitive modes.
Supervising the nation’s railroads is the Surface Transportation Board, an independent agency created by Congress, that is organized in much the same fashion as the Federal Trade Commission and Federal Communications Commission. The STB also is the successor to the old Interstate Commerce Commission and its commissioners are appointed by the President and approved by the Senate to serve for set terms.
Last Thursday Congress passed legislation reauthorizing the STB and expanding its membership from three to five commissioners. The new law streamlines the board’s procedures for reviewing railroad rate cases. It also shortens timelines and simplifies highly-complicated procedures used by the STB to mediate shipper disputes with railroads over freight rates.
Until now rail rate cases routinely cost shippers and the railroads more than $3 million to litigate and could take over three years to resolve. The new law also allows commissioners to discuss policy issues informally. Prior to this change any such discussions required them to post public notice and hold open hearings.
The reform legislation enjoyed support from major shipper groups and the Association of American Railroads, which supported the measure after a competitive switching provision that was included in earlier legislation was not included in this newer bill. Also called reciprocal switching and long sought by shippers, competitive switching would require railroads to share track with other railroads to guarantee competitive service for shippers who currently are served by only one railroad.
After this reform bill passed last week AAR president Edward R. Hamberger commented, “This legislation strikes the right balance of preserving a market-based structure for shippers and railroads, while also providing commonsense process improvements that will allow the STB to work more efficiently.”
The American Chemistry Council, which was one of the major supporters of the legislation, states, “It’s clear there is a widespread consensus among Congress that the status quo is not working and that our country’s freight rail policies need to be updated. Now that Congress has acted, we urge the STB to move forward on proposals to increase rail-to-rail competition and improve the board’s rate review process.”
The Rail Customer Coalition, consisting of trade associations that represent manufacturing, agricultural and energy companies, hailed the changes in how the STB handles rate disputes and has allowed it to be more proactive in resolving freight rail issues.
“In light of the recent service breakdowns impacting rail customers nationwide, this legislation also emphasizes the existing responsibility of the railroad industry to dedicate revenue appropriately to meet current and future service needs,” the coalition says. “Specifically, the STB has an opportunity to follow Congress’s lead by moving forward on proposals to increase rail-to-rail competition and improve the board’s rate review process.”