Tension over proposed railroad M&A runs high among Class I players

In various freight transportation and logistics sectors, merger and acquisition activity (M&A) is commonplace and happening with extreme frequency. That was especially the case in 2015 with heavy 3PL and, in some cases trucking M&A activity.

But when it comes to freight railroad M&A the situation is not nearly as fluid or fervent for that matter. That is with good reason, too, specifically when one considers that there are fewer players to merger and acquire with, too, which is definitely the case with Class I railroads.

What’s more, the freight railroad sector has shrunk from 56 Class I railroads in 1975 to seven in 2005. And with such few players it makes the current situation regarding Canadian Pacific’s unsolicited nearly $30 billion offer to acquire Norfolk Southern interesting in that aside from CP, obviously, there does not appear to be a ton of public support for the proposed deal.

One example of that was found in a recent shipper survey by investment firm Cowen & Company, which found that 71 percent of surveyed shippers were not in favor of a CP-NS merger.

And with the current balance of power in North America among the Class I railroads––two in the east, 2 in the west, one in the middle, and 2 in Canada––an industry stakeholder recently told LM that has created a very stable playing field, but were one of the legs of this “table” to be pulled, it would require some sort of response among the other members of the supporting cast, which he said is not likely in their best interests.

These things serve as a backdrop to the comments issued this week regarding railroad M&A by some of the biggest names in the business.

Union Pacific CEO Lance Fritz said in a Reuters report this week that railroad mergers are not in the best interests of the industry, adding that UP is working behind the scenes to make sure industry M&A does not occur, as well as talking to other railroads about the potential impact of a merger.

Fritz, who was speaking at the Midwest Association of Rail Shippers meeting in Lombard, Ill., made his case against railroad M&A clear on a few different levels, with UP speaking with state and federal legislators, customers, and regulators (the Surface Transportation Board).

The top UP executive said that a merger would create problems in the Chicago interchange, which is by far the busiest interchange of railroad activity in the U.S., adding that various mergers in the 1990s resulted in major service-related issues. And he also noted that an industry merger would “increase the pressure enormously” on other railroads to consolidate, too.

That thesis has received a lot of attention to be sure in the days and weeks since CP initially expressed interest in acquiring CP.

Speaking of CP, it issued a statement to express its dismay over Fritz’ comments in the Reuters report and that UP is “working behind the scenes with other railroads to support the status quo.”

CP said that a merger with NS would enhance competition and alleviate Chicago-area congestion, while also explaining that STB merger rules are designed to enhance competition and, as with U.S. antitrust law generally, are not designed to protect other railroads from balanced competition. 

It also took it another step further in explaining that UP has benefited from mergers in the past.

“We note that UP is itself the product of numerous mergers that created one of the largest route networks in North America,” said CP. “In a statement filed to the STB on April 11, 2011, UP CEO Lance Fritz argued that consolidation enabled the railroad to create ‘an efficient system removing bottlenecks and inefficient operations, including unnecessary interchanges, and increasing single-line service.’ According to Mr. Fritz, UP has ‘been able to provide safer, better, and expanded service because of our ability to leverage the economics of consolidation.’” 

With so few players and a lot on the line in terms of whether or not a CP-NS deal will actually ever come to fruition, it is clear that tensions are high either way. These deals are large and complex in terms of geography, assets, people, and service, among other factors, which makes it very difficult to make comparisons to large-scale deals in other freight transportation and logistics markets.

It is very difficult to say what happens next but it will be interesting, captivating, and exciting all at once, very much like the freight railroad sector itself.