The Railroad Week in Review:
January 8, 2000

Traffic World reports the STB proclaims "that Union Pacific Railroad's service crisis is over." Don't ask chemical shippers to raise any hosannas. In a couple of weeks the Chemical Manufacturers Assn. (CMA) and others comprising the Conrail Transaction Council will powwow in Philadelphia to compare notes on NS and CSX. They are not happy campers, and TW says there is "no apparent end to their service difficulties in sight."

Railroad readers know of customers on their lines who had to shut down or slow down operations because they couldn't get cars. Loads OR empties. Longer transit times added to their woes. And when 60% of the chemical industry sees itself as captive to the rails there's little choice but to ride it out according to TW. Said one CMA member, "You can put stuff on trucks, and a lot of people are doing that, but it's very expensive and not always feasible."

Writing in the Journal of Commerce Larry Kaufman says the proposed merger of the BNSF and CN will "face a broader review" by the STB. There's a fair amount of grumbling out there that the STB has become a "rubber stamp" for rail mergers, says Kaufman, especially given its approval of the joint purchase and division of Conrail operations by Norfolk Southern and CSX. And its safe to say that every merger save for the CN-IC deal has had rough sledding keeping cars moving and customers happy.

The Globe and Mail in Canada quotes NIT League's Ed Ratstatter who said, "We remain to be convinced that (the CN-BNSF deal) is a good idea, and it's going to take a lot of convincing. We're not opposed to it yet, but the members we've been talking to are very skeptical and so are we." The paper goes on to say that CN expects the STB will be "more stringent than usual because so many recent railway mergers in the United States have gone awry."

Both CN and BNSF cite success with recent mergers. Which may be true to a point. However BNSF mistakes in its own merger were largely covered over in the public eye by the larger UP-SP snafus going on at the same time. It's a fact that IC was a north-south railroad in an east-west world and neither it nor CN had a significant presence in many of the major markets affected by BN-SF or CR-CSX-NS. The view from here is that CN-BNSF ultimately will be approved, though surely not this year, and that approval will be rife with conditions. Shortlines and regionals had best start lining up their positions now.

Commenting on this latest proposal, the STB said, "[It] may trigger yet another full round of major transactions, as other railroads seek to position themselves and their customers to meet the competitive effects of a unified BNSF/CN." To which UP responded, "The decision issued by the STB is reasonable. It is fair to ask the question whether or not this proposed single transaction will, in fact, trigger a second round of mergers. Given the importance of the rail sector to the health of the economy, the Board is to be commended for looking at the future of the rail industry and how best to serve its customers in the long run." We'll see.

The Conrail transaction remains a Work in Progress. In a recent Sunday Feature the Newark Star Ledger took a good look at how the Conrail carve-up is going and was not pleased with what it saw. Noting that the region had been served by six railroads pre-Conrail, the paper correctly reported that the deal "was touted as a way of restoring competition to the heart of the nation's biggest consumer market."

But it isn't working out that way, the paper said. Even as the merger was supposed to decrease the need for long-distance trucks, "more goods are riding the highways as shippers cope with delays caused by snarled rail yards. As a result, delivery delays have forced some factories to suspend production after depleting stockpiles of raw materials." As for the added costs to the shipper, the paper cites an area user of chemicals from Louisiana. "With just one rail tank car needed to carry an equivalent load, highways are not only inefficient but also more expensive. The bill was $23,000 compared to $6,000 for rail." For a shipper to increase his freight costs by a factor of four, it has to be bad. And just what kind of reception do you think will greet the sales rep when he comes looking for repeat business?

There are however, the paper concludes, those who see "significant that improvements made during the last few months." This in turn bodes well for even further improvement during the first quarter, when freight volume traditionally drops. But still Newark and its environs continue to bear the brunt of service missteps, and, as anybody who does business in the northeast knows, we're an impatient lot. Loyalty to vendors gets scarce when it gets expensive.

Stocks of shortline holding companies -- RTEX, RAIL, PRRR, EMON, GNWR -- are continuing to be affected by merger fallout. Everybody knows that when the major rails are doing well the shortlines are brought along. And when the big roads tank -- well, one brush tars all. Yes, it can be argued that the shortlines have great numbers with PEs far below their projected growth rates. However for a market for their shares to exist there has to be active trading, and anything less than a $million a day in equity trading can hardly be called active. When stocks trade "by appointment" growth will be slow to come.

There's a lesson here for all shortlines, whether listed on the exchanges or not. To be successful the small rails must add value to the transportation package in a way the big rails cannot, and that's customer service. The big rails focus increasingly on hook-and-haul business. Thus the emphasis on intermodal, coal, automotive, and bulk unit trains. Consistent, dependable, cost-effective competition with highway haulers just isn't there. And the only way to make more money on hook-an-haul is to move more of it farther. Ergo BNSF+CN.

So the smart shortliner turns his sights to developing service packages that combine his local service advantages with the long haul economics of the big roads, and that's what the STB performance figures are all about. The accompanying remarks make it clear the measures specifically exclude local and yard services. Yet that's where the customers are, and since shortlines can do much of it better for less, the class1s need to exit a lot of that business.

They get to retain 75% of the branchline revenue base and the 25% "allowance" for the shortline is far less than the class 1 cost to operate and maintain the branch. Operating costs drop, the OR goes down, and scarce capital dollars can go to the mainlines to increase system velocity. But it's up to the shortlines to make the case. Those that do, win. Those that don't will either be bought or expire.

Joe Battaglia of Gruntal & Co. in NY often holds forth in the Multex "Investors "Corner" (http://aol.multexinvestor.com). This week Battaglia writes about the evolution to an information-based economy from an industrial-based one. Some predict that the "Internet economy -- which includes e-commerce, information technology infrastructure, and business spending -- should soar past the $1-trillion mark by 2001 on its way to $3 trillion by 2003."

Gruntal has determined that "Internet content and software companies account for only 7% of the overall NASDAQ market capitalization but carry expected long-term growth rates approximately twice those of other rapidly growing segments within technology." So, you ask, what's this got to do with railroads?

It means that the world is becoming increasingly Internet-savvy and that business-to-business e-commerce applications are growling like Topsy. It also means railroads and their customers will be doing more buying over the Net and will gravitate to the vendors with the widest selection of Internet-based purchasing options (a function of content and software). It is probably no coincidence that among railroads BNSF and CN are farthest down this road. Happy Y2K.

--Roy Blanchard

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