The CEO of Canadian Pacific Railway (CP), E. Hunter Harrison, took to the Internet yesterday in a one-man dissection of the state of an industry that he warned faces a difficult future unless it can conduct business free of excessive government involvement.
Harrison, who held an extraordinary solo conference call with all interested parties just hours after Calgary, Alberta-based CP posted record third-quarter results, said rail consolidation appears to be the only logical path to alleviating network congestion, which will only get worse as volumes continue to grow. Harrison said he was receptive to alternate remedies to the bottlenecks that have plagued North American railroads for more than a year. However, in affirming his support of rail mergers, he asked rhetorically, "If service isn't good right now, what's out there to improve it?"
Harrison painted a picture of an industry beset by service difficulties in "pain points" like Chicago and Minneapolis-St. Paul, by pushback from local communities that have adopted a "not-in-my-backyard" attitude toward rail service, and by merger rules from the Surface Transportation Board (STB), the federal agency that regulates U.S. railroads, that make it difficult for the industry to freely maneuver.
"We are quickly approaching a time where none of this works," Harrison said, referring to the constraints on a continental network that is simultaneously coping with increasing demand, especially in energy and grain traffic. "Soon it will be impossible."
Harrison spoke the day after CP terminated nascent merger talks with U.S. eastern railroad CSX Corp. Harrison said that CP contacted CSX about exploring possible opportunities and that the railroads had held three or four meetings. CP never made a formal offer, and CSX expressed no interest. No further talks are planned.
Harrison said that CP looked at CSX and the other eastern rail giant, Norfolk Southern Corp., adding that there was little difference between the two companies. He said a CP-CSX combination represented a tremendous opportunity to merge two complementary systems. The merger would have reduced the logjams in Chicago because of CSX's sizable interest in a connecting railroad in Chicago that could have allowed CP to bypass the city and to take the pressure off the entire network, Harrison said. Harrison claimed that he is "not obsessed with some transcontinental merger" that could evolve if the CP-CSX talks had moved toward a transaction.
Harrison said CP wasn't in the merger and acquisitions market at this time, saying he would be content if CP didn't pursue anyone and chugged ahead on its own. CP yesterday reported the strongest quarterly financial results in its history, with records in revenue and operating income. Perhaps most significant, its operating ratio, which measures expenses against revenue, fell to a record 62.8 percent, meaning that it cost CP only 62.8 cents out of every revenue dollar to run the business. In the first quarter of 2012, when Harrison was coaxed out of retirement to assume the CEO post, CP's operating ratio stood at 80.1 percent.
Harrison said it is unlikely CP would combine with either of the two U.S. western railroads, Union Pacific Corp. and BNSF Railway. Nor would it be interested in Kansas City Southern Railway, whose north-south network runs into Mexico, or any of the Mexican railroads, Harrison said. He said that a hostile offer is out of the question, but added that CP would consider being a seller if the terms of a buyout proposal were in the best interests of its shareholders.
The CP CEO took issue with those who said that a combination would be counterproductive during a period of subpar rail service. Harrison warned that the current situation could become the norm unless the industry has the flexibility to consolidate. "I've heard talk about 'bad timing,'" he said. "When is it going to be good timing?"
Harrison said that rail mergers succeed or fail on execution, not on the strategic imperatives behind the deal. He said that prior mergers have been done "out of weakness" where the argument could be made that an acquisition target could otherwise fail. He left unspoken the consensus opinion that all North American Class I railroads are today financially and operationally healthy, though to varying degrees.
In March 2000, the STB imposed a 15-month moratorium on mergers between Class I railroads so it could draft new merger guidelines. The agency acted in response to shipper concerns that a proposed combination between BNSF and Canadian National Inc. (CN) announced several months before would worsen service that had steadily deteriorated throughout the 1990s. The STB's moratorium—and a ruling by a federal appeals court in Washington, D.C. that the agency had the authority to implement such a policy—scuttled the BNSF-CN deal. There has not been another merger proposal between Class I rails since.
One of the most important changes in the STB policy was that applicants would be required to show that the combination would improve transportation service. Previously, the applicants just had to prove that their deal would not lessen competition.
