Merger Talk – An Unnecessary Distraction

The recent discussion of Class I railroad mergers, prompted by the news that Canadian Pacific had approached CSX about a possible merger, has been a waste of precious time and intellectual resources among leaders and knowledgeable consultants in the industry. A common refrain heard for the past few weeks is that “this is not a good time to be discussing mergers,” referring to the key challenges the industry faces in the autumn of 2014. The next question, “If now is not a good time to talk mergers, when will be a good time?” is often asked.  I submit that the second question should not be if there will ever be a good time, but should changing today’s industry structure ever be seriously considered.  Let’s take a look at both of these questions.

First, it’s essentially a no-brainer that this is not the appropriate time to talk merger, and the reasons have been discussed in railroad boardrooms, the press, and everywhere in between. Let’s review them. First, the railroads are trying to handle more traffic than they have the capacity for, in terms of crews, locomotives, and track. While, generally speaking, the power shortage is improving through new deliveries and aggressive rebuild programs, the hiring, training, and retention of crews remains tough. And, adding track capacity not only requires massive capital budgets, which the industry is able to afford at this point, but track projects cannot be completed overnight. Why do these problems matter? Because customer service is circling the drain. Premium intermodal customers, along with most rail customers, have been lamenting the declining service levels for over a year. While most shippers understand the reasons behind the poorer service, how long are those customers who have opportunities to ship by other modes going to wait around for things to improve? Not very long. The good news is that many analysts expect service levels to return to normal sometime after Q1 of 2015. Meanwhile, though, many shippers are either shifting traffic to trucks, or slowing the rate at which they’re shifting traffic from truck to rail. The point here is that rail executives need to be focused on improving service levels rather than hovering over maps to look at merger options. 

To add even more pressure to rail management, enormous amounts of time and resources are being expended on PTC implementation, and it’s generally agreed that most roads will not meet the December 31, 2015, deadline. This means that even more resources will be needed to complete the testing and implementation, and even when PTC is fully operational on U.S. railroads, there will likely be maintenance and reliability challenges for the first several years. This will likely have a negative impact on train velocity, so the congestion the railroads face today must be completely cleared before then, with capacity growth at least staying even with traffic growth. Again, another key focus for rail management that trumps focus on mergers.

As to the question of what the long-term structure of the industry should look like, I’m not sure that anyone’s crystal ball can point to that answer at the moment. And, we should be wary of those who claim that they know the answer, and that the answer is that it should be changed now. Many respected rail industry analysts believe that the seven Class Is that we have in North America provide an ideal balance of service economies and competition. Many industry veterans, too, including several CEOs, believe that the current structure is best. I agree with them. There has not been any convincing evidence that a merger of any of today’s huge Class Is will offer benefits that will exceed the pain that would be required to accomplish them. And, that pain would likely include service meltdowns, cultural integration issues, and regulatory opposition such that, even if the mergers are approved, open access and other regulations would likely be forthcoming. Unless there is a major structural change to the U.S. economy at some point that would result in significant advantages for a rail industry composed of two or three Class Is, our current structure is the best option.

The demand for rail transportation in the United States is projected to rise significantly in the coming decades. This reflects what will hopefully be significant periods of economic growth in the U.S. and around the world, and the railroads need to be financially and operationally healthy to meet this demand. In addition, our rail system needs to be ready to contribute to the national defense in a world where terrorism is a continuous threat, power balances are uncertain, and the goals and plans of other nations are unclear. We cannot afford to have the integrity of our rail system hampered by the personal ambitions of a few.