oltmanndIf GM becomes a solid, profitable automaker at the end of this, and the gov't stock can be sold at a decent price, it may have been worth the bailout. It just may have kept the recession from deepening and quickened the recovery. I think the jury is still out, though. I also wonder if Ford looks at this the same way.... They were the "ant", not the "grasshopper" and they've been watching the "grasshopper" be fed. Were they completely rewarded for their prudent behavior?
I agree that if GM becomes profitable, the bailout may have been worthwhile. Hopefully we will be able to judge the result. But with GM seeminly pinning their hopes on the Volt electric car, we ought to get a rather striking result one way or the other.
Ford's refusal of public bailout money is just as interesting GM's begging for it. I would love to hear what Ford executives say to each other about the Volt.
oltmanndThe RR mergers that went badly at the start all had good reasons to be done. What went poorly was the RR's ability to integrate the two properties. This was not because it was intrinsic in the nature of the merger. It was because the operational complexity of doing it exceeded the abilities of the employees to manage it - and this was unforeseen. You can rightly call this poor management, but it ain't greed! RRs are not, and never have been "too big to (allow to) fail." Everything a RR does can be replaced by a truck, wire or pipe. There would be little economic disruption if done slowly, but there would be an erosion in standard of living as the RRs lower costs were replaced by higher cost arrangements. But, wanting lower costs is just greed talking, I guess.
RRs are not, and never have been "too big to (allow to) fail." Everything a RR does can be replaced by a truck, wire or pipe. There would be little economic disruption if done slowly, but there would be an erosion in standard of living as the RRs lower costs were replaced by higher cost arrangements. But, wanting lower costs is just greed talking, I guess.
I've had the good fortune over a long period of time to be able to discuss merger theory with both railroad and non-railroad managers involved in merger efforts. And that points instantly to the general weakness in mergers in general: they are management initiated.
And, while merger theory isn't my general cup of tea, and my life isn't going to rise or fall on anyone else's incomprehensible exposition of what they think it all means, here's my understanding:
Cynics charge that the motives for mergers are obvious: ambitious people tend to be empire builders, and managers of larger companies can command higher compensation than managers of smaller companies. Around those motives are built highly artificial constructs of purported merger benefits marketed by management insiders to shareholders who generally don't have the insider's knowledge of their own company, let alone the other company involved in the merger.
And railroads, by and large, have followed the results of the business world in general: up to 80% of mergers fail -- absolutely fail -- to meet the primary "announced" goals or metrics justifying the merger effort.
http://www.allbusiness.com/buying-exiting-businesses/mergers-acquisitions/104661-1.html
Union Pacific is a reasonable example. Taking 1965 as a representative year prior to merger efforts, in a relatively lackluster economy as far as railroads were concerned, UP had an operating margin in 1965 of 26.5%. Today? 26.9%. Profit margins? 1965: 14.4%. Today: 14.8%. Given the huge productivity increases since 1965, that's not an improvement. Debt to Equity ratio, 1965: 9%. Today? 55%. That isn't good; risk has increased substantially. Return on Equity, 1965: 5%. Average Return on Equity, Union Pacific, 1996-2007 (from memory, here), 4.8%; so far in 2010, it is a little over 6%. Considering how debt has replaced equity in UP's capital structure, the return on equity should have improved dramatically. It hasn't.
In general, the Union Pacific has substantially increased its risk, with little if any real improvement in key operating statistics. Using averages, overall, UP has reduced its return on equity as a result of its mergers. And who bears that risk? The shareholders, not management.
And, in 2010, we are talking about a Union Pacific Railroad 28 times the size of the 1965 Company in terms of revenue. What, really, "improved"? Well, you could argue that in today's climate, the 1965 UP wouldn't be viable, but that underscores the comparison of 40 years later, with nearly all railroad mergers which resulted in deteriorated financial metrics, to at least some extent, within five years of the merger. In that context, the economic environment appears to me to have little significance, short term or long term, since the results are consistent. KCS is arguably better on most metrics, notwithstanding its lack of mergers on the scale of other US roads, than it was 40 or 50 years ago. The fact that it isn't 28 times larger than it was 40 years ago seems to have worked in its favor, rather than supporting the alternative view. And the fact that it isn't "too big to fail" arguably positions its attitude differently.
"Too big to fail," isn't a service concept. Nothing is going to be replaced by a truck or a pipeline. What it means is that the relative size of a corporation, and the relative political influence of its owners, unions and bankers is such that government can be "persuaded" to "bailout" those at risk. It has little or nothing to do with the ongoing activities of the corporation itself; which generally continue in bankruptcy under a "debtor in possession" plan.
"Too big to fail" is a political concept and it is a real one.
It's economic damage is what is called the "moral hazard" in which ultimate risk is transferred from investor to the government and instead of being able to rationalize physical plants, operations, or change managements, instead inefficiency, poor management, bad investment-making, including mergers, are rewarded by the bailout, instead of punished by being allowed to "fail" invoking a bankruptcy reorganization.
"Too big too fail" is the worst thing that can happen in a genuine free enterprise system.
Are railroads "too big to fail"? You bet they are.
If and when the good times are no longer rolling as a reasonably permanent feature of the landscape, there is not a politician in the country who would not feel compelled to offer a life preserver to his friends, his Wall Street campaign contributors and his constituents by insulating them from the risk of their private enterprise: risks which, as in the case of the Union Pacific, are far, far greater than they were in the old days before its merger era.
ICLandUnion Pacific is a reasonable example. Taking 1965 as a representative year prior to merger efforts, in a relatively lackluster economy as far as railroads were concerned, UP had an operating margin in 1965 of 26.5%. Today? 26.9%. Profit margins? 1965: 14.4%. Today: 14.8%. Given the huge productivity increases since 1965, that's not an improvement. Debt to Equity ratio, 1965: 9%. Today? 55%. That isn't good; risk has increased substantially. Return on Equity, 1965: 5%. Average Return on Equity, Union Pacific, 1996-2007 (from memory, here), 4.8%; so far in 2010, it is a little over 6%. Considering how debt has replaced equity in UP's capital structure, the return on equity should have improved dramatically. It hasn't. In general, the Union Pacific has substantially increased its risk, with little if any real improvement in key operating statistics. Using averages, overall, UP has reduced its return on equity as a result of its mergers. And who bears that risk? The shareholders, not management. And, in 2010, we are talking about a Union Pacific Railroad 28 times the size of the 1965 Company in terms of revenue. What, really, "improved"? Well, you could argue that in today's climate, the 1965 UP wouldn't be viable, but that underscores the comparison of 40 years later, with nearly all railroad mergers which resulted in deteriorated financial metrics, to at least some extent, within five years of the merger. In that context, the economic environment appears to me to have little significance, short term or long term, since the results are consistent. KCS is arguably better on most metrics, notwithstanding its lack of mergers on the scale of other US roads, than it was 40 or 50 years ago. The fact that it isn't 28 times larger than it was 40 years ago seems to have worked in its favor, rather than supporting the alternative view. And the fact that it isn't "too big to fail" arguably positions its attitude differently.
You can make similar comparisons of NS before and after Conrail, but the alternative at that point was to let CSX have all of Conrail and risk becoming a "large regional" railroad with much eroded shareholder value. NS paid a super-premium price and it sure didn't go well for a few years, but I'd bet they are in a better spot today than if they hadn't pulled the trigger.
-Don (Random stuff, mostly about trains - what else? http://blerfblog.blogspot.com/)
oltmanndICLandI think the comparisons are unfair and you hint that... A fair comparison is impossible to make. That would be "Where would the UP be w/o the merger(s)?" Since you can't rewind history - it's not possible to give a good answer.
ICLand
Well, I would have to kind of laugh if an honest merger prospectus said: "if we do this, this will allow us to stay just about where we are", or even better, "all comparisons to our pre-merger condition will be unfair because comparisons will be impossible to make."
That view gets everyone off the hook nicely, no matter what happens.
oltmanndYou can make similar comparisons of NS before and after Conrail, but the alternative at that point was to let CSX have all of Conrail and risk becoming a "large regional" railroad with much eroded shareholder value. NS paid a super-premium price and it sure didn't go well for a few years, but I'd bet they are in a better spot today than if they hadn't pulled the trigger.
I don't think you can make comparisons to NS before and after Conrail on the basis of conventional merger theory. Perhaps you could between Norfolk & Western and Southern which would be more apt comparisons.
NS today is the result of a government-created entity, Conrail -- a bailout pure and simple -- which created enormous risk to the remaining private investors in adjacent railroad properties. A good example of government intervention creating unintended consequences.
Conrail controlled 29.4% of the Eastern rail market, but it was a veritable monoply in the Northeast. Conrail’s operating ratio of 79.9% was only slightly higher than the industry average of 78.04%, almost the same as the Union Pacific Railroad, 78.9%, and below the largest railroad in the industry in terms of revenue, BNSF, at 81.2%. BNSF's OR is yet another example of a deteriorated OR of a merged railroad company compared to the smaller preceding systems.
Insofar as how NS viewed the Conrail situation, if CSX got the bid, the resulting company would control somewhere between 61% and 68% of the Eastern rail market. If CSX prevailed, not only would NS lose $345 million in direct traffic losses in the first five years after the proposed merger, the CSX-Conrail combination would offer shippers greater flexibility. Ominously, the new company’s monopoly over a substantial portion of the Eastern market would allow it pricing power, which it could then leverage against Norfolk Southern where the two railroads offered competing services. Norfolk Southern would be in a price war it could not win.
The discounted cash value of savings from the proposed transaction were worth approximately $1.6 billion to CSX, but only $1.423 billion to Norfolk Southern. However, the future price competition looked to be ultimately disastrous to Norfolk Southern. NS could justify on the basis of conventional merger valuations a stock offer of $70.19 per Conrail share. Underscoring the fact that this was far, far from a conventional merger scenario was the fact that Norfolk Southern had tendered $115 per share, cash.
The NS was not a conventional merger that looked at independent synergies of alleged merger benefits, it was a self-defense move that had little to do with conventional merger motivations.
ICLand [snip] And railroads, by and large, have followed the results of the business world in general: up to 80% of mergers fail -- absolutely fail -- to meet the primary "announced" goals or metrics justifying the merger effort. http://www.allbusiness.com/buying-exiting-businesses/mergers-acquisitions/104661-1.html [snip] . . . but that underscores the comparison of 40 years later, with nearly all railroad mergers which resulted in deteriorated financial metrics, to at least some extent, within five years of the merger. In that context, the economic environment appears to me to have little significance, short term or long term, since the results are consistent.
[snip] . . . but that underscores the comparison of 40 years later, with nearly all railroad mergers which resulted in deteriorated financial metrics, to at least some extent, within five years of the merger. In that context, the economic environment appears to me to have little significance, short term or long term, since the results are consistent.
Hey - you quit that now ! Saying that "The Emperor has no clothes . . . " Whaddya trying to do - disrupt the American way of life ?!?
Despite that, the 'conventional wisdom' seems to be that more mergers are inevitable. See Fred W. Frailey's TrainsTalk Staff Blog post of July 24, 2010 on this, entitled "Why railroads will keep merging" at:
http://cs.trains.com/trccs/blogs/trains-talk/2010/07/23/why-railroads-will-keep-merging.aspx
ICLand [snip] KCS is arguably better on most metrics, notwithstanding its lack of mergers on the scale of other US roads, than it was 40 or 50 years ago. The fact that it isn't 28 times larger than it was 40 years ago seems to have worked in its favor, rather than supporting the alternative view. [snip]
Maybe it isn't "notwithstanding its lack of mergers", but instead because of "its lack of mergers", as you seem to imply . . .
A more intellectually honest exercise than the above snapshots 40 years apart - and worthy of a college-level term paper, at least - would be to tabulate and graph the financial results of each of the major merged railroads from - say, 5 or 10 years before their respective M-days - right up to the present, and then compare that with the projections and their peers, both merged and non-merged, or at least many years post-merger. Still, I believe it would support ICLand's general assertions above. That's why I'm not in favor of any more Class I mergers in the US - such as even when I owned stock in both BNSF and CN and they were captained by 2 very sharp guys, Rob Krebs and Paul Tellier. The downside risk of the merger not working, the concessions to the influential shippers' groups, and the STB oversight hassles, just wasn't worth it. If the benefits of a merger are desired, I advocate doing it on a 'creeping' basis instead of 'one big crunch' on M-day. Those changes can be negotiated and implemented through various service arrangements, one route or market at a time, and the inevitable 'brush fires' put out as they arise, instead of involuntarily having to face and deal with a merger-sparked conflagration and 'melt-down' as we have often seen in the past. And what we're seeing now is lots of service-sharing, particularly in the NorthEast US with various combinations of CSX, CP, NS, and Pan Am, NS with CN and BNSF in the MidWest US, and CP and CN in Canada, etc. What cannot be done directly can often be done indirectly . . .
- Paul North.
ICLandoltmanndICLandI think the comparisons are unfair and you hint that... A fair comparison is impossible to make. That would be "Where would the UP be w/o the merger(s)?" Since you can't rewind history - it's not possible to give a good answer. Well, I would have to kind of laugh if an honest merger prospectus said: "if we do this, this will allow us to stay just about where we are", or even better, "all comparisons to our pre-merger condition will be unfair because comparisons will be impossible to make." That view gets everyone off the hook nicely, no matter what happens.
oltmanndICLandoltmanndICLandI think the comparisons are unfair and you hint that... A fair comparison is impossible to make. That would be "Where would the UP be w/o the merger(s)?" Since you can't rewind history - it's not possible to give a good answer. Well, I would have to kind of laugh if an honest merger prospectus said: "if we do this, this will allow us to stay just about where we are", or even better, "all comparisons to our pre-merger condition will be unfair because comparisons will be impossible to make." That view gets everyone off the hook nicely, no matter what happens.Not always and not completely. But to compare UP in 1965 with UP post mergers is really tough. There was a sea-change in regulation and in the industrial base of the country during that period. The merger effect might be noise among these changes...
Well, if you read the papers, the post-regulation railroads were supposed to be burning up the rails with their vastly improved financial statistics. Recall? Regulation was supposed to be a huge burden. The UP story, if enhanced by the post-regulatory environment, certainly was put into the dumpster relatively speaking by something: what else changed besides the regulatory environment, likely affecting UP more than anything else besides deregulation? Instead of taking off in the post-regulatory environment, something affected it adversely, and it stayed nearly the same on key metrics, with substantially higher risk. What happened?
Mergers.
I've been eagerly waiting for my Sept. issue to read what Don Phillips said. I get home and my copy is here.
I read the column, looking for where Mr. Phillips says the railroads have nothing to fear, and don't see it. I do see one where Rep. Jim Oberstar, D-Minn, thinks the railroads are over-reacting and have nothing to fear and then details in a future column.
I know Mr. Phillips is a big supporter of Government operated passenger rail. Does that necessarily mean he automatically supports re-regulation of the industry in general, the current proposals specifically?
I've read in other places that some think the railroads don't have as much to fear. Not because they think the current proposals won't harm them, but because they don't think the legislation can pass in it's current form. That any re-regulation that does pass will be tolerable to the industry. I hope they are right.
Jeff
OK, let's not do 40 years; let's do the first five years. Or is that yet another exception?
As a note, since NS was brought up and I happened to have done a study back then that I can actually lay my hands on:
Norfolk Southern's proposed improved net operating income INCREASES as a result of the Conrail Merger/Acquisition, used to justify the acquisition to shareholders (and the government):
Proposed Increases:
1997:$175 million
1998: $184 million
1999: $305 million
2000: $419 million
2001: $385 million
Well, compared to what? That's the good question on these kinds of studies. In the year that Norfolk Southern did the project, 1996, it earned $1.2 billion. The average of the five years prior to the merger was $1.012 billion, net railway operating income.
The projections, then, based on the five year average prior to the merger, which is a little more conservative approach, should have shown these results:
Prospective (Pro Forma) NROI after Conrail Acquisition Proceedings:
1997: $1.2 billion
1998: $1.2 billion
1999: $1.3 billion
2000: $1.4 billion
2001: $1.4 billion
Actual Results?
Actual NS NROI after Conrail Acquisition:
1999: $499 million
2000: $494 million
2001: $836 million
The average NROI for the five years prior to the Merger/Acquisition: $1.012 billion
The average projected NROI for the five years after the Merger/Acquisition: $1.3 billion
The average actual NROI for the five years after the Merger/Acquisition: $817 million
The total loss of projected earnings vs. actual earnings: $2.4 billion.
And the Norfolk Southern guys, according to the popular literature, were the smart ones!
This, to me, represents something relatively typical for railroad mergers. I haven't seen an exception.
ICLand -
I commend you for your intellectual honesty - that's exactly what I had in mind
And for your filing system/ document retrieval ability.
But I believe your presentation of the statistics and case have a significant factual error: the ConRail split-up and merger with NS may have been proposed/ approved in 1997 - but the actual operational changes did not take effect until mid-1999, if I recall correctly.
Now go back and review your statistics with that in mind - and you'll see that's exactly when the NS NROI fell off the table, from $1.2 billion to under $500 million for the next 2 years, then transitioning into what may have been a gradual rebound - do you have another couple of years of stats available ?
So your case appears to be much stronger than you thought . . . Q.E.D !
Paul_D_North_JrICLand - I commend you for your intellectual honesty - that's exactly what I had in mind And for your filing system/ document retrieval ability. But I believe your presentation of the statistics and case have a significant factual error: the ConRail split-up and merger with NS may have been proposed/ approved in 1997 - but the actual operational changes did not take effect until mid-1999, if I recall correctly. Now go back and review your statistics with that in mind - and you'll see that's exactly when the NS NROI fell off the table, from $1.2 billion to under $500 million for the next 2 years, then transitioning into what may have been a gradual rebound - do you have another couple of years of stats available ?
The dangers of pulling out 15 year old studies that I haven't thought of in years. But, partly, my feeling is that significant merger efforts take management's eye "off the ball." The five year period including and after 1999 reduces the five year average income even further, to $799,000 -- even further below the five year average of the period of time prior to the merger proceedings.
Similarly, the BN/SF merger projected synergies of $560 million, the UP/CNW $250 million, and the UP/SP merger $660 million. Projections by experienced railroad managements; nearly entirely wrong.
jeffhergert I've been eagerly waiting for my Sept. issue to read what Don Phillips said. I get home and my copy is here. I read the column, looking for where Mr. Phillips says the railroads have nothing to fear, and don't see it. I do see one where Rep. Jim Oberstar, D-Minn, thinks the railroads are over-reacting and have nothing to fear and then details in a future column.
Jeff, you are absolutely correct. I was assuming -- jumping to the reasonable conclusion? -- that Don meant the same thing as in earlier columns when he said Oberstar saw no threat ... and he, Don, agreed. (With explanation to follow in future columns.)
ICLandOK, let's not do 40 years; let's do the first five years. Or is that yet another exception? As a note, since NS was brought up and I happened to have done a study back then that I can actually lay my hands on: Norfolk Southern's proposed improved net operating income INCREASES as a result of the Conrail Merger/Acquisition, used to justify the acquisition to shareholders (and the government):Proposed Increases: 1997:$175 million1998: $184 million1999: $305 million2000: $419 million2001: $385 millionWell, compared to what? That's the good question on these kinds of studies. In the year that Norfolk Southern did the project, 1996, it earned $1.2 billion. The average of the five years prior to the merger was $1.012 billion, net railway operating income.The projections, then, based on the five year average prior to the merger, which is a little more conservative approach, should have shown these results:Prospective (Pro Forma) NROI after Conrail Acquisition Proceedings: 1997: $1.2 billion1998: $1.2 billion1999: $1.3 billion2000: $1.4 billion2001: $1.4 billionActual Results?Actual NS NROI after Conrail Acquisition: 1997: $1.2 billion1998: $1.2 billion1999: $499 million 2000: $494 million2001: $836 millionThe average NROI for the five years prior to the Merger/Acquisition: $1.012 billionThe average projected NROI for the five years after the Merger/Acquisition: $1.3 billion The average actual NROI for the five years after the Merger/Acquisition: $817 millionThe total loss of projected earnings vs. actual earnings: $2.4 billion.And the Norfolk Southern guys, according to the popular literature, were the smart ones! This, to me, represents something relatively typical for railroad mergers. I haven't seen an exception.
Run your numbers thru 2007, or at least thru 2004, and see what you get.
Also, I haven't been able to dig it up, but I believe the industry's return on capital on the whole has gone from the 3-4% range up nearly 10% in 2008. In the same span, rail rates dropped over 50% (infl. adjusted). Most of it is productivity improvements but some at least is due do merger efficiencies, though I wouldn't begin to want to try to untangle which was which.
Murphy Siding Wouldn't you need a cystal ball, of the calibur not yet invented, to be able to weigh the potential cost of failure agaist potential stockholder gain? As far as your last sentence, how, or who, would decide what is to big to fail?
Wouldn't you need a cystal ball, of the calibur not yet invented, to be able to weigh the potential cost of failure agaist potential stockholder gain? As far as your last sentence, how, or who, would decide what is to big to fail?
Well, I really think that the both of you have stomped on a flaming bag deposited on the front porch when you brought up PC.
That example probably proves my point better than any other. If saner heads had prevailed and denied the merger, forcing the weaker of the two into a classic capitalistic implosion, then the other would have emerged stronger without all the government influx of resources.
Neither PRR nor NYC were "too big to fail" in their own right... but after washington caved in to the money mongers that wanted merger, then the inevitable followed
ICLand Union Pacific is a reasonable example. Taking 1965 as a representative year prior to merger efforts, in a relatively lackluster economy as far as railroads were concerned, UP had an operating margin in 1965 of 26.5%. Today? 26.9%. Profit margins? 1965: 14.4%. Today: 14.8%. Given the huge productivity increases since 1965, that's not an improvement. Debt to Equity ratio, 1965: 9%. Today? 55%. That isn't good; risk has increased substantially. Return on Equity, 1965: 5%. Average Return on Equity, Union Pacific, 1996-2007 (from memory, here), 4.8%; so far in 2010, it is a little over 6%. Considering how debt has replaced equity in UP's capital structure, the return on equity should have improved dramatically. It hasn't. In general, the Union Pacific has substantially increased its risk, with little if any real improvement in key operating statistics. Using averages, overall, UP has reduced its return on equity as a result of its mergers. And who bears that risk? The shareholders, not management.
OK, correct me if I'm wrong about the formula, but it looks to me that the calculation for what you're calling an operating margin is "1-(operating expenses/gross revenue)". That would be what is commonly referred to as the operating ratio subtracted from 1.
Because the operating margin (determined by the operating ratio) didn't change significantly you seem to be drawing a conclusion that the UP mergers (and deregulation) didn't produce any significant efficiency. You need to remember that the ratio involves two numbers; one for expenses and one for revenue. If they both change the "operating margin" can remain reasonably constant in spite of a huge increase in efficiency/productivity. That is just what happened.
The Union Pacific, and other railroads, operate in a competitive freight environment. They certainly do not generate monopoly profits. The UP is a major coal mover. After deregulation, and during the UP merger period (1985 through 2004) railroad rates for moving coal fell by 35%. And that 35% figure is in nominal dollars unadjusted for inflation. Allowing for the reality of inflation, and adjusting for it, coal rates fell by at least 50% after the mergers and deregulation. During this time, rail rates fell across the board. (Grain went up in nominal dollars, but adjusting for inflation, it experienced a rate decline too.) To keep that margin constant the UP (and other railroads) had to tremendously increase their efficiency, and they did that in spades. And they did it through mergers and deregulation.
What happened is just what was supposed to happen and what was predicted to happen. The railroads simultaneously became much more efficient and financially healthy. The margin stayed pretty much the same, but the volume went up as the prices came down. Profitability = margin x volume. Any company wants a larger margin, but wanting and getting are two different things. The market sets the price. What happened was that competition forced prices down, as it's supposed to do. This was offset by improved efficiencies (lower cost per unit moved) UP may be operating at the same margin, but its profitability is way up because of the volume increase.
I've written enough, but I could go in to just why that operating margin was bound to stay about the same. Suffice it to say that the mergers and dereg worked as advertised. The most important result is that the US economy got a more efficient, lower cost rail freight system. In fact, I've read that much of our economic good times in the past were due to lower logistics cost. A second, very important, result of the rail consolidations and dereg was that the US railroad industry changed from a basket case to a financially healthy, growing, part of the economy.
Focusing on any one metric, such as an “operating margin”, or even a series of metrics, without understanding their context is a very good way to misunderstand a situation. The numbers are what they are; the key is to understand why they are what they are.
Convicted One Murphy Siding Wouldn't you need a cystal ball, of the calibur not yet invented, to be able to weigh the potential cost of failure agaist potential stockholder gain? As far as your last sentence, how, or who, would decide what is to big to fail? Well, I really think that the both of you have stomped on a flaming bag deposited on the front porch when you brought up PC. That example probably proves my point better than any other. If saner heads had prevailed and denied the merger, forcing the weaker of the two into a classic capitalistic implosion, then the other would have emerged stronger without all the government influx of resources. Neither PRR nor NYC were "too big to fail" in their own right... but after washington caved in to the money mongers that wanted merger, then the inevitable followed
Thanks to Chris / CopCarSS for my avatar.
oltmanndAlso, I haven't been able to dig it up, but I believe the industry's return on capital on the whole has gone from the 3-4% range up nearly 10% in 2008. In the same span, rail rates dropped over 50% (infl. adjusted). Most of it is productivity improvements but some at least is due do merger efficiencies, though I wouldn't begin to want to try to untangle which was which.
Prior to the merger frenzy of the mid-1990s, the ROI for the purposes of determining revenue adequacy were not in the 3-4% range, but as follows:
1995:
NS 12.1%
UP 11.7%
CSX 6.5%
BN: 6.3%
ATSF: 5.3%
After mergers, synthesis:
2003:
NS: 9.1%
BNSF: 6.2%
CSX: 4.0%
2004:
NS: 11.64%
BNSF: 5.84%
CSX: 4.4%
It is difficult to frame an analysis around the moving goalposts of "it can't be 40 years, it can't be 5, or 7, it has to be whatever years proves the point." That approach will always prove some point, rarely the one at issue. The fact is, most synergies are achieved in a railroad merger by year 3, at the latest year 5.
After the flurry of very large mergers, 1996-1999, during the next five years, virtually the entire industry suffered declining abilities to be revenue adequate. The Clinton Recession was over by 2003. 2004 represents perhaps the most comparable year, as import/export traffic and coal reached significant new levels in 2005
The best of the bunch? The unmerged Illinois Central. The two biggest declines? The two largest merger railroads. Moral of the story? To some, none, or even, "worked as advertised."
Some advertisement.
With that, the research has given me a headache. Thank you for your time.
greyhoundsThe Union Pacific, and other railroads, operate in a competitive freight environment. They certainly do not generate monopoly profits. The UP is a major coal mover. After deregulation, and during the UP merger period (1985 through 2004) railroad rates for moving coal fell by 35%. And that 35% figure is in nominal dollars unadjusted for inflation. Allowing for the reality of inflation, and adjusting for it, coal rates fell by at least 50% after the mergers and deregulation. During this time, rail rates fell across the board. (Grain went up in nominal dollars, but adjusting for inflation, it experienced a rate decline too.) To keep that margin constant the UP (and other railroads) had to tremendously increase their efficiency, and they did that in spades. And they did it through mergers and deregulation. What happened is just what was supposed to happen and what was predicted to happen.
What happened is just what was supposed to happen and what was predicted to happen.
Well, if it was predicted to happen, I guess I missed the memo. The ones I got said that the rail industry needed the freedom to raise rates to provide adequate returns. On the other hand, I can truly say that I read it here first!
Regarding rates, there is something of a misconception presented here. The driver of higher rates in the 1970s was primarily inflation. Equipment, materials, capital itself was costing on the order of 14-18%. And the price of diesel fuel doubled, tripled, quadrupled. And this really kicked in, 1975-1979. Railroads couldn't increase rates fast enough. Literally. That was the point of Staggers: enable railroads to increase rates more quickly and flexibly. It was a savage four years.
Adjusted for inflation, this is shown quite clearly. The average railroad rate today is the equivalent of railroad rates in 1975. Rates prior to that time are lower than today's rates. Indeed, the long decline in adjusted rates since Staggers was only an unwinding of the fast run-up in rates that occurred in a very short time between 1976 and 1982. And it took 30 years to unwind those rates as railroads enjoyed on the one hand impressive improvements in productivity, and, on the other hand, increasing real costs in terms of physical plant and equipment. And, again, the adjusted cost of diesel fuel, electric power, computing power, communications have all been declining during that time, accounting for much of the claimed "productivity" when in fact it was nothing of the kind. Otherwise, productivity and substantial cost declines won the day, but it has only restored rates to what they were in 1975 in adjusted dollars, and that represents a historic high in railroad rates up to that time.You're comparing post-Staggers rates with a very select, narrow, period of history that labored under extraordinary economic circumstances. This is why nearly all presentations on Staggers rates do not show inflation adjusted rates prior to 1980. There's a public relations reason for that. Compared to a long period of relatively stable inflation prior to 1975, today's rates are higher and have been higher since Staggers was enacted. On the other hand, due to productivity increases, profitability has increased compared to those times, although sometimes detailed examinations, such as comparing UP then and now, makes you wonder where the improvement really is.
There is a chart here which partially shows this:
http://www.fra.dot.gov/downloads/policy/freight5a.pdf
Talk to old, established shippers. They'll let you know.
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uphogger Term limits, anyone?
Term limits, anyone?
Be careful when you ask for term limits, you might get them. Here in CA it hasn't worked out so well. One of the reason for CA's budget impasses is that we are constantly recycling the Legislature and Governor. It takes them a few years to figure out how things work and by then they don't have much time left before being termed out. This turns real power over to those who REALLY know how things work: the lobbyists.
Jack
ICLandoltmanndAlso, I haven't been able to dig it up, but I believe the industry's return on capital on the whole has gone from the 3-4% range up nearly 10% in 2008. In the same span, rail rates dropped over 50% (infl. adjusted). Most of it is productivity improvements but some at least is due do merger efficiencies, though I wouldn't begin to want to try to untangle which was which. Prior to the merger frenzy of the mid-1990s, the ROI for the purposes of determining revenue adequacy were not in the 3-4% range, but as follows:1995: NS 12.1%UP 11.7%Illinois Central 17.2%CSX 6.5%BN: 6.3%ATSF: 5.3% After mergers, synthesis: 2003:NS: 9.1%UP: 7.3%BNSF: 6.2%CSX: 4.0%2004:NS: 11.64%UP: 4.5%BNSF: 5.84%CSX: 4.4% It is difficult to frame an analysis around the moving goalposts of "it can't be 40 years, it can't be 5, or 7, it has to be whatever years proves the point." That approach will always prove some point, rarely the one at issue. The fact is, most synergies are achieved in a railroad merger by year 3, at the latest year 5. After the flurry of very large mergers, 1996-1999, during the next five years, virtually the entire industry suffered declining abilities to be revenue adequate. The Clinton Recession was over by 2003. 2004 represents perhaps the most comparable year, as import/export traffic and coal reached significant new levels in 2005 The best of the bunch? The unmerged Illinois Central. The two biggest declines? The two largest merger railroads. Moral of the story? To some, none, or even, "worked as advertised."Some advertisement.With that, the research has given me a headache. Thank you for your time.
I would agree that most mergers performed very poorly a couple of years in - mostly due to the inability to integrate operations well. I'm less convinced that they 5+ years out, they weren't doing what they were supposed to do. There are all sorts of confounding factors - for NS the ups and downs of export coal, for example - that can make straight accountant-style year to year comparisons somewhat less statistically significant.
I understand the point you are making, however.
Jack_S Be careful when you ask for term limits, you might get them. Here in CA it hasn't worked out so well. One of the reason for CA's budget impasses is that we are constantly recycling the Legislature and Governor. It takes them a few years to figure out how things work and by then they don't have much time left before being termed out. This turns real power over to those who REALLY know how things work: the lobbyists.
Lobbyists, yes, but even more to unelected government careerists -- the bureaucrats. In the end, there is no good way for voters to escape their responsibility to make good decisions every two years.
In thinking about this a little more overnight and while away from the computer, I may have 'beat up on' NS and its financial results post-merger with 58%-of-ConRail a little unfairly. As someone else cogently pointed out above, NS didn't really have a choice at that time but to attempt the merger - if it didn't get into that game right then, it was going to be left marginalized = "on the outside, looking in". It likely appeared to NS management at the time to be a classic involuntary "bet the ranch" scenario. Although, it might be fun to speculate what could have happened if NS had sat back and just let CSX plunge ahead and merge with all of CR - would that have then melted down and imploded, and later provided an opportunity to move in and buy some lines ? But that course of inaction would have left the results to fate, chance, CSX, and the government, so being pro-active about it and jumping in anyway was the prudent course of action.
That said, it was still a poor performance. Recall that almost as soon as the N&W-SR merger into Norfolk Southern was completed circa 1982, NS started attempting to buy all of CR from the US government. I believe there were 2 serious attempts at that - 1 in the 1984-85 time frame, and one in the early 1990's. So it's not as if merging with CR was a suddenly new idea to the NS management - they were plotting at it for around 15 years beforehand. You'd think with all that time, they'd have been able to plan the integration better . . .
With respect, I think Don's point about the tech bubble burst of the 2000 time frame is a non sequitur = irrelevant. That was about WorldCom, Enron, Tyco, Adelphia, etc., etc. I doubt if any of them ever shipped 1 boxcar of anything - well, Enron had some pipeline operations, but you know what I mean. They dealt mainly in paper and electrons, in one form or another, and were in a fictional universe of their and Wall Street's making. Aside from some personal tragic financial losses, I don't think that affected industrial output much. NS even ran a series of pointed ads at the time to the effect of touting how railroads hauled the real goods and things of the economy, which no Internet 'super-highway' could do, and so on.
Overall, mergers have a checkered history. The only 2 large ones of near-equals that seemed to work were 1970 BN formation and the 1995 BN-SF merger. There are many larger-smaller ones that seemed to work OK, too - MP and WP being folded into UP, SP into DRG&W, IC into CN, Soo and WC into CP, etc. The 'problem children' were of course a couple of 'mergers of equals' - PC, UP-SP right after UP-C&NW, and then of course NS-58%ConRail and CSX-42%ConRail.
The point above about looking at all of the financial statistics of the merged railroad and its predecessors - and competitors, peers, and the rest of the industry - for about 5 years before and after the merger, in order to accurately understand whether and how it worked or not, is a good one.
In fairness, I would not want to be professionally responsible for effectuating a railroad merger - it's just too complex, as Don also alluded to above. Keep in mind that back in the hey-day of railroading, even the PRR spent more on paper than it did on rail, per an article in Trains some years ago - that provides some clue as to the magnitude of the accounting and clerical functions that have to be integrated. Splitting up CR was like one of those surgeries to separate conjoined Siamese twins, and all of the many critical subsystems that make up the functioning, living breathing human body - or railroad. Actually, a merger is analogous to joining 2 people together, and all of their systems - far more complex than even a major organ transplant - it's no wonder so few mergers turn out well !
Finally, on this issue I am reminded of a line from one of Tom Clancy's books - Debt of Honor, I believe [EDIT 08/18/2010 10:05 AM: at page 415, if I recall correctly]. In it, the Jack Ryan character is analyzing and discoursing on the likely motives for the war with Japan that the US has suddenly found itself involved in. He concludes that in almost all modern wars, the nation that started the war wound up being defeated - ergo, starting a war is not a rational act. It seems to me that many mergers are of like kind - they turn out so poorly as compared to the expectations and promises, that it's not rational or sensible to attempt one. But mergers are nevertheless still proposed from time to time . . . see Fred Frailey's blog that I referenced above.
Paul_D_North_JrWith respect, I think Don's point about the tech bubble burst of the 2000 time frame is a non sequitur = irrelevant. That was about WorldCom, Enron, Tyco, Adelphia, etc., etc. I doubt if any of them ever shipped 1 boxcar of anything -
Paul_D_North_JrIn fairness, I would not want to be professionally responsible for effectuating a railroad merger - it's just too complex, as Don also alluded to above. Keep in mind that back in the hey-day of railroading, even the PRR spent more on paper than it did on rail, per an article in Trains some years ago - that provides some clue as to the magnitude of the accounting and clerical functions that have to be integrated. Splitting up CR was like one of those surgeries to separate conjoined Siamese twins, and all of the many critical subsystems that make up the functioning, living breathing human body - or railroad. Actually, a merger is analogous to joining 2 people together, and all of their systems - far more complex than even a major organ transplant - it's no wonder so few mergers turn out well !
Doing an operating plan is actually fairly simple compared to getting all your data ducks in a row to support that plan. The integration and reliance on data from multiple systems is ever increasing and makes integration of data from disparate RR systems really important - and really hard to do after a merger.
ICLandThere is a chart here which partially shows this: http://www.fra.dot.gov/downloads/policy/freight5a.pdf
By 2008, it had gradually grown to about 10%, dropping back to about 9% in 2009.
That fits what I seemed to remember....
oltmannd In that doc is this line: "Between 1990 and 2002, the Class I freight railroads have averaged 7 percent return on their net investment, up from the 2 percent average in the 1970s." By 2008, it had gradually grown to about 10%, dropping back to about 9% in 2009. That fits what I seemed to remember....
Union Pacific, in 1977,had a 16.6% return on net equity investment. This was before it embarked on its series of mergers beginning with the MoPac. Several mergers later, it has never again reached that rate of return even though 1977 was a "bad" year. I don't have the numbers in front of me, but I recall Norfolk & Western having rates of return of over 12% regularly during that time frame.
As I recall, accounting changes after 1977/1978 permitted accelerated depreciation against physical plant compared to prior years. This had its own synergistic effect of more rapidly reducing net capital investment compared to net income, and accordingly, continually increased the apparent rate of return compared to the 1970s and previously. A significant portion of any apparent improvement in railroad rates of return on net investment is due purely to accounting changes designed, in fact, to show higher rates of return with the passage of time. At the same time, nearly all surviving railroads report significantly higher debt than their predecessors, and that, again, results in higher apparent rates of return against net investment. And so several things have happened that would have changed, for the better, reported rates of return even if nothing at all had actually changed from a revenue/expense standpoint.
Coupling that with the surprisingly low rates of return actually reported in the past few years, compared to many of the pre-eminent predecessor railroads reporting better rates of return in the 1960s and 1970s, certainly raises questions about the supposed comparisons and particularly in reference to merger effects. It would be interesting if someone would do a real study on those impacts, taking into account the accounting and debt structure changes which permitted a showing, on paper, of higher rates of return irregardless of actual improvements.
Accounting methods were dictated by the ICC and one very significant factor was their rules specified that RAIL and OTHER TRACK MATERIALS were not depreciable. The Generally Accepted Accounting Principles used in other capital intensive industries finally convinced the ICC to change to depreciation accounting for these items in the 1970's (don't know the exact date) and therefore statistical comparisons before and after that significant change need to be looked upon with question.
ICLand [snip] As I recall, accounting changes after 1977/1978 permitted accelerated depreciation against physical plant compared to prior years. [snip] And so several things have happened that would have changed, for the better, reported rates of return even if nothing at all had actually changed from a revenue/expense standpoint. Coupling that with the surprisingly low rates of return actually reported in the past few years, compared to many of the pre-eminent predecessor railroads reporting better rates of return in the 1960s and 1970s, certainly raises questions about the supposed comparisons and particularly in reference to merger effects. It would be interesting if someone would do a real study on those impacts, taking into account the accounting and debt structure changes which permitted a showing, on paper, of higher rates of return irregardless of actual improvements.
My recollection is that the the principal change then was to the income tax laws only (= IRS, not the ICC's traditional "additions-improvements-betterments" accounting system) so as to allow the railroads to depreciate their historic (= un-adjusted for inflation since then) fixed and hence otherwise irrecoverable investment in the right-of-way such as the land itself, and the grading, tunnels, bridges, etc. I believe those items could be deducted from income as depreciation on a straight-line basis over 50 years, which is 2 % per year. That doesn't sound like much, but even 2 % of a huge number was still a very big number, especially when compared with the comparatively small incomes of the railroads back then. At the time I owned some BN stock, and from these considerations it seemed that the huge historic investments of those predecessor railroads to cross the Great Plains and the Rocky and Cascade Mountains, etc. and the then-current spending on the Powder River Basin line would likely lead to a 'windfall' increase in income and dividends . . .
I'm inclined to think that such a study has likely been done, though perhaps never published widely, and not available 'on-line', either - it probably pre-dated the Internet age. My reasoning is that there have been several notable economists/ professors of finance who have been quite interested in those aspects of the industry - George W. Hilton of UCLA and Robert B. Shaw of Clarkson University in Potsdam, NY come to mind, and likely others as well. There are so many academics and their students, graduate students, and Master's/ Ph.D.candidates, each with papers to write, theses to research and defend, and/ or to otherwise "publish or perish" - and the data on the industry is so public and transparent - that it would seem to be an inevitable subject for such a study. But likely it is in a filing cabinet or on a bookshelf someplace, not on the Web. Before I would undertake such an effort myself, first I would perform a "literature search" and inquire of the eminent scholars in the field - such as the above - to be certain that it hasn't already been done in one form or another. But I suppose it's possible that it hasn't . . .
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