Merger idea... CP+IC&E+DM&E+KCS

[Murphy Siding]

Nanaimo- While it's entirely possible that some of the red units are ex-CP units,it seems most times when I've seen red diesels up close, they're lettered as CP RAIL. Granted, all I see would be DM&E trains. I'm a long way from ICE rails.

[nanaimo73]

DME bought 23 SD40s from CP Rail, 19 in 1999 and 4 in 2000. The CP numbers were 5501 to 5563. Would those be the CP units you saw, Murphy ?
CP has also sold a large number of SD40s and SD40-2s to leasing companies over the last 5 years, perhaps 100 all together.

[Murphy Siding]

Fuzzy- I had always thought that they were kept as two seperate entities ( IC&E and DM&E ) for some kind of paperwork advantage . For example, I've read that Guilford Transportation keeps several of their roads seperate, then runs them by way of a seperate holding company (Springfield Terminal?) . Seems it had to do with work rules, taxes or something. I know there was a specific reason why they did it. For what it's worth, the most common power I've seen mixed with DM&E blue and yellow diesels was bright red CP units.

[fuzzybroken]

My [2c] on this one:

I always thought that CP+KCS would be a logical end-to-end merger, till CP went and dumped the IMRL (later ICE).

I've also wondered why ICE, although owned by the same company as DME, is a separate company. So I think, maybe Cedar American is keeping ICE separate from DME for the time being as a contingency on the PRB extension. That is, if the extension is successful, they have good routes to Kansas City and Chicago; if less than successful, it would probably be easier to sell a whole railroad (ICE) as one unit than to have to re-separate the lines from the rest of the system!

My opinion is, the PRB extension is a done deal. Everything has been approved, line up the earthmoving equipment, ties, ballast, and rails.

KCS was in the running to buy the CP's lines that became the IMRL/ICE, but it went to Washington Corp. instead. They ended up turning their attentions to MExico.

CP would probably not be the railroad to go after merger with anybody else. I think it would be more likely that KCS and Cedar American would agree on a merger, then go after CP probably even before the dust settles!

But that's just the ideas swimmin' around in my head.

-Mark
www.fuzzyworld3.com

[Anonymous]

Ed,

You may have stumbled onto something here with the IC stock. Maybe the best rail investment is to buy and hold the stock of a likely merger candidate. Unfortunately, as per this thread the only likely takeover candidate left is KCS, perhaps one or more of the publicly owned regionals, but little else. Any parallel or coast to coast mergers probably isn't going to offer any stockholder gains at this point, and I am seriously doubting that there are going to be any mergers allowed beyond something involving KCS, maybe the takeover of a regional or two.

That's why it might pay to follow the DM&E thing and grab a few equity shares should they become available. Either the shares will increase when DM&E is takenover by a larger road, or they will become worthless when DM&E goes belly up.

The party's over for those investing in railroads to profer takeover gains.

[MP173]

The only rail I own is CN.

I purchased Illinois Central stock years ago and it has been quite an investment.

I do own a few stocks with lower ROE such as ADM and McDonalds (again, both purchased years ago) and I own one utility (Ameren), but the last few years I have refined my investment strategy to the ROE and free cash flow model, based on purchasing at a discount to fair value. Exxon Mobile is very capital intensive stock with less than 20 ROE, but again, it was purchased quite some time ago.

Ask me in a few years if this plan has worked! By setting parameters (financial) I really try to take the emotion out of it.

Funny, tonight I got stopped by a CN westbound and found myself both enjoying the train and counting the cars (in order to try and determine revenue...it was a 128 car monster). So, I got a little entertainment and good return out of that train tonight.

ed

[Anonymous]

Ed,

If you require a 20% ROE on your investments, then you probably don't own any railroad stock, or any of the capital intensive industries. Unless, of course, you are including an estimate of "intangible" benefits as part of that 20%!

[MP173]

I doubt if i would invest in DME, but I would take a look. There are certain threshholds that companies must reach before I invest. Two of the most important are return on equity and generation of free cash flow.

On this type of investment, I would require a projected ROE in the 20% plus range. Therefore, either their rates would need to be high, or the company would need to be very, very leveraged in order to achieve that ROE. High rates are doubtful, based on Futuremodals excellent description of what happens when a third party enters the market.

A high level of leverage is extremely risky, the threat of default is great (look at GM today, even flushed with cash, their bonds and stock has plummeted based on future earnings projections).

Further, if the debt is secured to the assets...and no doubt it would be, the interest rates would no doubt be rather high. This rail line would no doubt be a one function line....haul coal and lots of it. There is very little traffic that would warrent the pumping of capital into the line to rebuild it. Today's traffic obviously moves fine at a slow speed. Since the line would be built for coal and coal only and since there would now be three competitors...the rates would fall quicker than a prom dress.

No thanks.

ed

[gabe]

Possibly. What you have to remember is the utilities are virtually a silent partner on this deal. That means 2 things: (1) don't expect DM&E to make a huge amount at their expect but (2) don't expect the line to go under as well.

I would also point to the growing importance of Powder River Basin coal on the East Coast.

Gabe

[Murphy Siding]

Knowing what you know, would buy stock to finance something like this?

[Anonymous]

QUOTE: Originally posted by Murphy Siding

Future Model : Hang on a minute, my head is spinning , and I can't get it to stop. If the DM&E borrows 2 billion dollars, the figure they say need to BORROW, how does that not necessarily imply debt???? I'm not sure I understand your comments about the utility companies having the DM&E's back? In the real world of business, the utilities would buy their coal from the devil and ship it on horseback, if that was the most cost effective source. They won't pay the DM&E a premeum and I can't see how the DM&E would be able to do it at a discount?

Spinning, you say? Hmmmm, if only there was a way we could tap that for a new energy source.

If DM&E says they are borrowing 2 billion, that may be the up front money to pay for construction. It may be that later they will issue stock to pay down this debt. I wouldn't normally expect a company to borrow that much, but then again with interest rates as low as they are right now, it may make more sense for them to borrow with low interest rates and then later retire some or most of the debt later with equity financing. Bottom line - if someone is willing to loan them that amount at reasonably low interest rates, then common sense says go for it.

[gabe]

QUOTE: Originally posted by Murphy Siding

Future Model : Hang on a minute, my head is spinning , and I can't get it to stop. If the DM&E borrows 2 billion dollars, the figure they say need to BORROW, how does that not necessarily imply debt???? I'm not sure I understand your comments about the utility companies having the DM&E's back? In the real world of business, the utilities would buy their coal from the devil and ship it on horseback, if that was the most cost effective source. They won't pay the DM&E a premeum and I can't see how the DM&E would be able to do it at a discount?

I think FM is right on this one. I remember reading somewhere that a sizeable portion of the DM&E project was not funded out of debt.

MS, there are several ways this can be done. DM&E could issue shares of common stock is the most common method.

Gabe

[CSSHEGEWISCH]

I'm not sure that the utilities are all that willing to invest in DM&E to build a third PRB line since it may have a low rate of return. Also, would the existing parent firm be willing to cede a large part of its controlling interest for equity financing of the line? In a similar vein, the original Wheeling & Lake Erie was leased by Nickel Plate instead of merged by an exchange of stock since the NKP stockholders did not wi***o have their interests diluted.

At any rate, $2 billion is a lot of money and it will have an effect on DM&E's bottom line whether it is equity financing or debt, equity financing implies that the new stockholders will expect to receive regular dividends.

[Murphy Siding]

Future Model : Hang on a minute, my head is spinning , and I can't get it to stop. If the DM&E borrows 2 billion dollars, the figure they say need to BORROW, how does that not necessarily imply debt???? I'm not sure I understand your comments about the utility companies having the DM&E's back? In the real world of business, the utilities would buy their coal from the devil and ship it on horseback, if that was the most cost effective source. They won't pay the DM&E a premeum and I can't see how the DM&E would be able to do it at a discount?

[Anonymous]

QUOTE: Originally posted by Murphy Siding

Future Model: I wouldn't doubt that Midwest power entities would welcome the thought of the third railroad shipping from the PRB. It's unclear if any of them have actually backed this project. ( As in "put your money where your mouth is"). But, please explain how having 3 railroad choices is going to be any more competitive than 2 ? Also. isn't the DM&E, with 2 billion dollars in new debt going to have a harder time "being competitive" than 2 existing lines with a lot lower overhead costs?

It's about control. By having a stake in the DM&E expansion, the utilities can exert some influence in the ways and means of coal delivery. It therefore doesn't matter if there is suddenly "too much compeitition" because if push comes to shove the utilities have DM&E's back. Naturally this begs the question "why not just buy into BNSF or UP?". Because the purchase price for having sufficient say in matters is cheaper with the smaller domestically owned DM&E than with the multinational corporations like BNSF and UP. That doesn't mean that these utilities won't drop DM&E like a rock if BNSF or UP come up with a long term "sweetener" deal.

BTW, the $2 billion doesn't necessarily imply debt, a good part of that could be equity.

As for 3 choices being better than 2, I read an economic analysis on monopolies in which they rated the degree to which the monopolists prices compared with true competitive prices. For monopolists, it was something like an 86% average price differential. For duopololists, it was around 60%. However, for triopolists the price differential was only a few percentage points difference, something like 16% at most if I remember correctly, and as such it was determined that there was no statistically significant difference between triopoly pricing and true competitive pricing. Thus, assuming the utilities would go for whoever offered the lowest shipping price regardless of ownership alliances, they would have a nearly competitive transport market from which to choose. How this would fly against the railroad stand (or is it a railroad myth?) that they need revenues of 150% or so of variable costs to be judged "profitable", is not something to which I have the relevent insider information, so it's hard to say if railroading could survive in a triopoly environment or not.

[SALfan]

QUOTE: Originally posted by MP173

can anyone address the pricing of Powder River Coal? It is my understanding that in the early years, it was extremely lucrative to BN and CNW/UP. That high rate of return was no doubt necessary to build up the infrastructure.

My impression is that PRC is not what it used to be. A comment here, a comment there gives me that impression. Add a third routing and suddenly not only will UP and BNSF rates fall, but also the return for DME will fall.

$2billion of debt is a lot to service on low rated coal.

ed

At least for the first several years, PRB coal was NOT a big moneymaker for (then) BN because of the massive capital investment required for track, locomotives and cars. There was a TRAINS article about 7 to 10 years (IIRC) after BN started hauling PRB coal which said that overall BN at that time had not made any money on the stuff. There was an article within the past five years that said rates were about to go up for a number of utilities because the initial contracts were about to expire; the original deal was for the utilities to buy the cars (because BN couldn't afford them) and in return the utilities got a very low freight rate.

[gabe]

I have read several articles to that effect Ed, and I agree with your conclusion. I think that shows who is really behind pushing this deal.

Gabe

[MP173]

can anyone address the pricing of Powder River Coal? It is my understanding that in the early years, it was extremely lucrative to BN and CNW/UP. That high rate of return was no doubt necessary to build up the infrastructure.

My impression is that PRC is not what it used to be. A comment here, a comment there gives me that impression. Add a third routing and suddenly not only will UP and BNSF rates fall, but also the return for DME will fall.

$2billion of debt is a lot to service on low rated coal.

ed

[Murphy Siding]

nanaimo 73 [:)] ?

[daveklepper]

My only comment at this time is that both CN and CP have USA shareholders. Sme reports are that CN actually has more USA than Canadian!

[Anonymous]

DM&E would be competitive by moving PRB coal to Chicago to interchange with CSX and NS as demand for PRB coal increases in the east.

As for the merger scenerio of CP+IC&E+DM&E+KCS, it just doesn't match up. KCS will more than likely be next but to who??? Your guess is as ggod as mine. IC&E would be more attractive to Rail America or Genesee & Wyoming, both of these shortline portfolio companies wouldn't mind adding IC&E to their books. DM&E might be attractive to an eastern road as a means to get directly into the PRB, say NS+DM&E? NS is built on coal and the DM&E might be more attractive than KCS or CP since it is so much smaller.

But that's just my 2 cents worth......

[nanaimo73]

Gabe-I think it is fair to call this a $! billion project that NIMBY's have changed into a $2 billion project. I think they have killed the project for good. DME seems to be more concerned now with fighting UP over the track in Owatonna Minnesota, where the east-west DME line crosses the north-south IC&E line. DME is running on 3 miles of trackage rights here that C&NW designed to keep DME captive.
Murphy Siding-I'll do something about the shrinking number of class ones in a few weeks.And if you want to put a smile in,
[:)] just click on the show smile list to the left.

[Murphy Siding]

Future Model: I wouldn't doubt that Midwest power entities would welcome the thought of the third railroad shipping from the PRB. It's unclear if any of them have actually backed this project. ( As in "put your money where your mouth is"). But, please explain how having 3 railroad choices is going to be any more competitive than 2 ? Also. isn't the DM&E, with 2 billion dollars in new debt going to have a harder time "being competitive" than 2 existing lines with a lot lower overhead costs?

[Anonymous]

From what I understand, the DM&E project is backed by Midwest power entities, who apparently want a dependable PRB coal supplier without all the sudden price gouging currently being parlayed by BNSF and UP. The distance from mine to power plant is of a lesser concern than the long term delivered pricing of the PRB coal, so a KCS backing isn't out of the question either.

[Murphy Siding]

Gabe: I had to look up sylogism in the dictionary just to see what it is we're discussing. My comments weren't aimed at you by the way. My office sits 200 yards from the DM&E offices in Sioux Falls. Locally, we hear a lot of news about the DM&E. So I must chuckle now and then when people suggest it being part of a grand new merger scheme, considering where it is now,and where it hopes to go in the future. For what it's worth, as I sit at home right now, I can hear the horn of 2 Geeps from the Ellis & Eastern Railroad crossing 3 blocks from my house on the old C&NW line. I'd type a happy face, if I had any clue how!

[zardoz]

QUOTE: Originally posted by nanaimo73
Now, since it's not going to happen, I would rather hear everyone's views on which paint scheme this imaginary railroad would use, and what would it be called ?

CP+ICE+DME+KCS

Let's see; How about:
The Pacific, Midwest, & Southern RR
The Canada, Kansas, & Midwest RR
Canadian Southern
The NAFTA RR

The locomotives would be painted with a white nose, red lower-half carbody, blue upper-half carbody, green reflectorized striping, lettering, and accents.

The management and some employees would have to be tri-lingual (French, English, and Spanish).

[gabe]

MS,

I am not disagreeing with your sylogism. However, I am not arguing sylogistically. I am saying (1) DME has spent a heck of a lot of money relying on the financing being there--they are going to look awfully stupid if it is not (2) when the report was first released, it was noted that the financing was in place.

I, also, question the decision to finance such construction. But, I think I am going to rely on DME's assertions.

I wouldn't be surprised if power companies might be lubricating the financing.

Gabe

[Murphy Siding]

Gabe, the DM&E has jumped through most all of the environmental hoops to get approval for the PRB line. They do not have the 2 BILLION dollars in financing lined up. I have a hard time seeing how they will get this done. Convetional wisdom, ( and certain people's fertile imagination) say that the DM&E simply has to build a new line into the PRB, set their rates 1cent lower than BNSF and UP, and everyone will live happily ever after. If, as some believe, BNSF and UP are making such huge margins on the coal now, they could just lower their rates to "be competitive " and kill the DM&E on the vine. How do you get the financing based on that grand scenario?

[gabe]

QUOTE: Originally posted by nanaimo73

Gabe, a merger where DME shareholders exchange their DME stock for new KCS stock would work for KCS. I do not know how it would effect existing KCS stock. I don't think a majority of DME shareholders would approve.
I don't see any benefit to DME in merging with KCS.DME is set up to send traffic east.
www.dmerail.com

KCS could have bought just the line to Chicago from CP when I&MRL was formed or when I&MRL was sold. I think all they care about now is getting traffic through south Texas.The August 2003 Trains has a good article about this.

From what I have read, getting traffic to Chicago is more important to KCS today than it was when KCS had that option previously. I am not so sure DME would find no advantages for a KCS merger, it would open the grain on the line to better South of the border access, and KCS has 8 power plants that are capable of burning Powder River Basin Coal.

Gabe