CP says to CSX: Shall we dance?

Posted by Fred Frailey
on Sunday, October 12, 2014

You are entitled to believe that mergers in the railroad industry are driven by broad economic forces. I believe they are driven by the ambitions of men. The news today that Canadian Pacific has approached CSX regarding a merger appears to bear me out.

A young chief executive of a successful business is the last person you want to ask to sell. Why should the younger CEO give up the possibility of years of accomplishment and executive bonuses? The answer is that he won't unless backed against a wall. Canadian Pacific's president and soon to be CEO, Keith Creel, is in his mid 40s. His boss, chairman Hunter Harrison, has said for years that additional mergers are both inevitable and good for the railroad industry, in that they would break down the east-west wall that roughly follows the Mississippi River. By all accounts, Creel is eager to make a name outside the shadow of his mentor, Harrison. So CP's approach to CSX makes perfect sense.

But look who else is primed to act. At BNSF Railway, CEO Carl Ice and executive chairman Matt Rose are in their 50s. They are not directly affected by Wall Street's short-term outlook, either, being owned by conglomerate Berkshire Hathaway. Plus, they have Berkshire's huge trove of cash and sterling credit rating at their backs. And at Canadian National is Claude Mongeau, barely turned age 50 and a veteran at buying and absorbing regional railroads (Wisconsin Central, Elgin Joliet & Eastern, British Columbia Rail, among a host of others). Together, these railroads all have reasons to be buyers because they are led by men who feel they have a future before them.

Now look at the possible sellers. Michael Ward at CSX, Jack Koreleski at Union Pacific, Wick Moorman at Norfolk Southern, and David Starling at Kansas City Southern are all one to four years from the normal retirement age of 65. Each might be willing to listen to an offer that makes sense to their shareholders and makes sense as a future business combination. Most if not all of these CEOs have heirs apparent--Wick has Jim Squires, Michael has Oscar Munoz and Jack has Lance Fritz, for example--but the reality is that boards of directors listen to who has the top job now, not those who seek it later.

If you will accept my logic this far, then BNSF and Canadian National must be asking, where should we shop? I don't think BNSF wants to be a seller, so that leaves CN with NS or UP. BNSF has NS or it can choose to fight CP for CSX (a merger with UP would create a western monopoly, which no regulator would allow).

Is a triopoly of CP-CSX, CN-UP, and BNSF-NS sustainable? In other words, would these combinations create imbalances yearning to be solved by more mergers? Where does KCS fit in? I don't know the answers because we're possibly at the early stages of a long process. Right now all I can do is speculate, which I just did. There is also the reality of today's crappy service being given rail shippers. At the first sign of even bigger, more powerful railroads, shippers will scream bloody murder, and I don't blame them. But CP knew this going in; presumably it has a response.

Now let's see what happens. One possiblty is that CSX meant no when it said no and that's that. But you know how the world works: When a company says no, what it may really be saying is, is that your final offer? Plus, once set in motion, business dramas such as this take on lives of their own.--Fred W. Frailey

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