We hosted a call with a former Class I CEO on the implications of a transcontinental merger. Our panelist believes the merger will enable significant share gains over the long term, more so than an agreement, and ultimately be approved by the STB. Stakeholders seeking concessions will be inevitable but unlikely to impact any decisions, and associations likely to work directly with rail partners for agreements.
One team with one playbook is much more powerful than a partnership, according to our panelist. Transcon railroads exist in many other countries, and the long-term benefits outweigh any near-term challenges/headwinds. A unified network will enable Union Pacific to make long-term investments into network pockets that previously were not a priority, improving service quality for shippers.
Watershed freight will be significant for a unified network and will allow IMCs (intermodal marketing companies) to redesign the network to compete with long-haul trucking. Shippers will have the advantage of getting a single quote for a transcon move, enabling share gains. Our panelist pointed to autos as a material opportunity for a unified network; UP will theoretically be able to show the OEMs a rail map that could feed them to virtually all relevant cities, allowing UP to win a multi-year contract for up to 75%-80% of their volume. A merger would be bullish for the West Coast ports given a single-line service, and be a negative for the East Coast Ports, the Panama Canal and the Canadian ports to a lesser extent.
Historically, not much has been given to stakeholders who ask for concessions (especially other Class I’s). Our panelist does not believe any concessions will be given to another Class I, and concessions for short lines only will be on a localized basis (sales may only happen where the STB is very uncomfortable). Shippers and shipper associations likely will not get much out of seeking concessions with the STB; they often work directly with the railroad on an agreement. Associations historically are not very good at stopping a merger from happening. Because BNSF did not make a bid for CSX, our panelist doesn’t believe the STB will go after reciprocal switching, given it would now create a more imbalanced system without two transcons.
Unified single-line networks easily out-punch interline agreements per our panelist, verifying our intuition discussed previously. Citing CN’s experience, our panelist noted that gains from the CN’s combination with Illinois Central generated longer-lasting synergies than an agreement with Kansas City Southern which saw benefits fizzle out after five years. While an interline agreement is better than no coordination, it is not sufficient to adequately tap the watershed opportunity. According to our panelist, this is because the two railroads still ultimately need to negotiate revenue sharing terms around the short haul, which prevents commercial alignment. Our analysis of prior STB merger decisions has found that the Board has consistently acknowledged the reality that the synergy potential of mergers is not perfectly replicated with agreements. We highlight these once again below.
Integration always presents execution risk, but a Union Pacific+Norfolk Southern combination fares better than the UP+Southern Pacific or the Conrail split between CSX and NS. Prior cases of challenged integrations arose out of network overlap, which is not a big factor for UP+NS. Lack of overlap was also credited for the relatively smooth integration of Canadian Pacific and KCS. Our panelist acknowledged that IT constitutes the trickiest piece of integration, but noted that UP’s disclosed $2 billion in merger-related capex (most of which management attributed to technology) was reasonably calibrated, in his view. We note to investors that the $2 billion outlay is significantly higher than seen in prior mergers (barring UP+SP, which was a woefully underinvested network, see table below). Additionally, the panelist noted that overruns in integration spend are possible but are justified by the sizeable synergy opportunities. A single-line UP+NS will create winners and losers among the IMCs, with prime UP partners gaining. Hub Group and Knight-Swift intermodal would be able to readily tap the watershed opportunity, given their existing relationships with the combining railroads. The panelist also sees J.B. Hunt eventually faring well, given the intermodal leader’s scale spanning both Eastern networks.
STB on Mergers vs. Interline Agreements
CP+KCS 2023: Railroad mergers frequently can achieve a degree of coordination beyond that which is available under voluntary coordination agreements.
UP+Southern Pacific 1996: The ICC consistently rejected claims that coordination of benefits can be achieved voluntarily.
Santa Fe+ Southern Pacific 1983 (“Shouldn’t Paint So Fast”): Without the unified management resulting from the merger, few if any of the operating economies projected under the Operating Plan are attainable.
