Merger Talks: Creating Transcontinental Railroads Might Be a Good Thing

Norfolk Southern and CSX trains. (Dreamstime)

There’s a good argument that the U.S. would benefit from a freight railroad stretching from the East Coast to the West Coast. There may be an even better argument it would benefit from two of them.

The western rail giant Union Pacific confirmed on Thursday that it is in advanced talks to acquire the eastern railroad Norfolk Southern to make the first modern transcontinental freight network. Ever since word of the talks leaked out last week, there has been speculation it might spur a competing merger between Union Pacific’s western rival, Berkshire Hathaway’s BNSF, and Norfolks Southern’s eastern rival, CSX.

For now, both combinations remain a transcontinental dream.

“There are no assurances that we’ll reach an agreement, but we are talking,” Union Pacific CEO Jim Vena told analysts on the railroad’s June quarter earnings call at 9 a.m.

Analysts peppered him with questions, but he fended them off.

“I’m not going to comment,” the UP chief said. “Only a fool would expect me in the middle of when we’re having discussions to start getting into any details.”

A merged Union Pacific and Norfolk Southern railroad would span the U.S. Photo: National Rail Network Map via ArcGIS

Word of UP’s discussions with Norfolk were first reported last week, by the digital news site Semafor. Vena has been publicly talking up the idea of a transcontinental merger since May, noting the more relaxed antitrust inclinations of the Trump administration, and the rail industry’s desire to better compete with truckers.

Since this century began, railroads have lost freight volumes to truckers. And even though North America’s half-dozen large freight railroads—the Class 1 operators, with annual revenue above $1 billion—have improved their efficiency and profits in recent years, rail volumes stubbornly refuse to grow.

A transcontinental merger could eliminate switching and the handoffs from western to eastern railroads, which can delay a coast-to-coast shipment for days in the so-called “hump yards” of Kansas City and Chicago where a car is shifted from one train to another.

“The more you can remove touch points,” Vena said on Thursday’s call, “you can have a much more fluid, less-touching railroad…you remove some of that noise that happens when you hand off.”

“Every time you touch, something could go wrong,” he said.

While eliminating hump-yards can make rail shipping a speedier rival to trucking, mergers also include areas where the would-be merger partners overlap.

A map shows the UP and Norfolk networks overlapping in Illinois and Missouri. To appease the antitrust concerns of the Department of Justice and the Surface Transportation Board, merging railroads might need to divest some rail lines. That could add a year or two to the approval process. Regulators will also consider how much a merger might reduce the competitive choices available to shippers in those regions of overlap.

A map of a potential combination of the BNSF and CSX shows less overlap, mainly some bits in Illinois and Alabama.

A merged BNSF and CSX would have their own transcontinental railroad. Photo: National Rail Network Map via ArcGIS

The maps also clearly show the benefits of two sprawling transcontinental networks. A BNSF-CSX combo would have impressive reach across the northern states of the West and down the East Coast to Florida. A UP-Norfolk network would thoroughly cover the central western states and the Appalachians.

Vena’s analyst call this morning was about UP’s June quarter results. Those results were pretty good. Revenue rose 2% from the prior-year quarter, to $6.15 billion, while earnings rose 12% year over year to $3.03 a share (after excluding noncash and one-time items). Freight car velocity—the railroad’s preferred measure of efficiency—improved 10%, with each car averaging 221 miles a day.

A combination with Norfolk Southern would create a big company. UP’s current market cap is $135 billion, with debt bringing its enterprise value to $170 billion. The corresponding numbers for Norfolk are $63 billion and $70 billion. Revenues projected for this year by the FactSet analyst consensus are $25 billion for UP and $12.4 billion for Norfolk.

A BNSF-CSX combo would have similar revenue—synergies and divestitures apart. Within Berkshire, BNSF’s trailing four quarters’ revenue was about $23.5 billion. Analysts foresee $14 billion in 2025 year revenue for CSX.

As for performance, BNSF moves more carloads than does UP, but UP’s revenue per carload is higher. Conversely, Norfolk moves more carloads than does CSX, but the latter enjoys higher revenue from each car.

Vena sees such mergers as a national good. “You can do things to help the nation, help our customers win,” he said Thursday.

“If you stand still, you get left behind.”

Berkshire and CSX haven’t commented about a merger of their respective railroads, and there is no indication any talks have taken place.

But if their main rivals do end up merging, they might get left behind.

Write to Bill Alpert at william.alpert@barrons.com