Norfolk Stock Drops on Union Pacific Merger. That Isn’t Supposed to Happen.

A Norfolk Southern cargo train in the Shenandoah Valley. Norfolk Southern and Union Pacific announced plans to merge on Tuesday. (Dreamstime)

Railroads Norfolk Southern and Union Pacific announced their intent to merge on Tuesday, creating “America’s First Transcontinental Railroad.”

The combined network would span 43 states and over 50,000 miles. Most important, it would allow freight to travel coast to coast, without spending two days in Chicago shuffling between railroads.

“We’re going to cut a day or two off every transit time,” Union Pacific CEO Jim Vena told listeners on a morning call to discuss the deal. He would run the combined company.

The deal values Norfolk stock at $320. Each share will be swapped for one share of Union Pacific and $88.82 in cash.

Norfolk shares fell 3%, to $277.70, on Tuesday. Union Pacific shares fell 2.4% to $223.77, while the S&P 500 and Dow Jones Industrial Average dropped 0.3% and 0.5%, respectively.

The proposed deal implies a value of about $313 per Norfolk share at current prices. Norfolk stock closed roughly $35, or 11%, below the deal price. The spread might reflect some uncertainty about completing the deal. It also reflects timing. The merger, if approved, would take 22 months to complete. Investors in short-term government bonds could earn over 6% in that time frame.

Those skeptical of the merger proposal include labor unions. The SMART Transportation Division represents more railroaders than any other union. In a press release, it criticized the labor and safety record of Union Pacific.

The companies certainly expected a warmer welcome from investors. Norfolk CEO Mark George said shareholders could see “significant upside” from the combination, which “will be a must-own large-cap stock and should trade at a robust multiple.”

The combined 2024 revenue of the two railroads was $36.4 billion, with $18 billion in combined Ebitda, or earnings before interest, taxes, depreciation, and amortization.

In their morning presentation, the railroads said that a seamless transcontinental network will bring jobs to U.S. ports, by better competing with the transcontinental railroads of Canadian National Railway and Canadian Pacific Kansas City. And it will allow railroads to recapture freight volumes from the trucking industry.

“This industry has faced contraction…over the last couple of decades in terms of volume growth,” said Norfolk’s George. “We’ve been losing share to truck and this is one way to reverse that trend.”

Union Pacific CFO Jennifer Hamann estimated that within three years, the combo’s new services would add $1.75 billion in Ebitda from new revenue, with another $1 billion in Ebitda from trimmed costs. Combined free cash flow should grow from $7.3 billion, to $12 billion by 2029. Those synergies should be worth more than $30 billion in added market capitalization, she said.

There will be regulatory hurdles in the way of completing the deal. Since 2000, there has only been one Class 1 rail merger: the 2023 purchase of Kansas City Southern by Canadian Pacific. In that case, the rail industry regulator, the Surface Transportation Board, was persuaded to waive tough merger standards adopted back in 2001.

Vena hinted that he expected a good reception from regulators. Fewer than 20 customers will go from having two rail providers to just one, he said.

There would be one less hurdle, compared with other recently attempted rail mergers. Those proposals had planned to immediately buy out the acquired railroad’s shares and hold them in a voting trust, during the STB’s two-year review. Regulators worry such trusts are anticompetitive and hurt customer service.

Union Pacific won’t attempt a trust. That also gives it nearly two years to build cash, before it would buy Norfolk’s shares.

“Creating the Union Pacific Transcontinental Railroad is overwhelmingly in the public interest and will enhance competition,” said the companies in a news release. They “expect to file their application with the STB within six months, in which the companies will describe how the combined rail network will provide safer, faster, and more reliable service and increased competition to a broad range of stakeholders.”

Along with announcing the blockbuster merger, Norfolk Southern reported second-quarter earnings. Adjusted earnings per share were $3.29 on sales of $3.1 billion. Wall Street was looking for earnings per share of $3.31 on sales of $3.1 billion, according to FactSet. A year ago, in the second quarter of 2024, Norfolk reported profit of $3.06 on sales of $3 billion.

Earnings, however, are now secondary. Investors will focus on the merger.

If M&A activity heats up in the sector, it will likely involve additional players such as Berkshire Hathaway’s BNSF, Canadian railroads, or CSX.

Write to Al Root at allen.root@dowjones.com