Deconstructing Conrail

If all goes as planned, Conrail will soon be split between CSX and Norfolk Southern. What are the pros and cons of this massive merger? And how will it affect scrap shippers?

Take your pick.

If Conrail is divvied up between the Norfolk Southern and CSX railroads, the result will be:

A. Good for scrap processors in the East because it will create greater competition and more efficient rail transportation that will, in turn, make gondolas more available and reduce freight costs.

B. Bad for scrap processors in the East because CSX and Norfolk Southern will have as much trouble digesting this merger as the Union Pacific railroad had out West absorbing Southern Pacific, in which accidents and rail congestion plagued shippers for much of last year.

C. Pretty much up in the air, since there has never been a “merger” quite like this one, in which two healthy railroads are dividing an equally healthy third company at a record cost of more than $10 billion and creating several “novel” regions where both companies will jointly operate the tracks.

And the answer is ... D for “It depends.”

Okay, a trick question, but one that reflects the uncertainties and concerns about the proposed deal, which is technically a dual merger between CSX and roughly 42 percent of Conrail and between Norfolk Southern and the other 58 percent.

The benefits or deficiencies of the deal depend on many variables, including whether a shipper lies within one of those jointly operated areas or just outside it, how much tonnage a company ships by rail, whether the conditions that made the Union Pacific/Southern Pacific merger such a disaster are unique or universal, and whether CSX and Norfolk Southern can factor in the high purchase price for Conrail when setting freight rates.

One point is clear, though: The splitting of Conrail’s 11,000 miles of track between CSX Corp. (Richmond, Va.) and Norfolk Southern Corp. (Norfolk, Va.) will likely be approved by the U.S. Department of Transportation’s Surface Transportation Board (STB). “In the past 40 years, there’s been an average of one major railroad merger approved each year” by the STB and its predecessor organization—the Interstate Commerce Commission, notes Frank Wilner, a former chief of staff to the STB’s vice chairman and now an Alexandria, Va.-based author and consultant. “During that period, only three mergers have been denied. It’s almost unheard of for a railroad merger to not be approved.”

Other industry observers concur, noting that some of the obstacles the merger has faced—such as an unprecedented requirement that CSX and Norfolk Southern prepare detailed safety plans—will make the approval process smoother by resolving potential problems ahead of time. And the two railroads have lined up an impressive list of supporters, more than 2,500 in all, from the National Audubon Society to the Big Three automakers.

But that said, the final shape of the deal remains as cloudy as the smoke billowing from an old locomotive, with powerful groups—including the chemical and plastic industries, various municipal and state authorities, as well as both U.S. senators from New York—seeking significant changes to the proposal.

Caught somewhat in the middle are scrap processors, many of whom don’t have the economic clout—in terms of tonnages shipped by rail—to affect the outcome of these negotiations, observers say.

Rail Travails

The probability of Conrail’s being acquired by someone was almost inevitable. Ever since the 1980 Staggers Act deregulated much of the U.S. rail industry, the number of Class I railroads—including Conrail, CSX, and Norfolk Southern—has been shrinking steadily via mergers, declining from approximately 40 Class I lines in the early 1980s to potentially four major carriers today. In the West, Union Pacific Corp. and Burlington Northern Santa Fe Corp. dominate rail freight. If the Conrail merger succeeds, the eastern United States will likely belong to just CSX and Norfolk Southern.

At press time, however, Canadian National Railway Co. announced plans to buy Illinois Central Corp., a deal that would create a giant Y-shaped system running across Canada and then down from Chicago to New Orleans, and which the Wall Street Journal predicts could offer new competition to the four giant systems in the East and West.

Conrail’s own story begins slightly before the start of deregulation, when in 1976 the federal government formed the Philadelphia-based Consolidated Rail Corp.—hence Conrail—out of several bankrupt railroads. Serving predominantly the Midwest and Northeast, Conrail was originally meant to promote rail competition in those regions, but eventually the company developed a virtual monopoly in large parts of New York, Pennsylvania, New Jersey, and Massachusetts. Conrail also began to make a profit in the 1980s and became a publicly held company in 1987, making it a clear acquisition target for CSX and Norfolk Southern, its two largest competitors in the Midwest and Mid-Atlantic markets.

After making rival bids to purchase Conrail in late 1996 and early 1997, CSX and Norfolk Southern agreed last March to split the rail line between them, making a joint offer for $115 a share—well above the roughly $70 per share that Conrail stock had commanded just before the takeover fight began. A formal application to divide Conrail was filed with the STB in June 1997, with the board then setting a 350-day procedural period for interested parties to make comments supporting or opposing the transaction or to request that the board impose certain conditions on CSX and Norfolk Southern before granting approval.

Although the STB originally planned to vote on the Conrail deal in mid-April 1998, a snag emerged last fall. Two factors—an unfavorable safety report about CSX from the Federal Railroad Administration and the accidents that followed the Union Pacific/Southern Pacific merger—led the STB to require that both CSX and Norfolk Southern develop detailed safety implementation plans.

Because of these safety plans, which the railroads submitted in early December, the STB added 45 days to its review process. That means the STB will now hear oral arguments in the case on June 4, with a vote to follow on June 23. The written decision will appear July 23, and if approval is granted as expected the effective date of the merger will be Aug. 22, 1998.

An indefinite period of time would then be required—to meet any STB-imposed conditions, train employees, integrate computer systems, and implement labor agreements—before the two railroads would begin to operate their respective portions of the former Conrail system, according to Norfolk Southern.

Making Their Case

In preparing their case before the STB, CSX and Norfolk Southern have filed thousands of pages of documents citing the benefits of the proposed merger, refuting criticisms of the plan, and even making statements that have been interpreted by industry observers as ridiculing or belittling those who disagree.

For CSX and Norfolk Southern, the greatest benefit of breaking up Conrail is, paradoxically, the achievement of Conrail’s original purpose: competition. “Unlike prior railroad combinations, the [Conrail breakup] does not present a significant threat to competition,” CSX and Norfolk Southern stated in their 3,000-plus-page rebuttal to criticisms filed with the STB. “To the contrary, the [breakup] is the most pro-competitive transaction ever brought before the Board or its predecessor.”

Although most of Conrail’s trackage will simply switch ownership to either CSX or Norfolk Southern, four regions will be jointly operated by the two railroads. These “shared asset areas”—located near Detroit, New York City and Northern New Jersey, Philadelphia, and the southwestern Pennsylvania coal region—will offer shippers within the designated areas a choice of which carrier to use.

In addition, the two railroads claim that splitting Conrail will enable them to better compete with trucks, which they call “the dominant mode of freight transportation in the East.” If they take over Conrail’s tracks, CSX and Norfolk Southern expect a large enough increase in intermodal business—which involves moving the trailer portion of a trailer truck by flatbed railcar—to remove more than a million trucks a year from the nation’s highways. Such competition would improve highway safety and benefit the environment by reducing traffic-related pollution, they argue.

Both CSX and Norfolk Southern also plan massive capital spending to improve tracks, purchase new equipment, and make other improvements in preparation for taking over the Conrail system. CSX, for example, intends to spend more than $800 million this year while Norfolk Southern is investing more than $900 million in its system. And Conrail itself reportedly has more than $500 million in capital improvements planned for 1998.

At ISRI’s 1998 national membership meeting in Miami Beach in January, CSX and Norfolk Southern representatives also touted benefits such as the extension of single-line service (meaning that freight wouldn’t have to make expensive switches from one railroad to another), shorter transit times and reduced delays, more frequent trains, a greater availability of railcars (primarily through more efficient usage of existing cars), and lower costs resulting from all these greater efficiencies.

CSX also specifically predicts that “scrap metal processors will expand their market reach and have the ability to grow their business” because single-line rail service running north and south will “open up a large market of scrap metal processors for minimills located predominantly in the South.” And the rail carrier expects “greater opportunities for scrap paper backhauls.”

In the “very few instances” where the breakup might reduce competition, CSX and Norfolk Southern assert that they have “crafted effective arrangements to ensure the preservation of competitive rail alternatives.” Moreover, they argue that the overall benefits of the deal are so unimpeachable that many of their critics “complain not that they are harmed by the [breakup] but that they are not accorded the same new advantages as others.”

Jeers and Fears

Naturally, the critics of the Conrail breakup don’t quite see it the same way.

The American Trucking Association (Alexandria, Va.), for example, doesn’t refute the possibility that a million shipments might be diverted from trucks to rail by the proposed merger, but it does stress that diverted shipments don’t necessarily mean fewer trucks on the road. Instead, the group argues, the trailers and containers carried by rail will need to move by truck through “more congested highways in urban areas” to get to and from the trains and that much of this equipment will now be owned and operated by the railroads rather than motor carriers.

That raises safety concerns, the trucking association says, unless the railroads are subjected to the same federal motor vehicle safety regulations that trucking companies must meet.

The specter of mergers past also raises concerns for the Chemical Manufacturers Association (CMA) (Arlington, Va.) and the Society of the Plastics Industry (SPI) (Washington, D.C.). SPI President Larry Thomas worries that “the complexity of the Conrail deal holds the very real possibility of a service disruption for shippers in the East” similar to the Union Pacific’s problems in the West. Likewise, Randy Speight, CMA’s managing director of distribution programs, notes that the shrinking number of U.S. railroads leaves many shippers “captive” to a single rail line. “Captive shippers pay more for rail transport and have few avenues for redress of grievances,” Speight says. “Clearly, this is cause for concern.”

Meanwhile, the Port Authority of New York & New Jersey commissioned a study of the merger that predicted “paralysis” within its region due to increased freight traffic. Similar fears have led to demonstrations in Cleveland, where church-based groups say poor neighborhoods will see more shipments of hazardous cargo moving through their communities. In Indianapolis, the fear is a loss of competition because shippers there could previously choose between Conrail and CSX.

And in several instances, individual shippers—including scrap processors such as Louis Padnos Iron & Metal Co. (Holland, Mich.), William Reisner Corp. (Clinton, Mass.), and Royal Green Corp. (Temple, Pa.)—argue that the shared asset areas will put them at a competitive disadvantage because they will continue to be served by only one rail line while their competitors in jointly operated areas will have access to both CSX and Norfolk Southern, and thus will be able to negotiate lower freight rates.

Overall, shippers and their organizations—including ISRI—also worry that CSX and Norfolk Southern will have to raise rates to offset a nearly $4-billion “premium” that represents the difference between what Conrail stock was worth before the takeover efforts began and what the two buyers ultimately agreed to pay. These groups are asking the STB to regulate post-merger rates to prevent the railroads from including any premium in future calculations.

Refuting and Disputing

For their part, CSX and Norfolk Southern consistently refute the merger’s opponents, while also seeking accommodations that will smooth approval by the STB. Both railroads, for instance, insist that Union Pacific’s troubles won’t be repeated in the East because they blame the western disruption on Southern Pacific’s poor financial state and preexisting safety problems at the time of its merger with Union Pacific. Conrail, on the other hand, “is financially sound and has a strong safety record in its own right.”

CSX and Norfolk Southern also dispute the idea that they paid a premium for Conrail, arguing that the purchase price represents that line’s true market value. STB regulation over future rates, they assert, would “depart from [the board’s] precedent and regulations regarding accounting.”

To try to overcome opposition in Cleveland, CSX points to more than 100 jobs that the deal will create in one of the affected neighborhoods. Likewise, Indianapolis won’t lose competition because Norfolk Southern will be granted adequate trackage rights within that market, the railroads argue.

CSX and Norfolk Southern also urge the STB not to intervene in cases where a “legion of shippers” argue that “their ‘harm’ is not from a reduction in competition but rather from an increase in competition that results from rival shippers receiving greater benefits.”

At the same time, however, the railroads made numerous concessions in a settlement last December with the National Industrial Transportation League (Arlington, Va.). The NIT League, which represents shippers across the country, initially filed numerous conditions that its members wanted the STB to impose on the Conrail deal.

To gain the league’s support for breaking up Conrail, CSX and Norfolk Southern agreed to retain existing contracts between shippers and Conrail, and to let those shippers seek arbitration six months after the takeover if they’re unhappy with their new service.

The railroads also agreed to keep open all existing reciprocal switching points for at least 10 years and cap switching rates at $250 for the first five years, subject to an existing railroad rate adjustment mechanism. They further agreed to a three-year freeze on rates for shippers who previously had single-line service with Conrail but whose shipments would have to move across both CSX and Norfolk Southern lines.

In addition, the railroads agreed to establish a shippers’ council to encourage dialogue about post-merger operations. The railroads pledged to provide that council with information on labor agreements and information systems, as well as how the shared asset areas will be operated, including individual shippers’ concerns regarding railcar ordering, supply, and location.

The NIT League and the railroads couldn’t reach agreement on the premium issue, however, and so the league can still seek STB intervention on preventing premium-related rate increases.

ISRI, which also filed a list of conditions, based much of its document on the NIT League’s original conditions. At ISRI’s January membership meeting, the transportation committee voted to support the NIT League settlement and to seek a seat on the shippers’ council, while also retaining the right to seek STB action on issues affecting individual members and the premium question.

Looking Down the Tracks

With the Conrail merger likely to be approved in some form or another, scrap processors are wondering about life in the post-merger world.

Some, such as Ferrous Processing & Trading Co. (Detroit), publicly support the merger. Jeffrey Cole, the firm’s CEO, points out that two of his plants will be located in the Detroit shared asset area and thus will benefit from the newly created competition there.

Cole adds that the jointly operated zone, rather than being a new idea, is actually a return to conditions that existed in Detroit in years past when multiple railroads serviced the city.

In contrast, other scrap companies have filed statements with the STB urging relief from what they consider the deal’s anticompetitive aspects because their plants are located outside such shared asset areas. And still others look to the future with a mix of optimism and uncertainty.

One broker representing more than a dozen scrap plants served by either CSX or Norfolk Southern expects that the deal will open access both into and out of the Northeast, and he hopes it will ultimately bring about lower rates.

Overall, industry observers don’t expect the scrap industry to be a driving force in the final version of the Conrail breakup. “Scrap shippers’ ability to change the direction of this merger is nonexistent,” consultant Frank Wilner says bluntly.

Likewise, Crew S. Heimer, transportation engineering manager with R.L. Banks (Washington, D.C.), a transportation consultant, says the odds are against the STB taking action to help individual scrap shippers. “Based on past decisions, the STB feels that it’s not enough that you’re hurt in a minor way,” Heimer explains. “You have to have a strong, compelling case that there’s a real problem with the way the merger’s going to impact you. Most requests [for imposing conditions on the deal] will be tossed out.”

Heimer also notes that the railroads are increasingly interested in customers who can fill an entire train rather than the smaller users. But he adds that consistency in shipping is perhaps more important than the number of cars ordered at any one time. And Heimer is optimistic that CSX’s and Norfolk Southern’s plans for grouping freight shipments and moving trains could result in faster turnaround times for railcars.

Also, the railroads have a strong incentive to make this merger work. That’s because of an issue called “open access” in which anyone—from a major railroad to a company with a single locomotive engine—has the right, for a price, to run its train on any line of track anywhere in the country. Various shippers have already called for such open access, and the STB actually ordered Union Pacific to provide access to at least two other railroads for a stretch of track around Houston. Talk of open access makes the major railroads “very nervous,” Heimer says, comparing the issue to a requirement that a person rent out spare rooms in his house whether he wants tenants or not.

Both Heimer and Wilner predict that Congress will likely consider requiring open access—or some other form of new regulation—if there are any further big mergers, such as a union between either CSX or Norfolk Southern and one of the two major lines out West. For scrap processors who already worry that bigger isn’t necessarily better when it comes to rail service, such a transcontinental merger wouldn’t be welcome. But Wilner and Heimer differ on whether to expect such a deal anytime soon.

“It would be surprising to go as much as five years without an East-West merger proposed,” says Heimer. But as Wilner points out, “we’ve gone almost 170 years and still haven’t created a single railroad that serves both the Atlantic and the Pacific coasts.”

Still, in this age of massive rail industry consolidation, anything is possible, so the best advice for scrap processors is to keep their eyes on the tracks. 

Editor’s note: ReMA has a limited number of maps that detail the Conrail breakup. For a free copy, fax a letter of request to Cheryl Spector, 202/626-0908. Requests will be filled on a first-come, first-served basis as long as supplies last. •