Derailed Deal?

A delay in the Canadian National/Burlington Northern Santa Fe merger may mean the end of the line for the deal.

By John Clark

Now that North America's rush to railroad mergers has been brought to a screeching halt, the wonder is that the Canadian National Railway (CN) and the Burlington Northern Santa Fe Corp. (BNSF) didn't see it coming. They thought going to the US Surface Transportation Board (STB) for approval of their multibillion dollar, 80,000kilometre consolidation would be business as usual. But as the STB made clear this time, there's nothing usual about what's going on in transportation right now. The prospective partners launched their plans in the midst of great change in the rail transportation industry.

For 20 years, and with the encouragement of the US government, the railway industry has been remaking itself-rationalizing routes and merging companies-with less than resounding success. At this point, there are only six major railways left in North America and analysts expect that eventually there'll be only two. They will be virtual monopolies and there will be little competition on rates to shippers, unless there's a system in place guaranteeing it.

Alarm bells have been going off everywhere, not least in the Canadian forest industry. In the West, there is fear of losing one more competitive option that helps keep shipping rates down. In the East, lack of competition isn't so much the problem. It's the lack of service improvements on some already merged lines. The Canadian forest industry is in good company with its concern. Other railroads, financial analysts and economists, members of the US Congress, shipping interests and, not least, the US Pentagon have joined the chorus. The STB has been over whelmed and has decided to take 15 months to prepare new rules and policy frameworks before acting on the CNBNSF or any other mergers. But a 15month moratorium is a bitter morning-after pill for CN and BNSF.

As planning goes in a development of this size, the consolidation may or may not go ahead. BNSF chairman and chief executive officer Robert Krebs has already said the delay "could preclude us from going forward with the combination at all ." That would probably be okay to the forest industry. It says it would rather see BNSF as a competitor than as a partner of CN. Transportation, most of it on CN, comprises about one-third of the delivered cost of BC wood. Trucking is not as viable an option in Western Canada as it is for Eastern producers, who are closer to their markets. The West is therefore more vulnerable to a slippage in rail competition. In the East, they're more concerned about the cost of diesel fuel under OPEC's restricted quota production schedules. So Western Canadian shippers have some immediate protection from the merger mania. But whether this is in their long-term interests is something for them to consider during this timeout.

The proponents of the CNBNSF deal have cried foul. They say they shouldn't be singled out as the only victims of the moratorium because other rail companies haven't been as efficient. They're appealing the STB decision, which will take a while to go through the American courts. But CNBNSF complaints have some support from transportation analysts, even in Canada.

Bill Waters, a professor in the transportation studies department at the University of BC, says the delay, in effect, undermines the first mover. It gives other railways a chance to sharpen their own plans while blocking CNBNSF. "It puts CNBNSF at a disadvantage and invites the rest of the industry to catch up with them," says Waters. "It's a common regulatory approach, taking time to think. But things can happen-two years is a long time in a modern economy. Sitting around in business just talking about a plan doesn't do, the world doesn't stand still ."

The moratorium has its own built-in risks. If the transportation environment in North America changes while the rules are being rewritten, will the STB be ready even in 15 months to make a decision? Will it become harder for CN and BNSF to complete their merger when the timeout is up? If so, will the forest industry miss out on service improvements the two railways claim for their combined system and which the industry wants? What the STB is looking at is what everybody else has been looking at. At some of the merged companies there have been horror stories about computer glitches, traffic tie-ups leading to production shutdowns in customer factories and rail cars being lost on switching lines. CN and BNSF have indeed completed separate mergers on their own without a hitch. But the STB says this one will produce a spate of other combinations that make it nervous about letting it go ahead now. It says: "Customer benefits have not been fully realized and carrier relationships with customers, rail employees and local communities have been strained.

The performance of railroad stock market equities has been tending downward since service problems developed in the East. If it continues, the downturn in stock value, reflecting a loss of investor confidence, could threaten the capital investment needed to ensure that service improvement and growth can be maintained ."

For 20 years, and with the encouragement of the US government, the railway industry has been remaking itself- rationalizing routes and merging companies- with less than resounding success.

The Council of Forest Industries (COFI) in BC made much the same point in a submission to the STB: "Great service at high prices in our competitive market will not open doors to new business. Competitive prices on products that aren't reliably delivered will result in erosion of our customer base. We must be able to provide competitively priced product where and when the customer requires it or someone else will ."

There's growing suspicion among shippers that doing mergers may become a substitute for fundamental operational changes needed to improve service. COFI says: "Railroads need to reinvest in their infrastructure to maintain service levels and remain competitive. Concerns with the disposition of capital in the event of a CNBNSF consolidation have been voiced on both sides of the border. "Americans fear the proposed structure of the board of directors (a majority of Canadians) will result in capital being expended on nationalistic lines. Canadians fear return on investment will be the deciding factor and, due to the size of the US market, return on investment numbers will consistently favor investment south of the border, resulting in a deterioration of Canadian infrastructure ."

The forest industry is itself familiar with the urge to merge, of course, a fact not missed by the railways. The same impetus to seek economies of scale and reduced costs through rationalization applies to it as much as to the railways. When MacMillan Bloedel was taken over by Weyerhaeuser, the purpose was as much to improve investor returns as it was simply to create a powerhouse and perhaps a dominating position in the industry. But forest company people say the mergers in their industry don't come close to limiting competition in the way railway consolidations do.

Georgia Pacific, Louisiana Pacific, Abitibi Consolidated, Tembec, Fletcher Challenge, Canfor, to mention only a few, all compete with each other in the same big economy in the US. There's nothing captive about any of their markets. The big companies may be vulnerable to accusations of exercising too much control over log suppliers, an issue prompting governments to reexamine tenures in the publicly owned forests. But the industry as a whole is not as susceptible to monopoly structures as the railways.

About that the STB says: "It does not appear there are significant public interest benefits to be realized from further downsizing and rationalizing of rail route systems as there is little of that activity left to do. "The disruption that has beset the railroad industry in connection with the last round of mergers could reach unprecedented levels. Carriers whose management should be focused on fixing their service problems would instead be fixated on finding merger partners, defending their proposals and responding in the regulatory arena to other carriers' proposals. "In short, the already fragile rail industry could be further destabilized ."

The Canadian Transportation Agency and the Competition Bureau will have their own input into the merger question. But there's no doubt that the US STB will make the definitive decisions since the only significant consolidations left will involve American railroads. Whether the mergers can or should be stopped and whether competition can be preserved if they are not stopped will be very big questions. The answers are vital to the forest industry, at least, which is why it has been making the biggest noise in Canada about the CNBNSF plans.

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