ICC Chooses a Poor Way to Run a Railroad

It speaks volumes about the way the U.S. economy really works these days that last week, when the Interstate Commerce Commission ruled against the merger of the Southern Pacific and Atchison, Topeka & Santa Fe railroads, there was quiet rejoicing on Wall Street.

The blunt truth is that the Street's investment managers see more chances for cash deals and stock price action if Santa Fe Southern Pacific Corp., the holding company that owns both railroads, gets out of the rail business altogether--and the ICC's ruling makes getting out a real possibility. That is why Santa Fe Southern stock, after an initial decline last week, rebounded and rose on Monday despite a declining stock market.

It would be nice, of course, if railroad customers in industry and agriculture also benefited from developments that make for cash deals and stock price action. But that isn't the way things generally work these days in an economy that Wall Street traders seem to understand better than government regulators.

Misunderstanding by ICC

The ICC, for example, doubtless saw itself preserving competition and protecting the rights of railroad customers in turning down the consolidation of the two rail systems. By forcing Santa Fe Southern to divest one or the other of its railroads, the regulatory agency thought it would ensure that an independent, 14,000-mile Southern Pacific could continue to compete vigorously with the 11,800-mile Santa Fe in the Pacific Coast, Gulf Coast and Midwest markets, where the two railroads have fought each other for more than 100 years.

But the ICC misunderstood present realities in transportation, and its ruling will probably result in the dismantling of two historic railroads rather than their preservation.

Wall Street's traders understand this. They see that the Southern Pacific railroad is barely breaking even and that the profitability of the Atchison, Topeka & Santa Fe is no great shakes either. Economic conditions in the Grain Belt and along the Gulf Coast have hurt the two railroads, but, mainly, the Southern Pacific and the Santa Fe are losing out in the competition with trucks. The Interstate Highway System is proving a more economic right of way than their railbeds.

Worse, in Wall Street's eyes, the railroad businesses obscure the high profitability of Santa Fe Southern's other activities, which collectively produced $628 million of pretax profit last year, or 80% of the holding company's total, on only $1.8 billion--or 28%--of its revenue. These include a real estate operation that owns some of the most valuable acreage in California and Arizona, as well as highly profitable pipelines for oil products and chemicals.

Worth $3.2 Billion

So that the stock market may fully value such operations, the investment crowd wants Santa Fe Southern to sell both railroads, not just one. Money manager E. Magnus Oppenheim, the head of a New York investment firm bearing his name, calculates that the railroad properties have a net worth of $3.2 billion and could be sold for anything from $1 billion on up.

Santa Fe Southern would surely take a big writedown. But the way investment managers reckon such things, the company could use the tax loss to shelter future earnings, and the $1 billion-plus that it would take in could be added to its existing $600 million in cash assets and used to acquire other companies.

There is even the possibility that Santa Fe Southern would be a takeover target itself. Rumors persist that investment partnerships that specialize in turning industrial properties into cash are buying its stock.

What kind of a way, as the saying goes, is that to run a railroad? It is no way to run a railroad, which is precisely the point. Since the merger, Santa Fe Southern clearly has developed into more of a financial asset manager than a transportation company. The ICC's decision pushes it further in the direction it was already going.

Which is a shame, because the government might have turned the efforts of Santa Fe Chairman John Schmidt and his managers toward making a better railroad if it had allowed the merger to go through. Santa Fe had plans to bring needed efficiencies to the two historic railroads. And the interests of shippers would have been protected by increased competition from the Union Pacific, Denver & Rio Grande Western and the Kansas City Southern--which were to be awarded new routes as an offset to the merger.

Now, instead, the Southern Pacific, and maybe the Santa Fe, will be sold. Possibly they will be broken up in piecemeal sales of branch lines and rail segments, a cash-maximizing technique developed in other railroad sales in recent years.

It is extremely doubtful that this would benefit railroad customers in industry and agriculture. But, then, benefiting customers seems to matter less in the economy these days than does the rush to try to make as much money dismantling U.S. industry as was made in building it.

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