SFSP’s Future Unclear as It Gets ‘Divorce, Sells Assets, Fights Takeover : Railroad Giant Gets Sidetracked

Do yuh hear that whistle down the line? I figure that it’s engine number forty-nine, She’s the only one that’ll sound that way. On the Atchison, Topeka and the Santa Fe.

1945 SBK-Feist Inc.

Copyright Renewed.

It has been nearly half a century since Judy Garland immortalized the Santa Fe railroad with her song in the Metro-Goldwyn-Mayer movie “The Harvey Girls.” The company was much smaller then--known mainly for its Chicago-Los Angeles line--and things were much more tranquil.

Today, the railway’s parent firm, Santa Fe Southern Pacific, is a corporate behemoth with revenue last year of more than $5 billion. It owns vast amounts of developed and undeveloped real estate. It explores for gas and oil. It digs for coal, gold and silver. And it operates 3,000 miles of pipeline transporting gasoline and other refined petroleum products in six Western states.

But it is also a company in turmoil--the outgrowth of a 1983 marriage of two railroad giants that are now in the midst of a government-decreed divorce. SFSP also has been threatened with a fight for control. And it is selling off huge chunks of itself to fend off menacing sharks in the financial community. To say the least, its future is uncertain.

“How could there not be uncertainty,” asked Robert D. Krebs, SFSP’s president and chief executive, during an interview in his office here the other day, “ . . . when we have people outside (of the company) . . . talking about proxy fights, when on a given day the odds are as good as not, when you pick up the newspaper and look in the business section, there’s going to be something written about us? We’d like to get on with our business.”

On Friday, SFSP’s most immediate takeover threat was diminished as Henley Group, a La Jolla-based conglomerate, withdrew its promise to wage a proxy fight for seats on the railroad company’s board at its annual meeting May 24. But industry observers believe that SFSP is still “in play,” Wall Street’s jargon meaning that it could still face takeover attempts. They say the company has been a takeover candidate ever since the federal government ordered it to sell one of its railroads.

Before things return to business as usual, SFSP must complete a major overhaul, begun last year, that involves the biggest financial recapitalization in railroad history. Krebs views that step as a major factor in maintaining SFSP’s independence and creating a leaner, tougher and more profitable company; critics worry that SFSP will end up with a crippling load of debt.

In 1983, the parent companies of the Santa Fe and Southern Pacific railroads merged to form the SFSP holding company. The new corporation hoped eventually to win Interstate Commerce Commission approval to combine the two lines. While waiting, however, it was required to operate them separately.

Last year, the ICC gave its final ruling: There would be no merger of the two railroads. And SFSP was ordered to sell one of them.

The corporation decided to sell Southern Pacific Transportation, which includes the Southern Pacific railroad itself, a trucking company and the real estate directly owned by Southern Pacific. Although some critics say the company is selling the wrong railroad, management insists that it has made the right choice because the SP is the weaker of the two.

The two historic lines are known as the railroads that built the West. The SP has a slightly longer history, with its roots reaching back to 1856, when civil engineer Theodore D. Judah built a 23-mile line called the Sacramento Valley Railroad.

He won the backing of four Sacramento merchants--Leland Stanford, Charles Crocker, Mark Hopkins and Collis P. Huntington (later known as the Big Four)--in his search for a route over the Sierra Nevada for his railroad, which he renamed the Central Pacific. In 1869, the line linked up with the Union Pacific, coming from the East, with the driving of the famed golden spike at Promontory Point, Utah.

Later, with its name changed again--this time to Southern Pacific--the railroad heavily promoted its territory in the West to attract residents and businesses and became one of the most powerful actors on the economic scene in 19th-Century California.

Battle for the West

The Santa Fe was founded in 1859 with the original name of the Atchison & Topeka but, because of the upheaval of the Civil War and other problems, the company laid no track until 1868, by which time it had added Santa Fe to its name.

In the 1880s, the SP and the Santa Fe battled for the West, and SP repeatedly blocked Santa Fe’s efforts to build a route to the West Coast. In 1885, however, Santa Fe was finally able to complete its first through route from the Midwest to the coast, with its terminus in San Diego.

Both railroads operated famous passenger trains, with perhaps the best known being SP’s City of San Francisco and Santa Fe’s Super Chief. But autos and airplanes became the carriers of choice for most people after World War II, and both railroads left the passenger business in 1971, turning it over to Amtrak, the federally subsidized passenger rail service.

Today, the Santa Fe is an 11,600-mile freight railroad linking Chicago and the Southwest, moving through 13 states. Its main cargoes are truck trailers piggyback-loaded on flat cars (the so-called “intermodal” part of the business), 30%; general merchandise, 24%, and coal, 17%.

‘Rethink’ Whole Company

In explaining why SFSP decided to sell the Southern Pacific, Krebs said: “Our feeling was that we wanted to stay in the railroad business. And we wanted to . . . (keep) the railroad that had the best potential.”

The Santa Fe “had a real franchise,” said Krebs. “It is an acknowledged leader in the piggyback business. That’s the growing part of the railroad business. We decided we could make a better railroad out of the . . . (Santa Fe). We could improve its profitability.”

If SFSP remains independent, it plans to bolster the Santa Fe railroad, which will constitute 70% of the holding company’s revenue after the Southern Pacific is sold and the restructuring completed.

“As a result of the ICC’s action,” said Isabel H. Benham, president of Printon, Kane Research, a New York consulting firm that specializes in railroads, the management “had to rethink the whole company. They determined that what was needed was that they become a leaner railroad so they could defend themselves against their stiff competition. They would have to make their railroad more productive by reducing their employees by 5,000 and selling off 4,200 of branch trackage.”

The Santa Fe railroad subsidiary has 21,000 employees now and plans to bring that down to 17,000 in the next few years. The staff will be pared through attrition and early-retirement buyouts, Krebs said. He added that the company is being helped by its unions on some routes where there is intense competition with trucks.

The unions have allowed the railroad to use crews of only two or three members on some of these runs. The national average size of freight train crews is 3.6 people.

One major improvement needed by the Santa Fe, Krebs said, is the acquisition of a route to the Southeast that could link up with its highly efficient transcontinental route. Santa Fe’s Chicago-Los Angeles route is one of the nation’s most efficient freight runs.

The scheduled time it takes a Santa Fe freight train to travel between the two cities, a distance of 2,222 miles, is 48 hours, and the average speed is just over 46 miles an hour, the fastest in the industry for such a long route, according to Santa Fe. The railroad has run freight trains on parts of the route as fast as 79 miles an hour. “Nobody goes faster with freight trains,” Krebs said.

There are a number of reasons for Santa Fe’s speed on the long trip, the chief executive added, but the most important are that it has more double track and long sidings than other railroads. As a result, trains are seldom held up waiting for those coming in the other direction. Also, the Santa Fe’s routes are less mountainous than those of its competitors, and, Krebs said, its equipment is in excellent condition.

SFSP’s restructuring, which includes the distribution of about $4.8 billion to 100,000 owners of 156 million shares (shareholders have received $25 in cash dividends and $5 in bonds per share), is designed to put the company into enough debt that it will make itself less attractive as a takeover target.

Without some of the assets that it is selling, it is not expected to be as appealing to hostile acquirers. At the same time, the payouts are supposed to win the support of shareholders--a necessity if the company is to remain independent.

Aside from the powerful nudge toward reorganization that the federal regulators gave SFSP, observers say the exercise was engineered to stave off Henley’s takeover attempt. Henley owns 15.7% of SFSP’s shares and said in December that it would wage a proxy fight.

Henley’s withdrawal Friday came after it lost a key court battle in which it has sought to toss out part of SFSP’s corporate anti-takeover defenses and certain aspects of its restructuring. However, Henley’s future intentions remain murky. In announcing the withdrawal of its threatened proxy battle, Henley said it will keep its options open--from selling its investment in SFSP to increasing it.

“It (the recapitalization) was designed as a means of keeping anybody from coming in and acquiring a company at a price less than the assets are really worth,” Krebs said. “Now, if that’s fighting Henley, that’s fighting Henley.”

As part of the restructuring, SFSP has until 1992 to pay off its debts and it plans to do so out of cash flow and by using proceeds from the sale of assets. Henley charged that, in its haste to dispose of the properties, SFSP is letting some of them go for a song.

For example, Henley claimed, the Southern Pacific is worth much more than the $1.8 billion for which it is being sold. Rio Grande Industries of Denver has agreed to buy the SP in a deal that is awaiting ICC approval.

SFSP has already sold about $900 million worth of other assets, including a construction company, a finance concern, timber properties and two pipelines. Before the end of this year, it plans to unload $800 million in real estate.

In 1992, after it pays off all its debts--and if economic conditions do not deteriorate--the company expects to have $800 million in cash, Krebs said, more than enough to nurture its remaining businesses. And, even if a recession occurs, pushing down both oil prices and railroad profits, the company is confident that it will still have $300 million in cash four years from now.

But the critics say that SFSP has put itself so deeply in debt that its business will be restricted for years to come.

“I certainly can sympathize with any company wanting to enhance shareholder value,” said one analyst who declined to be identified by name. “But I have reservations about the radical nature of the (SFSP) restructuring. There is obviously a defensive, scorched-earth approach to this restructuring. They are conducting a fire sale of some of their most valuable assets in order to pay down their debt.”

The 45-year-old Krebs disputes all of these assertions. “It is not a scorched-earth policy. We’ve kept the best assets,” he said. “And we have sold the assets for . . . more than they would have been worth if we had kept them.”

Sale of SP a ‘Giveaway’

But, despite Henley’s withdrawal, some observers feel that the company has still not taken enough steps to repel a hostile takeover.

“They have been doing everything to make themselves unattractive,” said Jeffrey R. Perry, transportation analyst with C. J. Lawrence, Morgan Grenfel, a New York stock brokerage. “But I don’t think the company is any different than it was three months ago. They have added debt, but they have recognized values in doing that. There are still a sufficient number of asset values in the company. In my opinion, they have not yet made it sufficiently unattractive.”

So it is an unusual balancing act for the youthful-looking Krebs, who became SFSP’s chief executive only last July. He rose in the company through the operations side of the Southern Pacific and, after the 1983 merger, became SFSP’s chief operating officer.

Now he is charged with making the company a success while keeping it “sufficiently unattractive” to discourage takeovers.

In large measure, his future, along with SFSP’s, appears to hang on the outcome of the skirmish with Henley, a manufacturing, engineering and financial services company.

In late October of last year--after the Oct. 19 stock market crash--Henley offered to buy SFSP for $63 a share. And SFSP agreed. But then Henley changed its mind. Now, in the wake of the payouts to shareholders and other elements of the restructuring, SFSP stock is trading for about $17 a share.

Henley had favored SFSP keeping the Southern Pacific and unloading the more profitable Santa Fe. Henley Chairman Michael D. Dingman has said that the sale of the SP to Rio Grande Industries constitutes a “giveaway” and maintained that SFSP could benefit much more in the long run by selling the Santa Fe and retaining and reviving the SP.

Krebs insists that Henley was not interested in SFSP’s railroad business but simply wanted the company for its real estate, which it might have sold.

Some say that there is substance to Dingman’s “giveaway” charge. They point to a filing made last month with the ICC in which Rio Grande Industries estimated that it could gain back at least $1.4 billion of its $1.8-billion purchase price over a four-year period by selling real estate not needed to operate the Southern Pacific.

The most valuable single asset Rio Grande said it would not need is the SP’s Peninsula Branch right-of-way between San Jose and San Francisco; the report says it could fetch about $300 million. Another valuable property, a right-of-way from West Los Angeles through Beverly Hills, would garner almost $100 million if sold off in chunks, the report says.

There is another obstacle to SFSP’s sale of Southern Pacific to Rio Grande, whose offer for the Southern Pacific was for $1.02 billion in cash and the assumption of $780 million of debt.

Kansas City Southern Industries made a higher offer--somewhere between $10 million and $20 million more, Krebs acknowledged--and has complained to the ICC because SFSP accepted Rio Grande’s bid. Krebs said SFSP took Rio Grande’s offer because that deal has a much better chance of being approved by the government than the Kansas City Southern bid since it would create competition rather than eliminate it.

Coal Price Tied to Oil

“Why should we go through this risk?” Krebs asked. “We’ve just had one four-year case that we lost.”

During the interview, Krebs also assessed other areas of Santa Fe Southern Pacific’s businesses:

- Santa Fe Pacific Minerals earns its money from coal mining. It has about 8 million acres of mineral rights and 720 million tons of coal in the ground. “We have a lot of leverage to step up the earnings if we can that sell coal,” Krebs said. However, coal sales are closely tied to the price of oil. There is an interesting irony here for SFSP: If

the price of the company’s oil rises, its coal sales go up, and vice versa.

The minerals division has begun to develop some silver and gold deposits that Krebs said will soon add to profits. New silver mining operations in Nevada alone will contribute $5 million annually to earnings. A Nevada gold mine is in the development stage. The company expects the first gold to be produced by the end of this year.

- Santa Fe Energy is a large oil producer, with production averaging about 60,000 barrels a day. Krebs pointed out that proven reserves at the end of 1987 were 175 million barrels.

Despite the continuing production, it is estimated that new discoveries and development by the company will result in proven reserves in 1992 that will still total 160 million barrels of oil. In addition, the company has potential reserves of well over another 200 million barrels, Krebs said.

- The Southern Pacific Pipeline, which will not be sold, is “an excellent business with a good rate of return,” according to Krebs.

- The company’s real estate operations will change direction, the chief executive said. It will sell much of its developed properties and concentrate on improving other properties to the stage where building can take place.

“We plan to sell a couple of hundred of millions of dollars worth (of real estate) a year in the next five years,” Krebs said. “When we are done, we will still own a billion dollars worth.”

Some observers say Henley backed out because it was unable to gain the support of Olympia & York Developments, a big Toronto real estate firm that owns about 10.2% of SFSP’s stock. The Canadian company has been conducting a tender offer for SFSP shares, and last Friday extended it to March 23. The firm has publicly stated that it hopes to acquire up to 19.6% of SFSP.

Two Olympia & York executives were recently named to SFSP’s board and O&Y; now seems to be on SFSP’s side.

But neither Henley’s nor O&Y;’s intentions are entirely clear yet.

Krebs is optimistic but is not blind to the possibilities: “There are chapters yet to be written here,” he said.