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Merger Talk Hits the Rails, Lifting Shares

May 5, 1995

Birds do it. Bees do it. Lately, railroads have been doing it.

Merger fever has hit the railroad business, and many both on Wall Street and in the executive suite think it will continue. And that could boost shares of railroads viewed as potential takeover targets. Railroad stocks already are up 17 percent this year after being among the worst-performing industry groups last year with a 16 percent decline.

Not all the takeover rumors will pan out, of course _ but it’s more than just talk. The railroad industry is chugging on a course to mergers and more mergers. ``By the year 2000 I think we’ll have two (national) railroads,″ says Thomas Galvin, transportation analyst at C.J. Lawrence-Deutsche Bank in New York.

Mr. Galvin expects Union Pacific, which operates mainly in the West, to create one transcontinental line. He says it could acquire Western competitor Southern Pacific Rail and an Eastern line _ either Philadelphia-based Conrail or Richmond, Va.-based CSX.

That railroad giant would compete strongly with Burlington Northern, which in January won a takeover battle for Santa Fe Pacific Corp., which will push it past Union Pacific as the nation’s largest-revenue railroad. Mr. Galvin figures Burlington Northern might link one day with Norfolk, Va.-based Norfolk Southern.

``All the indications are that Union Pacific will do something big,″ agrees Walter Rich, chief executive of Delaware Otsego, a Cooperstown, N.Y., regional railroad whose stock trades on the Nasdaq Stock Market. ``There is an opportunity to do a deal because Burlington Northern Santa Fe (the company’s planned new name) is totally preoccupied and tapped out. Union Pacific will either talk to Southern Pacific or look at Conrail. They have to move within a year and they may move sooner.″

Union Pacific, which lost the bruising Santa Fe takeover battle, is already in the process of acquiring smaller Chicago & North Western Transportation.

Union Pacific spokesman Gary Schuster says: ``With so few railroads left there is a rumor an hour about who is engaged and about to marry. That kind of gossip is inevitable but seldom on the mark.″ What’s more, Union Pacific CEO Drew Lewis recently told analysts that Union Pacific is busy trying to put together a consortium of U.S. businesses to invest in Mexican railroads. He also acknowledged that Union Pacific talked to Southern Pacific before Union Pacific’s bid for Santa Fe; he says the two railroads aren’t talking now.

Conrail CEO David LeVan recently said he sees a strong future as an independent Conrail and doesn’t see a need for a merger. A company spokesman says Conrail’s new streamlining program is aimed partly at keeping the company independent. The other railroads named as possible targets decline to comment.

John Maack, a senior portfolio manager at Portland, Ore., money-management firm Crabbe Huson, has bought Southern Pacific and other railroad stocks _ but not just as takeover plays. ``The market is undervaluing the cash flow and earnings,″ Mr. Maack says. ``If a takeover occurs, that’s sort of icing on the cake.″ He says Southern Pacific, trading at just 10 times per-share earnings for the past 52 weeks, is undervalued. It currently trades at around $16.50 a share.

Tony Kreisel, senior portfolio manager at Boston’s Putnam Investments, has been buying railroad stocks including Conrail, Union Pacific and Norfolk Southern. Railroads are undergoing ``dramatic and sustained structural change,″ he says. ``This is a 50-year cycle. These are the robber barons coming back into their own, after the construction of the interstate highway system and the truckers’ inroads on their business.″

Jon Hickman, a portfolio manager at Wells Fargo Investment Management in San Francisco, owns Wisconsin Central Transportation, which isn’t among the most-mentioned targets. But if another acquisition takes place, ``the whole group will do well,″ he says.

C.J. Lawrence’s Mr. Galvin has buys on CSX, Conrail, Illinois Central, Union Pacific and Southern Pacific. He also strongly recommends a fast-growing short-haul carrier called RailTex, traded on Nasdaq. Its price-earnings ratio of 31 makes it expensive, but as big carriers go national, RailTex is picking up neglected short-haul routes.


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