This subject is the focus of large parts (if not the entire work) of graduate economic texts. Simple it is not - not even close enough to qualify as “handgrenades or horseshoes”. I do not pretend to understand this area as an expert, but I have gone through several parts of the subject in personal experience. The following comments are designed to illustrate major factors that contributed to the situation we see today.
A main factor in the disinvestment of a railroad in itself is stockholder expectations. In simple terms, stockholder mentality since sometime in the 1970’s has been to accept nothing less than double digit increases in stock prices and dividends. Nothing less than 10% generally has been acceptable. One manifestation of this is the stockholder lawsuits starting in the 1970’s forcing the “retained earnings” of the corporation be paid out to the stockholders in cash even if the corporation had to sell off “non-core” assets or even a part of itself. I can remember (and this was not so very long ago) when all railroad stocks were in the $20-35 range.
Even the vaunted money machine called UP was in trouble in referance to its stock price. Look at it now, closed today at $127.30. They made a success of the transition and have been handsomly rewarded by Wall Street. Pioneer Railcorp which operates short lines closed at $4.30. Return to the stockholder expectation concept and you can see that the expectation is not for a double digit return.
Another driver here is that there was a series of stockholder suits demanding that the corporations return all of the monies after taxes (that normally divided up between re-investment in the company and that paid out in dividends). A Delaware Court (Supreme, IIRC) ruled that a corporation or company was obligated to do just that. The concept was that for a company to use any monies to reinvest in itself (including maintence), i
Along the same lines as many of the previous posts, we need to remember
that railroads as an investment idea were at best ignored and at worst
despised by both Wall Street and the general public in the '80s and '90s.
It doesn’t matter what the true economics of railroading were at the time.
The only thing that matters is the perception. The one thing most people
thought they knew at the time was that railroading was a "bad business’
that couldn’t ultimately earn its cost of capital. The only thing anyone
remembered about railroads was Penn Central.
So–reinvesting in the railroad business itself would have been perceived
as a dubious move by Wall Street and by individual investors armed with
their trunk-fulls of self-help “how-to” investment books.
And, as if this gloomy view of railroading weren’t enough, the public was
caught up in the lure of double and triple digit returns in the computer-
related and telecom industries. The siren song was irresistable to many,
and everyone thought they had better opportunities elsewhere.
These views were so pervasive that I’m afraid they even made their way
into the executive offices and boardrooms of railroads themselves.
Now that the bubbles have burst in other areas and the possibilities of
railroading have become more apparent, perhaps the true landscape is
more easily viewable today.
Actually, had the term “cost of capital” been used as a financial measure of health back then, I think most companies would have laughed the railroads out of the room. Historically, most companies don’t earn their “cost of capital”. It is a useful financial metric, used for planning and IRR purposes, but it is next to useless as a measure of corporate health.
Well, we’ve beeen through this before, and there’s no point in beating a dead horse for new posters, nor any point in responding to the sarcasm that takes these threads down time after time. No one is saying that railroads are not capital intensive. However, they are not the most capital intensive nor are their capital needs particularly unusual in an industrial context.
Further, no one is saying that railroads do not have a high asset to revenue ratio. But that is trying to create an argument from scratch about an irrelevant metric. Why people do this, I do not know. The asset to revenue ratio is a creature of depreciation. The longest single depreciation period under IRS regulations is railroad property: “50-year property includes any improvements necessary to construct or improve a roadbed or right-of-way for railroad track that qualifies as a railroad grading or tunnel bore under section 168(e)(4).” No other industry has an asset class with a depreciation period that long. Accordingly, railroad “assets” are carried longer per dollar of investment. Railroads will always show a high number for that particular metric because of that.
Regarding capital investment. I can pick a long list of industries and companies that invest less than railroads. Perhaps I would then be proud of myself, but its a straw horse. Modern, highly competitive industries spend money.
(Expenditures-Depreciation)/Net Income – September 31, 2005 to September 31, 20
John Kneiling addressed this issue quite well in the 1970’s in his monthly column. I am not sure if the term “cost of capital” was used, but it was understood.
With the coming long weekend and winter storms I might dig out a few of his columns. It made for interesting reading…and sure got the unions fired up.
It appears to me, that the railroads weren’t “throwing off cash” by way of investing their profits elsewhere, as much as simply diverting money to investments that should have been plowed back into the plant.
I’m leaning toward should have. I kind of visualize owning an apartment complex. If I took in the rent, I should be paying the bills, including the mortgage, and budgeted some of the money toward upkeep and renovation. If, instead, I take the money out of the upkeep and renovation fund, I can invest it in something entirely different, and let my property run down. It would seem a better use of the funds, if I paid down the mortgage instead.
Since I wouldn’t go out and borrow money to invest in something, when I still owe on the mortgage, I’d have a hard time convincing myself that using up my upkeep/renovation fund was a really good idea. What’s my other plan? Keep diverting this money, and let the property go downhill, based on my belief that in the future, I wouldn’t be able to make a profit on the kept up building? Then what? Give the building to the creditors, and go live off the income from my Fruit of the Loom holdings?
Deferred maintenance- using the money that would/should have been put back into the plant, to go purchase Fruit of the Loom underware stock for example.
A. You’re not missing anything. You’re a socially responsible kind’a guy, that’s all. Nothing wrong with that. You and I, alas, will never be filthy rich either with that kind of attitude.
B. My opinion, which I’m betting will not be appreciated by all, is that railroad managers on average, compared to other industries, have historically come down more on the side of favoring the future of the railroad than the returns to investors. Many investors are aware of that and disfavor railroads accordingly, all other things being equal. Time and time again I have watched railroads go through severe pain clinging to physical plant, property, and services that a more investor-focused company would coldly slice off. Railfans with no education of what the railroad is growin
Well, that makes it sound pretty easy. I mean: show where the cash flow was generated, how much, and how that translated into the purchase of Fruit of the Loom. Connect the dots. If you have an example of where maintenance was deferred to increase cash flow, and that cash flow was actually put to an outside investment, I would like to see it. You have proposed an interesting case study, and made a specific example of where it happened. Well, how did it happen? What was the cash flow? Did it really make a difference? How much was the Loom purchase? Did the railroad actually make the purchase through cash? No holding Company? Follow through on your example. How was this done?
We’ve been to this place before, so let me back up a bit, and try this a little differently.
I’m not, nor can I claim to be, and expert on anything. I do read a lot about subjects that interest me, among them trains/planes/ships/WWI&WWII era history/history in general/architecture/maps/auto racing. Being of an inquisitive mind, I’m always one to read something, or see something and say: Hmmm…I wonder why?..
Beacause different things I read are often at odds with other things, I do feel the need to find out more info, to try to get a grasp on how it is/was verses how I’ve read it to be. That’s why I like this forum. There’s always people to offer an opinion on something. Granted, they may be right or wrong, or somewhere in between, but what an interesting way to learn!
Now, you and I both know that we look at things differently sometimes. I’m offering (actually questioning ) my understanding of the disinvestments of railroad companies. Since I’m not a railroadologist ([:P]), I certainly cannot support my thoughts with all the facts, figures as you are so good at doing. I don’
When you offer a specific opinion, I don’t mean to take you to task to ask what the opinion is based on, but I do offer the courtesy of believing that you do research before offering an opinion. I am asking what that research was based on.
Look at the 1967 figures I offered above for CNW. CNW’s investment in capital expenditures was 21% of its total revenue. The modern BN spends 13% and UP spends 16%. The net expenditure is even more interesting: CNW spending 13% while modern BN spends 6% and UP 7%. When a railroad spends 13% of its revenue on new capital investment, you consider it disinvestment, whereas one that spends less than half that percentage is considered forward looking? I admit that I am looking for what you consider “disinvestment” and find it frustrating that, having made the explicit accusation against those managements, you object to an inquiry about what you mean.
Let me restate it. Why is the capital investment at CNW in 1967 relative to revenue so high compared to a modern railroad? How does such a high percentage of capital spending throw off cash, or divert funds for outside investment? How does a high level of capital spending support your theory of “disinvestment” and diversion of funds? I think it is a fair question.
It is, by no coincidence, the year Northwestern Industries acquired Fruit of the Loom.
I offered a tidbit of proof on your proposition. I am asking for the same courtesy in response.
Illinois Central appeared to have deferred maintenance in the 60’s. I cant prove it other than employee timetables indicating downgrading of speeds on certain lines over a period of time.
IC Industries was created and made a number of purchases during that time in companies such as Midas, Pet, and others.
An interesting contrast to other many other railroads can be found in
the examples of the Southern, Norfolk Western, and, later Norfolk
Southern. These operations were run by railroaders who never
wavered in their belief in railroading. They did a better job of avoid-
ing the “conglomerate” fad than did many.
Yes, there was some diversification here. Coal mining properties,
real estate, and North American Van Lines were purchased. But
even these forays into different fields ended up serving NS well.
Although the trucking company turned out to be a dubious purchase
(it was later sold off), it provided NS with some key personnel and
some expertise which allowed the successful development of the
Triple Crown operation. The fact that Triple Crown is run very
much like a trucking company (at least as far as the customers
are concerned) is seen as one of the keys to its success.
The real estate purchases have assisted NS with its trackside
industrial development efforts, and some of the coal properties
add their fair share to the NS bottom line to this day.
Perhaps most importantly, these purchases wer never indirectly
financed through deferred maintenance on the rail lines themselves.
Awe shucks! Michael, you and I both know that I don’t have facts and figures and graphs and pie charts all laid out to defend my position before a Congressional Commitee. I’m not a grad student writing my thesis on railroad disinvestment. I’m a railfan, who’s curious about an era of railroad history. What I am doing, is asking questions, and offering some opinions, based on things I have read about railroads, to try to sift through things, hopefully to get a better understanding of how it actually was.
Some things are accepted as being true. In the 50’s/60’s/70’s, many railroads formed holding companies, to invest in non-railroad opportunities. Most would agree this happened. Most would also agree, that in the 60’s/70’s, railroads suffered from a lot of defered maintenance issues-The Milwaukee Road included.
You say that in 1967, CNW was spending a higher % for capital spending than today’s railroad. OK- Mr. Apple meet Mr. Orange. Was CNW spending more than other railroads at the time? Was CNW making huge profits at the time? The money to invest had to come from somewhere. If most books suggest that the fortunes of the railroads was in a downhill slide, starting in about 1955, where did all this investment money come from? In the 60’s/70’s, a lot of railroads ran out of steam and couldn’t keep their heads above water. Along with that, many could not find the money to keep up the lines. Note how PennCentral had to sell off alot of non railroad investments, just to keep the earnings in the black. I’m sure many other railroads did the same.
Is the combination of railroads in the 70’s being cash poor, and all the non-railroad investing done by the railroads up until then just a strange coincidence?
Although it was “railroad property” and arguably should have been spent on the railroad, the “air rights” assset, i.e., the space above the railroad in the downtown Chicago area, provided the where-with-all for the acquisition of the non-railroad businesses. You are correct that the money that the railroad was putting back into the plant was not keeping up with the rate of wear.
As a holder of most of the stock in the railroad, IC Industries could have pulled every available extra dollar out of the cash generated from IC Railroad operations, but that did not happen. Basicly, the railroad was allowed to use the cash it generated from operations just as if it would have been a “free standing” business not affiliated with Industries. (I was employed by the railroad up to late 1975, and the situation was described to me by a senior executive.) The problem was that the railroad was not generate enough cash to replace itself as it wore out.
So the “air rights” asset was the proverbial gold mine discovered under the company headquarters. The Industries Board had a choice. Should we put the money back into the railroad, an business that is going down the tubes, or should we buy companies that will easily give our shareholders a much better return on the investment? I think for the time, they made the right choice. Even though the lack of maintenance probably resulted in higher operating expense, I doubt that any addition money flowing into the railroad from the “gold mine” and the resulting off set of some operating c