Railroad disinvestment

Trains Magazine General Discussion
41

But, is just making stuff up a useful approach?

No one has disagreed with these points; but they do not ipso facto support a conclusion that, therefore, there was a lot of free cash running around.

I don’t understand this “style” of discussion. You acknowledge there was tons of deferred maintenance, then demand to know if CNW was making huge profits at the time. The point, if ever these things can be made, is that you pegged your criteria for disinvestment as evidenced by lack of expenditures on maintenance and capital investment. The annual reports suggest that the railroad was spending at or above the historical average on maintenance compared to revenue, and spending quite heavily on capital investment. How is that evidence of disinvestment, or at least an intent to disinvest?

Well, are you just going to make up an answer, or are you going to offer a proof? Cash flow is pretty easy to track.

[quote]
In the 60’s/70’s, a lot

42

Michael: I see where this is not going to get either of us anywhere. You apparantly don’t have an opinion on the topic at hand. Instead, you seem to be simply trying to disagree with each and everything I say. There’s not much to be learned from that, and no where else to go apparantly, but around in circles. Therefore, I’ll suffice to let you carry on without me. Cheers.

43

jeaton: Thanks for chiming in on this. I can see what you’re saying I guess, about the railroads doing what they perceived as best for the stockholders, even if it meant investing in non railroad entities. It does strike me as odd, that the railroad managers seemed to know, as far back as the 50’s, that they were on the downhill slide. Is it simply a difference in the tax codes now, that makes the railroads less apt to do outside investing?

44

I did specifically express my opinion, on page 1:

“When were railroads throwing off “lots of free cash”? By and large, these were balance sheet financings, and typically involved a process known as “bootstrapping”. The ICC did a holding company study in the mid-1970s.”

"This was a general phenomenon that had nothing to do with railroading or regulation in particular, except that railroaders adopted the strategy like many other industries across the board.

"It was called a “conglomerate” strategy generally implemented through a holding company structure. Like industry experience in general, it was not wildly successful in the railroad industry, and most, not all, conglomerates were eventually unwound in favor of the idea of concentrating on “core” businesses. That’s the current “mantra”, probably soundly based, and railroads follow that one too.

"The ICC found that railroads that adopted a holding company and diversification strategy generally suffered a reduction by between 1-2% of net earnings on revenue compared to railroad companies that did not adopt a diversification strategy.

"Most industrial conglomerates had similar results, but it sounded like a good idea at the time and the rail industry was no more or less susceptible to a bad idea that sounded good than any other industry.

"Most industries that adopted the model were unregulated to begin with, and the adoption of the business model therefo

45

Michael,

You have won the fight. Murph is not here to fight with you, or anyone else. He wants to learn from you, and the other knowledgeable members of the forum. When you notice some of his perceptions are not correct, couldn’t you just give a friendly explanation of the way things are, or were, as Railway Man does?

46

jeaton:

I completely forgot about the air rights issue. Thanks for setting me staight. Looking back, IC management made the right choice.

It would certainly be an interesting book on the post WW2 history of the IC. What they did in the 80’s/90’s was certainly special.

ed

47

Well, I started with the marketing department at the old ICG about the time Jay left (233 N. Michigan Ave., Chicago, IL - 27th floor) and I’m also of the opinion that for the board of directors to have put any additiional money into the railroad would have been throwing good money after bad. It would have been lost, for there was no reasonable prospect of such an investment being earned back.

As I see it, going into the 1970s there were four significant issues which prevented railroads from being a financially viable industry. These four issues tended to be intertwined. To a large extent, they’ve been solved. That’s why railroads are a much better investment today than they were back then. These issues were:

  1. Federal econcomic regulation of rail rates and service. This was one of the Choke Points. It often went so far as to actually prohibit a railroad from competing for potentially lucrative freight. For example, the Federal economic regulators rulled that Processed Beef Express, a subsidiary of IBP, could not use the rail line from Sioux City to Chicago to move its trailers loaded with beef. They ‘reasoned’ that since PBX was a ‘contract’ carrier it could not use a ‘common’ carrier. The meat went on the highway. Not because it was more economically sound to move it on the highway, but because some regulators in Washington, DC rulled th
48

What fight?

Murphy offered a strong opinion, cited a specific example, and led me to believe he knew something about it. Remember, I initially politely asked him for further information because he wrote as though he had it.

Instead, I got something of the runaround. I cited some specifically pertinent figures, and instead of acknowledging their significance, or lack thereof, I got run off in the direction of the Penn Central, or whatever other example that apparently it was up to me to search for.

In this instance, I did, in fact, offer my view on the matter in some detail on the very first page of this thread, and he decided to ignore the comments entirely for some reason. I don’t know why, except to then assert I had offered no opinion at all, that I was only out to get him.

Simply wasn’t true but, as I say, I appreciate the courtesy of an opinion backed up by facts, not, “here’s my opinon,you go to the time and trouble to supply the facts.”

He would not answer my questions regarding what his concept of “disinvestment” meant in terms of identifying it, nor my question about how his proposition might be practically implemented. If I became impatient, it is founded upon the odd reluctance of the original poster to simply explain what he meant in response to understandable questions posed to him in order to enable a coherent discussion.

It is hard even then to carry on a coherent discussion when the opinion offered is apparently invulnerable to any statistical measure, but only a “oh yeah, what about …” kind o

49

You have to remember this was not entirely restricted to the railroad industry in the 1960s. If a diverse investment portfolio was a good thing then a diverse business base model would be good as well. If your corporation or holding company had enough different business operations spread across a diverse market they should be able to balance each other out across the business cycles. If industrial commodities were down then women’s cosmetics might be able to pick up the slack until the economy was in rebound. There would always be undervalued companies out there to purchase by a company with a strong cash flow. Junk bonds would come later. Railroads are a cyclical industry, there will always be boom and bust cycles and anything which might temper the ups and downs would be welcomed. What does RR management need to know about PET Foods, anyway? You buy the management along with the company. So if the RR really wants to boost available cash for diversifying the corporation, you just defer a couple of years of maintenance in infrastructure, defer locomotive replacements and car upgrades and watch the cash roll in. So the RR expands into other lines of business and the railroad declines. Derailment costs rise, locomotive failures delay trains and obsolete freight cars drive customers away. Pretty soon the railroad has the lowest ROI of any companies in the portfolio. Any smart corporation directs new investment into the firms with the better ROI and puts the RR up for sale. Northwestern Industries spun the railroad off to the employees. Chicago Milwaukee Corporation lost the railroad. IC Industries went along without the railroad. BN Inc split the railroad and resources divisions but left most of the debt with the railroad company.

I cannot say I see where diversification lead to anything good within the railroad industry but it was trendy in industry in general at the time.

50

Thanks arbfbe, that’s the clearest explanation I’ve seen yet.

51

Diversification in general was not the panacea to generally declining returns. Didn’t matter what the industry. But, I cannot find a railroad that deferred maintenance and watched “the cash roll in.” For a railroad to just hand over a suitcase of cash to a holding company for outside investment was difficult for a variety of reasons.

Firstly, preferred shareholders of marginal earners looked to railroad dividends – for which they were “preferred” over common – to generate tax free dividends as distributions of capital rather than income. This shareholder class was notoriously difficult to shake loose in return for holding company shares because of their tax free status if, indeed, the railroad had marginal earnings. And they would force the dividend to themselves before the holding company saw a nickel.

Secondly, contingent interest bond holders were implacable. If there was a declaration of profit, they wanted their coupon payments. A railroad couldn’t just go and declare an artificial, deferred maintenance driven profit, because it would not get to the holding company. Contingent interest bond obligations were cumulative, and a railroad with a spotty record could not just up and send a bunch of money over to the holding company by holding off on maintenance for a couple of years. The holding company wouldn’t see a nickel. The railroad couldn’t even loan the money to the holding company: if there was cash, it either went to operations, or the contingent interest bondholders went to court to command payment.

Thirdly, corporate tax. A dividend to the holding company, presuming it made it through the contingent interest bond holders and the preferred shareholders, lost the corporate tax rate in value – twice, if the purpose was to generate dividends for the holding company shareholders. Given losses to corporate and transactional friction, that would reduce the net benefit to just about zero to anybody except the government.

Fruit of the Loom is

52

Something Michael S. said in the post immediately preceeding this one reminded me of something. I have had the feeling for some time a subject on which I was ignorant (among others, lol) is what is was that happened to the Milwaukee in the final few years of its existence. Does anyone happen to know where I might find a history of those years? If necessary, I have access to a good library exchange program, so I can probably get the loan of nearly any book in existence.

53

Let me back up and over myself here. Alan is exactly right, railroads did defer maintenance and let the cash roll in the door, but this was before the holding company era, and that restricted, too much, the overview. Railroads did defer maintenance to generate cash to hand to shareholders. Great Northern did this big time, starting in about 1958 when it dropped its maintenance expenditures just about in half, in order to keep the big bottom line and the dividends flowing. Milwaukee did it to a lesser extent, but also to the extent that dividends sometimes exceeded profit considerably, and these became distributions of capital, not strictly a “dividend” in the understood sense. During the late 50s and the 1960s, this may well have been in an effort to keep railroad stock prices up, even at the long term sacrifice of the health of the company. Too, merger proposals and agreements were typically locked to relative market valuations of stocks, and railroads attempted to maintain those valuations as part of merger agreements. A sudden cessation of dividends was not the way to do that.

And that is something to look at. It wasn’t disinvestment, it was an attempt to roll through what everyone no doubt thought were temporary times, and keep the investment quality of railroad stocks alive. What is interesting is that, for those companies I have some familiarity with, this did not by and large happen when railroads were taken into holding companies. The holding companies enabled f

54

Have to disagree with you, Murph. AT THAT TIME (back in the 1960’s), railroad traffic was declining and trucks were taking away traffic that formerly traveled on branch lines and industry spurs/industrial area tracks (like the Beer Line in Milwaukee). I would venture to say that no RR in its right mind spent money on branches that were hopeless money-losers, and probably only the heavily-trafficked industrial spurs/industrial area tracks were maintained. The lower levels of spending in that time period may have been adequate to maintain the main lines and other facilities absolutely necessary for continuing operations.

There was an article years ago in TRAINS describing how KCS trimmed maintenance expenditures below the adequate level and was the darling of Wall Street (at least among RR’s) during the late 1950’s and 1960’s. They reaped the whirlwind during the 1970’s when the track got so bad they derailed trains 2 or 3 times en route. They almost passed the point of no return.