Report points to the possibility of Union Pacific acquiring Norfolk Southern as increasing

The prospects for another major North American-based Class I railroad merger—following the April 2023 deal, in which Canadian Pacific acquired Kansas City Southern for $31 billion—appear to be gaining steam, with the key Class I players this time around being Omaha-based Union Pacific (UP) and Atlanta-based Norfolk Southern (NS).

That was made clear late last week, with both UP and NS issuing respective statements, indicating that, as each statement said, “the companies are engaged in advanced discussions regarding a potential business combination,” adding that, “[t]here can be no assurances as to whether an agreement for a transaction will be reached or as to the terms of any such transaction.”

Momentum regarding a potential deal gained further traction over the weekend, with a Bloomberg report, citing people familiar with the matter, as saying an agreement could be reached as soon as this week, adding, if the deal came to fruition, it would represent the largest railroad deal on record, while also transforming the market, in meshing the UP network across the western U.S. with NS Eastern routes. The report said this deal would include both cash and stock.

As previously reported by LM, speculation regarding a potential deal picked up earlier this month, following a July 17 report by business publication Semafor, indicating UP “is working with investment bankers at Morgan Stanley to explore the acquisition of a rival.” The report stated that neither UP nor Morgan Stanley offered up comments regarding this development.

The report said the acquisition target was not made available. But a May report in Trains magazine stated that UP CEO Jim Vena said a transcontinental merger would improve service and lead to growth by eliminating the inefficient and time-consuming interchanges that occur at Chicago and other gateways between the Eastern and Western railroads, adding that railroads would become more competitive with trucks if it did not take 24-to-36 hours to hand off freight cars in Chicago. Vena also observed in the report that being able to provide fluid, single-line service from coast-to-coast, as is the case with CPKC, as well as Canadian National moving freight north into Canada and south into Mexico, like CPKC does, would allow U.S.-based importers and exporters to be more competitive on a global basis.

A research note issued earlier today by TD Cowen analyst Jason Seidl observed that the separate matching statements by UP and NS were preceded by steps taken by the Washington-based Surface Transportation Board (STB), an independent adjudicatory and economic-regulatory agency charged by Congress with resolving railroad rate and service disputes and reviewing proposed railroad mergers, which he said show that the STB is preparing to handle a review of a potential deal in what Seidl described as a more expedited fashion, in the form of a mergers resource page, coupled with the STB being proactive in expediting regulatory processes. He also observed that STB Chairman Patrick Fuchs said the STB will host meetings next month focusing on improving competition and reducing regulatory barriers.

“We continue to believe it is highly likely a deal will be announced,” wrote Seidl. “A typical review of a Class I merger could take ~18 months, and it appears the current board will look to streamline the process further. We are still waiting for President Trump to appoint a 5th member to the board. Once an appointment is announced, it would likely take a minimum of 6 months for confirmation. The STB does have a few extra hands after the appointment of three senior advisors back in May to assist with driving efficiency and regulatory reform at the agency.”

Daniel C. Moore, senior research analyst, for Baird Equity Research, wrote in a research note that if the UP-NS deal were to go through, it could be followed by a similar deal, presumably between Fort Worth, Texas-based BNSF (owned by Berkshire Hathaway) and Jacksonville-based CSX, could follow, as, from a practical perspective, a single transcontinental rail would completely unbalance the playing field.

“It would leave BNSF at a structural disadvantage,” wrote Moore. “In that context, the logic for a second transaction becomes self-reinforcing. If one Western rail moves to acquire an Eastern Counterpart, the other may have no real choice but to respond. Could Berkshire respond with a counter to Union Pacific, assuming a normal offer for Norfolk is announced? Absolutely. It’s a very real possibility. While Union Pacific may move first, it can be argued that Norfolk Southern is a better fit for BNSF. Their respective networks and business mix are arguably more complimentary, although we concede that this view is also highly speculative. Ultimately, if Berkshire/BNSF does choose to respond, we believe the decision will be based on which eastern rail most effectively enhances long-term franchise value.”
In conversations with C-level freight railroad executives, Tony Hatch, principal of New York-based ABH Consulting said the takeaway from the majority of them is that the benefits from a merger are great, but that the risks are greater.

Regarding benefits, Hatch pointed to many, including: elimination of interline issues; service and capacity increases; global customers; reduced SG&A (selling, general, and administrative); repurposed midcontinent hubs, yards, and terminals; more focused IT spend; faster decision making; and address legacy succession.

As for the risks, he called out: how enhanced competition is not defined; mergers “open the books” on railroad practices; a new breed of shipper could get involved for the first time, citing Amazon, Walmart, UPS, FedEx, Target, and Amazon as possibilities; open access; and potential hostility from Canada and Mexico.

“If a merger happened, it could be a free-for-all,” said Hatch. “Some of these could cause major structural changes or it is going to be death by 1,000 cuts. It is a hot topic that has gotten hotter. I would have said that this is something that flares up every five years and now it’s over, but it is not over.”