Union Pacific floats transcon merger trial balloons: Analysis

Union Pacific appears to be using a familiar playbook that large, publicly traded companies trot out when considering mergers and acquisitions: Send up trial balloons and see how they fly.

These trial balloons let management gauge market reaction, political sentiment, and how the media might spin the story, all without committing to a deal. They also allow a company to shape the narrative.

Yesterday the Wall Street Journal reported that UP was having merger talks with Norfolk Southern. There was no guarantee the talks would result in a deal, the newspaper said, citing people familiar with the matter.

The Associated Press reported later on Thursday that UP and NS began merger talks in the first quarter of this year, citing people familiar with the matter. Similar reports emerged from Reuters and the Financial Times.

It was the second straight day of leaks to the media. Semafor, an online publication, reported on Wednesday that UP was working with the investment bank Morgan Stanley for advice on potential mergers, again citing people familiar with the matter. Semafor earlier had reported that UP was in merger talks.

An educated guess would be that these deliberate leaks came from within Union Pacific Center at 1400 Douglas St. in Omaha, Neb. It’s possible, but seems less likely, that the slow drip of information came from 650 W. Peachtree St., the NS headquarters in Atlanta.

There was certainly no leak involved when UP CEO Jim Vena touted the benefits of mergers — and acknowledged the regulatory risks — in an April interview with Trains. “I think it’s a win for our customers and a win for competition and it’s a win for how the country should move ahead. Now, on the regulatory front, it’s complicated,” Vena said.

The magazine’s May 12 report, “Some Class I railroads take a fresh look at mergers,” sparked a wider public conversation that included rail executives, investors, analysts, and the business media.

Within a few weeks, top executives from all of the major railroads gave their outlooks on potential Class I mergers. Investors weighed in, too. NS and CSX stock prices have rallied on merger speculation, while UP’s has remained flat, perhaps an indication of concern over regulatory risk. A TD Cowen shipper survey found that two-thirds of rail customers would support a transcon merger so long as it offered concessions such as reciprocal switching. And Surface Transportation Board Chairman Patrick Fuchs carefully sidestepped questions about mergers.

The progression here — Vena sounding like a man in a merger mood, followed by leaks that offered increasingly more detail — are a test of how the market, investors, competitors, customers, and regulators would react to a potential deal. It’s a strategic process that unfolded predictably.

What happens next is not so predictable. Certainly this is a case of where there’s smoke there’s fire, and you can believe the media reports that cite people familiar with the matter. Until there’s a formal merger announcement, though, we’re left with questions — lots of them.

Could another suitor emerge now that the railroad world knows UP and NS are in talks? To protect his shareholders, NS CEO Mark George will have to seek other offers, if only to know if whatever merger premium UP is willing to pay is in the ballpark.

If UP and NS reach a deal to form the first transcontinental railroad in the U.S., how will Western rival BNSF Railway react? Will it begin talks with CSX? Or will it tap owner Berkshire Hathaway’s nearly bottomless cash reserves and start a bidding war for Norfolk Southern?

If talks with NS are a dead end, will UP seek to partner with CSX?

In the current political environment, it seems unlikely that Canadian National or Canadian Pacific Kansas City could enter the fray. Can you imagine the reaction in Washington if a Canadian railroad were to propose acquiring one of the Eastern U.S. railroads? Hoo-boy.

Since one merger deal will inevitably lead to another — leading to two coast-to-coast railroads in the U.S. — how will that play with shippers, regulators, elected officials, and the Justice Department?

And how could any deal get past go without a voting trust? Among other things, voting trusts allow shareholders of the railroad being acquired to cash out right away, rather than waiting for the regulatory process to play out over 18 months or more. In the battle for Kansas City Southern, the STB shot down CN’s request to put KCS in a voting trust, and analysts believe that decision shut the door to use of a voting trust under the board’s tougher 2001 merger rules.

Amid these questions, three things seem clear. First, any merger application will face an uphill battle given the STB’s untested and tougher 2001 merger review rules. Second, no application will be filed until a third Republican is named to the STB, which would break the current 2-2 split along party lines. And, third, it sure will be interesting to watch this chess match unfold.

You can reach Bill Stephens at bybillstephens@gmail.com and follow him on LinkedIn and X @bybillstephens