Lance Fritz on CP or CN + KCS: ‘We Will be an Active Participant’

On Union Pacific’s April 22 1Q2021 earnings call, chief executive Lance Fritz was peppered with questions about the potential implications of Canadian Pacific or CN acquiring Kansas City Southern. Following is a transcript (edited for clarity) of Fritz’s responses to those questions.

“Regarding whether the CP or the CN were to acquire the KCS, our concern really is the same. What we’re focused on is what the STB says the next Class I merger must provide, and that is an enhancement to the competition and clear improvement for all customers, though for that to be true in any transaction our current service product has to remain intact. 

“Our concern is making sure that we have good operational and commercial access to all the customers we serve currently in Mexico and in other parts, whether near or on the CP or the CN. The first thing we’re focused on is making sure that the STB sets up a level playing field for all Class I mergers, and that it does not apply the waiver created potentially for the KCS back in 2000-2001. We think those new 2001 merger rules should apply to every Class I merger, so that the STB has a full opportunity to vet the game plan to enhance competition by the transaction.

“We’re focused on making sure we get value-based pricing in the marketplace, and that we’re efficient and productive both in assets and in operating expenses. We’re focused on growth, and I think growth is going to play a bigger role—it has to. Whether or not that changes our stance on overall M&A activity, our big concern on any Class I merger is that in the STB’s regulatory review, they are committed to enhancing competition and to taking a look at the downstream impacts and whether those create incentives … for further consolidation. In that context, we see a lot of opportunity for long-term value impact that’s not in our best interest. 

“We’re going to be very, very active and engaged in this process with the STB and, potentially, directly with the acquirers. We’re going to, first and foremost, focus on making sure that we protect our interests, and then help the STB enhance competition.

“At this point, we are not contemplating M&A. We’ve done plenty of work to understand what the costs and benefits could be, and we’ll just continue to be engaged and monitor the process.

“We’ve been very clear on consolidation. The process the STB is committed to undertake in terms of reviewing any Class I merger is to ensure it both enhances competition and has better outcomes for all customers, and that they contemplate the downstream impacts. The STB has full authority to put in whatever remedies and regulations are required to achieve that. We’ve always thought there is [the possibility of] destroying long-term value for the industry. That’s our big concern. If we are constantly evaluating long-term enterprise value creation, part of that is whether or not mergers make sense for us. That’s always been a primary sticking point. We’ll have to navigate this current process to see how it comes out. And of course we will be an active participant in it. 

“How do we ensure that the competitive option that the UP represents doesn’t get disadvantaged by either the CP or the CN, if either were to own KCS? The Laredo gateway is the primary gateway for KCSM, and we’d have to do two things. We have to make sure that, operationally, we’re treated fairly and equitably at the gateway. We’d have to make sure commercially that we’re treated fairly and equitably to all the points that we currently have an opportunity to serve with our franchise in the United States, in conjunction with KCSM. 

“Our franchise is damn good, the best in the industry. That’s why we represent about two-thirds of all rail cross-border traffic to and from Mexico. It would be a crying shame and against what the STB has committed they would do in evaluating the merger if that excellence is replaced by something that’s inferior, and it’s because we’re disadvantaged. So we’ll be crystal clear about that in front of the STB.

“There is a lot of truck traffic that can be converted to rail, and we’re constantly working with both FXE (Ferromex, of which UP owns 26%) and KCSM to try to get that done. We have been successful in actually growing our overall intermodal product; we call it the domestic intermodal product, even though it’s to and from Mexico, and we expect to continue to do that. That’s pick and shovel work, because we’ve got to get FXE or KCSM interested in a move that might be a relative short haul for them in comparison to what they might be able to do just staying within Mexico. If that’s the case, there is always an opportunity to use truck in Mexico as the origination or destination and transload at the border. It’s a little more complex, but we do that today, and we can continue to do some of that. 

“The market is big. It’s pick and shovel work to convert, and there has been plenty of advertising about the potential to convert and what it means in synergies. We have not seen the game plan that would be required to be filed with the STB. Once we see that game plan, all of us then can start evaluating how real is it, and if it is going to be done at our expense, in which case, there’s got to be a remedy that maintains our competitive posture.

“The combined carriers might have the opportunity to go to an inferior routing through a commercial construct. It’s not best for the customer, and it’s not best for the market.”

Susquehanna International Group Senior Equity Research Analyst – Industrials Bascome Majors summed up Fritz’s comments rather succinctly:

“Protect the House: UNP CEO Lance Fritz made it clear what UNP’s role would be in the bidding process and ultimate CN or CP acquisition of KSU, noting that UNP is “not contemplating M&A” and instead will be “active and engaged” with the STB as they work through the potential merger of KSU with a Canadian rail. This approach is what we expected, given the regulatory risk and network overlap between the KCS and UNP. 

“Given Fritz’s comments, UNP is very likely to play the role of obstructionist, using its outsized Washington clout to protect its markets in the Gulf and Laredo gateway during the STB review process. In UNP’s own words, with either a CP or CN merger with KSU, it sees a lot of “opportunity for long-term value impact that is not in [UNP’s] best interest.” Overall, UNP’s main concern is ensuring that its interests are protected by helping the “STB enhance competition as they see fit.”