BUSINESS WATCH

Exclusive: CN and CP in secret talks

‘Can we afford two uncompetitive, inefficient railroads, or do we survive through strategic alliances with American lines?’

PETER C. NEWMAN August 30 1993
BUSINESS WATCH

Exclusive: CN and CP in secret talks

‘Can we afford two uncompetitive, inefficient railroads, or do we survive through strategic alliances with American lines?’

PETER C. NEWMAN August 30 1993

Exclusive: CN and CP in secret talks

BUSINESS WATCH

PETER C. NEWMAN

‘Can we afford two uncompetitive, inefficient railroads, or do we survive through strategic alliances with American lines?’

Highly confidential negotiations are under way between the chief executive officers of two of the country’s most significant businessesCP Rail Systems and Canadian National Railways—that could lead either to the merger of their railway operations, or the takeover of one by the other. Either way, out of these discussions will likely emerge CN’s enforced privatization as part of what will become the country’s largest transportation empire.

“The status quo is no longer possible—it’s a nonstarter,” I was told last week by Paul Tellier, CN’s chief Executive Officer, who launched the merger initiative. “The reason is that both railways are dropping too much money. Last year, between us we lost $434 million on an operating basis, and if you include the special charges for the 11,000 employees we had to lay off, CN alone went $1 billion into the red the largest loss in Canadian corporate history.” The downsizing will continue; of CN’s current 32,000 employees, 10,000 more will leave the company through attrition in the next three years.

When Tellier switched to CN ten months ago from his former job as Clerk of the Privy Council in Ottawa, he immediately called on CP’s chief executive officer. Bill Stinson, and told him: “Look, we’re both losing our shirts on the rail lines. Shouldn’t we examine what can be done?” Out of that meeting was established a high-level committee to examine what might be feasible. Its report, confidentially circulated last week, concluded that at the very least a high degree of rationalization between the two rail companies is imperative, and that this should eventually lead to some form of fundamental restructuring. ‘We want to make sure,” says Tellier, “that whoever the government decision-makers after the next election might be, we can present them with a good problem definition and a set of available options. Instead of fighting each other, the way the two national airlines have been doing,

we want to come up with joint solutions.” Tellier was able to bull the idea through because, unlike every other executive involved, he’s outside the railway culture, based on CN and CP’s traditional independence. (Since the founding of Via Rail in 1977 both railways operate only freight services, but if the merger or other mutual arrangement takes place, it could facilitate the building of the highly touted Bombardier or Swedish express supertrains between Montreal and Toronto.)

Tellier points out that the real reason Canada’s railways have reached such an unprecedented crisis is that they can no longer hide the fact that their western lines are heavily subsidizing their eastern networks. Rail operations west of Winnipeg have been turning a profit (though even it is declining) while losses east of the Lakehead have been mounting. In 1992, CN’s three eastern divisions lost $280 million on revenues of $1.8 billion. And while its western operations are profitable, those earnings are beginning to decline. CN’s 1992 revenues totalled $3.8 billion; its assets are $7 billion. CP’s comparable rail figures are $3 billion in revenues and $5.5 billion in assets. The merged company would thus have an initial asset base of $12.5 billion.

The problems faced by both transportation giants is that Ottawa forces them to operate too many kilometres of tracks unwarranted by traffic loads. These lines will either have to be abandoned or spun off to private entrepreneurs, such as the recent deal which saw CN sell its tracks from Truro to Sydney, N.S., for $20 million to a private outfit called Rail Tex Inc. It will operate that 400-km service with half the labor force (53 compared with 113) required under CN’s complicated and antiquated union agreements. “The only other alternative,” Tellier insists, “is some kind of rationalization or amalgamation with CP.”

“The other factor weighing us down,” Tellier confesses, “is that we are saddled with some of the most generous collective agreements of any industrial sector in North America. Some 80 per cent of our labor force enjoy full employment security for life, which means that after eight years on the payroll, even if their job is abolished, employees must be offered an equivalent job in the same seniority area.” A new round of union negotiations is due to start next month in the context of a continually sliding share of goods carried by rail. In 1963, 70 per cent went by train; now it’s only 28 per cent, with trucks picking up most of the railways’ losses.

It’s too early to guess who’ll emerge as the dominant partner in the deal, but Tellier says that one possibility is for CN to take over the entire eastern operation, pointing out that CP has already abandoned its Halifax lines and is about to cut its historic ties with Saint John. “In the East,” Tellier contends, “it would be logical for CN to absorb CP because our operations are so much more extensive.” Tellier continues: “The real question is, can we afford two uncompetitive, inefficient railroads, and if amalgamation isn’t the answer, do we implement a North American solution, where in order to survive we forge strategic alliances with American lines? For CN, that would probably mean a joint arrangement with ConRail of Philadelphia in the East. Created by the U.S. Congress when Penn Central went bankrupt in the late 1970s, it has become highly successful, earning a 1992 net profit of $200 million. In the West, CN would probably join forces with Burlington Northern, the largest U.S. railway, headquartered in Fort Worth, Tex.” CP would have to find similar partners.

Canadian National was originally formed in 1923 out of some 400 bankrupt railroads that couldn’t be scrapped without isolating thousands of Canadians. They were built by crooked promoters who overcapitalized their projects, squeezed out the profits, and then pleaded bankruptcy. Ottawa had to step in to save the operations through an umbrella amalgamation. At the time, Lord Atholstan, then publisher of The Montreal Star, prophetically attacked the arrangement, advocating that CN be assignd to CP in exchange for a freshly minted dollar bill.

The cost has escalated somewhat, but within a year or two, the result will be the same—we’ll almost certainly end up with only one national railroad.