Breakingviews - Railway mega-deal would require heavy engineering

Reuters

18-07-2025

NEW YORK, July 18 (Reuters Breakingviews) - It's somehow fitting that in a country where coal, polio and shipbuilding are making a comeback, there's also an 1860s-style transcontinental railway under consideration. Union Pacific is in talks to buy smaller rival Norfolk Southern, in a deal that would create a $240 billion coast-to-coast U.S. operator by value of combined stock and debt. The idea holds greater appeal than stoking fossil fuel consumption or reviving eradicated diseases, but it also risks having financially harmful effects.
Consolidation ground to a halt after a series of mergers in the 1990s shrank dozens of freight carriers into just seven, and was blamed for derailments, disruptions and losses. The government introduced stiffer rules requiring that any large deal enhance competition rather than simply not hurt it. Anticipation of widespread regulatory rollbacks under the Trump administration and sluggish railroad growth prospects have changed the calculus, however, with Union Pacific CEO Jim Vena recently touting the advantages of a cross-country line before the Wall Street Journal reported, opens new tab early deal negotiations on Thursday.
Setting aside how pliable Washington's Surface Transportation Board may be, connecting 50,000 track miles into one unified network has some logic. The existing regional system adds costs, including from transferring railcars and complicating service routes. With about 40% of all traffic directly tied, opens new tab to international trade, according to an industry group, higher tariffs also pose a fresh hurdle to increasing revenue at companies which have already firmly squeezed expenses.
The harder question relates to value creation. The best, albeit imperfect, comparison is Canadian Pacific's 2023 acquisition of Kansas City Southern, which was grandfathered into the older merger rules, for $31 billion. The buyer promised, opens new tab $1 billion in annual synergies, the bulk coming from growth equal to about 8% of combined revenue and the rest from slashing almost 3% of combined operating expenses.
On that basis, Union Pacific would be able to generate about $3.6 billion of synergies, according to Breakingviews estimates. Assuming Union Pacific were to pay the same 23% premium as Canadian Pacific did, valuing the Norfolk Southern enterprise at some $91 billion including net debt, the implied return on invested capital, with the revenue uplift and expense savings factored in, would be about 7%.
To just match the target's 7.9% weighted average cost of capital, as estimated by Morningstar analysts, would require some $4.6 billion of synergies. That considerable sum may be within reach, at least according to Bernstein analysts. They see potential benefits of between $4 billion and $5 billion. At more than 12% of the top lines for both companies, or nearly a third of their total operating expenses, it sounds optimistic. Absent some creative engineering, the effort hardly looks worth the long haul.
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