Potential Kansas City Southern suitors have invested in railroads before

Infrastructure funds increasingly interested in acquiring railroads
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Kansas City Southern locomotives and train cross a bridge
A northbound Kansas City Southern intermodal train crosses the International Railway Bridge over the Rio Grande at Laredo, Texas, in November 2017.
Bill Stephens
KANSAS CITY, Mo. – The two infrastructure funds that are reportedly teaming up to acquire Kansas City Southern are no strangers to the railroad industry.

Blackstone Group owned Chicago & North Western in the late 1980s and early 1990s. It also owned Great Lakes Transportation, a collection of former U.S. Steel transportation companies that included Duluth, Missabe & Iron Range Railway and the Bessemer & Lake Erie, that was sold to Canadian National in 2003.

Global Infrastructure Partners owns airports, pipelines, and port facilities around the world. GIP is among the owners of Australian freight railroad Pacific National, a major hauler of intermodal, coal, and other bulk commodities. It was among a consortium that acquired the railroad in 2016 as part of the breakup of Australian freight logistics company Asciano Limited.

The private equity firms are proposing to take KCS private in a deal valued at $21 billion, the Wall Street Journal reported on Friday afternoon, citing people familiar with the matter. The railroad, the smallest Class I system, was worth $14 billion based on its closing stock price on Friday.

There was no guarantee that Blackstone and GIP would proceed with an offer or that KCS would agree to be acquired. KCS has been the subject of takeover rumors for two decades.

But a deal would continue a trend toward infrastructure funds acquiring railroads in North America. Railroads are increasingly on global investors’ radar amid rising demand for long-lasting infrastructure that can offer a combination of stability and growth.

Last year a pair of infrastructure funds took shortline holding company Genesee & Wyoming private in an $8.4 billion deal, while another infrastructure fund acquired shortline and port terminal operator Patriot Rail and Ports. Brookfield Infrastructure Partners, which acquired G&W, this year reportedly expressed interest in acquiring Grupo Mexico’s rail operations, which include the Mexican railroad Ferromex and regionals Florida East Coast and Texas Pacifico.

Independent analyst Anthony B. Hatch says infrastructure funds have long investment horizons and reasonable return expectations that fit well with railroads. Railroads, in turn, are attractive investments for infrastructure funds.

“Their solid performance in the pandemic so far actually proves out one thing that rails provide that infrastructure funds want – stability,” Hatch says.

Kansas City Southern’s revenue has doubled since 2009 largely due to rapid growth in cross-border traffic to Mexico. Kansas City Southern de Mexico controls the Laredo gateway, the busiest rail crossing linking the U.S. and Mexico.

The railway’s cross-border traffic has doubled since 2011 and now accounts for a third of KCS revenue and more than a quarter of its volume. Export traffic to Mexico includes grain, chemicals, intermodal shipment of auto parts, and refined products including gasoline, diesel fuel and propane. Imports include finished vehicles and intermodal shipments of manufactured goods such as appliances and electronics.

Foreign companies have invested more than $575 billion in Mexico over the past decade, primarily in the manufacturing sector. Some analysts believe more manufacturing will move to Mexico from Asia in the wake of the COVID-19 pandemic, which laid bare the risk on supply chains that are overly reliant on China.

KCS is focused on remaining an independent company, CEO Pat Ottensmeyer said on the railroad’s earnings call last month. “We have a lot of runway to have a successful run as an independent standalone publicly traded company,” he said. “And that’s our focus and that's what we’re going to do.”

But the KCS board has a fiduciary responsibility to act in the best interest of shareholders, which includes evaluating acquisition offers.

“If a $21 billion offer is made, as is being speculated in the stories coming out, exclusive of $6.5 billion of debt, the board will have to seriously consider the proposal,” says former KCS CEO and Chairman Mike Haverty, who in 1996 expanded KCS into Mexico to tap growing North American trade. “If the $21 billion includes the assumption of the $6.5 billion of debt, then that is another story.”

Typically rail acquirers have paid a 30% to 40% premium over the railroad’s stock price. “I always believed 40% was the appropriate premium if someone came after KSU on my watch,” Haverty says, referring to the railroad’s stock ticker symbol.

Would KCS benefit from being taken private?

“I can only say, in my opinion, it depends,” Haverty says. “Berkshire Hathaway is a longtime investor so when it acquired BNSF I viewed that as a good thing for BNSF. But many private equity investors look at taking companies private and flipping them or breaking them up to sell them off to make money. That’s just primarily the history of most private equity investments.”

Some have speculated that KCS could be worth more if some of its lines were spun off, such as its routes linking Springfield, Ill., and Saint Louis with Kansas City or the Meridian Speedway joint venture with Norfolk Southern. The KCS main linking Meridian, Miss., and Shreveport, La., is a key route for intermodal traffic moving between the Southeast and Texas and the Southwest.

KCS did not return Trains News Wire emails seeking comment. The railroad’s executive team is scheduled to participate in a 90-minute webcast on Tuesday to discuss its shift to Precision Scheduled Railroading.
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