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Feb. 17, 2014

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SURFACE & DOMESTIC TRANSPORTATION TRUCKING | RAIL | INTERMODAL | AIR & EXPEDITED | DISTRIBUTION 52 THE JOURNAL OF COMMERCE www.joc.com FEBRUARY 17.2014 By Mark Szakonyi E . HUNTER HARRISON, CEO and director of Canadian Pacific Railway, expects rail consolidation among the largest North American railroads within six years. The scenario he laid out for investors recently, however, is much bolder than what's been swirling around the industry. The conventional wisdom around con- solidation is that Kansas City Southern Railway, the smallest of the major railroads, gets scooped up by one of the five other Class I carriers or a third-party that merges two railroads. The major benefit to a KCS buyer would be gaining the only cross-border rail network that connects the U.S. to Mexi- co's rapidly growing manufacturing base. Harrison, however, envisions "a merger across the Mississippi River," in which each of the western U.S.-based Class I railroads — BNSF Railway and Union Pacific Rail- road — merges with an eastern counterpart, according to a Seeking Alpha transcript. BNSF or UP, for example, could merge with CSX Transportation or Norfolk Southern Railway. "I do think there will be consolidations in the future … I'm not suggesting it's going to be in the next two or three years, but I do think, given capacity issues at each point, environ- mental concern, you're not going to build any more railroad, that really if you look at the U.S., for example, you split up East and West, you got two in the East, you got two in the West. And a merger across the Mississippi River is not going to impact the competitive environ- ment," Harrison said. Such a merger wouldn't "impact the competitive environment," and shippers would gain better service by having two transcontinental lines, Harrison told inves- tors during the railroad's fourth quarter earnings call on Jan. 29. So-called captive shippers who have access to only one car- rier could benefit from consolidation as well. "If mergers were allowed, I think there's a model that we had that said, if somebody thinks they're captive and they don't think that we're giving them the right service or the right price, then you'd have to allow Brand X to come in to provide that," Harrison said. The creation of two U.S.-based transcon- tinental railroads wouldn't reduce shippers' choices, because most shippers generally have only two choices now, said Keith Schoon- maker, director of industry equity research at Morningstar, a Chicago-based investment research firm. Canadian shippers can choose Canadian National Railway or Canadian Pacific Railway, while Mexican shippers have either Kansas City Southern de Mexico or Ferromex, he said. Within the U.S., western shippers can tap BNSF or UP, while eastern shippers have CSX or NS. This is generally true for most shippers, but not for all. Carload shippers moving freight through Port Metro Vancouver, for example, can use BNSF, along with CN and CP. Similarily, the networks of CP and par- ticularly CN reach U.S. destinations, and CSX's line reaches Quebec. Under a dual transcontinental merger scenario, the need for handoffs at the Missis- sippi River or in Chicago would be reduced, speeding up transit times, said Schoonmaker, who asked Harrison about the prospects of consolidation during the earnings call. The mergers also would reduce corporate costs, because two sets of management would be redundant, and some railyards could be con- solidated, he said. "Only one CEO would be needed after each merger, so a leader willing to step down (probably in exchange for a lucrative change of control compensation) would facilitate the deal," Schoonmaker said. "Perhaps, a likely catalyst would be an activist share - holder." The potential mergers also would have to get the blessing of the Surface Transporta- tion Board, the U.S. regulatory agency. CN and BNSF pulled back from merger plans after the STB in March 2000 ordered a 15-month mora- torium on railroad mergers. Tony Hatch, an independent railroad analyst, said the STB would never allow a transcontinental merger, and noted any such merger or acquisition attempt could spur Congress to try to re-regulate the rail industry. A transcontinental merger wouldn't create major cost savings, nor would it greatly improve service, because interline traffic generally runs smoothly, he said. Railroads' differing cultures would only complicate a process ripe with political and financial risks, Hatch said. It's not as if the rail industry needs a merger to increase profitability, either. Railroads have consistently boosted profits through strong pricing and efficiencies, and despite moderate growth in volume. CSX, NS, KCS and UP raised their total profit in the fourth quarter by 11.9 percent year- WHERE EAST MEETS WEST Canadian Pacific's top official envisions transcontinental rail mergers "If somebody thinks they're captive and they don't think that we're giving them the right service or the right price, then you'd have to allow Brand X to come in to provide that."

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