First, a schedule update – I will be on an IANA/”The Business of Intermodal Continues” webinar tomorrow (Tuesday at 2 pm) on the topic of Next-Level Truck Technology and the Effects on Intermodal’s Competitive Landscape with trucking experts from NFI, Daimler, and Tu-Simple….
Going to Kansas City….Rumors and Speculations – via my tweets from last week, for those who didn’t see:
(#1) On KSU- new rumors suggest a Canadian RR could be involved with – or, maybe, instead of the two Infra funds from the WSJ report, Blackstone and GIP (assuming that there is merit to the ORIGINAL rumor; there has been no confirmation of any of this) but that – either joining or beating the funds - would bring in the STB & add great uncertainty – why would the funds want that? Why might a railroad? (#2)
But a RR that might have considered KSU "in a few years” might feel compelled to advance that time frame (given the 8-12+ years holding time expected from Infra funds – see below); on the one hand, the Massena/CSX+CN deal complications (imposed by the STB) shows us this is hardly a pro-merger environment; there certainly isn’t a “failing carrier” nor a “shippers demand/need capacity” argument…. (#3) But on the other hand, if I am wrong on consolidation, I have always said I would be very wrong; Maybe not on this rumor should it come true, as, strangely, a CP-KSU combination might actually remove uncertainty/provide stability for the industry by removing the smaller targets (and, it must be said, giving Keith Creel something to do for 5+ years and stop all those incoming calls from hedge funds!) – but that is only IF it didn’t spark off further (and unfortunate, IMHO) consolidation….
Infrastructure Funds are different! Loop Capital, after my gentle correcting of some assumptions on funds from their initial report on the KSU rumors, held an interesting call with the head of JLC Infrastructure, a mid-sized infra fund (co-owned by one Earvin Johnson), who discussed the history and development (and goals) of the infrastructure fund world, in some ways a 21st C phenomenon, and raised three points:
- Rates are low/capital is very cheap, and the fund capital is very patient (“sticky AUM”)
- Time frames are elongated and return expectations less robust:
- “Typical” Private Equity (PE) funds have a (relatively) short holding period (3-5 years) and a high teen return expectation; they often, therefore, perform a lot of value add (changing management, adding leverage, etc)
- “Value-Added” Infrastructure Funds lookout “8-13 years” anticipating “mid-teen” gross returns; this is where Blackstone and GIP would fit, with deal (“check”) size in the $2-3B on average (note: KSU fits at the upper end of the range of the Infra market as it exists today; the next smallest railroad is….CP, and is likely too big.
- “Core” Infrastructure Firms are the most-patient, often institutional (including Sovereign Wealth funds, global insurers, etc), and hold 20+ years or forever, whichever comes first, with “high single-digit” return expectations – they want stability, are “super-patient” and want to “clip coupons”. The VA funds, #2B above, would after 8-12 or so years, seek to sell to “Core” funds; KSU would be a big bite….perhaps it might be sold back into the public markets (reminder – all this presupposes a LOT….).
- It was noted in the call that “the velocity of capital” is a critical component of the VA-IF – part of that “value add”. I would note that KSU does not need capital, given its free cash flow generation even in this pandemic….
- VA-Ifs tend to want to rationalize businesses but not to break them up or make dramatic moves (that’s PE); so think about selling the railway in Panama perhaps but not a breakup of the KCS.
- JLC said that the funds get very involved in management (the phrase used was they would be “all over” them) – but more so than analysts and investors - and activists - today? I doubt it – but while they would hold them accountable on a weekly basis, they would not be required to report (on an audited basis) quarterly, etc….
- I still think KSU will not be interested but of course, they don’t (and haven’t) commented….
Ongoing Business Continues – KSU held a PSR Deep Dive with a favored analyst in an effort to “peel the onion” (a phrase heard so much I started to cry). The 90-minute session, presided over by the irrepressible Sameh Fahmy and a cast of, well, a lot, served as a sort of mini-Analyst Day (perhaps it should have been an actual one, sponsored by the company), and most effectively showed some real bench strength. It covered Network Operations, Service Design, Fuel, Equipment (utilization and mechanical) Engineering (and some ~15% annual MoW Capex savings)….One key takeaway was that operational changes in Q2/20 (etc) may lead to even more PSR savings than the promised $95mm. KSU is up YOY on most KPIs, even after the upward, post-trough gyrations (volumes are up some 40% from the trough, so the metrics have dropped form the Q2/20 reported numbers but the 2020 Goals remain in place). Taking a step back, since the PSR beginnings at KSU at the end of 2018, velocity and dwell have shown large, marked improvement. Examples were shown of major drill-down initiatives, such as in the Monterrey region. Another interesting factoid came from Service Design showing the KC-Shreveport corridor, where train starts were reduced from 28/week to 17 while trains were 40%+ longer – and customer service improved. That is a great refute to the wide criticism that PSR is only about reducing costs – and volumes/service, if necessary. This is the genesis of the ~$40mm additional savings, only some of which are in the previously expressed 2020 PSR productivity guidance. Further upside comes from several areas, including fuel efficiency, where great progress has been made but more is targeted to catch the Canadians or even FXE!); in addition car hire (and maintenance), engineering, etc….