DATE: Sunday, October 26, 1997              TAG: 9710250638

SECTION: BUSINESS                PAGE: D1   EDITION: FINAL 

SOURCE: BY CHRISTOPHER DINSMORE, STAFF WRITER 

                                            LENGTH:  250 lines

CONRAIL DEAL IS MAKING TRACKS. BUT NOT WITHOUT AN UPHILL CLIMB.

Back in June, it appeared that the deal to divide Conrail between Norfolk Southern and CSX was highballing it toward federal approval.

What a difference a few months make. While no one expects the deal to be derailed, the tracks are not as smooth as they once were. In fact, now there are a couple of tough hills to climb.

A rash of railroad accidents and economy-damaging service problems at the Union Pacific Railroad out west are prompting federal rail regulators to more closely scrutinize the $10.2 billion plan to break up Philadelphia-based Conrail Inc.

Two industry groups representing chemical and plastics shippers came out strongly against the deal last week. Those industries represent about 15 percent of the freight hauled on the three railroads.

Added to the mix is expected opposition from rail labor unions and concerns from the Justice Department, other shippers, some states and communities about service after the takeover.

Tuesday was the last day for opponents and proponents of the deal to file comments before the federal Surface Transportation Board, which is judging the railroads' plan. A ruling is expected next June.

Most observers say the opposition and concerns are by no means insurmountable for Norfolk Southern Corp. and CSX Corp.

``Everybody makes a noise and some of them get heard and some of them don't,'' said Robert L. Banks, president of the Washington-based rail consulting firm R.L. Banks & Associates.

The Surface Transportation Board has the power to approve or reject the merger, or approve it with conditions.

``It's a matter of what particular issues the STB is going to focus on in terms of service, but I have zero concern that the merger is not going to be approved,'' said Scott Flower, a rail stock analyst with the New York brokerage Paine Webber.

``The biggest issue here is the falling apart of the (Union Pacific/Southern Pacific) merger,'' Banks said. ``That will have a substantial impact in this merger.''

Brian Routledge, a Prudential Securities analyst, agreed. ``There's been safety problems out of the gate,'' he said. ``There's been service problems from the beginning that have gotten worse lately.''

The problems stem from Union Pacific's $3.9 billion acquisition last year of the Southern Pacific Rail Inc. Integrating the two systems has proved more difficult than expected. It seems the company has lost the ability to track its shipments.

Just how bad is it at Union Pacific?

Early reports said that shipments that were supposed to take five days were taking five weeks. When a shipment of liquid argon from Houston to southern California arrived 21 days late, it was 90 percent evaporated. The railroad almost hired a ship to haul containers from Los Angeles to the East Coast for shipment inland to avoid the backup at its intermodal terminals there. (Instead it's trying to give the business to other Western railroads.)

On particularly bad days as many as 500 out of 2,000 scheduled daily trains have sat idle for want of locomotives, crews or the track space to move the cargo. On-time delivery performance has fallen to about 25 percent, while the industry average is closer to 80 percent.

The Dallas-based railroad says it has turned the corner, but it also canceled all its intermodal trains between Chicago and Texas, a major traffic corridor, essentially ceding business to competing railroads.

The STB is holding a hearing Monday to look into the Union Pacific's problems. The railroad has already filed a plan to fix things, but it may be too late for the merging eastern carriers to get an easy ride.

``Regulators are going to be a lot more focused on service, safety and operations than they might have been if Norfolk Southern and CSX had been before them six months ago,'' Routledge said.

``At a minimum, both companies are going to go in with a much more deliberate, methodical approach to integration. . . . The regulators are probably going to require that anyway.''

``Through no fault of their own,'' Flower said, ``it certainly casts a shadow in the environment.''

While both Norfolk Southern and CSX say they intend to learn from Union Pacific's problems, they also say the East is different. Unlike recent mergers in the West, the breakup of Conrail is about competition and growth rather than consolidation, they say.

Rail freight in the Northeast has been dominated by Conrail since it was created by Congress in the 1970s. Norfolk Southern and CSX, which operate the dominant rail networks in the Southeast and Midwest, are dividing Conrail to create two balanced, competing systems east of the Mississippi River.

``Norfolk Southern and CSX are committed to assuring the service disruptions in the West will not replay in the East,'' said Norfolk Southern Chairman David R. Goode.

``The eastern restructuring is based on the expectation that we will increase our business by taking freight traffic off the highways,'' said Stephen C. Tobias, executive vice president-operations at Norfolk Southern. ``We will move with deliberate speed to ensure we maintain high-quality service while building traffic.''

Union Pacific's problems arose in integrating a combined workforce of 52,000 in which workers from one side were unfamiliar with the computers and operations of the other. Complicating matters were the cutbacks that occurred in the merger, which led to crew and equipment shortages.

While at least 2,000 mostly white-collar jobs are being shed in the Conrail takeover, Norfolk Southern is hiring train service personnel and buying locomotives and rail cars to ensure it has the capacity to handle the expansion and realize its benefits, Tobias said.

The Norfolk-based railroad has about $400 million of terminal and line expansion projects on the drawing board, he said. It recently spent $18.5 million on new computers to handle the additional dispatching and shipment tracking demands of its expanded rail network and its anticipated growth.

``Conrail computer systems will not be turned off until the transition to Norfolk Southern systems is fully tested and operational,'' Tobias said.

The company is already working with Conrail to develop and integrate the two railroads' data systems, he said. More than 70 ``implementation teams'' are working to make the transition as seamless as possible.

Norfolk Southern says this deliberate approach will help it ensure the safe operation of its new system as well. Already the nation's safest railroad, Norfolk Southern says it intends to extend its safety-conscious culture to the parts of Conrail it would take over.

Safety has become an issue because of a series of rail accidents this summer on Union Pacific and CSX. The Department of Transportation's Federal Railroad Administration has chastised both railroads and is calling on the STB to make safety an issue in the takeover.

The administration wants the board to make both Norfolk Southern and CSX develop safety implementation plans to ensure safe integration of Conrail into the railroads.

``We must see to it that, in any merger, the companies take comprehensive steps to ensure the safety of their operations,'' said Transportation Secretary Rodney Slater.

Despite the railroads' plans, the problems out west have prompted some shippers to oppose the Conrail breakup outright.

``It's very easy to look at this breakup and see the same things could happen,'' said Jim Pasierb, spokesman of the Chemical Manufacturers Association.

Paiserb's group and the Society of the Plastics Industry oppose the takeover for other reasons, including its complexity and its cost, which they fear they will have to pay for with rate increases.

``Shippers should not be asked to bear the very substantial risks created by Norfolk Southern's and CSX's multi-billion bidding war,'' the two industry groups said in a joint statement. ``(Norfolk Southern) and CSX can pay for their purchase of Conrail stock only if they faultlessly execute their strategy of increasing traffic while cutting personnel and costs substantially. . . and it is doubtful this can done.''

Breaking up Conrail is just too complicated, they argue. ``The complexity of this effort increases the likelihood of massive confusion, disruption and delay,'' they said.

Union Pacific's problems have cost Chemical Manufacturers Association members an estimated $100 million so far. Continued disruption would cost $60 million a month.

The strength of the industry groups comments perplexed Norfolk Southern officials.

``I can't imagine that they really want this not to occur,'' Goode said. ``If you wanted to create problems with the Eastern rail system, you could hardy imagine a better way to do that than to have an outright rejection.''

Besides, analysts point out, Norfolk Southern, CSX and Conrail are all well-run railroads. When Union Pacific bought Southern Pacific, it was buying a troubled operation and then made the mistake of cutting too much, said Charles Vincent, an analyst with PNC Financial Corp. in Philadelphia.

``I'd be surprised if they had anything worse than temporary glitches here and there,'' Vincent said.

Still, he added, ``it doesn't take a lot of disruption in one area for it to creep into your entire system. The system is rather sensitive to dislocation.''

The chemical and plastics groups may be just establishing a bargaining position for getting rate or service guarantees, suggest several observers. The groups themselves asked the STB to put binding conditions for rates, service and competition on the railroads should it approve the takeover.

``They'll have some sort of continuing oversight'' from the board, Banks said.

Banks suggested that Norfolk Southern and CSX need to make this work. ``There's always a threat of re-regulation,'' he said.

Other shippers, though, are welcoming the deal. The biggest shippers' lobbying group, the National Industrial Transportation League, didn't take a formal position on the deal. In the past, the group has actively fought railroad mergers.

``Not everybody is going to get better rail service, and not everybody is going to get more service, but, if you look at the big picture, (CSX and Norfolk Southern) are doing what shippers have asked to have done for years,'' said Edward Emmett, the league's president.

``All in all, it is an entirely different situation (from the West) because it is eliminating a monopoly and putting two railroads in,'' Emmett said.

That's true for much of Conrail's system, particularly throughout New Jersey, into New York and around Philadelphia. But the Norfolk Southern/CSX plan does little for upstate New York and New England, where Conrail lines are to be taken over by CSX.

The state of New York wants a second competing railroad to operate down the east bank of the Hudson River to better serve New York City and Long Island.

The Coalition of Northeast Governors has criticized the deal, too, arguing that the lack of renewed competition in some areas may result in higher rates and inefficient service for shippers. The coalition said it would like to see the Norfolk Southern and CSX extend their plan to share rail lines in New Jersey to upstate New York and New England.

If it isn't, the region could become a ``forgotten island lying off the coast of the demarcation line formed by the Hudson River,'' the coalition said in a statement.

Norfolk Southern sees New England differently. It intends to compete with CSX into upstate New York and New England by working with smaller regional railroads like the New York, Susquehanna and Western and Guilford Transportation, to which it connects thanks to a track-sharing agreement with Canadian Pacific Railroad.

The Justice Department also raised the issue about areas that are going from two carriers to one. In particular, it cited three areas where the elimination of competition might increase rates paid by utilities for coal shipments. Those areas include Indianapolis and Washington, D.C.

Still, it's notable that the Justice Department, which has opposed past rail mergers, is only asking that the STB require a competing railroad to be given access to those utilities.

Meanwhile, the rail labor unions have lined up firmly in opposition to the the division of Conrail.

``We see a proposed transaction that will abrogate labor contracts, cut jobs, severely erode service quality and safety conditions, . . . leave the nation with a multi-billion dollar railroad industry controlled by monopolists,'' the AFL-CIO's Transportation Trades Department said in a statement.

While the railroad unions have vowed to maintain a united front on the Conrail takeover, Norfolk and CSX may employ the same divide and conquer strategy Union Pacific used to dull union concerns.

Union Pacific reached agreements with unions representing 40 percent of its workers to get them to drop their opposition to the deal.

Besides eliminating 2,000 jobs, Norfolk Southern and CSX say they plan to transfer another 1,600 jobs, which the unions say is tantamount to elimination. The job cuts, projected to occur over three years, amount to less than 3 percent of the three railroads' 72,800 employees.

But both railroads are calling the Conrail takeover a growth transaction. They say the deal will create 1,100 jobs as the railroads take freight away from trucking companies with more efficient service.

The unions also say they doubt whether the railroads would pay full severance benefits to employees whose jobs are eliminated. Federal law requires railroads to pay workers displaced by mergers six years' pay, but that obligation ends if the employee refuses a transfer or a call back to work.

``Experience shows that CSX and (Norfolk Southern) will fight the payment of those benefits every step of the way,'' the union statement said. ``We need only look at past mergers to see that the railroads will use every means at their disposal to evade labor protection obligations.''

Labor concerns, however, have long fallen on deaf ears with the Surface Transportation Board and its predecessor, the Interstate Commerce Commission, Banks said.

In the end, the takeover still seems inevitable. Norfolk Southern and CSX already own Conrail, though they're not allowed to interfere in its operation. Undoing the purchase would likely cost both railroads so much money that they'd be hamstrung going forward.

Said the analyst Vincent: ``The split-up of Conrail is going to happen eventually, but there's going to be a lot of admonition in there that (Norfolk Southern and CSX) better get their acts together and do this right.'' ILLUSTRATION: Color photos

Map

JOHN EARLE/The Virginian-Pilot

DIVIDING CONRAIL

SOURCE: Norfolk Southern

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