Conrail: What should Uncle Sam do with it? Sell to Norfolk Southern
SINCE 1976, when the government created Conrail, American taxpayers have spent several billion dollars to purchase and restore the railroad's physical plant and to subsidize its operations. Conrail has done well the last four years. But much of its profits are a result of federal government ownership. The government forgave some of its obligations and satisfied others: Conrail pays no state taxes; the federal government pays all Conrail's labor protection costs; and until recently its employees were paid 1 2 percent less than their counterparts on other major railroads. In 1981 Congress directed the secretary of transportation to prepare a plan for the sale of the government-owned freight railroad. One of the nation's leading investment firms, Goldman Sachs & Co., was hired to advise the department. Working with them, we contacted more than 110 potential bidders, including all Class 1 railroads. My goal then, as now, was to sell the railroad. In the spring of 1984, I conducted a formal bidding process, followed by months of tough negotiations with those making the best
offers. As a result of these efforts, it became clear to all concerned that Conrail can be returned to the private sector. Thus, the debate shifted from whether it should be sold to how best to sell it.
Because it is a merchandise and terminal carrier, Conrail, like its predecessors, is susceptible to fluctuations in cash flow. It accumulates cash in the upswing and loses cash in the downswing. This fact forced me to reject any purchase offer that leveraged off Conrail's assets, that drew cash from the company, or that forced Conrail to pay high dividends.
After 21/2 years of planning and then implementing a competitive bidding process for the sale of Conrail, no offerer has proposed to leave Conrail in a stronger financial position after the sale, or to better preserve rail shipping patterns in the Northeast or to provide the government a better rate of return than Norfolk Southern.
I chose Norfolk Southern because it will pay the government a minimum of $1.2 billion in cash at closing. Not 1 cent of this is leveraged off Conrail assets. It all comes from NS assets. All other offers would have taken something from Conrail. NS will also surrender Conrail's accumulated tax benefits of $1.8 billion in net operating losses and $306 million in investment tax credits.
Also, NS has agreed to be bound by a strong set of protective covenants for five years during the transition to private ownership. It has agreed to invest hundreds of millions of dollars annually in Conrail's physical plant and to refrain from deferring maintenance to any level below Norfolk Southern's own standards, which are the highest in the industry. The covenants require Conrail to refrain from paying dividends to the parent company unless $500 million dollars in cash would remain after those divi dends are declared. NS will relinquish Conrail's expedited abandonment authority; any Conrail lines that it seeks to abandon must be offered to shippers and short-line railroads at 75 percent of their net liquidation value. And, NS will not receive any special tax treatment.
Norfolk Southern's offer has had to face a tougher standard than any previous rail merger. The Justice Department prescribed divestiture of a number of lines as a way to maintain a competitive balance in specific areas where it found there might be a reduction in competition. Norfolk Southern has negotiated conditional agreements to divest 1,700 miles of track to Guilford Industries and the Pittsburgh & Lake Erie railroad. The Justice Department has final approval of those divestiture agreements.
There have been some recommendations that we choose another approach to the sale or wait for a better time. Just recently a new proposal for a sale to a syndicate with a secondary public offering at some later unspecified date was unveiled. However, that proposal announced by Morgan Stanley & Co. is not fundamentally different from others we reviewed in the past. It requires heavy dividends and promises its investors substantial capital gains. Long-term ownership of the railroad by shareholders who have
an interest in the Northeast and rail service does not appear to be a primary concern in this scheme.
I remain firmly convinced the Norfolk Southern offer is in the long-term best interests of Conrail, its employees, and its shippers. Through a merger with the NS, Conrail's long-term viability is guaranteed. No one is left wondering whether NS wants to operate a railroad. Clearly it is not motivated by a desire to make a quick profit reselling Conrail's stock, to extract from Conrail every dime it can yield in dividends, or to break Conrail into two or three pieces to be sold off in an effort to maximiz e capital gains.
It is now up to Congress to close the books on this important issue: to carry through with its decision made in 1981 to get the government out of the business of competing for freight with privately-owned railroads and trucking firms.
Elizabeth Hanford Dole is US secretary of transportation.