Not Even a $23 Billion Buyout Is Rich Enough for a Railroad Anymore

Kansas City Southern rejected a $208-a-share offer from Blackstone Group Inc. and Global Infrastructure Partners (GIP) that would have valued it at almost $23 billion, including debt, according to the Wall Street Journal. The bid prices Kansas City Southern as if the pandemic—and the associated plunge in rail volumes—had never happened: It’s a 17% premium over the stock’s pre-lockdown high in February. The two sides aren’t in discussions, the Journal said.

Private equity firms were sitting on a record store of unspent cash at the start of the year, with about $98 billion raised in 2019 for infrastructure investments alone, according to Preqin. But with the stock market near record highs, bargains aren’t as plentiful as might have been expected in a pandemic.

After a flurry of consolidation in the 1990s, there are only seven major commercial railroads in North America. Of those, Kansas City Southern is the smallest and most digestible. A deal, if it were to happen, would be the first takeover of a major North American railroad since Warren Buffett’s Berkshire Hathaway Inc. agreed to buy Burlington Northern Santa Fe for about $36 billion during the last financial crisis, in late 2009. Although Buffett scored phenomenal terms on financing deals for the likes of Goldman Sachs Group Inc., he paid up for BNSF. “It was an opportunity to buy a business that’s going to be around for 100 or 200 years,” he said in an interview on PBS at the time. “You don’t get bargains on things like that.”

Railroads have only gotten more expensive as they boosted their profitability by minimizing the labor, capital, and cars needed to operate. Buffett offered about 18 times BNSF’s expected 2010 earnings per share, Bloomberg News calculated at the time; Blackstone and GIP were offering more than 25 times Kansas City Southern’s estimated 2021 profits on the same measure.

Kansas City Southern investors don’t seem too miffed at the prospect of the suitors walking away. Raymond James Financial Inc. analyst Patrick Tyler Brown raised his price target on the company to $210, but not because of the takeover talk, which he deemed “noise.” Instead he cited efficiency gains and the prospects for Kansas City Southern’s railroad business between the U.S. and Mexico as manufacturers look to localize supply chains. As of early September, daily volumes were back at pre-pandemic levels, thanks in part to a rebound in cross-border traffic and energy-related shipments, Kansas City Southern Chief Financial Officer Mike Upchurch said in a presentation on Sept. 9. The company is reinstating its goal of reducing its operating ratio—a measure of profitability for which a lower number is better—to 60% to 61% this year, compared with an adjusted metric of 63.2% in 2019.

With prospects like that, who needs private equity?
 
Sutherland is a columnist for Bloomberg Opinion.
 
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