WHO HAS TO PICK UP THE ACQUISITION PREMIUM?

WHO HAS TO PICK UP THE ACQUISITION PREMIUM?

Some critics of the Norfolk Southern Corp.-CSX Transportation Inc. joint purchase of Conrail Inc. have argued that the two Eastern rail giants paid too much when they coughed up $10 billion in cash to buy the Northeast rail carrier.

Mostly, these critics are customers or their representatives. Their concern is that the only way CSX and NS can ever pay for Conrail will be to raise rates. That concern is growing now that both railroads have released third-quarter financial results showing huge operating expense increases as they struggle to integrate Conrail into their operations.Washington shipper attorney Michael McBride put it succinctly recently when he said: ''I am not saying NS and CSX 'overpaid' for Conrail, nor have I ever argued that. The point is, rather, that they paid an acquisition premium, however folks define that, and it should not be the responsibility of the customers.''

To some extent an easy response would be, ''That's the cost of doing business.'' Customers always end up paying rates that cover all the costs of doing business unless a vendor - in this case NS and CSX - is pricing to go out of business. (Don't laugh; that's the way railroads were pricing before deregulation.)

The fact is that neither CSX nor NS paid too much. High as it was, they paid exactly what it took to get Conrail. Once CSX started the ball rolling on Oct. 16, 1996, with a cash-and-stock deal for all of Conrail worth about $8.4 billion, the market eventually determined the price.

Norfolk Southern leadership understood exactly what they were facing. If they did nothing, their company would be condemned to being a large regional system that eventually would be overwhelmed by the much larger CSX, which would have a market reach throughout the East that NS could never match.

Further, if NS did nothing, it would lose control over its future when the eventual transcontinental rail merger occurred. CSX would be the object of desire for either of the two big Western systems and whichever one did not merge with CSX would take NS as a second prize.

So NS counterattacked eight days later with a higher all-cash offer for Conrail. After much legal maneuvering and increased bids by both would-be acquirers, sanity was restored. NS and CSX agreed to divide Conrail, with Norfolk taking and paying for 58 percent and CSX 42 percent. Combined, they paid $10 billion.

That was the market value of Conrail. It was neither too much, nor too little. It did, however, represent an acquisition premium. Such premiums are common. If they weren't, what incentive would any company have for selling out?

In a competitive environment the acquisition premium would present little or no problem. Customers could take their business elsewhere if a railroad raised its rates beyond a level the customer considered justified by service quality considerations.

As Mike McBride says: ''If there were no barriers to entry, and thus competition as with barges, trucks, or airplanes, competition would prevent the customers from paying higher rates to cover the premium.''

That's certainly true of intermodal business, where the customer easily can dray containers or trailers to a competing railroad's terminal. In effect, there are no barriers to entry in intermodal.

The problem lies with carload service, the bulk of rail traffic. Most industries are served by tracks of only one railroad. The Surface Transportation Board, which handles what regulation of railroads remains on the books, has adopted the old Interstate Commerce Commission definition of captivity, under which there are virtually no captive customers.

Regardless of regulatory definitions, most customers do not have a practical alternative to doing business with the railroad that serves their facilities.

The STB is supposed to see to it that rail customers are protected from having to pay acquisition premiums through conditions in merger proceedings for those who would lose competition, or who would otherwise be harmed, as do regulators of other industries. Merging companies must recover premiums through cost reductions and growth, which is what CSX and NS said they would do when they sought STB approval for acquiring Conrail.

It's hard to find clear evidence of rate increases imposed by NS and CSX, particularly as most freight moves today under contract and details remain confidential. Many who watch such things for a living, however, say both railroads have raised rates, particularly where the customer has no effective alternative.

Customers - still called shippers in the arcane world of regulation - believe the STB has not held Norfolk Southern and CSX to the assurances made in the Conrail case.