 |
 |
|
 |
 |
|
 |
 |
 |
|
 |
 |
|
|
|
Strategic Rail Finance |
How Did Strategic Rail Finance Get Its Start?
I’m Michael Sussman, and I became interested in the railroad industry in 1994 when I was asked to coordinate financing for Massachusetts Central Railroad. Finding no rail industry lender that funded smaller transactions for used equipment, I presented the situation to a finance company with whom I worked in other industries. I researched the equipment’s salvage and market values and was intrigued to discover that these used boxcars made better collateral for financing than most other non-rail equipment.
After this successful financing, I asked Bob Bentley, the President
of Mass Central, if there were other businesses like his. Bob gave
us our first overview of short line railroads. Another turning
point occurred while meeting Dick Robey, President of North Shore
Railroads in Pennsylvania. Standing in front of a locomotive, I
asked how it could pull so much weight with not many more horsepower
than the muscle cars of my youth. Dick explained the efficiency of
a steel wheel rolling on a hardened steel rail. I realized then
that creating new sources of capital for this energy-efficient
transport mode would be both profitable to the industry and a
contribution to the country.
Why Is Strategic
Rail Finance Needed?
During numerous conversations with railroad owners, suppliers, and lenders, I heard about an industry with a severe shortage of funding options. I began an extensive study of the history of North American railroads, with a particular eye on 19th-century railroad finance. I wanted to know how the industry that was the primary reason European capital flowed into North America, could arrive at the end of the 20th-century misunderstood, undervalued, and under funded.
The
lending community, in its evolution toward consolidation and
standardization, has shifted its business sights away from much of
rail finance. Due to the many unique elements and the relatively
small number of rail-related entities, lenders that do get involved
only focus on the largest transactions. Where this development has
been most costly is in the mistaken conclusion that there is an
inherent weakness in railroading. As a consequence, lenders,
railroads and their advisors have settled for unnecessarily low
asset valuations and loan-to-value ratios. Understanding the real
value of railroad assets allows us to create breakthroughs for our
clients. We have developed Strategic Rail Finance to share this
knowledge for the betterment of the railroad industry as a whole.
Why Are Class II and III Railroads Often Misunderstood By Lenders?
Characterized by small-to-medium size transactions, distinct financial statement features, and undervalued assets, these railroads are hard-pressed to attract the lending community’s attention to their unique market position. While some of these owners can borrow substantially, exceeding their bank’s appetite is the norm. Rarely are they constrained by their own business acumen or ability. Neither are they constrained by their market – they often have a backlog of shipping projects waiting for funding support.
What constrains
them is the limited ability of lenders to accurately value their
assets. With little or no experience with railroads, most lenders
are less likely to understand the historical and national background
so vital to appreciating individual railroads. Significant
anecdotal evidence points to the financial stability and
creditworthiness of these business entities. Class II and III
financial statements, however, continue to reflect the unique
financial and accounting traditions of the railroad industry.
Without the deeper understanding that Strategic Rail Finance
provides, railroads’ strengths and assets fade into the line items
on their financial statements. Class II and III railroads, despite
their significant growth since the Staggers Act, are mostly
undervalued and undercapitalized.
What Is Unique About Class II and III Railroad Financials? The most fundamental analyses of Class II and III railroad financial statements confound an accurate comparison to other industries. For instance, most Class II and III railroads have current assets to current liabilities ratio of less than 1:1. This fact is by no means an actual indicator of instability. It can only be assessed accurately in light of the unique aspects of railroad cash flow and accounting. The assessment tools that lenders rely on for industry analysis such as Standard and Poor’s, Moody’s, and Robert Morris Associates, only include the seven Class I railroads and several public railroad holding companies. Bankers, as well as railroad management, are often unaware of the inherent conflict presented by their financial statements.
Over the last
25
years, Class II and III railroads have increased their importance in
the overall freight transportation system. To realize their fullest
potential, individual railroads must be freed from the limitations
of their current capital structure. Bridging this gap requires a
reinterpretation of railroads’ financial statements to more
accurately tell each railroad’s story.
Why Does Strategic Rail Finance Fund Class II and III Railroads?
There is also a
misconception of small railroad closures. Close investigation of
Class II and III operations over the last fifteen years reveals the
low incidence of small railroad bankruptcies. Almost all of the
closures, with only a few bad-faith situations as the exception,
transpire as what can be considered “organized closures.” In other
words, they go out of operation in stages, paying down creditor
balances, as demand for rail service on their line declines. In
this worst-case scenario, they still do not leave creditors in the
lurch, providing another fact in the case for Class II and III
railroads as a secure lending marketplace.
What About Public-Sector Funding Of Rail Development?
Given the contribution of freight railroads to transportation
efficiency, public policy that supports rail development is good
public policy. However, current statutes, regulations, and programs
have not been designed to stimulate private sector financing and
public–private funding partnerships. Government financing programs
can at best help to maintain railroads, at a time when rail service
growth can only be financed through private–sector
capitalization.
By enhancing
programs such as the Railroad Rehabilitation & Improvement
Financing program through a comprehensive understanding of rail assets,
railroad finance, and the capital marketplace, we can “seed” private
sector lending to fully accomplish what the public sector can only
partially satisfy. After all, the Land Grant programs of the 19th–century
were effective because the government contributed land, a publicly
owned asset, that railroads then leveraged into substantial
private–sector capital.
What Can Be Learned From The Great Early Railroad Leaders?
One of the things that struck me as I researched the great early railroad leaders, James J. Hill, Edward P. Harriman, William Ripley, J.P. Morgan and others was their preoccupation with finance. Major business transactions waited while they negotiated and structured funding mechanisms that supported long-term growth. J.J. Hill worked strenuously for 3½ years to consummate his first major railroad deal, the acquisition of the St. Paul and Pacific Railroad. He patiently negotiated with the Dutch owners of the railroad in receivership until the agreed terms set the financial foundation for what became one of the great rail empires. Over time this financial vision has been lost as short-term results have been stressed. Railroads, however, are most appealing for their long-term return on investment. They are strengthened through thoughtfully engineered capital planning. Victor Morawetz, Chairman of the Executive Committee of the Santa Fe System, and architect of one of the most admired railroad turnarounds in history, wrote in 1915: “All the railroad reorganizations planned at the time of the Santa Fe reorganization, and nearly all the reorganizations ever planned in the United States, have been faulty because they failed to make adequate provision for future capital requirements. Rarely, if ever, have railroad reorganizers realized the unceasing growth of the country and rarely have they appreciated sufficiently that in the United States a railway system must develop and grow with the country which it serves – that it must ever expand its capacity and improve its service.”
What Is Strategic Rail Finance’s Commitment?
Strategic Rail Finance is committed to providing new sources of capital to fund a dynamic expansion of our continent’s utilization of freight rail transportation. Railroads and rail-related businesses represent a stable, long-term opportunity for both public– and private–sector investment. The continent will benefit enormously by a relatively small investment from national transportation budgets. If we coordinate this public investment with important policy improvements we can provide the capital environment for the railroad industry to substantially increase its contribution to North America’s economic vitality. Capital provision must be one element of an overall strategy for upgrading an already efficient rail transportation system to support our ever-increasing continental growth. New capital must go hand-in-hand with comprehensive plans and action for the reinvigoration of railroads as a growth industry. |
|
Announcement – January, 2005 We have established Transportation Development Corporation to direct fund rail-related transactions. We are now a full-service, rail industry lender. |
Prior
to the passage of the Staggers Act in 1980, there were 220 Class II
regional and Class III shortline railroads. As of 2005, that number
has expanded to 585. Over the same period, financial institutions
have been merging, consolidating, and standardizing. Banks have
grown larger and hence less able to understand the operational and
financial facets of individual local and regional railroads.
Services | Client Success Stories | References | Ask SRF | What Makes Us Effective | Our Principles | Team | Articles | Home |
postmaster@strategicrail.com