Amidst all the squabbling and catfighting between the carriers, one interesting piece of merger news came out last week: POET filed a letter of support for the UP-NS merger. From the letter,
“POET, the largest bioethanol producer in the United States and one of the world’s largest producers of biofuels and bioproducts, submits this statement in support of the proposed combination of Union Pacific and Norfolk Southern based on the merits and commitments to benefit shippers proposed by the merging railroads. As a company focused on connecting American agriculture to domestic and global markets, we view this transaction through the lens of market access, supply chain efficiency, and the long-term competitiveness of American bioethanol and agricultural products, with an ultimate opportunity to benefit American farmers.”
Up to this point, the big rail shippers have largely been absent in their support of the merger. This was one of the glaring issues with the initial merger application. UP announced “more than 2,000 letters of support!”, but there were few, if any, notable shippers. If this was a move for growth, then where were the customers? That’s why this letter is significant and why, if game theory plays out, it could get interesting.
In the competitive commodities market that POET plays in, the name of the game is getting volume to market cheaply and efficiently. Producers do everything they can to drive cost out of their operation because that’s the only way they can make a buck. Ethanol from any producer is basically the same. That means the only “let’s make some money” levers that a commodity producer can pull is on keeping OpEx down.
(As an aside, not all competitors play by the same profitability rules. I noticed this while at ADM when we saw Co-op competitors spending cash in down years while everyone else was battening down the hatches. In the ethanol business, ADM at one point tried to wash out smaller Co-op competitors by flooding the market to suppress prices. That didn’t work because the Co-op owners have different incentives than public companies. A real “we can stay stupid longer than you can stay liquid” moment.”
Producers drive down OpEx by investing in and building plants in strategic locations, such as near feedstocks to minimize transportation costs or somewhere with low cost access to energy. One of the last projects I worked on at ADM was to expand our plant to be the largest soy crush plant in North America. Given its strategic location soaking up Central Illinois soybeans and with close proximity to the Mississippi and 3 Class 1’s, our plant was set up to pump soy meal to the export market. (This was before renewable diesel, when meal was king and the tanks were full of veg oil because no one wanted it).
So the fact that POET has decided to go on the record in support of the merger after sitting on the sidelines for more than a year clearly shows UP made it worth their while. Why? Because POET had absolutely nothing to gain without UP doing something, probably several somethings, to get POET to sign.
That has significant ramifications for the ethanol market and competitors like ADM and Valero, who together with POET make up an estimated 35% of the US ethanol market. As I said before, every penny counts when you’re in a perfectly competitive market and the only profits to be had are in local arbitrage opportunities. Now POET has some kind of advantage, whether it be cheaper rates, better service at select locations, or some combination of the two, that ADM and Valero do not.
Two things will likely happen now. First, POET’s competitors have to decide how to respond. Do they go cut a deal with UP too in order to level the playing field against POET? UP may be in the dealmaking mood and there could be some short term wins there. Do they come out in opposition to the merger to kill POET’s deal? Or do they do nothing, keep their head down, and live with the consequences of the POET deal if the merger does go through?
Second, POET may get some retaliation from the non-merging carriers. Some of you may or may not agree that carriers retaliate, but the Class 1’s are run by people and people remember things like this. Just ask Trinity. Last year Trinity wrote a letter of support for the merger and immediately found the cold shoulder of BNSF. Who did BNSF just buy covered hoppers from? Word on the street is FreightCar America, not Trinity. Coincidence, possibly, but when you come out as a fan of the other team you may get knocked off the Christmas card list. That’s something else ADM/Valero will have to contend with.
I remember one large shipper told me years ago when discussing getting something from a Class 1, “I like my job and want to be here for a long time. My counterpart at the railroad could be in their position for a longtime. I don’t want to upset the applecart.”
Shippers have to weigh up the potential consequences for supporting or opposing the merger. Make too much noise for one side and the other one may not like it. There’s a lot of money and jobs on the line with this merger. POET made its choice. It will be interesting to see how other shippers respond.
Good Win for UP
It seems that Omaha has been reading my articles again (love you guys) and followed my advice on peeling off Ag support from the opposition. From my last article, All Rail Service is Local,
“Sit down with each trade association, especially the NGFA. Remember, this is a political campaign, not a hostage negotiation. If you win NGFA support (and other smaller Ag players like the Iowa Farm Bureau, for example), then you win the ag states. Maybe you don’t care about Congressional support for the merger or have any concerns about getting called to the carpet for Congressional hearings by a more populist-leaning political class, but you should care about knocking down political obstacles that could interfere in the STB’s process.
“With the NGFA and the other shipper groups, you go to them and say something like, ‘Listen, we get you’re not thrilled about this merger, but we feel this is a great opportunity for you. Let’s figure out what it’s going to take to get you on our side of the table thinking the same thing. You have concerns about what life will be like on the other side. Let’s get those on the table and prioritize them so we can address them. Maybe we can’t get from here to there, but we want you to know you’re an important stakeholder and we’re going to do our best to help you see how great this is going to be for your member companies. Let’s see if we both can do something meaningful for your members.’”
“Every trade association is backed by a handful of really noisy constituents pushing in one direction or the other. Strategically, you have to figure out who these prime movers are and meet with every one of them directly. Eat a slice of humble pie before you do. Let them shout at you. They expect you to come in and push them around. Don’t do that. Move past emotion and get to cold hard facts as quickly as you can - Which facilities, what problems? A small amount of effort, like solving a local service issue at 1 plant, can add multiples of value if it helps to shift a key shipper at a trade group. Highlight potential benefits and opportunities you can deliver to them as part of the merger. Craft something specifically for them. Send them swag. Follow up on the issue repeatedly. At the end of the day, a personal touch means a lot. We’re all people; It’s not rocket science.”
Now that they’ve added POET to their stable of supporters, UP should continue to chip away at key shippers. You don’t need all of them and even just getting one could bring others along.
The STB Says No…but Leaves Some Hints
This has already been picked up by quite a few people, but I thought I’d highlight it anyway. Last weekend, the STB rejected the opposition coalitions request for a quick rejection of UP’s merger application.
That wasn’t surprising. What was notable was that new board member Dick Kloster felt the need to offer some additional commentary. From the ruling,
“To be clear, I am not yet making any decisions on the merits of the application, and I look forward to development of the record. However, I will provide a couple of initial observations. First, I believe that there has been a lack of transparency and depth in the application. Applicants have submitted thousands of pages of documents, yet they do not offer a very robust plan for how they will address competitive concerns or mitigate potential harms. They also rely heavily on the benefits to intermodal shipments, a market segment which, by today’s standards, is already competitive.
“I would also note that, in my view, the Applicants have approached this proceeding with an apparent strategy of “letting the line out slowly.” Opponents have suggested that it seems that the strategy is to offer conditions that provide minimal benefits on less significant matters, while waiting to gauge stakeholders’ reaction before offering more meaningful conditions on important matters. But Applicants should come with their best case in the application filed to justify the merger so that the Board can decide on its merits. The Board should not have to sift through vague language to try and figure out where any deficiencies may be in the Applicants’ proposal and what potential conditions could mitigate any harm.”
It seems Dick and I are of a like mind. I think I said somewhere recently that it seemed UP was approaching this like a contract negotiation rather than the political one that it was. They’ve given out as little as possible in the hopes that this skates through. All that’s done, however, has given fuel to the fire for opposition along with skepticism from the broader industry, Wall Street and the STB in particular.
Dick’s warning, because that’s exactly what it was, couldn’t have been more clear: Put your best foot forward and quit screwing around. This is yet one more example of the STB giving UP more hints to the test answers. UP should be grateful for these signals.
If Omaha is listening, it’s time for the lawyers to exit the room and the dealmakers to take over if they want to get this merger done.