Reflections on the proposed Genesee & Wyoming acquisition — analysis by Tony Hatch

From Jack Hellmann to Genesee & Wyoming Inc. employees July 1: "This morning we are excited to announce that G&W has entered into an agreement to be acquired by Brookfield Infrastructure and GIC, pending regulatory and shareholder approval. If approved, the sale is expected to close at the end of 2019 or early 2020. Brookfield and GIC are two of the most respected infrastructure investors in the world who have a long-term view of investing that is perfectly suited to long-lived rail assets. Not only will Brookfield/GIC support the continued execution of G&W’s growth strategy by our current management team, but they also will bring expertise from their ownership of other rail assets around the world ...”

Thanks in part to an unprecedented amount of info leaking (kudos to Bloomberg), the deal came as no real surprise. Toronto-based Brookfield Investment Partners, along with Singapore’s GIC and others labeled somewhat ominously as the consortium” hope to acquire short-line holding company leader G&W for $8.4 billion.

As far back as its November 2017 investor conference, G&W itself had said North American deal-making was getting harder as asset inflation accelerated (due in part to the differing return requirements between public, strategic, private equity and infrastructure investors). But there was an upside: G&W officials realized their own portfolio was under-valued. The short-line community had thought this was a done deal for some time; the investment community was a tad more cautious, an interesting role reversal. 

So what does the deal mean for G&W? For the rail industry? For other deals?

Key dates. A press release announcing the deal said GWR will not hold its planned earnings call/webcast on Aug. 2 (I am not sure why, given they will still be independent and publicly traded; in addition, as a parting gift to the analysts who followed then for 20+ years, they will cease producing quarterly traffic numbers.). In any case, here are some key dates:

• Expected release of the Q2/19 10-Q: Aug. 9

• Brookfield Analyst Conference in New York City: Sept. 26

• Jack Hellmann, who received the Progressive Railroading "Railroad Innovator Award” at RailTrends 2017, is scheduled to speak at other railway conferences, such as the Railway Tie Association’s annual conference in Tucson, Arizona, on Oct. 17 (I will be speaking there, as well)

• The deal “is expected to close by year-end 2019 or early 2020” subject to shareholder approval, as well as approvals from the Committee on Foreign Investment and the STB (the latter shouldn’t pose a problem).

Why did G&W do this? Well, the deal represented a 40 percent premium to the share price before the leaks began (for the 4 percent short — oops!), and at 13.3X 2019 estimated EBITDA and 26X 2019 estimated EPS, that’s a healthy haul! It's the sellers market bonanza, as described above and noted by G&W repeatedly for the last 18+ months, for one reason. In addition, G&W can be viewed in part as a victim of its own success: By creating a 114-railway behemoth in North America, they made it harder on themselves to continue to make deals that move the needle. A $10mm revenue deal that would be coveted by some short-line holding companies would require the same effort in due diligence and “go teams,” and yet be barely noticeable to their investors. It could be inferred (even though denied) that this problem could cause G&W management to take bigger risks and do deals in other regions (the UK, perhaps, if not Australia). A combined deal/operating company might not be best suited for quarterly results.

What does this mean for G&W? The company can recommit to the small, fill-in deals, for one thing — and at the same time have a parent with deep, deep pockets for larger ones, should they arise. But the deal leads to some questions. Will the current management stay? They say they will (see above). Did Brookfield see this as a pure infrastructure investment (stable, say mid-single digit returns/hands-off style), or will it view this more as a private equity investment (investing with an aim to provide something — capital/expertise/directional change — to improve results and achieve double-digit returns)? The deal press release states Brookfield et. al “fully supports the G&W business plan,” but some sources say that isn’t entirely accurate, citing issues of operational efficiency and growth potential.

In addition, a Canadian source close to Brookfield said the ownership and fund structure was complicated — with some seeing themselves as lifetime investors and others with a 10-year (still “long term," to be sure) horizon. The source suggests perhaps one-third of the ownership confederation would be in that more opportunistic (PE) category. That could be interesting — an internal “activist” in the mix?

Australia could be an issue, given Brookfield’s ownership of Arc, which owns 5,500 “track kilometers” in Western Australia (the above rail operations are run by Watco). As Hellmann pointed out in the G&W memo to employees, Arc was part of the ARG, which GWR sold in 2006. In a memo to G&W Australia (GWA) employees, Hellmann wrote that “it is with a heavy heart that I inform you that (BIP/GIC) intends to sell G&W’s 51 percent stake in GWA ... due to regulatory considerations related to BIP’s Arc ownership." To which I would add: The Australian rail regulatory environment is pretty crazy and inconsistent, but I would ask — why not keep GWA and sell ARC? Hellmann wouldn’t say who the buyer was (implying this was perhaps an already done-deal — perhaps to MIRA, the 49 percent owner? How long will this take?

What does this mean for other short lines and for short-line creation? This is merely confirmation of what’s been going on since 2017: Global (and local) investors want North American rail assets. In just the last three months, we have seen:

1. May: The ~$19mm purchase of the 17-railroad short-line holding company Pioneer Rail by the partnership of Brookhaven & Related. The former is the entity created by old friend Alex Yeros, formerly of The Broe Group, owner, of course, of short-line holding company OmniTRAX Inc. OmniTRAX also birthed Alpenglow, another short-line holding company investor.

2. June: The announcement of the RailUSA acquisition of the 430-mile CSX Panhandle (Florida) segment. RailUSA is Gary Marino, back for the third time in the short-line holding company creation world (RailAmerica, Patriot); this is RailUSA's second deal after the Grenada Line. It has backing from EGI (Zell) and others.

3. July: The G&W deal.

And we might not be done for the summer. Fortress’ Joe Adams has said on numerous occasions that the Central, Maine & Quebec (the former and ill-fated Montreal, Maine & Atlantic) is not core to them, and will be sold. Others, too.

What does all this mean for Class Is? Nothing, really — assuming G&W stays the same or improves. In announcing the deal, G&W officials have used the line “business as usual” a lot. A lot will depend on whether management stays and develops succession plans, or takes the money and runs. CSX has sold two line segments with more to come; the success of that project might help persuade other major rails to look to do similar things, but short-line sales by Class Is aren’t — or shouldn’t be — about the dollars but about value creation for the main, core rail network. 

As for the “trend” of going private: Well, fugeddaboutit. BNSF is already quasi-private (Berkshire Hathaway) and often alludes to the benefits of that status, only sometimes tongue-in-cheek (note Union Pacific's pushback of late in a most interesting war of words developing). The rest of the railroads simply are too valuable (UP’s market cap is $118B — $8B being the “Vena bonus”); and, frankly, as we have seen up North, the public markets can still work for capital-intensive transportation businesses.