Following the Staggers Act of 1980, a spate of consolidations occurred among the Class I railroads, resulting in what some captive rail shippers would characterize as operational monopolies because shipping options became reduced.
But Herman Haksteen, president of the Private Railcar Food and Beverage Association (PRFBA), suggests there is an investor monopoly as well among the Class I railroads. In examining filings from the Securities and Exchange Commission, Haksteen found four major institutional investors each own between 20% and 21% of three of the Class I railroads: Union Pacific (NYSE: UNP), CSX (NASDAQ: CSX) and Norfolk Southern (NYSE: NSC).
What’s significant about this stock ownership is each of these four have classified themselves as passive investors, which means they don’t take an active role in working with a railroad’s board of directors in steering the company. As a result, the boards have less pushback from their investors over company direction, acccording to Haksteen.
Haksteen recently chatted with FreightWaves about his findings. PRFBA’s membership includes large shippers of consumer packaged goods, such as PepsiCo, General Mills, Kellogg’s and Kraft Heinz, as well as other shippers, such as Boardman Foods and Molson Coors.
This question-and-answer session was edited for clarity and length.
FREIGHTWAVES: Why did you start looking into investor profiles of the Class I railroads?
HAKSTEEN: PRFBA meets twice a year. And that group of people are frustrated shippers, and we’re constantly trying to figure out a way to make the railroads more user-friendly.
We formed that group in 2015. Our first strategy was, if we get together as a large group of shippers, we’ll just meet with the railroads as one and maybe we’ll get more influence over the railroads by saying we have hundreds of thousands of shipments here as opposed to tens of thousands.
We went down that route, and it just didn’t seem to have an impact. The railroads didn’t like it when they were sitting in a room with 20 shippers that represented, combined, the largest shippers of the railroads. Having them all get together and say we have the same problem made the railroads very uncomfortable. They were town hall-style meetings. They weren’t beat-’em-up meetings. They were, hey, this is what we’re seeing.
So, that door got closed. And so we thought that we need to influence through the Surface Transportation Board because the railroads are a federally regulated body or industry. So, we spent a lot of time with the STB. We went to all their hearings, had ex parte meetings with them. And we were just a little bit frustrated by the speed of change that came from that.
So then we said, OK, so what’s next on the list? Well, maybe we need to talk to the lawmakers — House committee folks or the Senate folks. It was a great experience with Sen. [Tammy] Baldwin [a Democrat representing Wisconsin], who’s a very strong supporter of shippers and also wants the railroads to be more user-friendly. [But] if any of your readership has ever tried to get anything passed in D.C., they know it’s a very long, slow process, and certainly it wasn’t successful influencing the railroads.
So, at our last meeting a couple months ago, we’re all sitting around brainstorming about what influences our businesses. What influences us to make change? Customers are usually the No. 1 thing, but obviously customers getting together didn’t influence change. So, the next thing was, who are the owners? Who are your investors? If your stock gets beaten up because you’re not doing something right, or sometimes you get investors that try to get active on your board because they don’t think your business is doing well, you’re very susceptible to investor input. So, we thought, wow, that’s a good idea. That’s when I started the research to find the top railroad investors and say, look, how about you meet with us shippers and then we would like to tell you about how we think a picture of growth and working together could work for railroads and shippers into the future, as opposed to this contradictory influence or a contradictory relationship that is there now and see if we can get the investors to help influence railroads to grow. And so that’s where we started to research.
And it just came out to such surprising results. In our opinion, it’s just not something that we expected.
FREIGHTWAVES: What were you expecting to see, and what did you see?
HAKSTEEN: The four U.S.-based railroads have a very different investor profile than the two Canadian-based railroads. So, for instance, [Canadian railway] CN’s No. 1 investor who has a large ownership stake — by large I mean like 4 or 5% — is Bill Gates. So, Bill Gates is the kind of guy who very much cares about the environment, very much cares about the world, right? And so, in that case, we would pen a letter from the private rail car food and beverage shipper association to Bill Gates and say, hey, what can we do about getting your railroad to work with us more? Bill Gates has enough influence with the board and the railroad that he would probably say, I want to hear about it, right? [Investor fund] TCI has a very influential share in the CP [Canadian Pacific], and we could do the same thing with them.
But that’s just not available in the United States because of the shareholder structure of the top four railroads. The SEC makes investors file reports if they have a position of influence on a railroad — or in any company that you invest in. It’s usually that you’ve got to have 100,000 or 100 billion in shares. If you’re an inside investor, like if you’re one of the executives of the company, you’ve got to disclose it [to the SEC]. If you’re a big institutional investor, you’ve got to disclose it, and so on.
So, my research started with the SEC filings. It’s publicly traded information, so it’s not my information. I don’t have to worry about divulging any secret information. When you go through that filing, one of the things that the business has to file is what type of investor they are — institutional or private or whatever — and then their investment profile has to include whether they’re an active or a passive investor. When you declare yourself as a passive investor, you’re declaring that you’re not going to take an active role in the management of the company.
Before your board meetings, the railroads will put out for votes things like giving your board a raise, giving your CEO a fabulous severance package or the company is going to invest X amount of dollars on infrastructure. … But when you’re a passive investor, you are going to vote with the board. So, if you have a very high passive investor community within your company, you’re going to be able to lead your business pretty much unchallenged. Passive investors do not interfere with the management of the company.
I use the word influence throughout my discussions: How do we influence the railroads toward better behavior? The railroads have done such a good job of reducing influence in so many areas. Apparently, they’ve also secured very little influence from outside investors.
Let’s go through the examples. To start with, BNSF (NYSE: BRK) was purchased outright by Berkshire Hathaway in 2010. BNSF is only influenced by their single institutional owner. So that now is Warren Buffett. He is the one who has the only influence over BN that really matters, right? If he tells Katie Farmer, BNSF’s CEO, that he wants her to increase prices by 20%, Katie can say, well, let’s put that to a yes-or-no vote. That’s it. So, BNSF is influenced by no one other than their owner.
UP has no dominant single owner like BN, but in the SEC filings, there are only a total of 10 investors that have a 1% ownership stake or more in that railroad. And of those 10 investors, the top four represent 21% of the ownership vote. And the concern is that four in the top 10 have all filed with the SEC as passive investors. They’re going to vote with the board. What that does is that it gives the board a 20% cushion. Just to stress how good that cushion is, it would take the next 25 top investors to even match that 20% influence. It becomes very difficult to gather a majority vote to act against the railroad’s board recommendations. Realistically speaking, to get a majority of the votes you need 51%. If the first 20% are already in your pocket, that means you only have to get 30% while the other side has to get 51%. So, basically, the board isn’t threatened or concerned about these large shareholder meetings or the shareholder proxy votes.
You roll down to CSX. Twelve parties hold 1% or more of ownership. Those 12 represent 38% of the ownership. But of the 12, four of them are passive investors and they own 21%. NS — four investors own 20%.
Here’s the shocker — and this was a shocker to me. It’s the same four companies that are the passive investors. These are the biggest institutional investors in this country. These four have the same percentage ownership influence over the three railroads that are supposed to be competitors. I’m not making any accusations, but the same biggest investors are going to the annual shareholder meetings and board meetings of the three competitive railroads. How does that make sense? It makes great sense for the railroads because, again, they’re shielded by this 20% vote, but I don’t think it makes sense for the public’s interest.
So, in summary, the four passive large investor groups in the United States hold 20% or more of the outstanding shares of our Class I railroads, giving those railroads unlimited ability to manage their own direction. Their accountability to their shareholders is greatly shielded by that 20% ownership.
Now, on the flip side, I did the data on the Canadian side as well. And the Canadian side is absolutely the opposite. Among the top groups of investors, there’s at least 19 or 20 investors that own at least 1% or more, and of that, only 3% are claimed as passive. So, those railroads are very much impacted [by their shareholders]. And I think that when you look at the Canadian railroads and how they react to customers and how they react to legislation and influence, I think the CP and the CN are in a much different category.
I mean, reciprocal switching [when a shipper has access to one freight railroad but wants access to a nearby competing freight railroad in order to cultivate a competitive pricing environment] is one of the controversial things that’s going on in the U.S. It’s been in Canada for decades. The process of mediating final offer rates has been in Canada and been working for decades. So, they don’t seem to be as afraid of competition in Canada, and they don’t seem to be as afraid of outside influence in Canada. But our U.S. railroads are doing everything they can to protect themselves from this influence.
The Department of Energy wrote that climate blueprint, and they’re saying we want to have a carbon-free world by 2050 and, in order to achieve that, we have to have this modal switch from a lot of trucks to a lot of rail. And we got railroads saying we’re going to do less and make more. Our government wants them to do more. Shippers want them to do more. But the railroads seem to be free to do what they want to do, and they don’t want to do more. They want to make more.
FREIGHTWAVES: What do you think the next steps should be?
HAKSTEEN: What’s next is talking to folks like you to say, wow, do you guys realize this? The second part is we’ll probably reach out to the Department of Energy because we want to talk to them about that climate blueprint.
I’m trying to reach out to the lawmakers. I’m sure you heard in the last month or two about the big Taylor Swift concert and how everybody couldn’t get tickets in a fast and reasonable manner. There were all kinds of hiccups, and they were all blaming Ticketmaster. And so they very quickly put together a Congressional hearing, and they called in the CEO of Ticketmaster to try to establish the level of his monopoly.
And, you know, the sale of Taylor tickets didn’t really affect the U.S. economy. I mean, I don’t think it did. I want our lawmakers to say or to recognize — talk about a monopoly. Your railroads are accused of being a monopoly from their customers’ perspective, but it looks very apparent because here are the facts. The railroads are also monopolized by Wall Street’s largest industrial funds. I want the railroads to respect the fact that they’re a federally regulated industry and that they should accept the [recommendations] of the Surface Transportation Board.
I know we live in a democratic environment. I know this is a free country. But the fundamental issue here is that the railroads are a regulated industry, and they’re not acting like a regulated industry and our federal lawmakers aren’t challenging that. It’s about a behavior change at the railroads.
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