More 'DM&E for sale' news and analysis

Vox Verax is posting the entire TRAINS article about the pending sale of the DM&E railroad with an insightful commentary by Patrick Dempsey following:

TRAINS exclusive: DM&E/IC&E bidders winnowed to around 10

by Fred W. Frailey
June 12, 2007

SIOUX FALLS, S.D. -- Union Pacific and BNSF Railway -- move over. Another railroad is nearer to laying its tracks into Wyoming's Powder River Basin coalfields. Trains has learned that Cedar American Rail Holdings is auctioning some or all of its Dakota, Minnesota & Eastern and Iowa, Chicago & Eastern Railroads to one of about 10 bidders still in the running. Several of those bidding consortiums include other railroads.

DM&E operates a route bought in 1986 from Chicago & Northwestern, from Winona, Minn., west across Minnesota and South Dakota to Rapid City -- 649 miles. From there it goes northwest to Colony, Wyo., and south to Crawford, Neb. In all, DM&E runs over 1,103 route miles.

For a decade the railroad has sought to compete with BNSF and UP for coal business in the Powder River Basin. It proposes building a new 260-mile line from Wall, S.D., along the Cheyenne River to Edgemont, S.D., and then west into the coalfields. The last regulatory hurdle was cleared in Feb. 2006, when the Surface Transportation Board gave its final approval.

All that stands in the way is financing. The estimated cost of building the new line and rebuilding the existing DM&E back to Winona is $2.3 billion to $2.5 billion. Locomotives and facilities could raise the total spending considerably. A sought-after $2.5 billion loan from the Federal Railroad Administration -- part of the $35 billion Railroad Rehabilitation Improvement and Financing program authorized by Congress -- was denied on Feb. 26, on grounds that the railroad would not be able to repay the loan. (But sources tell Trains that the FRA staff actually recommended approval of the loan, and that the railroad's financial health has improved considerably in the past two years.)

Denied the loan, DM&E's owner, Cedar American Rail Holdings, hired Merrill Lynch and Citigroup to explore other ways to finance the Powder River Basin project. Of some 100 entities approached by the investment bankers, approximately 30 expressed an interest in either buying the railroad or partnering with it in some fashion. All were asked to make proposals.

Trains learned that from those 30 interested bidders, approximately 10 consortiums were invited to hear presentations by Kevin V. Schieffer, president and chief executive officer, during the past two weeks. Three railroad companies are reportedly among the 10 semifinalists: Canadian National, Canadian Pacific, and an unnamed shortline company. Each of the three rail companies is partnering with private equity groups or other deep-pocket entities to avoid the issue of controlling ownership of DM&E. Canadian Pacific's Twin Cities-Chicago main line connects directly with DM&E at Winona. Canadian National connects at Dubuque with the IC&E, a sister railroad to DM&E. The 1,400-mile IC&E, made up of former Milwaukee Road lines, was brought under the DM&E umbrella in 2002.

Sources tell Trains that the 10 consortiums have until the end of this week to either affirm (or possibly sweeten) their proposals. It's believed that one final round of due diligence and bidding may remain before Cedar American makes a decision. That decision could involve selling all or part of both railroads, selling part or all of DM&E only or part or all of IC&E. "The nice thing about the FRA loan was that it would have enabled Cedar American to keep control of the company," said one insider. "Now that may not be possible. They may have to accept being junior partner."

DM&E and IC&E connect with each other via an IC&E line that runs north-south from Owatonna, Minn., to near Mason City, Iowa. In addition to interchanging with CP at Winona or CN at Dubuque, IC&E could run its own coal trains right into Chicago, via Savanna, Ill. One insider estimates the cost of upgrading IC&E tracks for coal service from Owatonna to Chicago at hundreds of millions of dollars.

In a letter to employees last week, Schieffer pleaded that they be patient and not fearful. "In the coming weeks," he wrote, "we will have potential investors and possible partners on the property. There are lots of lookers, and we will allow many different players to look things over. But just because they are looking doesn't mean they will ultimately be in the deal, or that there will be a deal."

Cedar American is privately owned. But rail supplier L. B. Foster Co. (symbol FSTR) owns 13.4 percent of Cedar American - the result of a $9 million investment made when DM&E was bought from North Western. Foster's filings with the Securities and Exchange Commission state that the value of its share of Cedar American far exceeds that original investment.

Patrick Dempsey comments:

It's hard to say whether Canadian National or Canadian Pacific has a leg up. I know CP did not want to sell to the DM&E its IMRL assets, which became IC&E after the sale. So, there is no doubt they have interest. CN nearly merged with BNSF seven years ago, but was blocked by the STB and UP. CN has plenty of money to buy DM&E and upgrade the line without any financial difficulties and could further enhance their position around the Great Lakes acquiring DM&E/IC&E.

I could venture a guess on the 'unnamed short line' and it would be either RailAmerica or Genesee & Wyoming Rail. RailAmerica and G&W are large corporations that own several regional and short line roads across the globe. They would probably be 'partners' in a DM&E deal rather than a CN or CP, which would probably purchase the properties outright.

Opinion: A DM&E sale would be the worst possible scenario for Mayo/Rochester. CN or CP would not offer Mayo any mitigation and more than that, they wouldn't have to if they haul coal through Rochester at some point. They both have plenty of money to upgrade and expand to the PRB if either acquires the property. Also, a CN or CP purchase would probably mean wholesale abandonments in Minnesota and Iowa along everything except the coal haul arteries. These companies would have no interest in hauling ag products along its coal arteries. They could care less about the co-ops in towns like Jackson and Sherburn, Minn., and Estherville, Iowa. But I suspect a company like Twin Cities & Western Railroad or Progressive Rail would be able to come in and buy the proposed abandonments and operate the branches as short lines.

Note the Trains article indicates that FRA staff actually recommended approval of the loan. It was politics that killed the loan and not the financial health of DM&E, as I had tried to tell people from the start. An independent DM&E would have been the best situation for Mayo and the upper Midwest, but it looks like that will no longer be the case....

Based on some of my sources in the rail business, I think I am right in saying that one of the "unnamed short lines" might either be RailAmerica or Genesee & Wyoming. Since they are "unnamed" and knowing Schieffer to NOT be a quitter, I find it hard to believe he will sell to CP or CN. My bet would be that DM&E will partner with RailAmerica or G&W in a joint venture with each owning probably half of the Cedar American business. That would certainly be good for the rural communities along the DM&E/IC&E routes if RailAmerica or G&W were involved. I doubt abandonment would be in the plan with RailAmerica or G&W in the mix. RailAmerica and G&W have very deep pockets and access to a lot of capital -- more than enough to fund the PRB project.

Vox Verax note: Whether or not FRA staff recommended the $2.3 billion DM&E loan is for insiders to know and the rest of us (perhaps) to find out. Despite arguments by loan proponents, Vox Verax still believes that the loan was denied based on questions about the DM&E's financial future.

Regardless, the FRA loan program was expanded from $3.5 billion to $35 billion because of pure earmark-style politics. If the DM&E loan also failed because of politics, then let's call it "tit for tat."