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**CONFIDENTIAL**
NationsBanc Capital Markets, Inc.
STRATEGIC RAIL FREIGHT VALUE
OF THE
NORTH CAROLINA RAILROAD
November 1996
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Prepared by:
Corporate Strategies, Inc.
5415-A Backlick Road
Springfield, VA 22151
(703) 941-0560
[Letterhead of Corporate Strategies, Inc.]
November 18, 1996
* * CONFIDENTIAL * *
John Laughlin, Vice President
NationsBanc Capital Markets, Inc.
11th Floor MC-1-007-1109
NationsBank
100 North Tryon St.
Charlotte, NC 28255
Dear Mr. Laughlin:
Corporate Strategies, Inc. (CSI) has completed its study to evaluate the
Strategic Rail Freight Value of the North Carolina Railroad. The objective of
our study was to help NationsBanc Capital Markets, Inc. determine a fair market
value for buying out minority shareholders, whether there is an underlying value
of NCRR that supports an offer that is significantly higher than the current
price for NCRR stock, marketed in the OTC market.
Our study supports earlier findings, that for use as a railroad, the $8
million lease rate agreed to by the Norfolk Southern is not an unreasonable
amount or basis for valuation (along with other lesser income considerations).
The study also notes that NS would incur higher costs to avoid NCRR, mostly
through loss of revenues, and that upgrading its alternate route from Charlotte
to Greensboro via Winston Salem would be costly, add transit time, and that
urban related issues could limit the amount of traffic that could be moved via
this route. In summary, NCRR needs NS and NS benefits from NCRR, but the $8
million lease approaches the threshold where NS may justify the cost to gain 100
percent control of its operations without dealing with the owners of the NCRR.
Our report is divided into an Executive Summary, four chapters, and two
appendices:
Executive Summary
I - Introduction
II - Review of Prior Studies
III - Additional Cost to NS to Bypass NCRR
IV - Pro Forma Analysis of NS Without a Lessee
Appendix A - NS Unit Cost Development
Appendix B - NCRR Pro Forma Development Without Lessee
We would be pleased to answer questions concerning the enclosed report.
Very truly yours,
/s/ Robert H. Leilich
Robert H. Leilich
President
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**CONFIDENTIAL**
NationsBanc Capital Markets, Inc.
STRATEGIC RAIL FREIGHT VALUE
OF THE
NORTH CAROLINA RAILROAD
November 1996
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Prepared by:
Corporate Strategies, Inc.
5415-A Backlick Road
Springfield, VA 22151
(703) 941-0560
Corporate Strategies, Inc.
- --------------------------------------------------------------------------------
STRATEGIC RAIL FREIGHT VALUE
OF THE
NORTH CAROLINA RAILROAD
TABLE OF CONTENTS
EXECUTIVE SUMMARY
Chapter I - Introduction......................................... i
Chapter II - Review of Prior Studies............................. i
Chapter III - Additional Cost to NS to Bypass NCRR............... ii
Chapter IV - Pro Forma Analysis of NS without Lessee............. iii
Conclusions...................................................... iv
CHAPTER I - INTRODUCTION
Nature of the Problem............................................ I - 1
Study Objectives................................................. I - 2
CHAPTER II - REVIEW OF NEGOTIATIONS AND PREVIOUS STUDIES
NCRR Ownership.................................................. II - 1
Buyout of Minority Shares by North Carolina..................... II - 2
Summary of Least History........................................ II - 3
Summary of Rejected Lease Terms................................. II - 4
Applicable Interstate Commerce Act Law.......................... II - 5
Shareholder Derivative Legal Actions............................ II - 6
STB Petition.................................................... II - 7
Summary of Prior Studies........................................ II - 8
NCRR Comments................................................... II - 15
CSI Observations................................................ II - 20
CHAPTER III - ADDITIONAL COST TO NS TO BYPASS NCRR
Overview........................................................ III - 1
Diversion of Overhead Traffic................................... III - 1
Diversion of Other Traffic...................................... III - 3
Calculation of NS Cost Increases and Revenue Losses............. III - 3
CHAPTER IV - PRO FORMA ANALYSIS OF NCRR OPERATIONS WITHOUT NS AS
LESSEE
Overview......................................................... IV - 1
Pro Forma Development............................................ IV - 2
Conclusions...................................................... IV - 4
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LIST OF EXHIBITS
Exhibit Page
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I-1 Norfolk Southern and NCRR Leased Lines I - 3
II-1 1993 North Carolina Railroad Traffic Estimates II - 9
II-2 Summary of Pro Forma Evaluation II - 13
II-3 NCRR Action Alternatives II - 14
II-4 Charlotte to Greensboro Upgrade Costs (Existing Line) II - 16
II-5 Charlotte to Greensboro Second (Main) Track Construction II - 17
III-1 Summary of Estimated Incremental Ns Operating Statistics
to Bypass NCRR III - 4
III-2 Summary of Estimated Incremental NS Operating Costs to
Bypass NCRR - 1995 NS Cost Base - 3rd QTR 1996 Cost Level III - 5
III-3 North Carolina Railroad and Connecting Lines III - 9
III-4 Net NS Costs to Avoid NCRR III - 8
IV-1 Summary of First Year Pro Forma Estimates, NCRR as an
Independent Operator Under Ns Diverted Traffic
Assumptions IV - 3
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EXECUTIVE SUMMARY
The following summarizes observations, comments, findings, and conclusions
of the four chapters contained in this study.
CHAPTER I - INTRODUCTION
Principal study objectives are to:
1. Review the history of negotiations and contributing studies, making
constructive comments as appropriate;
2. Estimate the cost to NS to implement alternatives to using NCRR;
and,
3. Review the feasibility and financial impact of NCRR operations
without a lessee, including preparation of pro forma financial
statements for each of three NCRR segments (Charlotte-Greensboro,
Greensboro-Raleigh, and Raleigh-Morehead City).
A map of involved rail lines is shown in Exhibit I-1.
CHAPTER II - REVIEW OF PRIOR STUDIES
Key points extracted from prior studies, NCRR's Proxy Statement, and CSI's
comments are as follows:
o The $8 million lease accepted by NCRR after nearly two years of
negotiations is inadequate in the eyes of minority shareholders.
o By virtually every measure examined by the Board and consultants
(including CSI), the $8 million lease rate is reasonable or superior
in value.
o NS has indicated an unwillingness to increase its offer and is
threatening to divert up to 75 percent of all traffic (non-captive
overhead) to alternative routes if the lease is not renewed.
o NS could divert substantial additional NCRR originating and
terminating traffic in cities reached by its own lines (reducing
NCRR traffic to less than 12 percent of traffic currently handled,
as described in Chapters III and IV).
o The Surface Transportation Board (STB) has economic jurisdiction to
prescribe and apply a methodology for determining a reasonable lease
rate, but may not be able to force NS to accept a higher rate if NS
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decides not to renew the lease. A decision could take up to 18
months (longer with appeals).
o NS cannot discontinue service, nor can NCRR (or third party
operator) provide service without STB approval. This could take
months or years more to resolve.
o Meanwhile, NS is disinvesting in the property by withholding
maintenance expenditures and traffic development. Discussions with
the State on corridor development are on hold.
o One study determined that on a Net Reproduction Cost Less
Depreciation (NRCLD) basis the NCRR could be worth up to $400+
million. This exercise is meaningless as a measure of value, since
the railroad would never be built at this cost, given the far less
expensive alternatives which exist.
o Even though alternative use of NCRR property could increase value,
it is a fact of life that the property is a rail corridor, most of
which cannot be used for any other purpose (the public and STB would
not allow it).
o NCRR's primary value is as a railroad. Because so much traffic is
controlled by NS, it is of greatest value to NS. Without NS traffic,
NCRR would be of lesser value to the State or other third party.
o Alternatives of NS to divert traffic are real, though it will
require some major capital costs, some incrementally higher costs
per unit of traffic, and possibly longer transit times.
CHAPTER III - ADDITIONAL COST TO NS TO BYPASS NCRR
CSI's study concluded the following:
o All non-captive overhead traffic could be diverted via a variety of
alternate routes.
o Diversion of all traffic via NS's Charlotte-Greensboro line is
technically feasible, but severe constraints with respect to heavy
vehicular traffic and grade crossings, close proximity to
residential and industrial developments, bridges, sharp curves, and
even rolling (but not severe) gradients do not make this route a
practical alternative. However, we believe this line, properly
upgraded, could handle 15 - 20 trains per day.
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o Most line-haul traffic originating and terminating on NCRR in
Charlotte, Salisbury, Lexington, Greensboro, and Raleigh could be
retained by NS under switching rights or switching rates.
o NS could operate without Linwood (Spencer) yard and would not
require a new yard on any alternate route.
o Certain costs to upgrade the alternate NS line between Charlotte and
Greensboro are believed to be overestimated. For example:
- train control (signal costs) are too high;
- much less than 65 MPH second main track is required (CSI
believes long passing sidings every 5 - 10 miles would be
adequate); and
- the Winston-Salem Greensboro line is already a high quality,
heavy duty line (but without signals).
o The Wilbur Smith study did not address costly bridge rebuilding or
severe grade crossing issues which must be resolved.
The net cost for NS to bypass NCRR is estimated to be about:
NET NS COSTS TO AVOID NCRR
Annuity Dollars
Item (Millions)
Reduction in track maintenance costs ($9.4)
Savings in NCRR lease payments (8.0)
Savings in other operating costs (7.7)
Capital improvements amortization* 14.5
Lost revenue 13.8
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Net annual cost increase* $3.2
* This annuity is very sensitive to initial capital costs to upgrade
the alternative route. If costs are $50 million higher than the
$150 million assumed, it adds $4.6 million in annuity costs.
CHAPTER IV - PRO FORMA ANALYSIS OF NCRR WITHOUT LESSEE
Inadequate traffic details and uncertainties with respect to possible NS
actions and payments to NCRR make it impossible to reliably estimate NCRR
operating costs if NS were to divert traffic from NCRR. Other findings and
conclusions in this chapter were:
o The continued need for NCRR to maintain passenger level track
standards will far exceed payments from Amtrak and severely impact
the viability of NCRR on a stand alone basis.
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o The net cost of continuing passenger service is $1.8 million in
excess of Amtrak's $.6 million payments.
The probable "worst case" cost of independent operations of NCRR is:
SUMMARY OF FIRST YEAR PRO FORMA ESTIMATES
NCRR AS AN INDEPENDENT OPERATOR
UNDER NS DIVERTED TRAFFIC ASSUMPTIONS
($ Thousands*)
Charlotte- Greensboro- Raleigh-
Greensboro Raleigh Morehead City Total
---------- ------- ------------- -----
Revenue
- -------
Freight Divisions $ 2,126 $2,455 $ 2,122 $ 6,703
Switching 1,693 3,460 0 5,153
Demurrage 69 91 51 211
Property Rents 30 30 0 60
Amtrak 373 241 69 683
------- ------ ------- --------
Total Revenue $ 4,291 $6,276 $ 2,241 $ 12,808
Expenses
- --------
Maintenance of Way $ 3,618 $3,258 $ 2,335 $ 9,211
Maintenance of Equipment 270 327 174 771
Transportation 535 689 339 1,563
G & A 269 303 230 802
Car-Hire & Other 250 279 60 589
------- ------ ------- --------
Total Operating Expenses $ 4,943 $4,857 $ 3,138 $ 12,938
Net Ry Operating Expenses ($ 652) $1,420 ($ 897) ($ 129)
Fixed Charges (Debt) Interest 249 286 179 714
------- ------ ------- --------
Net Income ($ 902) $1,134 ($1,075) ($ 843)
*Numbers may not add exactly due to rounding.
CONCLUSIONS
None of the previous studies, nor this study support or justify
terminating the NS lease based on unreasonableness. Approached from every
reasonable viewpoint or basis of comparison using information available to CSI,
the $8 million lease rate offered by NS does not appear inequitable,
unreasonable, or below what NS should pay.
Delay in the resolution of the present disagreement between the Board and
the minority stockholders of the NCRR risks a significant, deleterious effect on
the value of the property. With uncertainty over continuing service over the
NCRR, Norfolk Southern can be expected to make incremental decisions that may
gradually shift more traffic away from NCRR. The longer the delay in resolving
lease related issues, the greater will be
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NCRR's risk exposure (a greater likelihood of negative impacts on NCRR). NS is
already "banking" maintenance cost savings for application to the outcome of
lease negotiations (to invest in its own lines, or reinvest back in the NCRR
route).
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STRATEGIC RAIL FREIGHT VALUE
OF THE NORTH CAROLINA RAILROAD
I - INTRODUCTION
NATURE OF THE PROBLEM
In late 1994, after two years of negotiation, the Board of Directors of
the North Carolina Railroad (NCRR) approved an extension of the 1895 and 1939
leases (called the Lease Extension Agreement) for Norfolk Southern (NS) to
operate over 317 miles of railroad and properties owned by NCRR. Annual payments
were to be $8 million, subject to inflation. As part of, and in preparations for
negotiations, NCRR commissioned Wilbur Smith & Associates, ALK Associates,
American Appraisal Associates/Standard Research, and Morgan Stanley to assist it
and NCRR's counsel to determine both fair values of NCRR and a fair lease rate.
Minority stockholders believe that the lease rate is inadequate and, on a
technicality that there was not a quorum of minority shareholders represented
when the Board approved the lease, filed a suit to have the decision overturned.
The court ruled in favor of minority interests. Consequently, NS is presently
operating over the property without a formally approved, legally binding lease
agreement.
With much of NCRR strategically located in fast growing areas between
Charlotte-Greensboro-Durham-Raleigh, the value and best use of the rail corridor
is perceived differently by the State of North Carolina, the NS, and minority
NCRR shareholders.
The NS prefers to conduct operations over NCRR in a manner which best
serves its corporate interests, much as it has done in the past. The State,
however, is concerned about a broader potential for the corridor including more
passenger train operations, high speed rail passenger service, and the support
of certain commuter rail services.
In the absence of consensus among stockholders and a partnership approach
to developing the corridor's fullest potential, NCDOT seeks to strengthen its
control of NCRR and ability to negotiate with NS without the impediments of the
present ownership structure. Buying out minority shareholders would serve those
interests.
While NCDOT is evaluating its options, NS is also evaluating alternatives
to uncertainties with respect to its continued operations over NCRR.
Alternatives include ceasing or greatly reducing its operations over NCRR. The
NS can provide most services via alternate routes. Though not as well suited as
NCRR routes, they could meet, or be upgraded to meet, priority operational
requirements. NS could also give up all or portions of its local NCRR freight
operations.
The recent announcement of a merger between CSX Transportation and Conrail
and NS's own bid for Conrail could add a new dimension to the future of through
and local traffic on NCRR (and within the state) if concessions are negotiated
by or forced on the
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merging railroads. These changes could increase or decrease the strategic value
of NCRR, adding another issue that the state needs to consider.
If NS were to direct traffic away from NCRR either on its own or as an
outcome of a Conrail merger, it would greatly reduce the value of NCRR to NS. It
would make it easier for the state, however, to resolve some issues with respect
to planned passenger services.
If there is a possibility of increased freight traffic as a result of
merger or merger concessions, it could require more plant capacity enhancements
in certain NCRR corridors. From a positive viewpoint, this too, could serve both
NS and state interests.
If North Carolina were to buy out minority shareholders, it would have
greater flexibility to address competitive service issues that are important to
the state. The state could also decide to terminate the lease or reduce the
miles of line it leases to NS. The state could even grant trackage rights
instead of leasing the property to NS, leaving it in more control of NCRR
operations. Finally, in the absence of a lease, the state could, conceptually,
contract the operation of freight services, passenger services, or both to a
third party.
The actions of each of the parties, the issues involved, and external
railroad merger possibilities have created very complex questions and issues
that could affect minority stock valuation. In the public markets of actively
traded stocks, it is customarily assumed that the market price of stock reflects
its perceived value. Any premium paid to acquire controlling stock interests is
presumed to reflect a higher value perceived by the party making a tender offer.
With 75 percent of NCRR stock owned by the State of North Carolina and the
privately owned stock not widely traded, other factors need to be reviewed and
considered in making an offer to buy out minority shareholders. This study is
intended to further help the state take the initiative in creating an
environment where the NCRR can be developed to its fullest potential, resolving
the present ownership impediments and uncertainties.
STUDY OBJECTIVES
Principal objectives of CSI's study are to:
1. Review history of negotiations and contributing studies, making
constructive comments as appropriate;
2. Estimate cost to NS to implement alternatives to using NCRR; and,
3. Review feasibility and financial impact of NCRR operations without a
lessee, including preparation of pro forma financial statements for
each of three NCRR segments (Charlotte-Greensboro,
Greensboro-Raleigh, and Raleigh-Morehead City).
A map of NCRR and relevant NS lines is enclosed as Exhibit I-1.
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EXHIBIT I - 1
CORPORATE STRATEGIES, INC.
NORFOLK SOUTHERN AND NCRR LEASED LINES
[Map Omitted]
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II - REVIEW OF NEGOTIATIONS AND PREVIOUS STUDIES
NCRR OWNERSHIP
Out of 10 million authorized shares of common stock, 4,283,470 shares have
been issued, of which 3,207,173 shares are owned by North Carolina, or 74.87
percent of the total. Directors and officers own 26,700 shares. (Directors
elected by "privately owned" shares own 15,080 of those 26,700 shares.) The
balance of 1,049,597 are owned by private shareholders, including NS. NS
beneficially owns 113,855 shares of the common stock of NCRR, approximately 2.7
percent of all stock outstanding or 10.6 percent of private shares. Further,
NCRR owns 9.6 percent of outstanding common stock of the State University
Railroad, where the majority of that railroad is owned by NS.
The State of North Carolina is not a party to the Lease Extension
Agreement. Accordingly, the Board of Directors has not considered the state to
be an interested party. In some instances, state law treats NCRR somewhat
differently than other corporations. For example, Section 124-5 of the General
Statutes requires approval of the Governor and counsel of state prior to NCRR
being able to sell or lease its assets. However, the state believes NCRR is
useful in the economic development of the state and wants a more active role in
its development.
Quorum Requirements
The original charter and by-laws of NCRR contain unique provisions
designed to balance the interests of the state and other shareholders. An
example of this is the special requirements for voting shares, which require a
quorum of both public and private shares. The NCRR charter provides that 10
Board members are elected by the state and 5 (additional) members of the Board
are elected by private shareholders, the latter of which is disproportionate to
the private shareholders ownership share. If the state purchases additional
shares or sells shares, there is no provision for reducing or increasing the
number of Board members.
The Board of Directors believed that whatever economic development
interests the state may have, those interests are substantially consistent with
the interests of the other shareholders of NCRR to the extent the growth of
revenue traffic along the line is promoted. The board unanimously approved a
Lease Extension Agreement because it determined that the agreement is in the
best interest of all the shareholders of the railroad. The Board felt that the
Lease Extension Agreement met the following primary strategic objectives:
Maximize shareholder value by maximizing distributable after tax
income to the shareholders consistent with minimizing the risks (1)
that income will be disrupted, and (2) that the value of the assets
of the NCRR will be impaired.
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The Board believed that the Lease Extension agreement promoted the foregoing
objective better than any other alternative realistically available to the NCRR.
In certain litigation, it has been alleged that the state's interest in
economic development is inimical to the interests of the other shareholders of
NCRR because of the state's desire to promote industrial growth in areas
adjacent to NCRR. The Board believes that this is equivalent to saying that the
state's desire to increase the number of shippers near the NCRR is in conflict
with the interests of other shareholders.
The Board believes that it is in the interest of all shareholders that
volume of revenue traffic over NCRR increase. The Board sees no conflict of
interest between the economic development interests of the state and the
interests of private shareholders. The interest of all is promoted by increasing
the value of the NCRR.
Legal actions described later, were filed after the market price of NCRR
stock dropped significantly following announcement of tentative terms of the
Lease Extension Agreement in November 1994. Certain stockholders believed that
the lease rate negotiated by the Board was inadequate, and the result of
conflict of interest. The value of stock preceding the announcement reflected
the anticipation of more favorable lease terms.
The Board noted that if NCRR were to operate the railroad, it could be
exposed to conflicts of interest if it approved rates which were sufficiently
low to be a major factor in promoting industrial development along the line, but
depressed earnings and stockholder value.
BUYOUT OF MINORITY SHARES BY NORTH CAROLINA
During negotiations, certain shareholders suggested that it would be in
the best interest of shareholders to either sell all or substantially all of the
stock or assets of the NCRR to the State of North Carolina or to reorganize the
ownership of the railroad. As an alternative to buyout of minority shares, it
was proposed that the state would own 100 percent of the eastern portion of NCRR
lines with lower traffic densities and other shareholders would own a greater
percentage of the western portion of the NCRR. The NCRR's Board determined that
it would not pursue serious consideration of such proposals unless it were
determined that the state had serious interest in pursuing such a buyout or
reorganization.
Some shareholders expressed concern that the economic terms of the lease
agreement will be the basis for valuation of NCRR stock. The Board declined to
take a position in this determination or to get involved in the speculation of
alternatives.
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Early in its negotiations, NCRR discussed sale of NCRR to NS. NS did not
show significant interest in purchasing NCRR.(1)
SUMMARY OF LEASE HISTORY(2)
The North Carolina Railroad Company was incorporated in 1849, and began
operations in 1854. In 1871, the NCRR leased virtually all of its assets to a
predecessor of the Southern Railway which, in turn, merged with the Norfolk and
Western Railway in 1982 to form the Norfolk Southern (NS) Railway. The term of
lease was for 99 years, at a fixed annual rate of $266,000 until 1901,
thereafter at $286,000, not subject to escalation.
In 1989, the NCRR acquired the Atlanta and North Carolina Railroad, the
assets of which were subject to a lease dating to 1939 with the Atlantic and
East Carolina Railway Company, a wholly-owned subsidiary of NS. The last
combined payment on both the 1895 and 1939 leases was $306,958 for calendar year
1994.
Both the 1895 and 1939 leases expired on December 31, 1994, with no
requirement for renewal. NS, however, cannot discontinue operations over the
leased lines without Surface Transportation Board (STB) approval.
In 1968, NCRR and NS renegotiated a portion of the 1895 lease for three
parcels of land in the Charlotte area. These parcels were released from the 1895
lease and, separately and entirely, were covered by the 1968 lease, which
expires in 2067. Annual rental is for $81,319 until 2018, after which it becomes
6 percent of the current value of the leased properties.
In the fourth quarter 1994, NCRR and NS reached tentative terms on a long
term extension of the 1895 and 1939 leases, with the exception of an expiration
date. On August 10, 1995, the NCRR Board of Directors approved a Lease Extension
Agreement, retroactive to January 1, 1995. In December 1995, the state approved
and voted its majority of shares to accept the lease. However, a shareholder
legally challenged the validity of shareholder approval. Additional derivative
litigation was filed to enjoin the Lease Extension. The Lease Extension
Agreement is currently in escrow, though the NS began good faith payments as if
the Lease Extension Agreement were in place. In August 1996, with no solution in
sight, NS stopped making lease payments, depriving NCRR of its principal source
of revenue.
Until the lease was suspended by the courts, NS had worked with NCRR to
structure payments to NCRR in such a way to facilitate NCRR's desire to become a
Real Estate Investment Trust (REIT) in order to take advantage of its income and
capital earnings pass-
- ----------
(1) Presumably, this reflects NS' conclusions that a lease is economically
equally or more advantageous to NS than purchase.
(2) Abstracted from NCRR's proxy statement for a shareholder meeting held on
December 15, 1995.
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through (no tax) provisions. NCRR's plans to seek REIT status have been
postponed as a result of litigation.
SUMMARY OF REJECTED LEASE TERMS
A summary of lease terms accepted by majority shares (State of North
Carolina), but rejected by minority shareholders were as follows:
o $8 million for calendar year 1995, subject to inflationary increases
in subsequent years as measured by the Implicit Price Deflator for
the Gross National Product (IPD-GNP) (subject to certain
limitations), but never less than $8 million.
o Expiration on December 31, 2024 with an option by NS to extend for
another 20 years. Exercise of option requires a payment of an option
fee equal to 25 percent of the previous year's lease rate, or $5
million, whichever is greater.
o A one-time payment of $5 million in exchange for NCRR release of
NS's obligation to return certain personal property on expiration of
the original lease;
o The $5 million payment does not waive NCRR's claim to the Linwood
(Spencer) yard, or other payments, but provides that such claims are
postponed to the termination of the Lease Extension Agreement.
o 317 miles of road, between Morehead City and Charlotte are included
in the Lease Extension Agreement.
o NCRR has rights to utilize non-operating properties as it sees fit,
but NS retains control over operating properties.
o NS will pay to NCRR 75 percent of the income it receives for
granting of certain rights and easements, such as fiber optic cable,
along NCRR right-of-way.
o NS required to fully maintain and operate railroad and to indemnify
NCRR from liability claims related to its operation of the railroad.
o The December 31, 1968 ("Charlotte") lease is not affected, and
continues as is until December 31, 2067. The "Charlotte Lease"
covers three parcels of land in Charlotte, for which NS paid $81,319
in 1995.
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The Board of Directors approved the Lease Extension Agreement as in the
best interest of shareholders because:
o There was no other potential lessee which expressed an interest in
the properties;
o The terms of the lease would permit NCRR to elect a Real Estate
Investment Trust (REIT) tax status, avoiding Federal corporate
income taxes on ordinary income and capital gains tax on
distribution to shareholders;
o Other comparable leases have lower lease payments per million gross
ton-miles;
o Most NCRR traffic is overhead traffic outside control of NCRR;
o Risks associated with continued negotiations appeared to offer no
likelihood of improved benefit to NCRR;
o NS has ability to divert overhead traffic away from NCRR, reducing
its strategic value to any other potential operator; and,
o Strength of NS offers revenue stability.
In spring of 1994, when lease negotiation progress ceased, NCRR
contemplated requesting the ICC to set compensation. NCRR's counsel advised that
it was unpredictable what the ICC might determine, how long the proceeding might
take, and that NS would still be free to seek to discontinue operations on all
or part of the NCRR's line which, if granted, would eliminate the requirement to
pay compensation for that portion of the line. It could also open the door for
the NS to re-petition the ICC for a reduction in payments. Since the
compensation rate would not be a negotiated rate, it virtually guarantees that
one party or the other will be unhappy with the rate. NS appears to be in a
better position to make it difficult for NCRR to meet the financial objectives
of its shareholders.
NCRR's counsel noted that the Interstate Commerce Act does not prescribe a
particular formula or methodology for the determination of the compensation one
railroad pays to another for operations over a line of railroad. The selection
of a methodology is left to the discretion of the ICC (now STB). NCRR was
advised that a possible methodology could be Reproduction Cost New, Less
Depreciation (RCNLD), but that other methodologies also exist. The methodology
the ICC (STB) might use is determined on a case-by-case basis.
APPLICABLE INTERSTATE COMMERCE ACT LAW
NCRR researched provisions of the Interstate Commerce Act as it might
apply to the issues. Under Section 10903, a railroad is not permitted to abandon
or discontinue
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operations over any line (including a line leased from another party) without
the prior approval of the ICC (STB). Before a railroad can file an abandonment
application, the line must have been listed in its system diagram map on file
with the ICC (STB) for at least four months as potentially subject to
abandonment.
The same section also provides that the ICC (STB) may authorize an
abandonment or discontinuance of operations over all or part of a line only if
it finds the present or future public convenience and necessity requires or
permits the abandonment or discontinuance. In applying these criteria, the ICC
must balance the harm to the shipping public that would result from the
abandonment or discontinuance against the burden imposed on the carrier and on
interstate commerce by continuing operations. The railroad has the burden of
proof to demonstrate that abandonment or discontinuance is justified. Generally,
the ICC (STB) will not approve an abandonment or discontinuance unless the
railroad can demonstrate that the revenues received from an operation over a
line fail to cover its costs as defined by the ICC (STB) to yield a reasonable
return.
The Act is not clear what happens if either party decides not to renew the
lease. Presumably, since the ICC (STB) had to approve the lease from NCRR to NS
in the first instance, it must similarly approve the termination of the lease.
Should the STB approve the termination of the lease, NCRR would then have the
burden to operate the railroad or find an operator to do so (which, again, would
require STB approval).
Should the lease be terminated and operations transferred to NCRR or its
designated operator, the STB would still have jurisdiction to adjudicate the
lease rate for the period between the expiration of the lease and the time a
certificate for termination of NS services is granted (a proceeding that could
easily take 2 years).
CSI notes that the STB could make the finding that, since NS and the Board
of Directors agreed to an annual $8 million lease, it represents a fair value.
The STB need not be bound by the unusual structure of NCRR ownership which gives
minority stockholders a disproportionate voice in shareholder decisions.
SHAREHOLDER DERIVATIVE LEGAL ACTIONS
Four minority (private) shareholder derivative actions were filed between
December 1994 and February 1995. Two of the filings sought to enjoin the lease
between NCRR and NS and to recover for the NCRR unspecified damages and other
relief from the directors. Two of the other actions seek similar relief and also
named the state and the governor and the NS as defendants.
Two of the actions allege misconduct by the Board of Directors, including
breach of fiduciary duty, mismanagement, and waste of corporate assets. The
other two actions assert similar claims but also allege collusion between the
state and NS, producing a below-market lease rental rate. The actions further
assert that the state has condemned NCRR's properties for public uses for the
benefit of the state.
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NCRR, along with codefendants, filed motions to dismiss or stay the
actions. On October 18, 1995, however, the court denied the motions to dismiss,
granted the motions to stay the proceeding until such time as the stockholders
voted on the Lease Extension Agreement, and granted the motion by the plaintiffs
for leave to supplement their pleadings. The NCRR is opposing the actions
brought by the plaintiffs to the extent the actions seek to enjoin any lease
arrangement or seek recovery against NCRR, or seek any remedy against the best
interests of the NCRR or its shareholders.
Dissenters Rights
The general statutes of the state specify situations in which shareholders
have a right to dissent and have their shares appraised and purchased [by] a
corporation. It does not cover votes on leases of assets. Consequently, no
appraisal rights are available to shareholders who oppose the Lease Extension
Agreement.
In other legal actions, NCRR has filed a complaint with the Superior Court
of Wake County, North Carolina, to adjudicate a dispute with NS concerning
title, property ownership, and other claims with respect to certain other
assets.
STB PETITION
The NCRR's proxy statement contained arguments why the $8 million annual
lease is the best NCRR could obtain. It noted that there are many reasons why
the STB should not be asked to set the level of lease compensation. In late
summer of 1996, however, the Board of Directors reversed its position and
directed NCRR counsel to seek Trackage Rights Compensation and force NS to
continue making payments as if the lease were in effect. The Board changed its
mind because NS stopped making provisionary payments and because of additional
pending litigations that may partly be adjudicated by the STB's jurisdiction
over railroad operating leases.
On September 23, 1996, the NCRR filed a petition with the Surface
Transportation Board to set trackage compensation. The petition proposed two
phases:
o Phase I - Request for STB to determine the appropriate methodology
for valuing the NCRR line; and,
o Phase II - STB's application of that methodology to the facts in
this proceeding.
The NCRR requested expedited handling of this request, filed under Finance
Docket No. 33134. A second petition was also filed on the same date, requesting
interim relief, ordering NS to continue making lease payments.
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SUMMARY OF PRIOR STUDIES
Prior to this study, the NCRR sponsored at least five studies to support
its interests:
o 1982 Valuation of NCRR by Printon, Kane (not reviewed);
o 1986 Valuation study by American Appraisal Associates/Standard
Research (not reviewed);
o 1992 Track Evaluations to upgrade NS' Charlotte-Greensboro line;
o 1993 Traffic Study and preparation of NCRR Pro Forma by ALK
Associates;
o 1993 Valuation Study of NCRR by Mercer Management Consulting; and,
o 1995 Analysis of NCRR Options by financial advisors, Morgan Stanley.
Selected highlights of the last three studies are reviewed here.
1993 ALK Traffic Study and Pro Forma
ALK used four data sources for its study:
o 1993 ICC waybill sample to derive traffic and revenue data;
o Princeton Transportation Network Model for distances, locations, and
routings;
o Uniform Railroad Costing System to develop cost ratio factors and
average tare weights; and,
o Analysis of Class I railroads, published by AAR to verify overall
traffic levels represented in ICC sample and as a source of NS cost
and financial data.
According to ALK, the 1993 waybill sample for NS under represents cars,
tons and ton-miles and over represents revenue and car-miles.
The revenue allocation methodology used by ALK is based on dividing
movements into 100 mile blocks, rounding up to the nearest whole number. The
origin carrier was given an additional 100 mile block and the terminating
carrier was similarly given a 100 mile block. Revenue was then divided among the
carriers in relation to the mileage blocks
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attributable to each carrier. For purpose of ALK's study, the NCRR was treated
as a carrier separate from NS.
Exhibit II-1 is a summary of ALK's revenue estimates, derived from the
waybill sample of revenue movements. The column L,F,R,OC is the sum of Local,
Forwarded, Received, and Overhead Captive Traffic. Local traffic originates and
terminates on the NCRR. Forwarded traffic originates on NCRR but is delivered to
NS or interchanged to another railroad.
EXHIBIT II-1
1993 NORTH CAROLINA RAILROAD TRAFFIC ESTIMATES
Revenue Movements Only
- ----------------------------------------------------------------------------------------------------------------------
Total Total Overhead Overhead
All Traffic L,F,R,OC Local Forwarded Received Captive Non-Cap
- ----------------------------------------------------------------------------------------------------------------------
Cars 392,686 95,488 1,188 27,956 56,756 9,588 297,198
- ----------------------------------------------------------------------------------------------------------------------
Tons (000) 24,686 5,528 84 886 3,731 827 19,158
- ----------------------------------------------------------------------------------------------------------------------
Revenue ($000) 84,441 25,098 757 5,851 14,905 3,585 59,343
- ----------------------------------------------------------------------------------------------------------------------
Car-Miles (000) 33,526 8,355 93 2,517 4,700 1,045 25,171
- ----------------------------------------------------------------------------------------------------------------------
Ton-Miles (000) 2,041,863 510,189 5,729 92,647 324,029 87,784 1,531,674
- ----------------------------------------------------------------------------------------------------------------------
Percent of Total
- ----------------------------------------------------------------------------------------------------------------------
Cars 100 24.4 .3 7.1 14.5 2.5 75.6
- ----------------------------------------------------------------------------------------------------------------------
Tons 100 22.3 .3 3.5 15.2 3.3 77.7
- ----------------------------------------------------------------------------------------------------------------------
Revenue 100 29.7 .8 7.0 17.7 4.2 70.3
- ----------------------------------------------------------------------------------------------------------------------
Car-Miles 100 24.9 .2 7.5 14.1 3.1 75.1
- ----------------------------------------------------------------------------------------------------------------------
Ton-Miles 100 24.9 .2 4.6 15.9 4.2 75.1
======================================================================================================================
Rev/Ton-Mile 4.14 4.92 13.21 6.32 4.60 4.08 3.87
(cents)
- ----------------------------------------------------------------------------------------------------------------------
Tons/Car 62.9 57.9 70.7 31.7 65.7 86.3 64.5
- ----------------------------------------------------------------------------------------------------------------------
Revenue/Car $215 $263 $637 $209 $263 $374 $200
- ----------------------------------------------------------------------------------------------------------------------
NOTE: L,F,R,OC is Local, Forwarded, Received, and Overhead Captive Traffic
- ----------------------------------------------------------------------------------------------------------------------
Source: ALK 1993 Traffic Study and Pro Forma for the North Carolina
Railroad, Table 2, p.5.
Received traffic terminates on the NCRR, coming from NS or another
railroad. Overhead captive is traffic which neither originates or terminates on
NCRR, but which must move over NCRR. A good example of this is traffic
originating or terminating on the Durham-Oxford branch or the Highpoint-Ashboro
branch of NS (see Exhibit I-1). Overhead noncaptive is traffic routed via NCRR
which neither originates nor terminates, but which could be diverted or
rerouted.
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The exhibit shows that over 75 percent of all carloads are noncaptive
overhead traffic which could be diverted away from NCRR. The revenue associated
with this traffic is approximately 70 percent of total NCRR revenues.(3)
Since the waybill sample contained only loaded movements, ALK estimated
empty car-miles by using system average ratios of empty to loaded car-miles for
NS for each car type (using the Association of American Railroads Fact Book).
Gross ton-miles were computed by adding net loaded ton-miles, tare weight
ton-miles for the loaded movement and corresponding percentage tare weight
ton-miles for empty movements. Average tare weights were calculated using 1993
Uniform Railroad Costing System (URCS) ratios.
To develop operating expenses assigned to NCRR, ALK appeared to use a "top
down" approach. This includes the use of URCS data, Rail Form R-1 Annual
Reports, and information compiled by the AAR, in its Analysis of Class I
Railroads (which also includes data from other AAR sources).
First, using URCS percentages, they calculated the variable portion of
total cost, which they then apportioned on a formula basis between operating
variables such as gross ton-miles and car-miles, etc., then assigned the
apportioned costs to the NCRR in relation to the number of operating units on
NCRR in relation to operating units for total NS.
In its study, ALK noted that its computer based methodology was unable to
estimate revenues and costs associated with switch movements.
The calculation of expenses was based on apportioning total NS expenses
based on ratios of NCRR to total NS operating statistics most closely associated
with those expenses. Their approach was, at best, simplistic, and given the wide
margin of error for both estimating revenue and expenses, it is not possible to
have confidence in the reliability and validity of their findings.(4)
Given the above constraints, ALK estimated that NCRR, as operated by NS,
contributed $17.1 million to NS' Net Railway Operating Income (NROI). If
non-captive overhead traffic is excluded, NROI drops to $3.4 millon.(5)
- ----------
(3) A significant percentage of originated and terminated traffic could also be
diverted, as discussed in Chapter III.
(4) CSI is also handicapped in its efforts to develop a pro forma because of
insufficient, detailed traffic and revenue divisions data, especially as it
might apply to a stand alone NCRR. Without good traffic data, it is difficult to
put together a good operating plan, from which many expenses derive.
(5) As CSI notes in the next chapter, substantial originating and terminating
traffic could still be retained by NS, with a much more adverse impact on NCRR
NROI.
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Mercer Valuation Study of NCRR
In September 1993, Mercer Management Consultants presented to NCRR its
determination of the going concern value of the railroad. The Mercer study was
done prior to the availability of information generated by ALK. Mercer estimated
the going concern value of NCRR to be $150 million comprised of the following
components:
Millions
--------
Charlotte-Greensboro Segment
-Overhead Traffic $64
-Originating and Terminating Traffic 72
Greensboro-Raleigh Segment 21
Raleigh-Morehead City Segment (16)
Amtrak Rental 6
Other Easements 3
----
TOTAL $150
Mercer noted that the $150 million going concern value could be increased
by rentals of right-of-way assets for nonrail purposes (such as fiber optics).
Mercer did not have information which could quantify existing or potential new
rentals.
On the down side, Mercer noted that the most critical risk to going
concern value is the potential for NS diversion of traffic of noncaptive
overhead traffic away from NCRR either on its newly upgraded line through
Knoxville-Bristol or by line sharing with CSX Transportation, such as NS was
proposing in South Carolina. The Mercer report emphasized that much of the
freight activity on NCRR is dependent on continued operation of the line by NS.
Initiatives ongoing at the time this 1993 study was prepared that could
jeopardize future NCRR traffic levels included:
o Significant upgrading by NS of its Atlanta-Hagerstown line, north of
Bristol (involving tunnel expansion and extension or reopening of
passing sidings); and,
o The beginning of major efforts by NS and CSXT to consolidate train
operations where they have parallel lines such as in the South
Carolina Columbia-Charleston-Spartanburg corridor.
Mercer noted that for a typical railroad line the sum of the parts is
often greater than the whole; i.e., the value of the right-of-way "unbundled" is
often higher than if it is treated solely as an operating railroad line. Mercer
provided no evidence to support this opinion, however. (See CSI evaluation of
NCRR as a stand alone operation in Chapter IV.)
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Mercer believed that maximizing the value of NCRR requires a two pronged
strategy of (1) securing a more equitable long-term lease with NS, providing for
a reasonable, guaranteed current dollar return in exchange for NS' intensive use
of NCRR properties; and, (2) preserving as much as possible NCRR's right to
independently develop and financially benefit from current and prospective
incremental uses of its properties.
Mercer estimated that NS receives approximately $66 million (1993) from
all freight traffic operated over NCRR properties. (This compares to ALK's
similar estimate of $84.4 million.) Mercer further noted that NS earns an
estimated additional $86 million in revenues attributable to traffic originating
or terminating on NCRR.
Mercer believes that for NCRR lines as a whole, estimated operating
expenses consumed about 72 percent of estimated operating revenues (compared to
75 percent for all NS, as reported to the ICC). Mercer estimates that the
Charlotte-Greensboro segment has the lowest operating ratio of approximately 66
percent, but that the Raleigh-Morehead City segment incurs operating expenses
which are almost twice its attributable revenues.
From its working papers, Mercer estimated that NCRR (excluding the money
losing Raleigh-Morehead City line) contributes approximately $20.4 million in
net railway operating income to NS (compared to ALK's estimate of $17.1
million). The Charlotte-Greensboro segment contributed $17.6 million of this
amount, with the balance coming from the Greensboro-Raleigh segment.
Mercer extended its financial analysis to also develop profit and cash
flow for the three distinct segments of the railroad and to make comparisons to
other NS lines in North Carolina, NS lines in other states, and the total NS
system.
Estimated, known post-tax net cash flows attributable to NCRR were
estimated at $15 million (which would have been about $1.5 million higher
without losses on the Raleigh-Morehead City segment). Discounting an assumed
stream of $15 million into perpetuity at a discount rate of 10 percent yields a
going concern value for NCRR of $150 million. This discounting approach is
consistent with other Mercer valuations of rail properties similar to NCRR.
Mercer noted that the estimated $150 million value is also consistent with
NCRR's trading price per share in the low to mid $30's, with 4.3 million shares
outstanding.
Mercer also examined valuation on the basis of transaction multiples, or
ratio of purchase price to revenues. This has ranged from less than 1.0 for
Canadian Pacific's purchase of the bankrupt Delaware and Hudson in 1991 to in
excess of 3.0 for Kansas City Southern's purchase of the profitable Mid-South.
At a value of $150 million, the ratio of NCRR would be 2.3 which lies at the
higher end of the range noted and is consistent with NCRR's overall
profitability.
From another valuation viewpoint, Mercer developed an estimated
Reproduction Cost New Less Depreciation (RCNLD). It calculated RCNLD for NCRR as
a whole at just under
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$400 million, divided into $225 million for the Charlotte-Greensboro and
Greensboro-Raleigh segment and $165 million for the money losing
Raleigh-Morehead City segment. It was not clear whether Linwood (Spencer) yard
was included in this total.
Tables making comparison of railroad sales transaction multiples and
components of estimated RCNLD costs were provided in Mercer's Executive Summary
Report.
Commenting on factors which could increase or decrease the value of NCRR,
Mercer was of the opinion that each 1 percent diversion of NS overhead traffic
would decrease NCRR's going concern value by about $.6 million. Mercer noted
that if NCRR claims additional derivative value for traffic originating or
terminating on NCRR, but handled beyond via NS, that each 1 percent of NS
operating income from this attributable revenue increases the value of NCRR by
about $1.6 million.(6)
Mercer believes that the Raleigh-Morehead City line drags down overall
NCRR valuation by about $15 million. Mercer noted that there are several
unknowns related to additional value NS derives from NCRR, such as Amtrak
payments to NS and easements let by NS from which it derives income.
Exhibit II-2 illustrates the contrast between ALK and Mercer estimates of
NS revenue, expenses, and profit attributed to NCRR.
EXHIBIT II-2
SUMMARY OF PRO FORMA EVALUATION
($ Millions)
----------------------------------------
ALK Mercer
----------------------------------------
Gross Revenue $87.2(1) $66.0(2)
----------------------------------------
Total Expenses 70.0 45.6
----------------------------------------
NROI $17.1 $20.4
----------------------------------------
1) Included $84.4 million in freight and
$2.8 million in non-freight revenue.
----------------------------------------
2) Freight revenue only.
----------------------------------------
Morgan Stanley
In January 1994, the NCRR Board retained Morgan Stanley to serve as its
financial advisor in connection with negotiations. Its finding with respect to
fairness of the lease agreement was provided to the shareholders, but did not
constitute a recommendation to how shareholders should vote to approve the
lease.
- ----------
(6) CSI notes that the reverse claim (NCRR derives derivative income from NS)
could also be made. One cancels out the other, making this claim of derivative
value totally irrelevant. It could easily be argued that NCRR benefits far more
from the NS than vice versa.
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In a presentation to the Board of Directors on August 10, 1995, Morgan
Stanley graphically presented a recent history of NCRR stock. For the first 10
months of 1994, the average between the bid and ask price of NCRR stock (OTC
symbol NORA) hovered in the mid to upper 30's per share. Almost immediately
after NCRR announced the primary terms of the lease extension with NS, as well
as intent to qualify for REIT status, the value of the stock dropped
approximately 10 points, to the mid 20's, reflecting stockholder disappointment
between expectations and realizations about the new proposed lease extension.
Subsequent to the lease extension announcement, stock prices climbed back
to the lower 30's by mid 1995. On November 5, 1996, the average of the bid and
ask price was approximately 39-7/8 ($37.75 bid, $42.00 asked) reflecting
stockholder expectations pending outcome of a new lease agreement, the result of
litigation, or a buyout by the State of North Carolina.
Morgan Stanley summarized its evaluation of alternatives as shown in the
Exhibit II-3. Comments in italics add CSI's comments to the Morgan Stanley
summary.
EXHIBIT II-3
NCRR ACTION ALTERNATIVES
(Summary by Morgan Stanley, to NCRR Board, 8/10/95)
- ----------------------------------------------------------------------------------------------------------------
Alternative Advantages Disadvantages
- ----------------------------------------------------------------------------------------------------------------
Enter into Lease o Certainty of outcome o Potentially higher valuations available
with NS o Stability of income through other alternatives, although
o Inflation adjustment highly uncertain outcomes
- ----------------------------------------------------------------------------------------------------------------
Sale or Lease to o Certainty of outcome o No identified interest from parties other
Third Party o Stability of income than NS
- ----------------------------------------------------------------------------------------------------------------
Appeal to ICC via o Potentially higher o Uncertainty of valuation standard or
Litigation valuation valuation outcome
- A lower rate determination could be
enforced by the STB, replacing NS'
higher $8 million offer
- A higher lease rate could not be
enforced if NS decides not to renew
the lease
o Uncertainty of timing
o Disruption of income
o Significant expected cost
- ----------------------------------------------------------------------------------------------------------------
Operate Property o Potentially higher o Uncertainty of overhead traffic (potential
valuation diversion by NS)
o No experience operating railroad
o Unknown level of profitability
o No ability to qualify as a REIT
- ----------------------------------------------------------------------------------------------------------------
NOTE: Comments in italics are made by Corporate Strategies, Inc.
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Using comparative analysis and various discount rates, Morgan Stanley
converted an annual payment stream of $7.5 million ($8 million annual lease
minus NCRR overhead of $.5 million) to arrive at an implied equity value in a
nominal range of $143 million (at a 5.5 percent discount rate) or $33.42 per
share, assuming REIT election. If REIT status was not achieved, nominal implied
equity value would be approximately $90 million or roughly $21 per share. Morgan
Stanley's analysis did not include other miscellaneous lease and rental income
or the $5 million payment made by NS to waive certain claims against property.
In other studies, Morgan Stanley reviewed 13 purchase and sale
transactions in the railroad industry during the 1985 - 1995 period. Though not
directly comparable, these transactions had a median and mean aggregate value
per mile of $247,000 and $279,000/mile, as compared to the $416,000/mile for the
NCRR lease extension agreement (as suggested by perpetuity value analysis and
assuming REIT election and a 6 percent discount rate). On a per MGTM basis,
Morgan Stanley translated the above numbers to $22,900/MGTM and $34,500/MGTM
compared to $29,500/MGTM for the NCRR Lease Extension Agreement.
These transactions had a median and mean ratio of aggregate value to
revenues of 1.41x and 1.68x respectively, as compared to 1.56x for the NCRR
Lease Extension Agreement.
Wilbur Smith Study
In December 1992, Wilbur Smith submitted an estimate to upgrade NS' line
between Charlotte and Greensboro (via Winston-Salem), adding CTC, and adding
65.5 miles of second main line track.
Those tables are reproduced as Exhibits II-4 and II-5. CSI did not review
any written material that may have accompanied the text.
NCRR COMMENTS
Besides commenting on previous studies in some detail, additional comments
prepared by NCRR's general counsel in the 1995 proxy statement include the
following abstracts. In some instances, CSI has added comments to abstracts made
from the proxy. These comments are noted in italics.
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EXHIBIT II-4
CHARLOTTE TO GREENSBORO
UPGRADE COSTS (EXISTING LINE)
(Secondhand Rail)
- --------------------------------------------------------------------------------
ESTIMATED
COST ITEMS QUANTITY UNIT UNIT TOTAL COST
COSTS
- -------------------------------------------------------------------------------
Rail, 132 lb. S.H. CWR 105.3 Mile $237,600 $ 25,019,280
- -------------------------------------------------------------------------------
Cross Ties, New Main Line 105.3 Each 49 4,643,730
miles @
900/mi.
- -------------------------------------------------------------------------------
Turnouts, New 132 lb. No. 10 118 Each 35,000 4,130,000
- -------------------------------------------------------------------------------
Ballast, Granite 105.3 Ton 7.5 631,800
miles @
800/mi
- -------------------------------------------------------------------------------
Surfacing 105.3 Mile 5,808 611,582
- -------------------------------------------------------------------------------
Road Crossings 136 Each 3,600 489,600
- -------------------------------------------------------------------------------
Motion Detectors 36 Each 10,000 360,000
- -------------------------------------------------------------------------------
Circuit Controllers 118 Each 5,000 590,000
- -------------------------------------------------------------------------------
Train Control Signals 105.3 Mile 556,000 58,546,800
------------
- -------------------------------------------------------------------------------
Upgrade Subtotal $ 95,022,792
- -------------------------------------------------------------------------------
Engineering and Construction 9,502,279
Supervision @ 10%
- -------------------------------------------------------------------------------
Subtotal $104,525,071
- -------------------------------------------------------------------------------
Contingencies @ 10% 10,452,507
- -------------------------------------------------------------------------------
Subtotal $114,977,578
- -------------------------------------------------------------------------------
Less Salvage Value of Material
Released 2,001,294
------------
- -------------------------------------------------------------------------------
Net Upgrade Cost $112,976,284
============
- -------------------------------------------------------------------------------
Note: Unit values current as of December 1992.
- -------------------------------------------------------------------------------
Source: Wilbur Smith Associates
- -------------------------------------------------------------------------------
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EXHIBIT II-5
CHARLOTTE TO GREENSBORO
SECOND (MAIN) TRACK CONSTRUCTION
(Secondhand Rail)
- --------------------------------------------------------------------------------
UNIT ESTIMATED
COST ITEMS QUANTITY UNIT COSTS TOTAL COST
- --------------------------------------------------------------------------------
New Track Construction 65.5 Mile $564,960 $ 37,004,880
- --------------------------------------------------------------------------------
No. 20 Turnouts, New Complete 48 Each 100,000 4,800,000
- --------------------------------------------------------------------------------
No. 10 Turnouts, New Complete 20 Each 42,000 1,840,000
- --------------------------------------------------------------------------------
Remove turnouts from Existing 24 Each 15,000 360,000
Main & Install Track Panels
- --------------------------------------------------------------------------------
New Circuit Controllers 20 Each 5,000 100,000
- --------------------------------------------------------------------------------
Road Crossings 71 Each 3,600 255,600
- --------------------------------------------------------------------------------
Motion Detectors 9 Each 10,000 90,000
- --------------------------------------------------------------------------------
Move Crossing Signals 9 Each 5,000 45,000
- --------------------------------------------------------------------------------
Train Control Signals 65.5 Mile 204,000(1) 13,362,000
- --------------------------------------------------------------------------------
Subtotal $ 56,857,480
- --------------------------------------------------------------------------------
Engineering & Supervision @ 10% 5,685,748
------------
- --------------------------------------------------------------------------------
Subtotal 62,543,228
- --------------------------------------------------------------------------------
Contingencies @ 10% 6,254,322
- --------------------------------------------------------------------------------
Track Subtotal $ 68,797,550
- --------------------------------------------------------------------------------
Earthwork 4,196,895 CY 10.00 41,968,950
- --------------------------------------------------------------------------------
Bridges 3,649 LF 3,000 10,947,000
- --------------------------------------------------------------------------------
Extend Drainage Structures LS 118,500
- --------------------------------------------------------------------------------
Subtotal 53,034,450
- --------------------------------------------------------------------------------
Engineering & Supervision @ 10% 5,303,445
- --------------------------------------------------------------------------------
Subtotal $ 58,337,895
- --------------------------------------------------------------------------------
Contingencies @ 40% 23,335,158
- --------------------------------------------------------------------------------
Grading & Drainage Subtotal $ 81,674,053
============
- --------------------------------------------------------------------------------
Estimated New Construction Cost $150,476,603
- --------------------------------------------------------------------------------
(1) Difference in double and single track costs, single-track cost having
already been included in Exhibit II-4.
- --------------------------------------------------------------------------------
NOTE: Unit values current as of December, 1992.
- --------------------------------------------------------------------------------
Source: Wilbur Smith Associates
- --------------------------------------------------------------------------------
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Without overhead traffic, NCRR's consultants believe that if NCRR handled
only traffic originating or terminating online, or local to the NCRR, gross
revenues would be approximately $13.4 million and a net income of approximately
$3.8 million before taxes would be earned--substantially lower than the $8
million annual rental contained in the lease extension agreement. There were
many additional caveats noted by NCRR and its consultants, related to the need
for additional capital (which could dilute interests of NCRR's shareholders) and
whether it could operate the line as efficiently and effectively. Both studies
ignored the very real possibility that NS could continue to handle most
terminating and originating traffic in Charlotte, Lexington, Greensboro, and
Raleigh. This is discussed in Chapter IV.
NCRR and its consultants also noted higher operating risks and exposure to
liability from which it is currently insulated. A fixed annual lease rate and
defined indemnities to most risks and liabilities provides low risk to
shareholders.
NCRR's consultants noted that total diversion of overhead traffic, due in
part to high traffic volumes over NCRR lines, would require NS to spend
"hundreds of millions of dollars" in capital improvements to achieve total
diversion of overhead traffic. Additionally, higher operating costs would be
incurred. The combined effect, could reduce or minimize NS's diversion of such
overhead traffic. NCRR and its consultants further noted that if capital
investments were made by NS to divert traffic, it would likely result in
permanent diversion of that traffic. CSI believes capital costs to upgrade NS'
alternate route are uncertain, as discussed in Chapter IV.
If NS were to successfully divert overhead traffic, NCRR could find itself
acting as an overflow resource to be used in high traffic years or under other
circumstances when it is convenient to NS to route overhead traffic over NCRR.
NCRR management concluded that it would be in the best interest of shareholders
to accept a stable annual rental payment. In summary, NCRR found no compelling
reason to terminate NS' lease.
Under RCNLD, NCRR's consultants estimated that the gross annual lease rate
could be as high as $74.7 million or as low as $4.6 million.(7) The higher range
exceeds the gross annual revenues attributable to the line, at least as
estimated by Mercer. Under RCNLD, the railroad would never be built, as less
costly alternatives are available.
NCRR counsel noted many problems with a lease rate based on property
valuation. This included the observation that valuation is not based on traffic
or revenues or the perceived value of the property to NS, but simply the
appraised market value of property. Also, ownership of substantial property,
such as Linwood (Spencer) yard and the bypass around Thomasville, is in dispute.
These ownership issues cannot be resolved by the ICC (STB), and must be
adjudicated by the courts. This could further delay the determination of a lease
rate based on property valuation.
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(7) Proxy Statement for December 15, 1995 Board Meeting, p. 18.
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The Board of Directors has reviewed a number of prior appraisals and
evaluations of the NCRR and concluded that no single evaluation depicts a fair
value of the NCRR as a basis for defining a fair annual return on assets.
Under a variety of alternatives, the one most closely studied by the Board
was the Reproduction Cost New Less Depreciation (RCNLD). A major defect in this
formula is that it does not regard the income producing value of the property.
Even then, the value of NCRR's properties for RCNLD purposes ranged from a low
of $40 million to a high of $450 million, depending on which assets were
included in the valuation.
Ownership of significant portions of NCRR assets are disputed. While NS
invested in improvements or additions, NCRR claims ownership of these
improvements and additions under the terms of the lease.(8)
On a Net Liquidated Value (NLV), NCRR's assets (other than Spencer yard)
would be in the range of $42.2 to $43.9 million.(9)
Finally, the Board considered a going concern value for the property.
Their consultant, Mercer Management, estimated a going concern value of $150
million, including consideration of overhead traffic.
The NCRR Board also attempted to determine a fair trackage rights fee for
overhead traffic that at least equalled the estimated cost to NS of upgrading
the adjacent Winston-Salem line and replacing Spencer yard. These capital costs
were estimated at $263 million.(10) During negotiations, however, it developed
that NS has options other than the Winston-Salem line and that any assumptions
the Board might make are "dangerous."
In its presentation to the Board, Mercer made specific comparisons to the
NS lease of the Cincinnati, New Orleans and Texas Pacific railroad, owned by the
City of Cincinnati (frequently referred to as NS's "Rat Hole" division) and the
CSXT lease of the Western & Atlantic railroad, owned by the State of Georgia.
Both lines are modern, high density single or double track, well maintained
railroads. Though neither of these two leases involves private stock ownership,
Morgan Stanley noted that the current lease rate offered by NS is approximately
twice that paid by NS or CSXT as measured on a MGTM basis.
- ----------
(8) For the purpose of lease calculation, NS undoubtedly believes that the
investment it made in its own interest should not count in the determination of
value. It is nothing more than paying for the same investment a second time.
(9) Wilbur Smith & Associates.
(10) See Exhibit II-4 and II-5.
II - 19 **CONFIDENTIAL**
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CSI OBSERVATIONS
None of the NCRR's prior studies could anticipate the potential rail
environment of a merger of either NS or CSXT with Conrail; the potential
restructuring of service routes ("open access") or other concessions that could
make the re-routing of overhead traffic even more cost effective than operating
over NCRR. Conversely, the value of NCRR as a strategic partner to NS (or
perhaps even CXST) could increase under certain conditions that might emerge as
a result of a pending merger. It is impossible in the short time frame of this
study to assess potential outcomes. Critical information needed to make such
assessments is only available to CSXT, NS, and Conrail, and even then, they are
months away from concluding their assessments of the possibilities, if they are
even considering them.
In reviewing the alternatives of valuation, RCNLD is a fictitious number.
At the calculated cost, the railroad would never be built since less expensive
routing alternatives already exist. NLV is a real number for valuation purposes
(because the property exists), but still possibly hypothetical in the sense that
it is unthinkable that the rail corridor could or would be permitted to be
eliminated by the STB, state, or shippers. If neither alternative is
realistically possible, then their use in calculating an implied equity value of
the NCRR has no real merit. By reason of history, the NCRR's maximum value is as
a rail corridor as it now exists. If not of greatest value to NS, then it must
be of higher value to the NCRR as an independent operator, CSXT, or to a third
party operator. All studies convincingly argue that, with the proposed lease,
NCRR is not of higher value to any other operator. Even this argument, however,
does not, alone, answer whether the $8 million lease is fair.
If for no other reason than NS agreed to it, the NCRR is worth $8 million
per year to NS. Viewed from perspectives other than suggested by NCRR's
consultants, if the 317 route miles of the NCRR are representative of all NS,
then it suggests NS might be willing to pay an equivalent lease of $321 million
per year for the remaining 12,568 route miles it owns and operates. By
comparison, this "equivalent lease" (including NCRR) represents 8 percent of
gross freight operating revenues, as reported in the railroad's 1995 Annual
Report R-1 submitted to the ICC (now STB). Depending on whose NCRR revenue
estimates you use (ALK's $84.4 million, or Mercer's $66 million), the agreed
lease rate of $8 million represents 9.5 and 12 percent of revenue respectively,
higher than the equivalent of a lease price for all of NS.
From yet another perspective, the $8 million lease rate translates into
$1,792 per MGTM.(11) Applied to the remaining MGTM's of NS (256,408 as reported
in Schedule 755 of its Annual Report R-1 to the STB) the lease rate applied to
all freight traffic handled by NS would be $459 million per year or 11 percent
of its total 1995 freight revenues. By virtually any measure applied by previous
consultants or CSI, the lease rate appears to range from reasonable to generous.
- ----------
(11) As reported by Morgan Stanley, in its August 10, 1995 Board Meeting, based
on the 1993 ALK study.
II - 20 **CONFIDENTIAL**
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The attorney for minority shareholders has made it clear to CSI that
private shareholder interest in being bought out by the state is purely cash
driven. They perceive the NCRR is significantly undervalued because the NS lease
rate is unnecessarily low--below that which NS should and is willing to pay (and
further presumes would pay). CSI was also advised by minority shareholder
counsel that the potential value of the NCRR as a corridor for high speed
passenger and commuter service also adds significant additional value to the
owners. On top of minority shareholder claims, NS believes it should earn a
return on allowing passenger trains to operate over lines it owns, leases, and
maintains, at rates of return similar to those earned by freight service.
Claims noted above could undermine the very objectives of value that
minority shareholders seek. At some point, the whole concept of high speed rail
service and/or commuter service becomes economically unsupportable and/or
unaffordable. The same would apply to NS claims for compensation. In any event,
a substantial additional investment must be made to improve infrastructure and
capacity in order to provide either additional new passenger or improved freight
service.
Although outside the scope of study, it is reasonable to question that if
public moneys are spent to improve both freight service and line capacity in the
corridor (in order to meet passenger and/or commuter transportation needs),
whether NS (or any other railroad) is entitled to additional compensation. It is
also appropriate to examine whether the potential utility value of the NCRR adds
value to stockholders. An examination of past situations where property was
condemned for the purpose of building rail lines for commuter or other passenger
transportation could add insight whether the potential of providing these
services added value to these condemned properties. The fact that the NCRR is
the most logical and least expensive corridor in which to build may not be
relevant in public works projects.
The bottom line of value of the NCRR to NS centers on what NS is willing
to pay. There is simply no viable alternative, short of unthinkable liquidation
of the property or alternatives uses, all of which indicate substantially lower
value. Undoubtedly, a factor in NS's reluctance to increase its lease rate offer
is the danger of setting a precedent that could affect its other leases.
NS is also very much aware that no one else can match or exceed its offer
for NCRR. Given NS's bargaining position, the only recourse to obtaining a
higher rate is the STB. There is no assurance, given the facts we have reviewed,
that STB has an adequate basis to justify, let alone compel, NS to pay a higher
lease rate for NCRR.
What NS is willing to pay can be judged in other frames of reference such
as lease comparisons made by Morgan Stanley or in another context, the
alternative cost to NS of foregoing the lease. One portion of this study
attempts to estimate that incremental cost to Norfolk Southern.
In its valuation of the NCRR, Morgan Stanley assumed lease payments in
perpetuity to arrive at its implied equity value of $143.2 million. If the lease
rate were discounted for
II - 21 **CONFIDENTIAL**
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30 years (the initial term of the proposed lease) and the estimated residual
value of the property were similarly discounted, it is conceivable that the
implied equity value of NCRR could be greater than the $143.2 million. For
example, assuming a 30 year annual payment of $7.5 million, a discount rate of
5.5 percent (which factors in the inflationary increase in lease payments) and a
future property value of NCRR of $300 million (30 years from now), the implied
equity value would be as follows:
Millions
--------
$109.0 Present Value of $7.5 million net lease.
60.1 Present value of $300 million residual property value.
169.1 TOTAL
We concur with earlier studies that no single basis of valuation is
appropriate for establishing minority stockholder value.
The next two chapters address NS's incremental cost (i.e., cost increases
plus loss of revenue) to bypass NS, and a pro forma for NCRR without NS.
II - 22 **CONFIDENTIAL**
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III - ADDITIONAL COST TO NS TO BYPASS NCRR
OVERVIEW
If NS were to not renew the NCRR lease, it has alternatives to reroute 100
percent of all non-captive overhead traffic moved by NCRR and to handle
terminating traffic in Charlotte, Salisbury, Lexington, Greensboro, and Raleigh
that currently moves by NCRR. Under circumstances described below, NS could also
handle most, if not all, originating traffic from these cities.
Conceivably, NS could also work with CSXT to deliver traffic NS originates
on its own lines or receives from connection for delivery to destinations in
Durham. Under the worst scenario, NCRR could be reduced to an originating and
terminating carrier for traffic where NS does not have a competitive point of
entry and a switching provider for all other traffic in the above named cities.
Even if NCRR were to handle terminating traffic at other points not named above,
it would, most likely, receive only a short haul since NS is under no obligation
to maximize NCRR's length of haul by interchanging traffic at just Charlotte or
Greensboro.
DIVERSION OF OVERHEAD TRAFFIC
NS could conceivably divert all overhead traffic which currently moves
between Charlotte and Greensboro via its alternate line through Winston-Salem.
This light density line is not constructed or maintained to the same high
standards as the NCRR main line. Also, both Yadkin River bridges, on the
Winston-Salem - Mooresville Sub (MPL 13.8) would probably require rebuilding.
The same is true of many other lesser bridges, such as the present
out-of-service bridge over Peter's Creek in Winston-Salem. Many sections of the
line have heavily traveled at-grade crossings, curves, and gradients which will
be major obstacles to handling a major increase in traffic, especially in excess
of 15-20 trains per day. Many sections of line, besides bridges, will require
substantial engineering changes to reduce curvature and perhaps gradients. Large
numbers of private and public grade crossings will be a major problem to
resolve.
Access to the NS, from its yard in Charlotte, or directly via a
discontinued direct connection with its Atlanta main line, will be a problem. In
Greensboro, NS must operate over about 2 miles of NCRR to reach its main line to
Danville and beyond. CSI briefly inspected the line, by car and foot, to be
discussed in a separate, non-confidential report to be submitted to NCDOT
(December 1996).
Some of the diverted traffic could move north out of Winston-Salem to
Roanoke instead of back to the double tracked former Southern line running north
out of Greensboro. For some traffic, moving to and from the Hagerstown gateway,
this would actually reduce the length of haul, as well as reduce highway
conflict problems in Winston-Salem and east through Greensboro.
**CONFIDENTIAL**
Corporate Strategies, Inc.
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Consulting studies have variously estimated NS' costs to upgrade its line
through Winston-Salem as high as $250 million--$150 million to upgrade the line,
and another $100 million for 65 miles of additional double track. None of these
studies addressed the issue of moving Linwood yard or, at worst, building a
whole new classification facility.
In addition to the one time capital expenses to upgrade the line through
Winston-Salem, NS would annually incur incrementally higher annual maintenance
costs on the line due to the additional diverted traffic and required higher
track standards. But it would avoid all of the maintenance expense it now incurs
for the maintenance of NCRR--a more than substantial offset. Additionally, NS
would save the lease expense attributable to the Charlottesville-Greensboro
portion of the NCRR. Effectively, NS would pay for the ownership and maintenance
of only one railroad between Charlotte and Greensboro instead of two. The same
comments apply to NS' Greensboro-Raleigh route. NS would save all maintenance
expenses on the Raleigh-Morehead City route. NS' own route from Raleigh to New
Bern is capable of handling the additional diverted traffic without any capital
improvements.
NS would incur higher operating costs related to the additional length of
haul, increased traffic delays, and longer transit time to move trains by all
alternate routes.
In the real world, if NS were not to renew the NCRR lease, it would not
simply reroute overhead traffic from Charlotte to Greensboro via the alternate
Winston-Salem route, but would (or, more emphatically, must) consider other
alternatives, some of which were noted in previous studies (ALK and Mercer).
These include:
o All traffic originating in the Birmingham area or south and west of
Birmingham, which now moves via Atlanta-Charlotte-Greensboro and
north, could be routed via Chattanooga-Knoxville-Bristol.
o Traffic originating in the Atlanta area or coming from points
southeast of Atlanta could move via Rome-Knoxville-Bristol.
o Traffic originating northeast of Atlanta but south of the North
Carolina border could move by Saluda-Asheville;
o Some traffic could be interchanged to another railroad for
rerouting; and finally,
o NS would give up some marginal traffic which cannot bear the cost of
rerouting.
CSI does not have information to what extent traffic dispersion or traffic
loss might occur, but is safe to assume that less than 100 percent of overhead
traffic between Charlotte and Greensboro would be rerouted via Charlotte -
Winston-Salem - Greensboro. Thus CSI's estimate of incremental costs of traffic
diversion are the maximum NS might incur as a result of re-routing.
III - 2 **CONFIDENTIAL**
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DIVERSION OF OTHER TRAFFIC
It is highly probable that NS could force NCRR to either grant switching
rights within yard limits of Charlotte, Salisbury, Greensboro, Lexington, and
Raleigh or, alternatively, require NCRR to publish switching charges that are no
higher than what might be prescribed by the STB. With the NS able to control
most originating and traffic terminating in the above named cities, NCRR would
be left with very little originating and terminating traffic on the rest of its
railroad if NS were able to persuade shippers in these five cities to route by
NS (NS could absorb switching costs as an incentive to keep this traffic if it
so desires).
It is conceivable that NS could elect to give up its freight business east
of Raleigh, as it once contemplated prior to the construction of a new woodchip
producing facility west of Wilson. There is also some uncertainty with the
present lucrative movement of oil from Morehead City (Radio Island) to Cherry
Point, Seymour Johnson Air Force Base, and Fort Bragg. A proposed plan by the
Department of Defense to move this oil via the Colonial Pipeline to Selma and
thence by truck or rail to destination is uncertain at this time.
In summary, there are so many uncertainties with deteriorating
relationships between NCRR and NS that if NS were to terminate the lease and
aggressively to seek to preserve all traffic originating and terminating in
Lexington, Greensboro and Raleigh that now moves by NCRR, NCRR would be little
more than a light density shell railroad for its entire length of line.
CALCULATION OF NS COST INCREASES AND REVENUE LOSSES
Exhibits III-1 and III-2 develop CSI's estimates of NS' maximum
incremental cost and revenue losses to retain traffic currently moving via NCRR.
Not having access to detailed traffic and operating information needed, CSI used
the best available information, developed from prior studies, other information
obtained by CSI, and contributions from knowledgeable NCDOT staff.
In general, CSI attempted to estimate NS traffic and operating units as it
now exists (NS operation on NCRR) and then as it might exist (without dispersion
of traffic to alternate corridors) if NS were to operate only on its own
railroad. If NS could not handle the traffic, it was assumed as being delivered
to NCRR for line haul or switching placement.
Differences in operating and traffic units were multiplied by
corresponding unit costs or unit revenues to calculate increases and decreases
in cost and revenue payments. To these estimates, further adjustments were made
as shown in the two exhibits and described below.
Besides the described studies, additional information sources used by CSI
include the 1996 NS track chart, which shows 1995 millions of gross ton miles
(MGTM) by line segment (these statistics not always reliable, but are the best
we have), NS' Annual Report
III - 3 **CONFIDENTIAL**
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EXHIBIT III - 1
SUMMARY OF ESTIMATED INCREMENTAL NS OPERATING STATISTICS TO BYPASS NCRR
================================================================================
- ---------------------------------------------------------------------------------------------------------------
Estimated Current Units Moving on Segment:
-----------------------------------------------------
N N N N
o o o o
t Charlotte- t Greensboro- t Raleigh - t
e Greensboro e Raleigh e Morehead City e
- ---------------------------------------------------------------------------------------------------------------
1. Miles of Route 1 90 81 143
2. Average Running Time, Hours 2 2 3 7
3. MGTM 3,827 3 926 3 265 3
4.Carloads Handled on Segment
Overhead - Non Captive to NCRR 297,198 4 0 4 0 4
Overhead - Captive to NCRR 5,753 4 3,835 4 0 4
Forwarded and Received - To/From This Segment 28,209 4 49,430 4 7,074 4
- To/From Other Segments 39,553 5 6,367 6 0
Local 0 9 0 9 1,188 9
Total Carloads Handled on Segment 370,713 59,632 8,262
6. Equivalent Trains Operated (Total - Both Ways)
Intermodal & High Priority 11 10 0 0
Other Freight 14 10 5 10 0 10
Locals 2 10 1 10 2.5 10
Amtrak 6 10 4 10 4 10
7. No. of Switch Engine Tricks (Shifts) Operated 8 11 5 11 0 11
8. Ave Cars Per Train
Intermodal & High Priority 70 12 54 12 0
Other Freight 70 12 54 12 0
Locals 25 12 25 12 25 12
9. Freight Train-Miles Operated 18 874,800 174,960 128,700
10. Freight Car-Miles 19 58,548,656 8,627,284 3,217,500
11. Freight Locomotive Unit-Miles 20 2,595,240 443,232 154,440
12. Switch Engine Tricks (Shifts) Operated 21 2,288 1,430 0
13. Orig & Term loads Interchanged to NCRR for Line Haul - - - - - -
14. Captive Overhead Interchanged to NCRR (Bridge Move) - - - - - -
15. Carloads Lost (Local traffic) - - - - - -
16. Ave Lost Rev/Carload (Divisions on Orig & Term Loads) - - - - - -
17. Carloads Subject to Switching Charge - - - - - -
18. Assumed Bridge Divisions per Carload - - - - - -
19. Revenue per Local Carload
- ---------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
Estimated Units Moving on NS
Segment If NCRR is Avoided
-------------------------------------------------
N N N N
o o o o
t Charlotte- t Greensboro- t Raleigh- t
e Greensboro e Raleigh e New Bern e
- -----------------------------------------------------------------------------------------------------------
1. Miles of Route 1 105 103 132
2. Average Running Time, Hours 2 3 6 6
3. MGTM 4,109 17 761.98 17 0
4.Carloads Handled on Segment
Overhead - Non Captive to NCRR 297,198 0 0
Overhead - Captive to NCRR 0 0 0
Forwarded and Received - To/From This Segment 16,925 7 34,601 7 0
- To/From Other Segments 27,002 8 3,973 7 0
Local 0 0 0
Total Carloads Handled on Segment 341,125 38,574 0
6. Equivalent Trains Operated (Total - Both Ways)
Intermodal & High Priority 11 0 0
Other Freight 13 4 0
Locals 0 0 0
Amtrak 0 0 0
7. No. of Switch Engine Tricks (Shifts) Operated 2 11 2 11 0
8. Ave Cars Per Train
Intermodal & High Priority 69 12 47 12 0
Other Freight 69 12 47 12 0
Locals 25 12 25 12 0
9. Freight Train-Miles Operated 18 907,200 148,320 0
10. Freight Car-Miles 19 62,323,611 6,913,268 0
11. Freight Locomotive Unit-Miles 20 2,831,220 415,296 0
12. Switch Engine Tricks (Shifts) Operated 21 572 572 0
13. Orig & Term loads Interchanged to NCRR for Line Haul 11,284 13 14,829 13 7,074 13
14. Captive Overhead Interchanged to NCRR (Bridge Move) 5,753 3,835 0
15. Carloads Lost (Local traffic) 0 0 1,188
16. Ave Lost Rev/Carload (Divisions on Orig & Term Loads) $193 14 $193 14 $193 14
17. Carloads Subject to Switching Charge 16,925 15 34,601 15 0
18. Assumed Bridge Divisions per Carload $91 16 $91 16 $91 16
19. Revenue per Local Carload $637 22
- -----------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
Estimated Increase (Decrease) in
Units to Avoid NCRR Total
----------------------------------------------------
N
o
t Charlotte- Greensboro - Raleigh -
e Greensboro Raleigh New Bern
- --------------------------------------------------------------------------------------------------------------
1. Miles of Route 1 15 22 (11) - -
2. Average Running Time, Hours 2 1 3 (1) - -
3. MGTM 281.49 (164.37) (264.97) (147.85)
4.Carloads Handled on Segment
Overhead - Non Captive to NCRR 0 0 0 - -
Overhead - Captive to NCRR (5,753) (3,835) 0 - -
Forwarded and Received - To/From This Segment (11,284) (14,829) (7,074) - -
- To/From Other Segments (12,551) (2,394) 0 - -
Local 0 0 (1,188) - -
Total Carloads Handled on Segment (29,588) (21,058) (8,262) - -
6. Equivalent Trains Operated (Total - Both Ways)
Intermodal & High Priority 0 0 0 - -
Other Freight (1) (1) 0 - -
Locals (2) (1) (3) - -
Amtrak (6) (4) (4) - -
7. No. of Switch Engine Tricks (Shifts) Operated (6) (3) 0 - -
8. Ave Cars Per Train - -
Intermodal & High Priority (2) (8) 0 - -
Other Freight (2) (8) 0 - -
Locals 0 0 - -
9. Freight Train-Miles Operated 18 32,400 (26,640) (128,700) (122,940)
10. Freight Car-Miles 19 3,774,955 (1,714,016) (3,217,500) (1,156,561)
11. Freight Locomotive Unit-Miles 20 235,980 (27,936) (154,440) 53,604
12. Switch Engine Tricks (Shifts) Operated 21 (1,716) (858) 0 (2,574)
13. Orig & Term loads Interchanged to NCRR for Line Haul
14. Captive Overhead Interchanged to NCRR (Bridge Move)
15. Carloads Lost (Local traffic)
16. Ave Lost Rev/Carload (Divisions on Orig & Term Loads)
17. Carloads Subject to Switching Charge
18. Assumed Bridge Divisions per Carload
19. Revenue per Local Carload
- --------------------------------------------------------------------------------------------------------------
III - 4 **CONFIDENTIAL**
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EXHIBIT III - 2
SUMMARY OF ESTIMATED INCREMENTAL NS OPERATING COSTS TO
BYPASS NCRR - 1995 NS COST BASE - 3RD QTR 1996 COST LEVEL
================================================================================
- ---------------------------------------------------------------------------------------------------------------------------------
N Morehead
o City(NCRR)/
t Charlotte- Greensboro- New Bern
Summary of Applicable Unit Costs Unit Cost e Greensboro Raleigh (NS) Total
- ---------------------------------------------------------------------------------------------------------------------------------
1. Route Miles via NCRR 90 81 143 314
2. Route Miles via NS 105 103 132 340
3. Increase in Traffic Route Miles 15 22 (11) 26
- ---------------------------------------------------------------------------------------------------------------------------------
NS Incremental Operating Statistics via Alternate Route
4. Millions of Gross Ton-Miles (MGTM) 281.49 (164.37) (264.97) (147.85)
5. Locomotive Unit Miles (LUM) 235,980 (27,936) (154,440) 53,604
6. Freight Car-Miles (Loaded plus Empty) 3,774,955 (1,714,016) (3,217,500) (1,156,561)
7. Train-Miles 32,400 (26,640) (128,700) (122,940)
8. Switch Engine Tricks (Shifts) Operated (1,716) (858) 0 (2,574)
9. Cars Assessed Switching Charge 16,925 34,601 0 51,526
10. NCRR Cars Subject to Revenue Divisions Payment 11,284 14,829 7,074 33,187
11. Captive Overhead Cars Subject to Revenue Divisions 5,753 3,835 0 9,588
12. Local Traffic Carloads Lost 0 0 1,188 1,188
- ---------------------------------------------------------------------------------------------------------------------------------
13. Present MofW Long Run Costs Per Mile of Route - NCRR 23 $52,000 $46,000 $27,000
14. - NS Alternate Route 23 $20,000 $20,000 $26,000
15. MofW Costs Per Mile on Alternate Route if Traffic is Diverted 23 $48,000 $38,000 $26,000
------- ------- -------
16. Incremental Cost Increase Per Mile on Alternate Route $28,000 $18,000 $0
- ---------------------------------------------------------------------------------------------------------------------------------
Some cost increases (becreases) are based 1995 NS System Average Costs indexed to 396. Some costs decrease
because there are fewer units of traffic, in spite of the longer length of haul via NS Alternate Route.
17. Gross Ton-Mile Costs ($/GTM)
Fuel Portion $0.00080 25 $225,280 ($131,545) ($212,059) ($118,325)
MofE Portion $0.00022 25 $61,518 ($35,922) ($57,908) ($32,312)
MofW Portion $0.00147 25 $415,126 ($242,401) ($390,764) ($218,039)
All Other $0.00178 25 $501,883 ($293,060) ($472,429) ($263,606)
18. Locomotive Costs ($/LUM)
Fuel Portion $0.99343 25 $234,430 ($27,753) ($153,426) $53,262
MofE Portion $0.50399 25 $118,931 ($14,079) ($77,836) $27,016
MofW Portion $0.00466 25 $1,101 ($130) ($720) $250
All Other $2.71414 25 $640,483 ($75,822) ($419,172) $145,489
19. Train-Mile Costs ($/TRN-MILE)
Train Labor $5.10870 25 $165,522 ($136,096) ($657,490) ($628,063)
All Other $1.74352 25 $58,490 ($46,447) ($224,391) ($214,348)
20. Car-Mile Costs (Incl 38% Private Cars) ($/CAR-MILE) $0.06711 26 $253,340 ($115,029) ($215,929) ($77,618)
21. Yard Switching ($/ENGINE MINUTE) $4,493 25 ($3,701,168) ($1,850,584) $0 ($5,551,753)
------------ ------------ -- ------------
22. Subtotal Cost Changes, Based onSystem Average Costs ($1,027,065) ($2,968,869) ($2,882,123) ($6,878,056)
23. Subtotal, Excluding MofW Costs Included Above ($1,443,291) ($2,726,338) ($2,490,639) $6,660,268
Revenue and Other Cost Adjustments - Increase (Decrease)
Revenue Adjustments
24. Switching Payments to NCRR $100 24 $1,692,540 $3,460,100 $0 $5,152,640
25. Divisions Paid for NCRR Traffic Subject to Divisions $193 14 $2,177,735 $2,861,997 $1,365,282 $6,405,014
26. Divisions Paid to NCRR for Captive O'hd Traffic $91 16 $522,372 $348,218 $0 $870,590
27. Lost Revenue, NCRR Local Traffic $637 22 $0 $0 $757,000 $757,000
28. Amtrak Receipts 28 $331,967 $199,180 $68,852 $600,000
-------- -------- -------
29. Subtotal - Divisions Paid or Revenue Lost to NCRR $4,724,614 $6,869,495 $2,191,134 $13,785,244
MofW Cost Savings
30. Savings - No Longer Maintain NCRR ($4,680,000) ($3,726,000) ($3,861,000) ($12,267,000)
31. Additional Cost to Maintain NS Route $2,940,000 $1,854,000 $0 $4,794,000
32. Maintenance Cost Adjustment, first 5 years 31 ($1,093,419) ($849,136) ($1,942,555)
------------ ------------
33. Subtotal - Reduction in MofW Costs ($2,833,419) ($2,721,136) ($3,861,000) ($9,415,555)
Other Cost Increases (Decreases)
34. Car Hire Saved, Cars Interchanged to NCRR on Divisions 27 (350,459) (438,222) (231,336) ($1,020,017)
35. Lease Payments to NCRR 29 ($6,100,881) ($1,476,723) ($422,397) ($8,000,000)
36. Capital Improvements (Annuity Value) * 30 $9,760,759 $4,787,420 $0 $14,548,179
---------- ---------- --
37. Subtotal, other adjustments $3,309,420 $2,872,475 ($653,733) $5,528,162
40. GRAND TOTAL ANNUAL COST INCREASE $3,757,323 $4,294,497 ($4,814,237) $3,237,583
- ---------------------------------------------------------------------------------------------------------------------------------
SUMMARY
Cost Reductions
41. Reduction in Maintenance Costs ($2,833,419) ($2,721,136) ($3,861,000) ($9,415,555)
42. Savings in NCRR Lease Payments ($6,100,881) ($1,476,723) ($422,397) ($8,000,000)
43. Other Operating Costs ($1,793,750) ($3,164,560) $2,721,975 $7,680,285
Cost Increases
44. Amortization of Capital Improvements* $9,760,759 $4,787,420 $0 $14,548,179
45. Lost Revenue $4,724,614 $6,869,495 $2,191,134 $13,785,244
---------- ---------- ---------- -----------
46. GRAND TOTAL ANNUAL COST INCREASE $3,757,323 $4,294,497 ($4,814,237) $3,237,583
- ---------------------------------------------------------------------------------------------------------------------------------
*This annuity payment is very sensitive to initial cost, interest rate,
and life of amortization. If capital costs were $50 million higher than the $100
million assumed for Charlotte - Greensboro and $50 million Greensboro - Raleigh,
the annuity cost to NS would increase by about another $4.648 million per year.
III-5 **CONFIDENTIAL**
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NOTES TO EXHIBITS III - 1 AND III - 2
1 From NS Track Charts
2 CSI Estimated Average
3 From NS 1995 Track Charts:
-----------------------------------------------------------------------------------------------------------
Segment
Segment ----------------------------------
Miles from Station Name Miles from Miles (between Millions of Gross Ton MGTM
Station Name Raleigh Raleigh (stations) Gross Tons Miles Total
-----------------------------------------------------------------------------------------------------------
Charlotte 173.4 Salisbury 130.6 42.8 39.8 1703.44
Salisbury 130.6 Linwood 120.9 9.7 55.3 536.41
Linwood 120.9 High Point 96.5 24.4 43.3 1056.52
High Point 96.5 Greensboro 84.1 12.4 42.8 530.72 3827.09
Greensboro 84.1 Durham 25.5 58.6 11.5 673.9
Durham 25.5 Raleigh 0 25.5 9.9 252.45 926.35
Raleigh Selma 28.4 2.3 65.32
Selma Goldsboro 18.7 2.5 46.75
Goldsboro New Bern 56.5 1.2 67.8
New Bern Morehead City 37 2.3 85.1 264.97
Total 5018.41
----------------------------------------------------------------------------------------------------------
4 Estimated Breakdown of Carloads by Segment, From ALK Data. Apportionments
to each segment are made from pooled knowledge of CSI and NCDOT staff,
since no other information was available to the Study Team upon which to
make such assignments.
-----------------------------------------------------------------------------------------------------------------------------
Overhead Overhead
Total Total LFROC Local Forwarded Received Captive Non-Captive
-----------------------------------------------------------------------------------------------------------------------------
On NCRR
Carloads - As Estimated by ALK 392,686 95,488 1,188 27,956 56,756 9,588 297,198
CSI Apportionment by Segment
Charlotte Greensboro 331,160 33,962 0 11,182 17,027 5,753 297,198
Greensbor - Raleigh 53,265 53,265 0 15,376 34,054 3,835 0
Raleigh - Morehead City 8,262 8,262 1,188 1,398 5,676 0 0
Distibution Assumptions made by study team:
Charlotte Greensboro 0% 40% 30% 60% 100%
Greensbor - Raleigh 0% 55% 60% 40% 0%
Raleigh - Morehead City 100% 5% 10% 0 0%
----------------------------------------------------------------------------------------------------------------------------
5 CSI assumed that 70 Percent of all traffic orignating or terminating EAST
of Greensboro, moves over this segment to Charlotte (70% x (49430 + 7074)
= 39553)
6 CSI assumed that 90 percent of all traffic orginating or terminating EAST
of Raleigh, moves ove this segment to Greensboro.(90% x 7074 = 6367)
7 CSI assumed that NS could keep 60 percent of all traffic originating or
terminating on the Charlotte to Greensboro segment through switching
rights at Charlotte, Salisbury, and Greensboro, and possibly Lexington
through its 50% ownership in the Winston Salem Southbound (WSS) (60% x
(11182 + 17027 = 16925) For the Greensboro - Raleigh Segment, we have
assumed that NS could keep 70 percent of all originating and terminating
traffic - basically most of that orignates or terminates in Raleigh (again
through switching rights), or terminating traffic in the Raleigh area
which it could interchange to NCRR at Raleigh. (70% x (5676 +15376 +
34054) = 34601) For the Raleigh - Morehead City segment, we have assumed
that all other traffic orginating and terminating is lost, except for
grain and coal traffic which terminates in Selma, Goldsboro, and Morehead
City, which would be interchanged to NCRR at Raleigh (.7 x 5676 = 3973).
8 CSI assumed that 70 Percent of all traffic orignating or terminating EAST
of Greensboro, moves over this segment to Charlotte (70% x (34601 + 0) =
24221)
9 Local traffic is believed to be mostly jet fuel moving between Radio
Island and points served by NCRR
10 Estimated by NCDOT staff and CSI current data on NS operations. Some
trains originate or terminate at Linwood. CSI attempted to convert trains
operated to the equivalent of operations over the entire segment. Actual
operations vary as extra trains may be operated, or some schedules may be
annulled.
11 It is CSI's understanding that the following switch tricks (shifts) are
operated. Most are five day, but some are 7 day schedules.
1 Charlotte Switcher (5 day)
6 Linwood (7 day) is CSI's current estimate. Formerly, up to ten 5 and
7 day jobs were bulletined at this facility.
1 Greensboro
1 Durham
3 Glenwood Yard (Raleigh) (7 day)
1 Raleigh
Assuming NS pays NCRR to do switching, assume the number of tricks
(shifts) is cut back to 1 in Charlotte, 1 in Greensboro, and 2 in Raleigh.
12 Ave Car-Miles per Train-Mile is 64, according to AAR's Analysis of Class I
Railroads for NS. Average Cars Per Train were estimated by adding total
carloads handled on each segment, adding an allowance for empty cars
(equal to 74% of loads), subtracting an average of25 cars (loads and
empties) per local x 250 days (5 days per week, 50 weeks), and divinding
by the number of trains operated (360 day year).
13 Overhead Captive plus Carloads Originated and Terminated on NCRR Segment
Minus Cars Still Handled via NS Route Charlotte to Greensboro (5753 +
28209 - 16925 = 11284) Greensboro to Raleigh (3835 + 49430 - 34601 =
14829) Greensboro to Morehead City (0 + 7074 - 0 = 7074)
14 Average Divisions assumed using ALK formula = 100 Mile block plus an
assumed ave of 40 mile haul on NCRR, or basically the equivalent of 140
miles times average revenue per loaded car-mile of $2.27 would yield
$317per car, which we believe is much more than NS would allow. CSI
believes NS would more likely allow the equivalent of a switch charge,
some additional allowance for station clerical (NS's own costs is about
$12.82 per carload), and, at best, an average revenue per loaded car-mile
of $2.00, which is more than most regional or short lines earn per loaded
car-mile if orginating and terminating allowances are excluded. Under this
basis, an average division rate would be closer to 40 miles x $2.00 per
loaded car-mile + $100 switching + $13 clerical = $193
15 All orginating and terminating traffic which was not assumed interchanged
to NCRR was assumed to be handled by NCRR under a switch charge. This
study assumed no traffic losses to truck or interchange to CSXT.
III-6 **CONFIDENTIAL**
Corporate Strategies, Inc.
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NOTES TO EXHIBITS III - 1 AND III - 2
16 Assumed same average Revenue per Car-Mile as NS $2.27). Assumed 40 mile
payment.
17 Millions of Gross Ton Miles were calculated by Multiplying the ALK
estimated numbers by the ratio of route mileage, NS/NCRR and the ratio of
Carloads Handled over the segment, NS/NCRR. For example, from Charlotte to
Greensboro, Adjusted MGTM = (105/90 x 3827.09 x 341125/370713 = 4108.58)
18 Freight Train Miles Operated is calculated as segment length times trains
operated times 360 days year
19 Freight Car-Miles is calculated as the sum of cars per train type times
trains operated times 360 days per year
20 Locomotive Unit Miles are calculated as train miles by train type times a
CSI estimated average of 3.5 units for Intermodal and High Priority 2.8
Units for Other freight, and 1.2 unit for local trains. The NS average of
Locomotive Units Miles per Train-Mile is 2.5
21 Assume an average of 5.5 days per week, 52 weeks per year.
22 ALK, $757,000 divided by 1,188 Carloads
23 Based on AAR's Analysis of Class I Railroads (Lines 172, 174, and 335), NS
average Mofw Costs per mile of route operated were $43,910 in 1995,
includinding depreciation, and $30,246 excluding Road Property
Depreciation. Estimates assumed by CSI for this study are based on
reasonable assumptions relative to NS, personal observations of portions
of the routes involved, and industry experience. Actual costs may be more
or less than CSI's estimates. Without Amtrak on its own lines, NS will no
longer need to maintain track to 79MPH standards for passenger service.
24 Switching Charges may vary greatly. $100 is estimated as a reasonable
average composite rate for all traffic that may be handled, especially
since some some traffic is switched in multiples, and the line-haul
carrier typically absorbs car-hire for about 3 days.
25 See Appendix. Based on Rail Form A Costs for NS, prepared from NS's Annual
Report Form R-1. Though URCS unit costs are now officially used by the
Surface Transportation Board, URCS still uses the Rail Form A formula
defualts, yielding essentially the same unit costs used here. NS 1995 unit
costs were escalated to Third Quarter 1996 cost levels using AAR's
composite QMPW (Quarterly Price, Material, Wages) Indices.
26 CSI made rough estimate that 30 out of every 80 cars handled were private
line cars (38%), not subject to time (and, in most cases, mileage)
charges.
27 The average car delivered to NCRR is assumed to spend 2.5 days loading or
unloading, plus another 2 days on line, or a total of 4.5 days. Car-Hire
is assumed at roughly $10 per day for cars with railroad markings, or
$6.20 for a weighted average of both private and railroad owned cars. NS
cars are treated the same as foreign railroad cars (cars owned by other
railroads). Then, 4.5 days x $6.20 = about $28 per carload. For Captive
Bridge Traffic, only a 1 day savings per carload was assumed, or $6 per
carload.
28 Apportioned based on Passenger Train Miles. On Raleigh to Morehead City
section, passenger trains operate between Selma and Raleigh, a distance of
about 28 miles. Passenger train-miles per day are about 6 x 90 = 540
between Charlotte and Greensboro, 4 x 81 = 324 between Greensboro and
Raleigh, and 4 x 28 = 112 between Raleigh and Selma. Total daily passenger
train-miles are about 976.
29 Pro rated on MGTM by segment, calculated in Note 3.
30 CSI believes Wilbur Smith's estimates of about $250 million to upgrade
just NS's Charlotte - Greensboro line are high in some areas, low in
others. Based on informal onversations with a knowledgeable NS MofW
expert, and our own observations, we believe the upgrade costs for the
Charlotte to Greensboro line will be closer to $1 million per mile, and
perhaps on the Greensboro to Raleigh line, closer to $500,000 per mile.
The Winston Salem to Greensboro section is already in excellent condition,
and requires only additional passing sidings, train control, and grade
crossing improvements to handle much higher traffic volume. To calculate
annuity cost, we have assumed a 40 year life, and a 9% interest (discount)
rate.
31 As a result of major capital upgrade expenditures, average maintenance
expenses will be greatly reduced for the first five years or so. We have
estimated these savings at roughly 60 percent of average maintenance cost
per year, for the first 5 years. These savings were converted to an
annuity cost by first calculating the present value of these savings at 9%
interest, then converting that PV to an annuity equivalent over 40 years
Misc. NS Statistics for Analysis of Class I Railroads for 1995
Ave Tons Per Carload (Analysis of Class I Railroads, 1995 - NS)
Line 174 - Total MofW (1,000) 632957
Line 172 - Road Depreciation (1,000) 196958
Line 335 - Miles of Road Operated 14415
Ave MofW Per Mile of Road Operated $43,910
Ave MofW Per Mile of Road Operated (Excl. Deprn) $30,246
Line 528 - Total Carloads Originated 3,435,207
Line 529 - Total Tons Originated 223,000,888
Ave. Net Tons Per Carload Originated 64.9
Line 655 - Loaded Car-Miles (1,000) 1,702,523
Line 656 - Empty Car-Miles (1,000) 1,257,532
Ratio - Empty to Loaded Car-Miles 74%
Line 725 - Road Locomotive Unit-Miles per Train-Mile 3
Line 726 - Freight Car-Miles Per Train-Mile 64
Line 727 Gross Ton-Miles Per Train-Mile 5,289
Line 728 Net Ton-Miles Per Train-Mile 2,632
Line 734 - Rev Ton-Mile Per Gros Ton-Mile (Ex. Loco) 54%
Line 735 - Percent of Loaded to Total Frt Car-Miles 57.52%
Line 736 - Net Ton-Miles Per Loaded Car-Mile 72
Line 738 - Freight Revenue Per Rev Ton-Mile (Cents) 3.06
Line 739 - Freight Service Rev Per Rev Ton-Mile (Cents) 3.15
Line 740 - Freight Service Revenue Per Loaded Car-Mile $2.27
III-7 **CONFIDENTIAL**
Corporate Strategies, Inc.
- --------------------------------------------------------------------------------
Form R-1 for 1995, as submitted to the STB, AAR's Analysis of Class I Railroads
(which contains additional information and useful statistics on NS and other
railroads), and the Rail Formula A unit cost database for NS for 1995. Exhibit
III-3 is a graphical summary of traffic density (MGTM's) on selected NS routes
(including NCRR).
CSI has attempted to be methodical in each step of its development of
incremental revenue and cost. Extensive footnotes to the Exhibits further
describe, in more detail, assumptions made or used in our calculations and, in
many cases, exactly how each computation was made.
Given that 1993 Waybill Samples developed by ALK and 1995 MGTM statistics
from NS track charts were used in the study, it was important to make cross
checks to determine if there is reasonable consistency and reliability in
combining data from different sources. One of these checks is in the calculation
of average cars per train. CSI used carload information supplied by ALK,
apportionments of certain carloads over segments using estimating factors
developed by CSI, average empty car return ratios from NS 1995 data, and average
number of trains operated as reported by NCDOT and NS. The calculation of
average cars per train, using information described, yielded an average cars per
train that compares favorably with NS system averages on the
Charlotte-Greensboro corridor and fits reasonably well with our knowledge of NS
operations on the Greensboro-Raleigh corridor. Given the assumptions made (and
possible variations), CSI is of the opinion that the costs developed, as
represented in the exhibits are within plus or minus 20-25 percent of actual
costs as they might have been calculated if better information were available.
While the development of cost calculations are shown in Exhibits III-1 and
III-2, the bottom section of Exhibit III-2 summarizes cost reductions, cost
increases, and lost revenue in the following categories:
EXHIBIT III-4
NET NS COSTS TO AVOID NCRR
Annuity Dollars
Item (Millions)
Reduction in track maintenance costs ($9.4)
Savings in NCRR lease payments (8.0)
Savings in other operating costs (7.7)
Capital improvements amortization* 14.5
Lost revenue 13.8
----
Net annual cost increase* $3.2
* This annuity is very sensitive to initial capital costs to
upgrade the alternative route. If costs are $50 million higher
than the $150 million assumed, it adds $4.6 million in annuity
costs.
III - 8 **CONFIDENTIAL**
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EXHIBIT III - 3
North Carolina Railroad
and Connecting Lines
Norfolk Southern Tonnage
Millions of Gross Tons - 1995
[GRAPHIC OMITTED]
III - 9 **CONFIDENTIAL**
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As noted above, the net increase in cost calculated is the maximum cost
(or loss of revenue) that NS would sustain under the assumptions made. Traffic
diversion options other than an assumed rerouting of all overhead traffic over
its own line between Charlotte and Greensboro may significantly reduce the net
annual cost summarized above.
Linwood (Spencer) Yard
Initially, CSI believed that Linwood (Spencer) yard was an indispensable
part of NS operations over the NCRR. We have learned from a variety of sources,
however, that this yard no longer has the importance it once had. First, the
yard was built by Southern Railway (the former lessor of NCRR) for its
particular needs. With the merger of the Norfolk and Western (N&W) and Southern,
other major yards on the former N&W made the Linwood yard less important. With
the increasing industry trend toward run through and intermodal trains (which do
not require switching), there is simply less need for yards, not only on the NS
but other railroads throughout the US. In fact, it is our understanding that
some traffic which could be classified elsewhere, is moved to Linwood for
classification, just to keep the yard busy. Thus, the need to move Linwood
(Spencer) yard or build a new yard in order for NS to move off NCRR does not
appear necessary.
Capital Upgrade Costs
Wilbur Smith Associates' estimate to upgrade NS' present Charlotte -
Winston-Salem - Greensboro line is, we believe, high in some respects, and low
in others. Specifically, we note that Wilbur Smith estimates over half of the
cost of upgrading the existing line is in installing train control signals.
While CSI staff are not qualified C&S (Communication and Signal) engineers, it
is our belief that NS' investment in train control would be far less than the
estimated half-million plus dollars per mile. We do note, however, that no
specific allowance for bridge upgrades was made, especially two major structures
over the Yadkin River. From conversations with NCDOT, and our own observations
in Chapter III, large increases in traffic over this line will cause problems in
Charlotte, Winston-Salem, and several smaller communities through which the
present light density line runs. The extent to which additional capital costs
would be required to alleviate concerns is not known.
III - 10 **CONFIDENTIAL**
- -------------------------Corporate Strategies, Inc------------------------------
IV - PRO FORMA ANALYSIS OF NCRR OPERATIONS
WITHOUT NS AS LESSEE
OVERVIEW
As noted in Chapter III, besides diverting all non-captive overhead
traffic, NS is in a decisive position to keep all traffic it presently
terminates in Charlotte, Salisbury, Lexington, Greensboro, and Raleigh that is
currently located on NCRR lines (assuming traffic did not originate on NCRR). NS
could also keep most if not all of originating traffic in the same switching
areas if it chose to do so, by providing rates and the service that induce
shippers (which remain with rail) to route via NS. NS can, in all probability,
obtain either switching rights in these towns or force NCRR to provide switching
service at STB prescribed rates.
If NS diverts traffic away from NCRR, it is likely to be an all-or-nothing
approach, at least with respect to non-captive overhead traffic, since it
spreads the high cost of plant improvements over more traffic. Other traffic
would be selectively diverted, depending on what NS determines is in its best
interests. Once the fixed plant upgrade investment is made, NS would not be
interested in resuming operations over NCRR except under terms which are much
more favorable than the present lease.
Traffic diversion would include all intermodal and time sensitive freight.
Fully upgraded, the alternate route would probably add 1 to 3 hours between
Charlotte and Danville (via Greensboro), and perhaps break even or save time on
traffic routed via the Hagerstown gateway (through Roanoke). Running time from
Greensboro to Raleigh could be 2 - 4 hours longer.
CSI notes that pro forma analyses were previously done by ALK in March
1995. Their approach focused on what NCRR's contribution is to NS, using a
pro-rata operating statistic basis of apportioning cost groups. This approach
has several weaknesses:
o At least 20 percent of railroad costs are fixed and statistically do
not vary with operating statistics;
o Many costs are a function of more than one operating statistic;
o There is auto-correlation between operating statistics and costs.
For example, train crew wages can be statistically proven to
correlate well with either train-miles (most logical), car-miles
(logical), or gallons of diesel fuel consumed (not logical, but
there is a strong relationship between fuel consumed and
train-miles);
o Productivity varies with volume; and, very significantly,
o The NCRR must still be maintained for passenger train speeds.
**CONFIDENTIAL**
- -------------------------Corporate Strategies, Inc------------------------------
CSI's approach to pro forma development is similar to that used by a short
line operator interested in purchasing or leasing the railroad with the
exception that it makes no capital investment or lease payments (i.e., all
profits pass to the owner).
Because of insufficient traffic details, some uncertainties with actions
NS might take if the lease were not renewed, and further uncertainties with
respect to rate "divisions" (or other form of revenue sharing) our evaluations
contain many uncertainties, though we believe they represent a considerable
improvement to ALK's ratio approach to pro forma development.
PRO FORMA DEVELOPMENT
Chapter III develops possible traffic losses, divisions payments, and
switching payments to NCRR if NS were to bypass NCRR. These losses to NS
represent inputs to NCRR's traffic base and freight related income stream.
Additionally, NCRR will continue to derive payments from Amtrak, leases, and
other income associated with operating and nonoperating properties.
Similar to our analysis in Chapter III, the NCRR was divided into three
segments for the preparation of a pro forma. Each segment was analyzed as an
independent operation, though some consideration was given to the economies of a
single management organization and management covering all three segments.
With the above approach, costs were estimated based on reasonable
allowances for the size of railroad, traffic, and other considerations, similar
to an approach one might use to prepare a "zero based budget" for operation of
each "division" of the NCRR. Some costs, however, vary directly with traffic and
operating activities. These relationships are built into CSI's regional railroad
costing model.
Selected inputs to the pro forma model for each NCRR segment are contained
in Appendix B, Exhibits B-1 through B-9 for the Charlotte-Greensboro segment,
Exhibits B-13 through B-21 for the Greensboro-Raleigh segment, and Exhibits B-25
through B-33 for the Raleigh-Durham segment.
Among the many outputs which can be generated by the regional railroad pro
forma model, are 10 year pro forma statements of Profit and Loss, Cash Flow, and
the Balance Sheet. These outputs are included as Appendix Exhibits B-10 through
B-12 for the Charlotte-Greensboro section, Exhibits B-22 through B-24 for the
Greensboro-Raleigh section, and Exhibits B-34 through B-36 for the
Raleigh-Morehead City section. Summary findings from the pro formas are shown in
Exhibit IV-1.
IV - 2 **CONFIDENTIAL**
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EXHIBIT IV-1
SUMMARY OF FIRST YEAR PRO FORMA ESTIMATES
NCRR AS AN INDEPENDENT OPERATOR
UNDER NS DIVERTED TRAFFIC ASSUMPTIONS
($ Thousands*)
Charlotte- Greensboro- Raleigh-
Greensboro Raleigh Morehead City Total
---------- ----------- ------------- -----
Revenue
- -------
Freight Divisions $2,126 $2,455 $2,122 $6,703
Switching 1,693 3,460 0 5,153
Demurrage 69 91 51 211
Property Rents 30 30 0 60
Amtrak 373 241 69 683
------ ------ ------ -------
Total Revenue $4,291 $6,276 $2,241 $12,808
Expenses
- --------
Maintenance of Way $3,618 $3,258 $2,335 $9,211
Maintenance of Equipment 270 327 174 771
Transportation 535 689 339 1,563
G & A 269 303 230 802
Car-Hire & Other 250 279 60 589
------ ------ ------ -------
Total Operating Expenses $4,943 $4,857 $3,138 $12,938
Net Ry Operating Expenses ($652) $1,420 ($897) ($129)
Fixed Charges (Debt) Interest 249 286 179 714
------ ------ ------ -------
Net Income ($902) $1,134 ($1,075) ($843)
*Numbers may not add exactly due to rounding.
The pro forma, as developed by CSI under stated assumptions, suggests that
the Charlotte-Greensboro segment would lose approximately $.9 million annually
in net income, the Greensboro-Raleigh segment would earn approximately $1.1
million, and the Raleigh- Morehead City segment would lose approximately $1.1
million. Combined, the NCRR would lose approximately $.8 million per year as an
short line, independent of traffic NS could haul.
The most significant issue in operating NCRR as a stand alone railroad is
the need to maintain the railroad to passenger train standards (79 MPH in
signalled territory, 59 MPH in "dark" or unsignalled territory). CSI estimates
that NCRR could save approximately $12,000 per track mile if it need only
maintain track to Class III level, or 40 MPH operation. Applied to the line
between Selma and Charlotte, this would produce a reduction in maintenance of
way costs of $2.4 million per year. The $600,000 annual payment from Amtrak does
not come close to covering the extra maintenance costs required solely to
protect passenger service.
IV - 3 **CONFIDENTIAL**
- -------------------------Corporate Strategies, Inc------------------------------
If passenger services were excluded, the $.8 million loss would turn into
a $1.0 million profit (a $2.4 million reduction in maintenance cost minus $.6
million loss Amtrak payments, minus $.8 million loss, equals $1.0 million
profit). This earning level, however, is far below current net earnings of
approximately $7.5 million based on the rejected minority shareholders lease. By
short line or regional railroad standards, a $1.0 million profit on $12.8
million in revenue is a marginal level of contribution to fixed charges not
considered in this study (capital costs of ownership) and profit.
Our study highlights the role of maintenance of way costs in running a
light traffic density railroad. With both heavy freight and passenger operation,
the freight operator benefits from a high speed, well maintained rail--a luxury
that a small short line or regional railroad operator with low traffic density
cannot afford. Should the NCRR be an independent operator, it then puts the
state in a difficult position of subsidizing the higher cost of track
maintenance required to support passenger trains or seeing passenger traffic
rerouted (some of it perhaps, ironically, over the NS upgraded bypass line).
CONCLUSIONS
None of the previous studies, nor this study support or justify
terminating the NS lease based on unreasonableness. Approached from every
reasonable viewpoint or basis of comparison using information available to CSI,
the $8 million lease rate offered by NS does not appear inequitable,
unreasonable, or below what NS should pay.
Delay in the resolution of the present disagreement between the Board and
the minority stockholders of the NCRR risks a significant, deleterious effect on
the value of the property. With uncertainty over continuing service over the
NCRR, Norfolk Southern can be expected to make incremental decisions that may
gradually shift more traffic away from NCRR. The longer the delay in resolving
lease related issues, the greater will be NCRR's risk exposure (a greater
likelihood of negative impacts on NCRR). NS is already "banking" maintenance
cost savings for application to the outcome of lease negotiations (to invest in
its own lines, or reinvest back in the NCRR route).
* * * * * * * *
CSI appreciates the opportunity to work with NationsBanc Capital Markets,
Inc. to assist in its value determination of NCRR as part of the State of North
Carolina's plan to buy out minority shareholders. We would be pleased to answer
questions about this report.
IV - 4 **CONFIDENTIAL**
[APPENDICES OMITTED]