Vision Accomplished: The History of Kansas City Southern (Railroads Past and Present) 0253068339, 9780253068330

Citation preview

RAILROADS & TRANSPORTATION

$40.00 “Bill Galligan has opened a window on the history of an important railroad that historians and journalists have mostly ignored. His account of how Kansas City Southern survived one crisis after another and then flourished in this century is riveting. Read it and be amazed at what determined people can do.” —FRED FRAILEY, former special

correspondent and columnist for Trains magazine and author of Last Train to Texas

“With the publication of Vision Accomplished, the KCS story is made eminently readable by no less than Bill Galligan, who led its communications team.” —HENRY POSNER III, Chairman, Iowa Interstate Railroad

“Vision Accomplished is delightful. Galligan shows us how this small but feisty railroad survived over the not-sokind years as the character and personalities of its leaders kept a long-standing company culture intact. Emphasizing how they met the challenge without burying the reader in numbers makes it a page turner.” —W. C. (BILL) LYMAN

Vision accomplished

WILLIAM GALLIGAN was employed at Kansas City Southern from 1992 to 2018, responsible for the company’s investor relations program as well as being involved in special projects. Now retired, he now splits his time between Kansas City, MO, and Guilford, CT.

Vaccomplished ision The History of Kansas City Southern

T

he remarkable story of the Kansas City Southern tells of a company that from day 1 followed its own path, led by a succession of visionaries who were not afraid to take risks in pursuit of the railroad company’s success.   Without the resources of the earlier land grant railroads, the Kansas City–based company forged a unique approach to growing its franchise. It compensated for its modest size by developing an outsize, personalized commitment to its customers, suppliers, and rail partners. While larger railroads, with their vast rail networks, sometimes cajoled customers and smaller railroads into conforming to their service offerings, Kansas City Southern sought to develop mutually beneficial relationships with multiple constituents.  

Galligan

Vision Accomplished is the story of a succession of individuals who through the strength of their personalities, vision, courage, and character led the railroad through one perilous situation after another and in so doing crafted a corporate culture truly unique in the railroad industry. It is a story of a railroad that by rights should have died dozens of times but continued to survive and grew to become a major participant in the North American supply chain.

iupress.org ISBN 9780253068330

54000 >

RAILROADS PAST AND PRESENT H. Roger Grant and Thomas Hoback, editors

Galligan_Vision Accomplished_JKTMech.indd 1

9 780253 068330

PRESS

William H. Galligan 10/18/23 11:00 AM

Vaccomplished ision

Railroads Past and Present H. Roger Grant and Thomas Hoback, editors Recent Titles in the Railroads Past and Present series The Pennsylvania Railroad Albert J. Churella

My Life with Trains Jim McClellan

Electric Indiana Carlos Arnaldo Schwantes

The Railroad Photography of Lucius Beebe and Charles Clegg Tony Reevy

Sunset Cluster H. Roger Grant The Railroad Photography of Phil Hastings Tony Reevy The Station Agent and the American Railroad Experience H. Roger Grant The Diesel That Did It Wallace W. Abbey Crossroads of a Continent Peter A. Hansen, Don L. Hofsommer, and Carlos Arnaldo Schwantes Narrow Gauge in the Tropics Augustus J. Veenendaal, Jr. Amtrak, America’s Railroad Geoffrey H. Doughty, Jeffrey T. Darbee, and Eugene Harmon The Panama Railroad Peter Pyne Last Train to Texas Fred W. Frailey Transportation and the American People H. Roger Grant American Steam Locomotives William L. Withuhn

Chicago Union Station Fred Ash John W. Barriger III H. Roger Grant Riding the Rails Robert D. Krebs Wallace W. Abbey Scott Lothes and Kevin P. Keefe Branch Line Empires Michael Bezilla with Luther Gette Indianapolis Union and Belt Railroads Jeffrey Darbee Railroads and the American People H. Roger Grant Derailed by Bankruptcy Howard H. Lewis Electric Interurbans and the American People H. Roger Grant The Iron Road in the Prairie State Simon Cordery The Lake Shore Electric Railway Story Herbert H. Harwood, Jr. and Robert S. Korach The Railroad That Never Was Herbert H. Harwood, Jr.

Vaccomplished ision The History of Kansas City Southern

William H. Galligan

I N DI A NA U N I V ER SIT Y PR ESS

This book is a publication of Indiana University Press Office of Scholarly Publishing Herman B Wells Library 350 1320 East 10th Street Bloomington, Indiana 47405 USA iupress.org © 2024 by William H. Galligan All rights reserved No part of this book may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying and recording, or by any information storage and retrieval system, without permission in writing from the publisher. The paper used in this publication meets the minimum requirements of the American National Standard for Information Sciences— Permanence of Paper for Printed Library Materials, ANSI Z39.48–1992. Manufactured in the United States of America First Printing 2024 Library of Congress Cataloging-in-Publication Data Names: Galligan, William H., author. Title: Vision accomplished : the history of Kansas City Southern / William H. Galligan. Description: Bloomington, Indiana : Indiana University Press, [2024] | Series: Railroads past and present | Includes bibliographical references and index. Identifiers: LCCN 2023031546 (print) | LCCN 2023031547 (ebook) | ISBN 9780253068330 (hardback ; alk. paper) | ISBN 9780253068354 (ebook) Subjects: LCSH: Kansas City Southern Railway Company—History. | Railroads— United States—History. | BISAC: TRANSPORTATION / Railroads / History | BUSINESS & ECONOMICS / Corporate & Business History Classification: LCC HE2791.K17 G35 2024 (print) | LCC HE2791.K17 (ebook) | DDC 385.0976—dc23/eng/20230713 LC record available at https://lccn.loc.gov/2023031546 LC ebook record available at https://lccn.loc.gov/2023031547

In memory of Dave Starling and Vicente Corta But for the remarkable contributions to KCS of these two fine men, this book, if written at all, would have had a much different, and certainly less extraordinary, ending.

CONTENTS Acknowledgments  ix Maps  xi Introduction  1 1. The Story Begins  5 2. Arthur E. Stilwell: Early Years  9 3. The Push South: 1890–1893  17 4. The Final Drive to the Gulf: 1894–1897  29 5. Receivership: The End of the Line for the KCP&G  41 6. Stilwell’s Final Years  51 7. The Dawn of a New Century Brings Prosperity  55 8. William N. Deramus II: An Era Begins  65 9. William N. Deramus III  77 10. The KCSI Years  85 11. Years of Turmoil: 1960–1979  101 12. Recovery  115 13. The Great Contraction: Consolidation in the 1990s  133 14. A Change at the Top: The Haverty Era Begins  143 15. Growth on the Fast Track: 1995–2000  155 16. The Panama Canal Railway Company  169 17. The Birth of Mexico’s Railroad System  185 18. The Game Changer  195 19. From KCSI to KCS; from TFM to KCSM  213 20. KCS Turns a Page  241 21. KCS Looks to the Future  261 22. Service Begets Growth  273 23. Game On: Private Equity Strikes First  279 24. The Canadians Pay a Visit—and Decide to Stay  299 25. The Curtain Falls on a 136-Year Adventure  315 A Note on Sources  339 Index  343

ACKNOWLEDGMENTS This book would not have come to be but for Pat Ottensmeyer. Not only did he suggest that I take on the project, his encouragement, support, and, most of all, friendship never wavered at any point during the arduous five-year process. I owe him a great deal. Mary Stadler and Ashley Thorne, the readers of the first very rough draft, not only provided edits but enthusiastically suggested that the manuscript had merit. Ashley was to make a remarkable later appearance in the process, spearheading the final stages of the preproduction and helped drag me across the finish line. She, along with Sheila Dougherty and Deb Lamir, did an outstanding job of finding the photography and preparing the maps and charts for production, all within an extremely tight schedule. The contributions of Tom Hoback and Roger Grant were extraordinary. They took a manuscript with a molecule of promise but a lack of focus and guided me in the writing of a work worthy of publication. I could not have done it without them. I cannot emphasize enough the importance of Jeannie Buck to the book’s publication. She was central in the process from the earliest days to the final ones, working through countless drafts and changes of direction, all the while fulfilling her day-to-day duties. Her efforts were heroic. My thanks also go to Melissa and Matthew, whose tiny but very special restaurant, Bufalina, provided delectable food and drink and muchneeded comfort during the hectic final days of manuscript preparation. And, lastly, I have to express my thanks to my great friends, Bob Garber, Patrick Valadez, Doug Banks, and Gene Goode, along with my family. Their combined brilliance, through humor and patience, kept me grounded, humble, and, most importantly, smiling.

ix

MAPS

xi

K AN SAS CI TY P I TTSBURG

HEAV EN ER SHREVE PO RT BEAUM O N T P O RT ARTHUR

LAKE C H A R L E S

Map 1. 1900. The KCP&G was reorganized as the Kansas City Southern Railway (KCSR) on April 1, 1900.

O M AHA

K AN SAS CI TY

DALLAS

P O RT ARTH U R

NEW ORLEANS

Map 2. 1939. The Louisiana and Arkansas Railway (L&A) is consolidated into KCS on October 20, 1939. In addition, trackage agreements providing KCS access to Omaha, Nebraska, boost its grain franchise.

OM A H A

K A NS A S C I TY

BIRMINGHAM MERIDIAN

DA L L A S

P ORT A RTH U R

NEW ORLEANS

Map 3. 1994. The MidSouth Railroad is acquired on January 11, 1994. The 327mile route between Shreveport, LA, and Meridian, MS, dubbed the “Meridian Speedway,” becomes part of the fastest intermodal corridor from southern California to the Atlantic coast.

OM A H A

K A NS A S C I TY

BIRMINGHAM MERIDIAN

DA L L A S

P ORT A RT H U R

LA R E DO

NEW ORLEANS

C OR P U S C HR I S T I

Map 4. 1995. KCS acquires 49 percent of the Texas-Mexican Railway (Tex-Mex) which operated between Corpus Christi and Laredo, TX.

MI NNE A P OL I S / S T. PAU L

C H I C AG O

OM A H A

K A NS A S C I TY

BIRMINGHAM MERIDIAN

DA L L A S B E AU M ONT H OU S TON P ORT A RTH U R

LA R E DO

NEW ORLEANS

C OR P U S C H R I S T I

MONTE R R E Y B R OW NS V I L L E

TA M P I C O M E X I C O C I TY TOL U C A

V E R AC RU Z

L Á Z A R O C Á R DE NA S

Map 5. 2005. On April 1, 2005, KCS acquires full ownership of Mexico's NorthEast Line rail concession.

E DM ONTON CALG ARY VA NC O UVE R

REG IN A

HUNT INGDON KINGS GAT E

WIN N IPEG

CO UTTS

QU ÉB EC C IT Y

N OYES

PO RTAL

JACKMAN

DULUT H

D ET R OIT O MAHA DAVEN PO RT

A LBA NY BU F FA LO NEW YOR K

(THE BRONX, FRESH POND)

C H IC AGO

KAN SAS CITY

B IR M INGH A M M ER ID IA N

DALLAS BEAUMO N T HO USTO N PO RT ARTHUR

LA R E D O

NEW OR LEA NS

CO RPUS CHRISTI

MO N TERREY BROWN SVILLE

TAMPICO MEXICO CITY TO LUCA

SEA R SP ORT

ROUSES POINT

TOR ONTO M ILWAU K EE

MIN N EAPO LIS / ST. PAUL

SA INT J OH N

M ONT R ÉA L

THUND ER BAY

VERACRUZ

LÁZARO CÁRDEN AS

Map 6. 2023. On April 14, 2023, KCS was officially acquired by the Canadian Pacific Railway (CP).

Vaccomplished ision

The Southern Belle

Introduction

The year 1887 is not particularly notable in US history. Congress did pass one important piece of legislation, the Interstate Commerce Act, which took dead aim at the rate-making and monopolistic practices of railroads. Though the legislation was to have an increasingly negative impact on the rail industry in the years ahead, it did not capture the attention of most Americans at the time of its passage—possibly less than the public’s interest in the recording of snowflakes fifteen inches wide and eight inches high in Fort Keogh, Montana, or the first-ever sighting of a chubby woodchuck casting his shadow in Punxsutawney, Pennsylvania. One item that even failed to make the year’s modest list of notable events was the January 8, 1887, incorporation of the Kansas City Suburban Belt Railroad. To be fair, the announcement hardly merited attention, certainly none outside of Kansas City. And yet, on that day, the railroad that would become the Kansas City Southern Railway was born. By 1887, the era of large-scale American rail expansion was coming to an end. President Abraham Lincoln had signed the Pacific Railroad Act in 1862, the first in a series of congressional legislative initiatives to promote the construction of a transcontinental railroad system. The impulse behind the congressional actions was to help spur expansion into the western territories. The legislation authorized the issuance of government bonds and grants of land to railroad companies, which in turn would spur economic growth from the Missouri River at Council Bluffs, Iowa, to Sacramento, California. The federal legislation proved to be a major catalyst in the creation of four transcontinental railroads, the possession of vast amounts of land by railroads, and the accumulation of fabulous wealth by a number of rail owners and investors. By 1871, railroad companies owned over 10 percent of all 1

the acres comprising the United States, and railroads had become a major factor in the migration of Americans from the manufacturing centers of the Northeast to the Midwest and wide-open expanses of the West. For the greater part of the next one hundred years, the nation tended to look west— not north, not south, not east—and economic growth became increasingly pronounced along an east–west axis. Railroads were part of it all. The railroad that was to become Kansas City Southern (KCS) benefited from none of this. Without land grants, the infant railroad was forced to rely on more traditional financing, which was hard to come by during times of economic turmoil in the late 1890s. Adding another layer of difficulty, the railroad’s founder, Arthur E. Stilwell, chose to build his railroad in the “wrong” direction, north–south rather than east–west. Admittedly, in 1887, there were railroads with a north–south orientation in the Midwest: the Illinois Central; Missouri-Kansas-Texas; and Missouri Pacific, all three having been built during the boom years of rail construction. But their very existence begged the question: Why was a fourth north– south line necessary? Conventional wisdom suggested that it wasn’t. However, it was precisely Stilwell’s disregard of conventional wisdom that gave birth to a core tenet of KCS’s identity. From the very beginning, those responsible for charting the company’s strategic direction based their decisions solely on what they felt was best for the company and its employees, customers, and shareholders, even when some of their initiatives flew in the face of conventional thinking. There remained throughout its 135-year history a strong contrarian element to the company’s corporate culture. As one later executive of KCS was fond of stating, “The one thing you can say with some certainty about conventional wisdom is that it’s usually wrong.” Looking back, it can be said that flying in the face of conventional late nineteenth-century thinking proved to be exactly the right decision. To declare that this north–south railroad company beat the odds and survived understates the magnitude of its eventual success. In 2009, during its celebration of twenty years of broadcasting, the cable news network CNBC brought together a panel of financial news reporters to guess what company’s stock, if purchased in 1989 and held to 2009, had provided its shareowners the greatest percentage profit. While the guesses were predictable—Microsoft, Apple, IBM—the correct answer was a shocker: KCS. Not too shabby for a railroad built in the “wrong” direction! The story of KCS is of a company that charted its own path from day one. It was a company led by a succession of individuals with vision, who were 2 V ision accomplished

not afraid of taking risks in pursuit of fulfilling those visions. Without the resources of the earlier land grant railroads, this Kansas City–based company forged a different approach to growing its franchise. It compensated for its modest size by developing an outsized, personalized commitment to its customers, suppliers, and rail partners. While larger railroads with their vast rail networks sometimes cajoled customers and smaller railroads into conforming to their service offerings, KCS sought to develop mutually beneficial relationships with multiple constituents. For years, KCS heard from shippers that they liked doing business with the company. When you’re smaller, every relationship is a priority. This hands-on, relationship-based philosophy born in the late nineteenth century remained a core operating principle of KCS through the entirety of its existence as an independent railroad. From its earliest days, the company sought to build strong relationships, and not just with shippers. During periods of dire financial crises that befell the nation in the late 1890s, threatening the young railroad’s existence, prominent financiers in the United States and abroad stepped up more than once to provide financial support. They did so in good part because they liked, respected, and trusted the management, particularly Arthur Stilwell. Maintaining relationships based on trust with the financial community remained a central focus of the company. The KCS culture affirmed the belief that it is hard to dislike a company when you like and respect its employees. All of this is important. No company operates in a vacuum. A company’s culture determines how it reacts to its business environment. The culture determines the type of people chosen to lead the company and defines the breadth of independence and authority given to management, so they can make timely decisions and put their programs and initiatives into place. It imbues its employees with a confidence to take on challenges that employees of other companies might find daunting. A company’s culture can inspire its people to relish the opportunity to fight above their weight class. For well over a hundred years, KCS employees wore as a badge of honor their ability to accomplish more with less and view their company’s smaller size as an attribute rather than a liability. This book is the story of a succession of individuals who through the strength of their personalities, vision, courage, and character led the railroad through one perilous situation after another and in so doing crafted a corporate culture truly unique in the railroad industry. It is the story of a railroad that by rights should have died dozens of times but did not. Not only Introduction 3

did it survive, it grew to become a major participant in the North American supply chain. This narrative ends with an account of KCS’s board of directors and its transaction team negotiating with outside rail and nonrail entities seeking to acquire the company. The process resulted in fourteen failed bids and a fifteenth that would become the winner. The book ends there, but the spirit of KCS will live on in some form. It will, over time, be absorbed into the Canadian Pacific’s own long-cherished corporate culture. But that is okay: KCS was unique, and that never will change. Nevertheless, the future belongs to the Canadian Pacific Kansas City as its employees make railroad history as the only single-line freight railroad serving three major countries. Arthur Stilwell would be very proud.

4 V ision accomplished

The Story Begins

1

It was a Tuesday afternoon in December 1886, and Edward Lowe Martin was worried. Martin was a successful businessman and a figure of considerable prominence in Kansas City. He moved to the area from his native Kentucky at the age of twenty-six and founded the Kansas City Distilling Company in 1868; later, he founded E. L. Martin & Co., a wholesale liquor distribution company. Among his numerous civic activities, he served as mayor of Kansas City in the mid-1870s. Later, in recognition of his contributions to the greater Kansas City community, the municipality of Martin City was named in his honor. But on this cold early winter afternoon, despite being a man of importance, E. L. Martin felt he was out of his depth. Always shrewd and alert for promising opportunities, he had recently purchased an option for the right to build a small belt line railroad. The railroad would provide local service to the Kansas City terminal area and would serve as a feeder and distributor for the larger railroads in the area. Martin’s problem was threefold. First, he was not a railroad man. Second, he was neither a financier nor experienced in obtaining financing for larger-scale projects. Third and most immediately troubling, it was Tuesday afternoon and his option was scheduled to expire on Friday. It was not the thought of missing out on a potentially lucrative business venture that ate away at Martin’s self-esteem. Rather, it was the possibility of failure; his career to date had been full of achievements, not losses. That afternoon, Martin was scheduled to attend a board meeting of the Guardian Trust Company in downtown Kansas City. The founder of Guardian Trust, Arthur E. Stilwell, was an individual who Martin considered 5

not only a business colleague but a friend. Earlier in the day, Martin had arranged with Stilwell to meet after the Guardian board business was completed to discuss a personal business matter. It was with this discussion that the KCS saga would begin. According to Stilwell’s account of the meeting, after Martin laid out his situation Stilwell asked: “How much does it take to start this Belt Line?” “About $330 to $350 thousand.” “Who is a good contractor?” “H. C. Smith is.” “All right, let’s get him up here this afternoon.” That same afternoon, Stilwell told H. C. Smith to have his work crews positioned in the Bottoms section of Kansas City by that Thursday afternoon and wait to get a “go” or “no go” telegraph. If it was a “go,” Smith was to have his people begin moving dirt immediately, thereby meeting Martin’s option deadline. It was all well and good to have a contractor in place, but the real makeor-break challenge confronting the two was to secure enough financing prior to Friday’s option deadline. While Kansas City was growing, Stilwell and Martin were aware that local businessmen lacked the pockets deep enough to support their belt line rail project. The money would have to come from other sources. Fortunately, Stilwell had business contacts in Philadelphia from earlier in his career, so he and Martin quickly packed their bags and caught the first available train east. Things were moving fast. It had been only a few hours before that Martin had broached the railroad project to Stilwell. Now they were on an overnight train to Philadelphia, but still lacked a plan for financing the venture. Energized by the idea of building a railroad, Stilwell sketched out a financing plan during the wee hours of Wednesday morning as Martin caught some sleep. The rail line would be called the Kansas City Suburban Belt and it would be financed through the issuance of $1 million of 6 percent bonds and $2 million of common stock. The bonds would be sold at $666 for a $1,000 bond and twenty shares of $100 stock would be given with each bond as a bonus. Now all that was needed were investors to buy in. Upon arrival in Philadelphia, Stilwell was a man possessed and worked the city’s banking establishment with indefatigable determination. He began the day with a meeting in the offices of A. J. Drexel, who some years earlier had started an investment bank with a young junior partner by the name of J. P. Morgan. Drexel immediately pledged to buy bonds, as did two 6 V ision accomplished

Arthur Stilwell, the founder of what was to become the Kansas City Southern Railway (KCS). His vision, determination, and optimism became the foundation of the railroad’s corporate culture.

other associates of the firm, John Lowber Welsh and E. T. Stotesbury. Later, Stilwell received a pledge from Joseph Shipley, an owner of Brown Shipley & Co., which ultimately became Brown Brothers Harriman in the United States. Noted rail financier George Troutman also signed up, as did Colonel William Procter, founder of Procter & Gamble. The list grew as the hours clicked by. Still displaying boundless energy after hours beating the streets of Philadelphia in search of investors, Stilwell met with Edward Martin back at their hotel. According to Stilwell, Martin appeared “a little drawn and depressed from prolonged worry over the likelihood of his venture collapsing.” Pressed by Martin for an update, Stilwell casually replied, “Every dollar you need has been pledged. Telegraph Smith to start digging.” At first, Martin thought it was a bad joke, but in fact, with virtually no preplanning, Arthur Stilwell had in one day sold a group of prominent East Coast investors on the idea of building a modest belt line railroad in a still-developing city half a continent away. It was not the last time he would pull off the near impossible to keep his dream alive of building a railroad from Kansas City to the Gulf of Mexico. Th e Story Begins 7

Arthur E. Stilwell

2

The Early Years

Arthur Edward Stilwell is properly regarded as the founder of KCS. To say he was a fascinating and complex individual does not come close to doing him justice. Not a midwesterner by birth, Stilwell was born and raised in Rochester, New York. His parents and grandparents were prominent citizens of the city. His father Charles had been a medical doctor, but while still a relatively young man, he had made the unwise decision to give up his medical practice to own and operate a jewelry store. The venture was not successful and contributed to the family’s decline in economic and social stature. Young Arthur was anything but a hale and hardy toddler. In his memoirs, Stilwell claims, “I was extremely delicate and had to be carried around on pillows until I was about seven years of age.” As a consequence of his early ill health, his education was seriously neglected and he never got beyond fourth grade. The person who had by far the most profound impact on the young man was his grandfather, Hamblin Stilwell, a notable figure in the history of New York State. During his career, Hamblin Stilwell was credited as being one of the builders of the Erie Canal and was responsible for the construction of a portion of the New York Central Railroad. The affection Arthur had for his grandfather was fully reciprocated. The two spent a good deal of time together and Hamblin doted on his first grandchild. The elder Stilwell would frequently take his grandson to New York City and allow him to sit in on meetings with the legendary railroad and shipping magnate, Cornelius Vanderbilt. Arthur was captivated by their discussions, particularly when the subject turned to railroads. It was after one of these meetings with Commodore Vanderbilt when his grandfather asked, “What is my little man going to do when he grows up?” 9

Without a moment’s hesitation, Arthur answered, “I’m going West and build a railroad.” He was eleven years old at the time. Arthur was without question a precocious young fellow, a trait not to diminish one bit with age. As he matured, his confidence in his instincts never wavered. He was fearless. He was creative. He was ambitious. But then this was the Gilded Age, a time in which enterprising men rose to positions of wealth and power. In this respect, Stilwell was every bit a man of his time. By his midteens, Stilwell felt that his career prospects in Rochester were limited: “I could get a job tending a soda fountain at three dollars a week. Not much to enthuse over.” So, with but seventy dollars in his pocket, he ran away, having scarcely turned fifteen years of age. He made his way to St. Louis, Missouri, where he landed a job as a cashier in the Southern Hotel’s billiard room for sixty dollars a month. But Stilwell’s escape from his hometown was short lived. His mother summoned him home to help the family through a financial crisis. His father had lost most of the family fortune in a series of imprudent speculations involving the oil fields of Titusville, Pennsylvania. As a result, the family was forced to sell their spacious house in the affluent area of Rochester and move into a small dwelling that rented for thirty-five dollars a month. Arthur’s help was desperately needed and, as so often would be repeated in the years ahead when problems arose, he came through. Young Arthur had four hundred dollars in the bank, an inheritance from his beloved grandfather Hamblin. It was with this modest sum that Stilwell launched his business career. He used the inheritance to buy a printing press. He soon discovered he had considerable sales ability and before long, he was making a reasonable sum of money serving the printing needs of much of the Rochester business community. His success in sales soon resulted in his being hired as a “commercial traveler” for a printing and stationery firm. In the course of his travels from the Northeast into the mid-Atlantic states, Stilwell noted that the New York Central railroad, with which he was familiar because of his grandfather and Commodore Vanderbilt, placed advertisements in its timetables; railroads further south did not. Employing his talents as a salesman, he quickly retained exclusive contracts with a number of railroads to print their timetables and sell advertising. His sales calls put him into contact with rail people: office clerical staff, engineers, conductors, car men, and locomotive mechanics. He soaked up 10 V i s i o n a c c o m p l i s h e d

Genevieve “Jennie” Stilwell, wife of Arthur, remained his partner and staunchest supporter throughout their forty-nine years of marriage.

knowledge from all of them. He learned about the cost and life span of ties, rails, and equipment. And, as he learned more, his passion for railroading grew. He felt he was tantalizingly close to pursuing a path that would allow him the opportunity to achieve his adolescent dream of building a railroad. But he was still nowhere near having the financial wealth and investor contacts to seriously pursue such a lofty ambition.

The Travelers At nineteen years of age, Stilwell married the girl of his dreams, Jennie A. Wood. He was ambitious by nature, and his drive to succeed only intensified. His foray into commercial printing eventually took him to Virginia, Kansas City, and Chicago. In Chicago, his professional life took a major turn when he met the Illinois state agent for the Travelers Insurance Company, who was impressed with Arthur’s sales ability and drive. Not long after their meeting, Stilwell left his printing sales job to become the assistant state agent A r t h u r E . S t i l w e l l 11

for Illinois and immediately got down to studying the insurance business with the same level of intensity he had studied railroading while selling timetable ads. What occurred during the next stage of his career development provides insight into Stilwell’s character. His actions demonstrate his ambition as well as an innate intelligence and creativity, all grounded in his fundamental human decency. From the outset, Stilwell was an immensely successful agent for Travelers. He became a rising star within the company and his financial status improved accordingly. Although pleased with his success, he could not shake the suspicion that the straight-life policies he was peddling were not in the absolute best interests of his clients. In Stilwell’s mind, what was not in the best interest of his clients was, in the long run, neither ethically correct nor in the best interest of the company. Standard straight-life policies of the time were structured such that the buyer would continue to pay the premiums, if he could, until he died, at which time his heirs would receive the financial benefits. This did not sit particularly well with Stilwell. Although he saw the wisdom of the policy while the person was young or middle-aged and making a decent salary, Stilwell was troubled by the fact that when the client grew old and was in a weakened state, he received no benefits but was expected to keep paying the premiums. Meanwhile, it was the younger, healthier heirs who would reap all the benefits, and this ran counter to his sense of fair play. Stilwell was all for business succeeding, but not at the expense of decent, hardworking people. So, when still a relative neophyte in the insurance business, he designed and copyrighted the “coupon annuity,” in which the purchaser paid his premiums until age fifty-nine, at which time his payments ended. At age sixty, the individual would begin receiving one-twentieth of the worth of his policy annually as income. In the event the policyholder died before reaching sixty, the family received the full face value of the policy. As Stilwell stated, “This enabled the policyholder to protect his family during the years they needed protection, and to protect himself during the years he needed protection.” Stilwell also developed what he called an “endowment accident policy.” This, too, was more equitable than existing accident policies at the time. Never the shy and retiring type, the young Stilwell took his copyrighted policy ideas directly to the Travelers headquarters in Hartford, Connecticut and maneuvered his way into a meeting with the company president, James Batterson. By Stilwell’s own admission, the meeting did not get off to a promising start. 12 V i s i o n a c c o m p l i s h e d

“Mr. Batterson,” Stilwell said, “I have come to see you about two plans of insurance I have devised which are revolutionary.” “Stilwell,” Batterson replied just as abruptly, “Whenever we want you to run this company, we shall send for you.” Undaunted, Stilwell pressed on with his sales pitch, which Batterson heard first with impatience and then with growing interest. According to Stilwell’s account, a day later, Travelers had two new insurance products of which Stilwell received a modest percentage from each policy sold. Within a couple of years, Stilwell’s coupon annuity represented a significant percentage of Travelers’ sales. This account gets to the heart of who Arthur Stilwell was and how he would conduct himself throughout the remainder of his professional career. A compassionate man, he had perceived an injustice in the business in which he was engaged. As a businessman, he sought to develop a product that would be in the best interests of both his clients and the company for which he worked. An innovator, he developed a unique approach. A confident and fearless individual, he went right to the office of a senior executive to argue his case. And, always the consummate salesman, he closed the deal. This pattern of combining business acumen with his humanitarian instincts was destined to play a central role in Stilwell giving form to KCS’s corporate identity. For the next two and a half years, Stilwell’s life proceeded happily and prosperously. Nevertheless, he grew restless and increasingly disturbed by the dismal economic conditions in the Midwest, particularly as they related to the plight of farmers. Mortgages were being foreclosed in great numbers. Corn and wheat were being sold at absurdly low prices, so cheaply that corn was actually being burned for fuel. Farmers were desperate. Stilwell concluded that the problem was not with the farm industry itself—which was, after all, the backbone of America. Rather, the farmers’ sorry financial condition was the result of the high transportation costs they were forced to pay to get their crops to ports for export. The accuracy of Stilwell’s contention that rail costs caused the midwestern farmers’ perilous economic state is beside the point. More importantly, it energized him to pursue his childhood vow to go west and build a railroad. The naive declaration of an adolescent had grown into to a more defined mission to help farmers and bring greater prosperity to the Midwest. Specifically, he imagined building a railroad from the heartland of the United States to a southern port on the Gulf of Mexico, which would be an outlet A r t h u r E . S t i l w e l l 13

for exporting grain to Europe. He figured his railroad, by cutting off about six hundred miles of transit, would be the shortest distance between the farming communities and a port with export capabilities, thereby reducing the transportation cost for farmers by at least one-third. In turn, this would help reenergize the Nebraska, Kansas, and Missouri agricultural communities currently floundering under the weight of unjust freight charges that the railroads imposed on them. A worthy goal to be sure, but he had lacked the financial wherewithal to carry out his grand scheme. Stilwell’s bank account showed he had $25,000—a goodly sum for a man of his age, but nowhere close to the kind of money that would be needed to achieve his railroad dream. But, true to form, Stilwell saw this as merely a temporary obstacle and by no means a serious determent to his moving ahead.

The Guardian Trust Company Stilwell settled on the idea of creating a trust company to finance his railroad’s construction. This decision led to the question of how exactly he intended to make his trust company generate enough money to support his ultimate goal. Again, as in the case of his developing a new type of insurance policy, Stilwell the creative innovator found an answer. He wrote in his memoirs: “I decided I would create a trust company to finance my railroad through, and as means of making the trust company a profitable enterprise from the outset, I designed a plan for building houses. My plan was to sell the projected house for 20 percent cash and the balance payable in monthly installments during ten years. The houses and lots would average from $2,500 to $5,000. In case the person for whom we build the house died, the debt was canceled.” So, Stilwell designed a mortgage product supported by an insurance policy. He might have been a man driven by visions and dreams, but he was also an innovator and businessman who had a skill for turning ideas into money. Once he felt he had designed a workable plan that would be the foundation of his trust company, Stilwell again stunned the Travelers president by announcing that he was resigning. Batterson argued, “You’re headed for the presidency of this company if you stay.” Stilwell remained adamant, but Batterson continued, “If it is the amount of salary which is troubling you, we can fix that up. How would double the amount do?” 14 V i s i o n a c c o m p l i s h e d

For Stilwell, it would not do at all and his resignation became official. Amusingly, he observed that “Mrs. Stilwell was fearful that I had been a little precipitate” in his decision to resign. Seriously? By his own admission, he knew nothing about banking—a bit of a drawback when starting a trust company. He also admitted to knowing nothing about building houses. On top of that, he had no real railroad experience, not even scant knowledge of how to build a railroad. A little precipitate? Yes, perhaps. But such was the force of his visions and his determination, and such was her love for and trust in her husband, that Jennie Stilwell never gave serious thought to trying to hold him back. So in the year 1886, at age twenty-seven, Arthur Stilwell arrived in St. Louis and incorporated the Real Estate Trust Company. A year later, the company was worth $1 million. Visionary, creative, entrepreneurial, charismatic—Stilwell was all this and more. By 1887, he had already changed the name of his trust company to Guardian Trust Co., with its office in Kansas City. And, of course, all this led to the fateful discussion between Stilwell and Edward L. Martin after the Guardian Trust board of directors’ meeting on that cold winter’s day.

A r t h u r E . S t i l w e l l 15

The Push South

3

1890–1893

Having secured initial funding for the construction of their belt line railroad, Stilwell and Martin moved ahead. Construction of the forty-mile line was completed in less than three years, and commercial operation began on August 8, 1890. The Kansas City Suburban Belt provided switching and interchange services to the major trunk lines and facilitated rail service to Kansas City’s stockyards, packing houses, grain elevators, and mills. An early indication that Stilwell’s vision extended beyond the belt line was evident when he led the construction of a passenger terminal in downtown Kansas City. Stilwell immodestly named it Grand Central, an impressive name for a passenger station that initially served no passenger trains. He soon remedied this by building the “Air Line,” an eight-mile railroad that provided passenger service between Kansas City and Independence, Missouri. It was anything but an overnight success. His problem was that Independence was not viewed as a destination by Kansas Citians. What ensued was the first glimpse of something that would be frequently repeated over the next ten years: Stilwell as promoter. To help finance the extension of his railroad, Stilwell dreamed up an assortment of promotional schemes to provide funding, create interest in the railroad, and promote enthusiasm for developing the communities located along the right-of-way. Independence, Missouri, was the first site of his venture.

Fairmount Park Stilwell purchased land in the Sugar Creek area of Independence. On it he built a fifty-acre amusement park, which became Fairmount Park. Stilwell’s 17

park offered rides, a zoo, a lake for swimming, band music, Swiss bell ringers, dancing, Shakespearean theater, vaudeville daredevil acts, and a ninehole golf course. Cottages were built for those who desired and could afford a summer home near Kansas City. Fairmont Park quickly became Kansas City’s “Home of the Picnics,” as local companies used it to treat their employees and families to a day at the park. At its height, fifty thousand people would visit Fairmont Park on holiday weekends. Stilwell also brilliantly established the park as a stop on the Chautauqua circuit. The Chautauqua, as it was known, dated back to 1874, where it began on the shores of Chautauqua Lake in upstate New York. Chautauqua quickly became a sensation from the East Coast to the South and the Midwest, bringing entertainment in the form of music, magicians, lectures, cultural events, and religious revivals to rural and developing communities. They became wildly popular. According to Theodore Roosevelt, the Chautauqua circuit was “the most American thing in America.” The circuit provided a venue for people like Russell Crowell to give his “Acres of Diamonds” speech, a lecture he is reported to have given over six thousand times during his life. His message was, “I say that you ought to get rich, and it is your duty to get rich. . . . The men who get rich may be the most honest men you find in the community. Let me say here clearly . . . ninetyeight out of one hundred of the rich men of America are honest. That is why they are rich. That is why they are trusted with money.” This message was in near-perfect harmony with Stilwell’s own philosophy reflecting the concept of the “self-made man,” which represented the heart of the American Dream during the Gilded Age of late nineteenth-century America. Stilwell wholeheartedly embraced the idea that almost all important businessmen were honest and committed to the greater good. Sadly, his naive acceptance of the belief that the actions of America’s wealthy business elite were guided by their adherence to the highest moral and ethical principles would leave him intellectually and emotionally vulnerable a few years later when he was confronted by men of power who were neither honest nor interested in the greater good. For more than two decades, the Chautauqua circuit’s most popular speaker was William Jennings Bryan, the Great Orator. Bryan and Stilwell would cross paths on multiple occasions during their lives, sometimes as friends, sometimes as adversaries. Though Bryan’s candidacy for US president in 1896 would put later Stilwell’s railroad in serious jeopardy, their

18 V i s i o n a c c o m p l i s h e d

first encounter was cordial. Stilwell recruited the populist speaker to participate in a Chautauqua at Fairmount Park. Bryan complained to Stilwell that whereas other Chautauqua “headliners” each received honoraria of one hundred dollars, he received only fifty. Stilwell agreed to pay him one hundred dollars, later claiming he was the first to pay Bryan that amount. Bryan’s presentation in Independence was a huge success and further boosted Fairmount Park’s popularity, which in turn benefited Stilwell’s “Air Line.” Although passenger service would remain part of Stilwell’s vision for a railroad to the Gulf, it was predominantly freight transportation that sparked his and E. L. Martin’s expansion ambitions. This was evident in Martin’s proposal that the team build a line to the coal mines of Hume, Missouri, a distance of eighty miles from Kansas City. Although not dismissive, Stilwell was unimpressed with the quality of the Hume mines and the scope of Martin’s vision. Instead, he countered that they should not stop at Hume but continue south to additional coal mines in Pittsburg, Kansas; then on to the lead and zinc mines at Joplin, Missouri; and then even further south to the Arkansas-Oklahoma coal mines. Stilwell’s argument eventually held sway, and the Kansas City, Nevada, and Fort Smith Railroad was organized in 1889. By 1891, the track had been laid to Hume.

The Texarkana and Fort Smith Railway To expedite the progression southward, Stilwell did not rely entirely on construction but also sought out strategic rail acquisitions when they fell within the scope of his expansion plans. Two opportunities presented themselves nearly simultaneously. The first was a small railroad owned by William L. Whitaker, an interesting figure in his own right. Educated at the University of Heidelberg and then at the University of Virginia, Whitaker amassed a fortune in the lumber business. In 1885, he incorporated his own railroad, the Texarkana and Northern, solely for the purpose of gaining access to more timber. By this point, Whitaker was doing brisk business by selling ties and supplying lumber to railroads that were expanding into Arkansas and Texas. Although hardly an expansive property—it only extended for ten miles from Whitaker’s timberland in Texarkana to the Arkansas border—the Texarkana and Northern did possess a good rail bridge spanning the Red River. The bridge presented a real benefit to someone like Arthur Stilwell, who sought to build southward. For a time, Whitaker actually had a similar

T h e P u s h S o u t h 19

interest as Stilwell. Bitten by the railroad expansion bug, he had explored the possibility of extending his own small railroad to the Gulf. In anticipation of bigger things, Whitaker had changed the name of his line to the Texarkana and Fort Smith Railway and then sought the backing of East Coast rail financiers. His attempt landed with a thud. Whitaker found the East Coast money men less than enthusiastic with his plans. Although there were still investors in the early 1890s willing to gamble on rail expansion, Whitaker’s plan was too much of a stretch to gain traction. With his own expansion ambition dashed, it was actually Whitaker who sought out Stilwell, of whose vision he was well aware. Stilwell jumped at the opportunity, having discovered that George Gould, son of railroad tycoon Jay Gould, was interested in buying Whitaker’s railroad to thwart Stilwell’s move southward. On December 13, 1892, Stilwell acquired the now sixteen-mile Texarkana and Fort Smith Railway and reorganized the two railroads as the Kansas City, Pittsburg, and Gulf Railroad (KCP&G). The transaction was significant, as Whitaker’s railroad became the Texas link for a possible route from Kansas City to the Gulf, as well as the launching pad for the extension into Louisiana. Of notable significance, as part of the reorganization, the directors of the newly formed KCP&G approved Stilwell’s proposal to build a railroad through Pittsburg, Fort Smith, Texarkana, and Shreveport with an eventual terminus at Sabine Pass (Texas) or “some city on the Gulf of Mexico.” This was the first acknowledgment in writing that Stilwell’s dream of building a railroad from Kansas City to the Gulf had begun to take form. Meanwhile, construction of Stilwell and Martin’s railroad proceeded steadily and reached Joplin, Missouri, by 1893. At this point another acquisition emerged, and with it, a truly fascinating and colorful figure was added to KCS’s history.

Splitlog’s Railroad Some historians have written that Matthias Splitlog was born in 1812 in Ontario, Canada, and that he was one-half French Canadian and one-half Cayuga Indian. Others believe he was born in New York State and was of the Wyandotte tribe. Then others feel he was taken in by members of the Cayuga tribe who moved from New York State to Ohio and settled around Sandusky,

20 V i s i o n a c c o m p l i s h e d

home of the Wyandottes. Still others suggest that he was stolen by Native Americans as a baby, reared by the Wyandottes in Ohio, and made an Indian scout at fifteen. It is safe to say that enough time has passed to accept that no one will ever know with certainty from where Splitlog originally hailed or to what tribe he belonged at birth. What is known is that in 1843, he and approximately eight hundred members of the Wyandotte tribe were forcibly removed from their Ohio homeland in a forced migration tragically reminiscent of the “Trail of Tears” that had taken place only five years earlier. The migration was a continuation of the displacement of Native Americans from their ancestral homelands in the East and Southeast to an area designated as Indian Territory, west of the Mississippi River. Splitlog survived the brutal trek westward and, along with others, obtained a land allotment at the fork of the Missouri and Kansas (Kaw) Rivers in Kansas City. He also received an additional land allotment in an area that would become Westport, so named because it became the staging area for wagon trains heading westward to the California, Oregon, and Santa Fe Trails. In 1857, a group of land speculators began buying land and plotting what would eventually become the City of Kansas City. They approached Splitlog with an offer but were rebuffed. Three years later they returned, this time offering to buy his property at a highly inflated price. This time, Splitlog agreed and overnight became a wealthy man. The transaction gained considerable regional notoriety, and Matthias Splitlog was characterized in the press as “the Indian Millionaire.” Although he was neither able to read nor write, it is claimed that Splitlog spoke seven languages and was a mechanical genius. He built the first grist mill in Kansas and constructed a steamboat to carry goods to small settlements along the Kaw River. He opened a blacksmith shop and built a threestory factory for the manufacture of buggies, two-seat hacks, and last but not least, coffins. In 1893, Splitlog received another huge sum of money when the Union Pacific Railroad (UP) paid him what was described as a “fabulous” amount of money for right-of-way over a parcel of his land allotment. Life was good for Matthias, and his entrepreneurial successes continued unabated for the next two decades. By the 1880s, Joplin had become the center of the region’s mineral deposits, particularly lead and zinc. On March 7, 1887, Splitlog was granted a Missouri charter for the Kansas City, Fort Smith,

T h e P u s h S o u t h 21

and Southern Railway, which he built to capitalize on the mining activity in the region. The railroad ran south from Joplin through Neosho, Missouri into Splitlog City, a town he had developed. The rail’s infrastructure was primitive to say the least: there was almost no ballast, the ties were logs dropped into place, and the tracks were laid on the ties without spikes to fasten them. The line between Joplin and Neosho was completed in 1888, and construction south of Neosho to Splitlog City was completed in June 1889. And then things went terribly wrong. One of Splitlog’s railroad’s directors came to him with supposed insider information that gold deposits had been discovered in McDonald County in southwest Missouri. Jumping on another opportunity to grow his empire, Splitlog quickly purchased forty acres where the deposits were said to have been discovered and then acquired even more land in the surrounding area. He incorporated the “Splitlog Land and Mining Company,” the vehicle through which he leased up to five thousand acres of land to Native Americans and others desiring to get into what appeared to be a potentially very lucrative opportunity. But the sad truth was that the only gold in McDonald County was fool’s gold. The so-called gold deposits had been planted by unscrupulous con artists, of which Splitlog’s director was one. The land had been “salted.” Splitlog was devastated, feeling responsible for having sold or leased the largely worthless property to people who trusted and admired him, people for whom he cared deeply. To rectify the situation as best he could, Splitlog exhausted nearly his entire wealth to make financial restitution to the people who had invested in his property. Among the fallout from the fraudulent mining scheme was that Splitlog no longer had the financial resources to invest in his railroad. Interestingly, he too had dreamed of extending his rail line to the Gulf of Mexico. His vision was to run it through Indian Territory and thus doing enhance the economic well-being of Native Americans. That dream, too, was now dead. Without adequate funds, the railroad fell into bankruptcy. A group of Philadelphia investors led by L. L. Bush, a railroad promoter, took over and reorganized the railroad. The swindle drained Splitlog of his passion for business. However, his financial downfall kindled within him a stronger-than-ever empathy for his Native American brethren, and he spent the remaining years of his life working to improve their lot and championing their causes. As such, he spent much of his later life in Washington, DC, always self-funding his lobbying 22 V i s i o n a c c o m p l i s h e d

efforts. Years before, he had been adopted into the Seneca tribe and later was elected chief of the Senecas. It was with this honor that Splitlog, “the Indian Millionaire,” found his true riches. During a lobbying trip to Washington, DC, he contracted pneumonia. On January 2, 1897, at the age of eighty-five, the amazing Matthias Splitlog died in that city. Arthur Stilwell had been aware of Splitlog and admired him both as a man and as an entrepreneur. Far from overwhelmed with the physical quality of the railroad, Stilwell noted that it would fit nicely into his expansion plans. In 1892, after “the Splitlog” was in the hands of the Philadelphia ownership group, Stilwell initiated negotiations to acquire the railroad. A deal was struck, and on May 11, 1893, for the modest sum of fifty thousand dollars, the Kansas City, Fort Smith, and Southern Railway was formally transferred to the KCP&G. Why is the saga of Matthias Splitlog and his small railroad of any importance to the KCS story? True, “the Splitlog” happened to be situated in a place of strategic importance to the expanding KCP&G, but buying it was a convenience and a cost-saving measure more than it was a necessity. The answer has more to do with the fact that a company’s character, personality, and culture are not defined solely by the sum of its assets. The character and personalities of the people who form a company, and those of the leaders who follow, are every bit as important, arguably more important, than its physical assets and balance sheet. It is people, not inanimate physical objects, who create a company’s identity and character. Splitlog’s fascinating life and legacy became part of the evolving KCS spirit. In many respects, he was another version of Arthur Stilwell. His drive, rags-to-riches story, entrepreneurial spirit, intellect, desire to pursue diverse business opportunities, and humanity—all qualities Stilwell shared—were infused into the young railroad company. Stilwell’s railroad was not just adding track miles; it was also building an identity. Track construction on the KCP&G continued at a good pace. This, coupled with the two acquisitions, set Stilwell’s team on a tear. By the end of 1883, the KCP&G commanded 212 miles of track. Except for a small gap, the KCP&G now stretched from Kansas City to Texarkana. Even though cash was still tight and additional funding was needed for construction and the purchase of locomotives and rolling stock, the mood of Stilwell and his team was buoyant. The company appeared primed in 1893 to begin the final push to the Gulf of Mexico. Instead, what occurred was the first serious threat to Stilwell’s plan. T h e P u s h S o u t h 23

The Panic of 1893 The 1880s had been a period of extraordinary economic expansion in the United States, driven in good part by excessive railroad speculation. Banks had been financing railroad expansion without carefully reviewing company financials, and speculators made fortunes buying rail debt and stocks. By the 1890s, the thirst for continued profit-making had led to serious overbuilding and too-often-shaky rail financing. Nearly all the railroad companies had underwritten their construction projects and acquisition activities through high-interest bond issues. What had emerged was a pattern of overborrowing by railroads and continued reckless lending by banks. It had worked for a while: railroads grew in size, banks collected interest on the debt, and speculators reaped large profits. But more often than not, railroad revenues proved to be inadequate to service the interest payments on the bond issues. The most common remedy of the time had not really been a remedy at all but a recipe for eventual disaster. Faced with a cash crunch, a railroad would seek to acquire another property or take on another expansion project, reorganize, and issue additional bonds at ever higher interest rates. Layering on more debt while falling well short of the profit levels needed to pay interest was a death spiral. The first crack in the nation’s economy occurred on February 23, 1893, when the seriously overextended Philadelphia and Reading Railroad filed for bankruptcy. From that moment on, the US economy went into free fall. Ultimately, more than 500 banks, 74 railroads, and over 15,000 companies failed. By some estimates, the unemployment rate hit 18 percent by 1894. The Northern Pacific, the UP, and the Atchison, Topeka, and Santa Fe Railways were among those forced into bankruptcy. Until the Great Depression of 1929, the Panic of 1893 was the worst economic meltdown in US history. In his memoirs, Stilwell understated the threat to the KCP&G. He declared that he never allowed the company to spend beyond its means or get ahead of itself. Maybe, maybe not, but the fact was he did not have the financial resources to push much farther south, and a railroad running from Kansas City to southwestern Missouri was not, over the short or long run, going to have the level of financial success that Stilwell needed. The bottom line was Stilwell’s railroad needed money at a time when financial markets were in turmoil.

24 V i s i o n a c c o m p l i s h e d

Yet, Stilwell appeared undaunted, confident that even in the midst of the greatest economic depression in US history, he could arrange the financing to continue construction and acquire the equipment needed by his growing operation.

The Dutch to the Rescue Contemporaries characterized Stilwell as having a “commanding presence” with a “musical, powerful voice.” People were mesmerized by his “deep blue eyes” and “blond, wavy hair” and noted that he was a “figure of eloquence.” According to one observer, “His demeanor was mesmerizing.” But good looks and a commanding demeanor were not going to be enough to save his railroad. Fortunately, just as he had done previously as a young agent at Travelers, Stilwell soon proved that when he set his sights on a goal, he was a force with which to be reckoned. While not a ruthless figure, he was driven and ambitious. He knew exactly what he wanted and was creative enough to pursue unconventional paths to achieve his ends. And, not to be discounted, he was an honest, compassionate, and generous man. Hard-edged East Coast financiers had come to call him the “whirlwind stock salesman of the West.” But Stilwell claimed it was not the force of his personality that made him a successful salesman, but his honesty. When he sought money, none of it was to line his own pockets. He always shared his victories with his partners and investors. Although he was proud to be labeled a self-made man of the Gilded Age, he possessed none of the greed of a number of industrial tycoons of the time. He was liked, respected, and trusted by a good deal of the East Coast financial community. With the US economy in a tailspin, Stilwell’s financing options were, to put it gently, scant. It was at this point that he claimed to have had one of his “hunches” prompting him to inform a group of his investors that he intended to travel to the Netherlands and raise $3 million. Stilwell and his wife had briefly—very briefly, as it turned out—visited Holland years before. The idea of going there to raise money had not been entirely fanciful, as the Dutch had invested heavily in US rails. But the timing could not have been worse, as the economic panic had rapidly spread from the United States to Europe. That he had appeared to be embarking on a fool’s errand was underscored by his response to a question from a Kansas City friend as to whether he had contacts in Holland’s financial community. T h e P u s h S o u t h 25

“No, I do not,” he replied. If that response alone was not enough to shake investor confidence with his plan, he added that he had only spent two days there and that those were only as a tourist. Nevertheless, he assured the group, “I am positive that I can go to Holland and raise the money to build to Shreveport.” So off he sailed. Once he arrived, he put together a prospectus offering $3 million of stock at one hundred dollars per share. He then proceeded to set up meetings with all of Amsterdam’s principal bankers. But, after two weeks pounding the streets, he had to admit that his initial attempt had failed. Somewhat bloodied but still unbowed, he contemplated his next move. By his own admission, out of nowhere came a memory of his meeting an engaging young fellow, years earlier, on a ship taking Stilwell and Jennie back to the States. He had been taken by the young man, a coffee merchant, feeling he was of the enterprising sort, one with the energy and intelligence to take on a challenge and see it through. With dogged determination, he tracked down the coffee merchant, whose name was John de Geoijen. Under the guise of wanting to renew their friendship, Stilwell invited de Geoijen to lunch. It was there that he laid out his plans of building a railroad from Kansas City to the Gulf of Mexico and then surprised the young man by suggesting he give up his successful coffee business and sign on to help build the railroad. Descriptions of Arthur Stilwell provided by contemporaries made frequent note of the man’s charisma. That charisma must have been fully in evidence during that lunch; de Geoijen accepted the offer. Over the next week, Stilwell lectured his new hire in the intricacies of the railroad business. The two worked together to develop a revised offering. Although Stilwell took off to Berlin on other business, de Geoijen remained in Amsterdam on the day the revised offering was issued. By afternoon of the day, in a state of total despair, de Geoijen wired his mentor to tell him that this offering, too, had failed. On his return, Stilwell pushed ahead, this time taking his sales pitch to the local newspapers claiming that his intention had always been to make an offering to the general public and that the restrictions written into the offering that limited the opportunity to only the wealthiest investors had been inserted without his approval. Whether that was true, Stilwell hit a responsive chord. The press published some very positive stories praising the quality of the investment opportunity. When the revised offering was put to the market, the entire deal was subscribed in twenty-seven minutes; in one hour it went to a premium of 25 percent. 26 V i s i o n a c c o m p l i s h e d

Against all odds, Stilwell had raised $3 million as promised. As a result, he was later able to boast that in 1893, in the midst of the great financial panic that forced seventy-four railroads into receivership, the KCP&G had built one-third of the total new railroad miles constructed in the United States that year. As a token of his gratitude, as the KCP&G’s construction progressed southward, Stilwell bestowed Dutch names to the developing rural communities. Thus, DeQueen, which is an Americanization of his friend John de Geoijen’s name; Mena, named after de Geoijen’s wife; and Vandervoort became Arkansas towns. Bloomberg and Nederland appear in Texas; and Hornbeck and DeRidder become Louisiana towns. Zwolle, Louisiana, was named after de Geoijen’s birthplace; and Amsterdam, Missouri, took the name of the Dutch capital city. DeQuincy, Louisiana, was named in honor of Baron DeQuincy, a Dutch nobleman and stockholder in the KCP&G. Stilwell’s success in obtaining Dutch financing stands as a significant moment in KCS’s history. It was an extraordinary achievement given that it was accomplished during a period of international economic turmoil and when railroads had temporarily lost appeal in the eyes of investors. Although it was not the last of Stilwell’s victories, it can be argued that it was his greatest.

“Hell’s Half Acre” A postscript to the Netherlands story tells us much about Stilwell, the man. It happened that a group of the Dutch investors made a healthy profit from selling the securities. When they found out that Stilwell awarded himself not one share of promotional stock, they cabled him forty thousand dollars as a gift of gratitude and appreciation for what he had done for them. But Stilwell was a builder. His primary motivation was not financial profit through speculation. Although he appreciated the thought behind the gift, he wanted no part of it for himself. So, the full forty thousand dollars went toward building a mission home in the “Hell’s Half Acre” section of Kansas City, also known as the Bottoms. Hell’s Half Acre had been originally settled in the late 1860s by African Americans who had been hired to help build the Hannibal Bridge, the bridge that established Kansas City as an important railroad hub. Over the next two decades, German, Italian, and Irish immigrants moved in. Unfortunately, so did hordes of ne’er-do-wells, hooligans, and prostitutes. Living conditions T h e P u s h S o u t h 27

became deplorable with eight or more people living in tiny shanties. Serious disease spread through the community along with infestations of lice and bedbugs. There was no clean water and no sanitation of any kind. Hell’s Half Acre had become a filthy slum beset by poverty, crime, and dreadful living conditions. Stilwell felt compelled to do something to ease the plight for at least some of the slum’s inhabitants. Thus, he established and funded the Bethany Night School, which provided free baths for children. It also served as a day care facility where the children of working mothers could be left and cared for. It provided clothes and shoes. Cooking and sewing classes were offered, as well as consulting services for people in the neighborhood who faced assorted problems. During Stilwell’s involvement, the Bethany Night School educated four hundred children, Stilwell claimed, with at least half of them eventually attending college. His comment about the school is telling: “It often seemed to me that if nothing else had come out of the building of the Kansas City Southern but the redemption of Hell’s Half Acre and the diversion of so many lives to the right channels, it would all have been worthwhile.” Strong leaders leave behind powerful legacies. Part of Stilwell’s legacy, a large part in fact, was that the ultimate victory is one in which many people prosper. His decency and humanitarianism, shaped in no small part by his adherence to Christian Science doctrine, made him a good deal more than just a product of the Gilded Age ethic. There can be no mistaking that Arthur Stilwell was a driven businessman. However, it was not the accumulation of wealth that drove him but the building of things that could benefit people, country and, of course, his company. That spirit and sense of community, along with loyalty to the company, were to become embedded in the KCS spirit.

28 V i s i o n a c c o m p l i s h e d

The Final Drive to the Gulf

4

1894–1897

While Stilwell’s success in obtaining Dutch financing during the depths of the 1893 depression was remarkable, it was more an important battle victory rather than the winning of a war. It did not come close to satisfying the KCP&G’s need for growth capital, and if Stilwell’s railroad was ever to become self-sustaining, expansion was absolutely necessary. The simple truth was, given the railroad’s heavy debt load, operating only from Kansas City to the Arkansas border would never generate the revenues necessary for it to be a viable entity. Existence demanded enlarging the network. Even a cursory look at the KCP&G’s 1894 financials underlined this point. The total cost of the railroad and its equipment for the year amounted to $11,500,000; its revenues totaled only $288,238. Stilwell had been desperate to get his railroad first into the rich timberland of Arkansas, then on to the Gulf of Mexico. By doing so, he envisioned being able to move grain from the Midwest to a port on the Gulf for export to Europe. While one should not underestimate the importance of the Dutch infusion of cash, on its own it was not sufficient to underwrite the KCP&G’s construction to the Gulf. And track construction was not the sole drain on the company’s cash. The railroad lacked adequate locomotive power and rail cars, and track conditions were inadequate for long stretches of the network. Clear eyed and undaunted, Stilwell attacked his financial problems in multiple ways. To begin, his 1893 trip to the Netherlands was by no means his last business travel abroad. He made multiple trips to Europe in the 1890s, expanding his search for funding beyond the Dutch to include the English, French, and Germans. He was also a frequent visitor to bankers and financiers in East

29

Coast cities, including Philadelphia, New York, and New Haven, Connecticut. Repeatedly, he returned to the major financial centers in the United States and Europe. While his success rate in securing additional financing was laudable, the increasing debt level put the KCP&G in ever-greater long-term jeopardy. But it was Stilwell’s belief that once the railroad was complete, its revenues would be more than adequate to offset the high debt costs. The problem was his genius was that of a builder and a promoter, not as an astute financial manager or a business forecaster. Stilwell had unrealistic expectations of the kind of revenues the KCP&G could reasonably expect to generate. To augment the cash brought in from operations and financings, Stilwell became a land speculator and promoter of new communities along his railroad’s right-of-way. While the promotional activities did contribute to his personal wealth, his primary objective was always to secure additional funds to provide capital for the KCP&G’s continued expansion. At first blush, his foray into community development appeared to be as mistimed as his plan to build a north–south railroad in the 1890s. Just as the golden age of railroad expansion was waning by the time he got started with his venture, it is generally recognized by historians that after 1890, urban growth no longer took form in the creation of new cities and towns but the expansion and development of those already established. For the most part, the growth of new towns was mostly limited to the birth of suburbs surrounding already existing urban centers. Stilwell was likely unaware of this cultural and economic phenomenon; if he was, he certainly was untroubled by it. What he did know was that only a few decades earlier, railroad companies had benefited enormously from land development. Railroad surveyors moved ahead of rail construction, buying land, locating towns, and laying out lots and streets. Sales of these sites were large financial windfalls to the railroads, their owners, and their investors. The impact of this development had an additional benefit of generating the expansion of economic activities that led directly to increased rail revenues. Stilwell sought to replicate this model. Despite entering the game late, his natural gift for promotion resulted in a reasonable amount of success, though exactly how much of that success translated to improving the financial condition of the KCP&G is debatable. The development of Mena, Arkansas provides a glimpse into the nature of Stilwell’s promotional endeavors. In 1895, with the KCP&G still forty

30 V i s i o n a c c o m p l i s h e d

Arthur Stilwell was a master promoter. As this poster illustrates, while building his railroad southward he was also developing and marketing undeveloped areas along its right-of-way.

miles to the north of the largely undeveloped townsite, Stilwell began a coordinated promotional effort. Newspapers throughout the Midwest began to describe the glories of Mena: ideal climate, unlimited trade possibilities, and abundant opportunities for business development. Stilwell directed his construction team to lay one mile of track a day, and he made sure that their

T h e F i n a l D r i v e t o t h e G u l f 31

progress was reported daily in newspapers across the region. Excursions took prospective buyers—first by train and then when the track ended, by wagons—to experience Mena firsthand. Public interest mounted, and during the height of the promotional activities, up to five thousand excursion tickets were sold per week. A promotion was established in which an individual buying a lot in Mena received one free roundtrip from Kansas City to Mena, including three nights in a luxury sleeper car and three meals a day. Buyers were required to make 50 percent down payments on lots valued at less than two hundred dollars, and onethird down payments for properties at $200 or more. Displaying his typical civic-mindedness, Stilwell inserted a provision into the deeds that 2.5 percent of the money from the real estate sales would be allotted to a school building fund. Within a few years, Mena became a thriving trading community that could boast of an electric power plant, a water works, a telephone system, a few good-sized lumber operations, and an orchard and nursery business. A couple of years later, Mena possessed a flour mill and two newspapers, and was the seat of the county government. While little of this resulted in direct line-haul revenues for the railroad, the development and land speculation companies Stilwell incorporated provided additional funding to keep construction progressing. Mena was but one of a number of towns developed by Stilwell. In Louisiana, Zwolle was developed as a sawmill center. Hornbeck became a cotton center. DeRidder developed into a prosperous lumber community and became the seat of government for Beauregard Parish. All of these Louisiana towns promoted by Stilwell were also part of his larger scheme to promote the large-scale cutting of longleaf pine from Shreveport to Lake Charles. To that end, he organized a company to handle the timber business. In this case, direct revenue did flow to the KCP&G through increased lumber carloadings. Once construction moved into Texas, Stilwell formed another company called the Port Arthur Rice Farm. It is through this entity that he enticed Hollanders to immigrate to Texas to become rice farmers. He established the town of Nederland between Port Arthur and Beaumont as the settlement for Dutch immigrants. To help ease the integration of the displaced immigrants into their new surroundings, Stilwell even convinced the local paper to publish news columns in Dutch. In time, the Nederland development was a resounding success. While Stilwell did not initiate rice farming 32 V i s i o n a c c o m p l i s h e d

in Texas, he contributed greatly to its expansion. In 1889, records show Texas rice production on 20 acres resulting in 13,996 pounds of rice. A decade later, with Stilwell’s development efforts, the numbers had increased to 5,859 acres and 5,643,194 pounds of rice.

An Eleventh-Hour Change of Course Through his success in attracting East Coast and European investors to back the KCP&G, and his energetic promotional activities, Stilwell was able to keep his railroad afloat and construction ongoing. With construction closing in on Shreveport, it was time for Stilwell to commit to an exact location for the KCP&G’s southern terminus. By 1894, it appeared that he was considering two different strategies for extending the railroad from Shreveport to the Gulf of Mexico. One plan had the KCP&G continuing to build to a terminus point at Sabine Pass. Stilwell felt additional funds would become available to expand to the Gulf once the railway from Kansas City to Shreveport opened. To that end, on September 29, 1894, a charter was filed that provided for a railroad to be constructed from the northern boundary of Louisiana southward, via Shreveport, to Sabine Pass. From the beginning this had been Stilwell’s plan. Maps printed by the KCP&G, advertisements for the railroad, and even company stationery indicated that Sabine Pass was the goal. But in early 1895, it appeared that Stilwell had second thoughts. The catalyst for deciding to continue as planned or choose another option was that Stilwell had gotten wind that the Houston, East, and West Texas Railway (HE&WT) was going to be put up for sale. The HE&WT, and its Louisiana subsidiary railroad, operated a 231-mile line that connected Shreveport to Houston. Stilwell rushed to New York and obtained an option to buy the HE&WT for $3 million, a fraction of what it would cost him to build from Shreveport to Sabine Pass. Buying the HE&WT would cement the decision to make Sabine Pass the terminus of the railroad. With the option in hand, Stilwell turned to negotiating for access over a short line that would get the KCP&G to the Gulf of Mexico and Galveston. Once he had successfully completed the negotiations, Stilwell assembled his directors in Kansas City to approve the plan to acquire the HE&WT. Then, seemingly out of nowhere, he changed his mind and informed his directors there would be no purchase of the HE&WT. T h e F i n a l D r i v e t o t h e G u l f 33

His decision appears to have been based on two factors. First, after visiting the area that would be the endpoint for the KCP&G, he was disappointed in its layout. Second, and most importantly, he had not been able to come to a satisfactory business or financial arrangement with the group who owned land in and around Sabine Pass. There was simply no way that the shrewd developer, Stilwell, was going to build to a terminus he could not control. Stilwell did not disclose to his directors the primary reason for his change of direction. He merely said he was concerned that ferocious storms hitting the Gulf Coast could seriously damage the railroad. As a result, for over one hundred years, rail enthusiasts have remarked on the prescience of Stilwell’s decision in light of the devastating hurricane that struck Galveston on September 8, 1900, resulting in the loss of over six thousand lives. To this day, that hurricane remains the worst natural disaster in US history in terms of loss of life. Regardless of the primary motivation for Stilwell’s decision, it proved to be a sound one for the railroad and its investors. Although it may have been the right decision for the long term, it also meant that, once again, the KCP&G was in dire need of cash to keep its expansion on track. Unfortunately, just as in 1893, the timing could not have been worse for a company in desperate need of money.

The Election of 1896 The US economy had never fully recovered from the crippling 1893 depression. Three years later, the dispute between the Populists and the Republican Party had grown fierce and divisive. The Populists favored a greater use of silver to back the US dollar, while the Republicans advocated for gold as the sole standard. Simply put, the Populist Party, enjoying wide support from US farmers, wanted to use silver as the vehicle for putting additional money into the economy. The goal was to spark inflation. In theory, inflation would push grain prices up and thereby provide farmers with a greater opportunity to pay off their fixed cost debt. The Republican Party wanted the opposite; a deflationary economy was a boon for business interests, as costs were kept low and profits high. Leading the Free Silver forces was Arthur Stilwell’s acquaintance William Jennings Bryan. Known both as the “Great Commoner” and the “Great Orator,” Bryan traveled the country condemning the greed of big business, especially the robber barons and railroads. He called for increased regulation 34 V i s i o n a c c o m p l i s h e d

of the railroad industry, which he felt was the worst example of greed and corruption run rampant. His message gained widespread support, and his growing momentum propelled him to win the Democratic Party’s nomination for president in 1896. William McKinley won the nomination of the Republican Party. The two candidates could not have been more opposite in terms of their personalities and political and economic philosophies. Whereas Bryan was gregarious, outspoken, a natural campaigner, and a “man of the people,” McKinley was taciturn, rejected campaigning entirely, and was an ardent supporter of big business and monied interests over the common man. As Bryan crisscrossed the country spreading his message, McKinley retreated to his home in Canton, Ohio, letting surrogates campaign for him. Not surprisingly, Bryan’s popularity soared, and the odds increased that a major political upset might be in the offing. The American public was galvanized by the campaign. During the period, L. Frank Baum wrote The Wonderful Wizard of Oz as an allegory of the election campaign. “Off to see the Wizard” signified going to Washington, DC; the Tin Man represented the worker; the Scarecrow was the farmer; the Cowardly Lion was William Jennings Bryan; and the Yellow Brick Road was the gold standard. The election was of paramount importance to Stilwell and the KCP&G. Stilwell had earlier returned to Amsterdam and had been able to gain the support of Dutch investors for an additional $3 million financing package. The catch was that the financial support was conditional on McKinley winning the election. Fearing that the US economy would spiral downward with a Bryan election, the Dutch said that they would withdraw their financing if the Democratic candidate won. The sentiment of the Dutch investors was widely shared by US financiers as well. While Stilwell had maintained a cordial relationship with Bryan dating back to the Chautauqua lectures at Fairmount Park, he was passionately committed to William McKinley. Having spent a weekend at McKinley’s home, Stilwell was driven to write: “I saw a man with firm steady eyes that were full of both warmth and heart and delicacy of soul. I felt that I was in the presence of a great man and a good man. Before I left Canton, I was convinced that Major McKinley is the greatest living American.” As historian Keith L. Bryant observed, “Stilwell discovered characteristics in McKinley that no one, except perhaps Mrs. McKinley, had discovered before or since.” T h e F i n a l D r i v e t o t h e G u l f 35

Fully endorsing McKinley’s economic platform, as well as being motivated by self-interest, Stilwell became a member of McKinley’s “speakers’ bureau” and toured much of the country on his behalf. He also wrote and published a series of pamphlets extorting the benefits of the gold standard over silver. At the same time, big business interests, including the likes of Standard Oil, robber barons like John W. Gates; major banks; and the large railroad companies poured money into McKinley’s campaign. Still, the directors of the KCP&G grew increasingly fearful of the election going to Bryan. Without Stilwell’s consent, the board, including his longtime friend and business partner, E. L. Martin, decided to seek out friendly parties who could serve as receivers if the company was forced to restructure. On hearing this, Stilwell was outraged. After an emotional debate, the directors reluctantly granted Stilwell permission to seek additional financial backing in lieu of the Dutch reluctance to commit prior to the election. Again, just like in 1893, Stilwell pulled off the near impossible. Starting with George M. Pullman, he approached all of his big monied contacts and convinced them to invest in the KCP&G. In a matter of weeks, he had secured the funds necessary to keep construction of the rail line going. In the end, a sharp upswing in the US economy in September and October 1896, along with the support of deep-pocketed finanacial interests, successfully turned the electoral tide in McKinley’s favor; the Republican won the election. The gold standard prevailed, and the forces advocating for a freer currency and higher inflation were vanquished. The Dutch released the $3 million in backing for the KCP&G. Stilwell had again saved his railroad.

The KCP&G Reaches the Gulf Having already declined the option to acquire the HE&WT and after rejecting Sabine Pass, Stilwell needed to pick a terminus location. He settled on a large expanse of land along a bayou located on the western shore of Sabine Lake and directed his property team to buy approximately forty-six thousand acres of level prairie land that had been used as a cattle range. The land was located seventeen miles from the Gulf of Mexico. Never a victim of false modesty, he named the property “Port Arthur.” Stilwell the promoter immediately began developing the town. While the streets and lots for homes, businesses, churches, and parks were being laid out, he simultaneously sought approval to begin dredging a canal from Port Arthur to Sabine Pass to access the Gulf. The project encountered delays 36 V i s i o n a c c o m p l i s h e d

Though rightfully considered the founder of KCS, the railroad built by Stilwell was the Kansas City, Pittsburg, and Gulf Railroad (KCP&G), which was completed in 1897. Later the KCP&G was reorganized under the name Kansas City Southern Railway.

caused by litigation brought by parties trying to thwart Stilwell’s plan. The fight forced him to plead his case in a number of venues, including testifying before the US House of Representative’s Ways and Means Committee. Finally, after two years of delays, Stilwell prevailed, but the ordeal cost him both a great deal of time and, more importantly, money. However, as soon as he received the necessary permits, he proceeded to build a port facility and incorporated the Port Arthur and Mexican Steamship Company, which inaugurated service to a number of Mexican port cities. In addition to Mexico, Stilwell initiated steamship freight service to England and Holland. In the first six months of operation, ship traffic from Port Arthur equaled the four previous years from Sabine Pass. Concurrent with the development of Port Arthur township, the last miles of track work on the KCP&G was being completed. During the final phase, construction continued on multiple fronts. Track was built from Port Arthur to Beaumont. Tracks were also laid down, both coming into Shreveport from the north and leaving Shreveport southbound toward the Gulf. On March 2, 1897, the KCP&G began service between Kansas City and Shreveport. During the spring and summer of that year, construction proceeded T h e F i n a l D r i v e t o t h e G u l f 37

through the western tier of Louisiana parishes. By July, the rail line had reached DeQuincy, Louisiana. From there, construction moved in a southwesterly direction toward Beaumont, Texas. Finally, on September 11, 1897 at Mauriceville, Texas, twelve miles north of Beaumont, the last spike was driven. Stilwell had reached the Gulf of Mexico. The 215-mile rail line between Shreveport and Port Arthur had taken less than two years to complete and the entire railroad from Kansas City to the Gulf of Mexico a tad over ten years. Both were remarkable accomplishments for a perpetually cash-constrained enterprise. Celebratory events were held in Mena, Shreveport, and Beaumont. But the greatest celebrations took place in Kansas City and Port Arthur. Stilwell was seated in a private box at Fairmount Park in Independence, Missouri, attending a horse show. There was a pause in the performance, and a cannon was fired on an adjacent hillside. A large billboard was unveiled that read “Kansas City is now connected with its own seaport, Port Arthur, by its own rails, the Kansas City, Pittsburg & Gulf. The last spike has been driven.” A band played “Port Arthur March,” and that night searchlights placed atop several downtown buildings swept across the skies, symbolizing Kansas City as a beacon of commerce. There is a tragically ironic postscript to the day’s celebration. Much has been written of Stilwell’s premonition of a devastating storm that would strike Galveston and his decision to build his terminus in a safer, inland location on Sabine Lake. Mostly forgotten is the story of what happened at the celebration that took place at Port Arthur. On the afternoon that the last spike was driven, excursion trains rolled into Port Arthur from Kansas City and other areas along the system. There were speeches, a parade, music, dancing, and plenty of food and drink. The celebration ran deep into the night. The happy revelers had no idea that a huge storm had formed in the Gulf and was bearing down on the coast. Before daylight on September 12, 1897, a major hurricane struck Port Arthur. With visitors having inflated the city’s population, and with many of the new residents still living in tents, floodwaters swept through the city, reaching depths of five feet in places. People rushed to the partially completed KCP&G roundhouse seeking refuge from the howling winds and torrential downpours. The roundhouse could not withstand the winds and rain and collapsed, killing four people. In all, thirteen people died before the storm subsided, and many homes were destroyed. Three years later, Stilwell’s decision to forsake buying the 38 V i s i o n a c c o m p l i s h e d

HE&WT and bypassing Galveston would prove to be fortuitous, but that decision did not come without its own tragic consequence. While the deaths cast a pall over the celebration, nothing could diminish Stilwell’s feat of building a railroad from Kansas City to the Gulf of Mexico in ten years despite being chronically short of growth capital and confronted with two major US economic crises. Logically, the project should have failed. That it did not is a testament to Stilwell’s fearless determination, creativity, salesmanship, vision, and unsinkable optimism. While some of the strategies he employed to get the railroad built would shortly come back to haunt him, the fact that he achieved the near impossible cannot be, should not be, forgotten. From nothing, Stilwell had built a railroad and in doing so gave birth to a truly unique corporate culture that served as the bedrock of the company’s identity for 135 years. That culture, so important in getting the railroad built, was also crucial to the company surviving future periods of crisis and ultimately was the single most important ingredient in its remarkably successful history.

T h e F i n a l D r i v e t o t h e G u l f 39

Receivership

5

The End of the Line for the KCP&G

The hurricane that struck Port Arthur was not the only calamity that befell the KCP&G on the day of the celebration. On that very same day, a yellow fever quarantine was declared between Shreveport and the Gulf of Mexico. As a result, nearly all traffic was halted along the route. The quarantine stayed in effect for six weeks, a real blow to the cash-strapped railroad. As dire as the impacts of the hurricane and quarantine were, they were soon overshadowed by a host of structural challenges confronting the railroad. Though the construction of the main line was complete, the KCP&G’s commercial physical plant and financial underpinnings were dangerously fragile. In addition to his railroad’s infrastructural challenges, Stilwell was forced to accept that for his core revenue strategy to take hold—namely, the transport of grain and other commodities from the Midwest to the Gulf for export—the KCP&G needed interchange partners to gain access to shippers not on its main line. The railroad by itself simply could not originate enough traffic to make it on its own. Stilwell’s initial attempt to remedy this shortcoming was clumsy and largely self-defeating, as it sparked a rate war in grain markets. The KCP&G’s shorter distance to the Gulf made it competitive compared to other rail routes from the Midwest to the East Coast. Even so, Stilwell cut prices lower than his railroad’s lesser track miles and operational costs could absorb and make the kind of profits needed. The KCP&G reduced grain prices from Kansas City to the Gulf to twelve cents per hundred pounds compared to the Kansas City to New York rate of 19.5 cents. In addition, the KCP&G absorbed the elevator charges. Stilwell’s actions did push grain onto the

41

KCP&G but alienated other railroads, particularly the Missouri Pacific (MoPac) and the UP, both of which had been possible interchange partners. The increased volumes could have been a real positive for the fledgling line if the business had been more intelligently priced and if the KCP&G had enough equipment to handle it. Unfortunately, neither proved to be the case. Slashing grain shipping rates was not Stilwell’s only reckless plan to grow market share. He also sought to extend his railroad in a northerly direction to gain greater direct access to northern Midwest grain origination regions. His plan was to acquire two insolvent lines: the Quincy, Omaha, and Kansas City Railroad Company and the Omaha and Saint Louis Railway. After doing so, he envisioned the construction of one hundred miles of track from Kansas City to connect with the two railroads. The acquisitions of the two short lines, plus the extension of the KCP&G, would give his railroad direct line access to Council Bluffs, Quincy, and the agricultural hinterlands of Iowa and Nebraska. He also toyed with the idea of acquiring a line to Chicago and extending the track from there all the way to Manitoba, Canada. Stilwell’s growth horizons were vast; unfortunately, his financial war chest was not. His northern expansion plans were seriously ill conceived on multiple levels. First, he repeated a mistake that pervaded much of his strategic planning; he greatly overestimated the revenue potential that the expansion and construction would generate. Second, his efforts to finance the expansion put his railroad’s fragile finances in even further jeopardy. And third, it put him in the company of some less-than-ethical investors, particularly John W. Gates, who probably more than any other single person was responsible for Stilwell’s eventual downfall. Increasingly, as time went on, Stilwell’s desperate need for cash was pushing him onto a slippery slope. Rather than pausing and retrenching, he aggressively pressed forward. At the same time that Stilwell was plotting to extend his railroad’s northern boundaries, the deficiencies of the KCP&G’s track and facilities had become serious problems along with its shortage of both locomotives and rolling stock. In the spring of 1898, the southern portion of the system was again hit by a series of calamities. Heavy rains had turned the roadbed south of Shreveport into gumbo, and the approaches to the bridge over the Arkansas River had been washed away. The line was closed for twenty-one days, resulting in expensive detour routings. If that was not enough, another yellow fever quarantine was declared, halting traffic to the Gulf.

42 V i s i o n a c c o m p l i s h e d

Weather and mosquitos were not the only problems. Observers noted that the fifty-six-pound and sixty-pound rails from Pittsburg to Kansas City were too light, the line lacked ballast, the embankments were too narrow, and the roadbed was poor due to a serious disregard for construction specifications. It was felt that the line from Stilwell to Mena had too many curves resulting in a high rate of derailments, and the route between Mena and Shreveport suffered due to the condition of the bridge over the Red River. The division from Shreveport to Hornbeck and Port Arthur suffered from heavy use, and punishing rains frequently turned the roadbed into a quagmire. A number of engineering consultants claimed that the railroad’s ties throughout the entire system were of inferior quality. While some of criticism came from people with vested interests in competing railroads, their observations were too often accurate. Adding to the KCP&G’s struggles was its equipment shortage, which became a more serious issue every day. Constantly having to refinance at high interest rates to fund construction projects and acquisitions left the KCP&G with little capital to purchase the equipment it sorely needed. As more grain, lumber, and minerals began to move, the shortage of equipment evolved from being an operating challenge to a full-fledged crisis that was limiting the very growth that Stilwell desperately needed to keep his railroad solvent. The KCP&G was caught in a classic catch-22 situation: it needed the growth to survive, but it could not handle additional growth due to its lack of equipment and poor track infrastructure. Stilwell felt he had a card to play to relieve the KCP&G’s equipment issues, one that he had once before used successfully in 1896 when the contentious presidential election campaign had threatened his financing efforts. He again pinned his hopes on his friendship with the renowned railcar manufacturer George M. Pullman. The relationship between Stilwell and Pullman dated back to Hamblin Stilwell, Arthur’s grandfather, with whom George Pullman had become acquainted while still a young man. Apparently the elder Stilwell had taken Pullman under his wing, a kindness that had never been forgotten and resulted in Pullman thinking of him as an early mentor. That relationship predated Arthur’s birth. When Stilwell first visited Pullman’s offices in 1895, he had been taken aback to hear of the feelings Pullman had for his grandfather, an affection he had very much shared. At the meeting, Stilwell had been on a mission to place an order with the Pullman

R e c e i v e r s h i p 43

Company to build cars for his railroad at a reasonable cost. After a good deal of time reminiscing about Arthur’s grandfather, Stilwell recalled Pullman declaring, “Why, of course, you can have all the cars you want and on any terms you want.” A year later, Stilwell had found himself once again back in Chicago, this time requesting funding from Pullman due to the Dutch investor syndicate’s reluctance to release the $3 million financing commitment in light of their concerns about the possible outcome of the presidential election involving McKinley and Bryan. Rather than waiting for the Dutch to release the money, Stilwell sought underwriting from a number of friends as well as past and present investors. George Pullman was his first call. Stilwell asked Pullman for $150,000. In response, the railcar manufacturer declared, “Arthur, I am sure Bryan is going to be elected and that I am going to lose every dollar I have in the world.” To which Stilwell replied, “As long as you are going to lose everything you have on earth, what a satisfaction it’s going to be to you after you’ve gone broke to realize that as your last act of affluence you loaned your best friend $150,000.” Pullman laughed heartily and, according to Stilwell, immediately wrote a check. As amusing as the story is, perhaps the most singular part is Stilwell’s referring to himself as Pullman’s “best friend.” While Pullman seemed to have felt a kinship with Stilwell, “best friend” was a stretch. As confident, self-assured, and fearless as Stilwell could be, at times he appeared to be in search of a father figure. While never overtly contemptuous of his biological father, a hint of resentment crept into his writings from time to time. One gets the sense that he resented that his father had frittered away the family money and had given up his medical practice to run, poorly as it turned out, a jewelry store. In his eyes his father had fallen short of being the kind of self-made man whom Arthur Stilwell envisioned as the true American hero. On the other hand, that is precisely how he thought of George M. Pullman. History has not been as kind to Pullman’s legacy as Stilwell was in his writings. He had amassed a fortune in the manufacturing of railcars, the most famous being the “Pullman Sleeper.” In 1869, Pullman expanded his rail manufacturing capacity, buying the Detroit Car and Manufacturing Company. In 1870, he bought the patents and business of the Central

44 V i s i o n a c c o m p l i s h e d

Transportation Company. Pullman had become the leading manufacturer of railcars in the United States. But soon Pullman’s ambition, oversized ego, and self-proclaimed belief that he possessed superior moral and ethical standards were to get the best of him. His downfall began in the 1880s with the construction of a “company town” adjacent to one of his factories near Lake Calumet, some fourteen miles south of Chicago. Ostensibly, the town, which was named “Pullman,” was dedicated to solving the issues of labor unrest and poverty. The town was self-contained, featuring housing, shopping areas, churches, theaters, parks, hotels, and library—all for his factory employees. The consumption of alcohol was prohibited. Pullman believed that the country air and fine facilities—without labor agitators, saloons, or vice districts—would result in a happy, loyal workforce. But Pullman ran his town like a feudal baron. Besides alcohol, he prohibited independent newspapers, public speakers, town meetings, or open discussions. His inspectors regularly entered homes to inspect for cleanliness and could, and would, terminate workers on ten days’ notice if they did not comply with regulations. Rather than an idyllic oasis, the town of Pullman became a festering pit of resentment and outrage. As one resident wrote, “We are born in a Pullman home, fed from the Pullman shops, taught in the Pullman school, catechized in the Pullman church, and when we die we shall go to the Pullman Hell.” Anger among his workers continued to escalate until the powder keg finally blew sky-high on May 12, 1894, when one of the most violent strikes in US history erupted. Known in history as “the Pullman Strike,” it pitted the American Railway Union against the Pullman Company, the main US railroads, and the federal government. Starting at Pullman’s company town, the dispute grew to become a national railroad strike that resulted in the deaths of thirty-four strikers. Throughout, Pullman remained inflexible and unwilling to engage in negotiations. With no resolution in sight, President Grover Cleveland was forced to order the US Army to intervene to stop the strikers from obstructing train service. The Pullman Strike is recognized as a major turning point in the development of US labor law. Pullman’s reputation was forever tarnished by the ordeal. A presidential commission formed afterward described his company town as “un-American.” The report also condemned Pullman for refusing to negotiate and for the economic hardships he had brought on his employees. In 1898, the

R e c e i v e r s h i p 45

Supreme Court of Illinois forced the Pullman Company to divest ownership in the town, which was soon annexed by the City of Chicago. It is curious that not a hint of Pullman’s company town or his stubborn, cruel response to his workers’ grievances appear in any of Stilwell’s writings. For Stilwell, George Pullman remained the epitome of generosity and a premier example of America’s self-made man. The individual Stilwell described in his autobiographical memoirs bares scant resemblance to the George Pullman chronicled in histories of the strike. Because of his relationship with Pullman, it was natural that when the KCP&G was again desperate for equipment but short on liquidity, Stilwell returned to Chicago in 1897 and sought Pullman out as a potential savior of the railroad. There is no third-party confirmation that Stilwell’s account of Pullman’s response to the latest request for financial support was accurate, but one cannot miss the deep emotion with which he related it. Stilwell claimed that Pullman stood before a group composed of Pullman executives and the KCP&G’s directors and said: Gentleman [sic], the grandfather of your president was my dearest friend and started me in life. I owe a great debt of gratitude to Hamblin Stilwell. But my good friend is dead and I cannot repay him in person. Fortunately, there is a way, in spite of this, for me to show my appreciation. It is for me to help his grandson, who has come along to take in my affections a place beside the tender love with which I revere his memory. . . . I have made up my mind that you need $3,000,000 of equipment. I am going to furnish you the money on a fifteen-year car trust, in which none of the principal will be due for five years and no cash payment required. I myself will build 1,000 of your cars. You can order the rest wherever you wish and I shall assume the obligations as fast as they are made.

There is some doubt as to whether Stilwell’s account of the scene was accurate or whether Pullman even committed to a deal with those terms. What is not in question is that Stilwell believed Pullman had and rushed back to Kansas City to immediately place orders with multiple manufacturers for equipment. According to Stilwell, about a week later Pullman telegraphed him suggesting that he should return to Chicago to finalize the arrangement. Eagerly, Stilwell left to consummate the deal. On stepping off the train in Chicago, he heard news boys throughout the station shouting, “Extra—special extra! Full account of the death of George Pullman.” Stilwell’s benefactor was dead and so was the financing.

46 V i s i o n a c c o m p l i s h e d

While Arthur Stilwell’s downfall cannot be linked to a single incident, the untimely death of George Pullman marked a turning point. Stilwell had signed contracts for equipment his railroad desperately needed, and suddenly he did not have the money to cover the costs. As he scrambled to find other sources of funding, his directors and advisers began to lose confidence. By the beginning of 1899, the company had fallen into serious danger of failing to meet its financial obligations and appeared to be moving toward receiver’s court. Receivership was an arrangement designed to protect the interests of persons from whom the railroads had borrowed money. A receivership followed by reorganization usually meant turning bonds into stock, thereby reducing the company’s fixed charges (debt). Faced with the challenges of high fixed costs, burdensome leases on equipment, poor infrastructure, a rate war, and insufficient working capital, the KCP&G had reached the point where it could no longer stave off receivership. With only a modest personal financial investment, Stilwell had, for the previous twelve years, been able to control the development of the railroad through his vision, boundless enthusiasm, creativity, and charismatic personality. He was the consummate promoter. However, like other promoters in the rail industry, he lost influence when shares of the company were traded openly on the stock market at a low price. He, along with his railroad, became vulnerable to corporate raiders. Innocent to the ambitions of certain speculators that he had brought in as investors, Stilwell had inadvertently opened the doors to, in his words, “the cannibals of Wall Street.” A few years prior, E. L. Martin had attempted to convince Stilwell to put the railroad in the hands of some “friendly” receivers who would be more receptive to current management if the company fell into receivership and was forced to reorganize. Stilwell had balked at the idea and had been able to fight off the need for receivership. Three years later, he was now dealing with individuals who were anything but friendly. Three Gilded Age titans had infiltrated the ranks of the KCP&G. E. H. Harriman had made a career as a rebuilder of bankrupt railroads. He was certainly successful at it. At the time of his death in 1909, Harriman controlled the UP, the Southern Pacific (SP), the Saint Joseph and Grand Island, and the Illinois Central (IC). Ernst Thalmann was a partner in the banking firm of Ladenburg, Thalmann and Company. He had a seat on the New York Stock Exchange, was director on a number of railroad boards, and

R e c e i v e r s h i p 47

had very close ties to Standard Oil. John W. Gates, described as a “short, fat, Falstaffian character,” was a charlatan who infringed on patents, watered stock, and manipulated securities. An inveterate gambler, he was nicknamed “Bet-a-Million” Gates. He had successfully raided and assumed control of dozens of companies and had clearly cast his sights on the KCP&G and certain other companies that Stilwell had established during the preceding ten years. The three men were unimpressed by Stilwell and did not believe he could effectively manage the railroad. At the same time, they saw its potential value and wanted control of it. To them, Stilwell was a nuisance who stood in their way, and they were determined to destroy him. And they did. By Stilwell’s own admission made years later, he had been guilty of handing the keys of the company to men he understood too late were, in his eyes, ruthless, dishonest scoundrels. Stilwell’s description of the events leading up to the KCP&G going into receivership is filled with stories of deceitful characters and his own selfless courage. Given the reputations of the three, it is likely there was more than a kernel of truth to his accounts. In late March 1899, he confronted Thalmann accusing him of manipulating the KCP&G’s equity in order to make large purchases of stock for himself and gain control of the railroad. He let Thalmann know that he would do everything in his power to protect the shareholders from the dishonest raiders. A few days later on April 2, Easter Sunday, Stilwell opened the newspaper to find that Thalmann had thrown the KCP&G into receivership. Stilwell claimed that his opponents had justified their action solely based on the failure of the KCP&G to pay a forty-four-dollar printing bill. Highly agitated, he wrote that while reading the newspaper account, his eyes were drawn to a drawing of Jesus Christ on the same page, and “this calm face still pointing upward, still peaceful . . . moved me on to greater triumphs over self and material conditions.” He vowed to fight on to thwart “the cannibals of finance.” While it appears that he truly did learn about the receivership in the newspaper, his account neglects to mention that a Stilwell associate, Missouri circuit judge James Gibson, had in fact requested receivership for the KCP&G at 11:30 p.m. on April 1, the day before Thalmann’s action. Stilwell’s complicity in Judge Gibson’s receivership request was suggested by a comment he made to a newspaper reporter: “It is a friendly receivership.”

48 V i s i o n a c c o m p l i s h e d

The Kansas City Star reported that Stilwell’s opponents claimed that the reason for the April 1 filing was that $575,000 in interest had fallen due and not because a forty-four-dollar printing bill had not been paid. The Gibson receivership notice had kept Stilwell in control of the company, a practice typically denounced by critics of railroad finance. The opponents of the Gibson-Stilwell plan claimed that the officers who led a railroad to default were the last ones who should be named receivers. The Thalmann group filed suit in federal court stating their belief that the state court in Kansas City was prejudiced and the officers of the company should not be receivers. Their petition was granted. An eight-month battle ensued over which committee—the speculators’ New York group or a Philadelphia group composed of Stilwell backers—would take the company into receivership. Stilwell still had strong alliances with influential investors. Through the summer and early fall of 1899, the Philadelphia and New York committees fought each other in and out of court to gain control. Then Stilwell made a fatal tactical error by allowing the duplicitous John Gates to join and assume a prominent role on the Philadelphia receivership team. Unbeknownst to Stilwell, a few months later Gates and E. H. Harriman crafted an agreement to merge the New York and Philadelphia receivership positions. The agreement also called for the dismissal of Arthur Stilwell from the reorganized company. The end was near at hand. Stilwell had been completely outmaneuvered. As late as early December, Gates told Stilwell that he would be retained as president of the reorganized railroad. That was an outright lie: there was absolutely no intention of allowing Stilwell to have any association with the railroad, let alone be its president. On March 19, 1899, the Kansas City Southern Railway Company (KCSR) was incorporated to acquire the KCP&G and its subsidiaries and to obtain control of the Port Arthur facilities. At a public sale on April 1, 1900, in Joplin, Missouri, the Reorganization Executive Committee bought the line at a foreclosure sale. Arthur Stilwell was not listed as an officer of the firm. He was out, thus ending his relationship with the company he had imagined, created, loved, and built.

R e c e i v e r s h i p 49

Stilwell’s Final Years

6

Arthur Stilwell might have been forced out of the railroad he built, but that did not mean his railroad days were over quite yet. At a testimonial dinner in Kansas City held in his honor on the evening of February 10, 1900, Stilwell stunned the attendees by announcing he intended to build “a railroad 1,600 miles long, which will bring the Pacific Ocean 400 miles nearer to Kansas City than any other present route. Not only that, but it will be 1,600 miles nearer to Central and South America than San Francisco and open the Orient to American Business.” His new railroad was to be named the Kansas City, Mexico, and Orient Railway (KCM&O). Stilwell’s plan was to build a railroad through Kansas, Oklahoma, and Texas that would cross into Mexico at El Paso, proceed southward to Chihuahua, go west over the Sierra Madre Mountains, traverse Copper Canyon, and finally terminate at Topolobampo Bay at a destination to be named Port Stilwell. Unfortunately, like the KCP&G, his new rail venture would be underfunded due to lukewarm investor interest that turned frigid. The Mexican Revolution, which broke out a week and a half after Stilwell had made his pronouncement in Kansas City, made construction activities increasingly dangerous. Stillwell had pressed on until late 1911, when it became clear that his investors had had enough. With no hope of obtaining additional financing and his railroad facing imminent bankruptcy, he recognized he had but one option left: receivership. The property would be turned over to a friendly receiver, and at a later date reorganization could be affected with Stilwell and his associates retaining primary control of the property. In early 1912, he resigned as

51

president, and receivers were appointed in March. The receivership process was not the orderly and friendly process Stilwell had envisioned. While he fought to remain integral to the KCM&O’s reorganization, his prospects dimmed. Then in 1913, he sustained a serious, life-altering injury in an elevator accident in a New York City hotel. Stilwell’s resultant infirmity forced him to withdraw from active participation in the railroad’s reorganization plans. The KCM&O marked the end of Arthur Stilwell’s active career as a promoter and businessman. What a career it had been. He is, properly, mostly remembered as the founder of the Kansas City Southern Railway. However, his importance extended far beyond being a builder of a railroad. In 1898, while still president of the KCP&G, Stilwell presided over at least fifty-two companies he founded. The breadth of his interests was extraordinary. He founded the Guardian Trust Company; established the Kansas City Suburban Trust Company; built the KCP&G; orchestrated the construction of the Port Arthur Ship Canal; started a steamship line serving England and Holland from Port Arthur; formed another steamship operation that served various Mexican ports; founded the National Surety Company; built the first modern office building in Sioux City, Iowa; financed the Great Central Coal and Coke Company of Kansas City; built the Kansas City Northern connecting rail line; rebuilt the Omaha and St. Louis Railroad; rebuilt the Quincy, Omaha, and Kansas City Railroad; built nearly one thousand miles of the KCM&O; in Kansas City, built five office buildings, one theater, and a convention hall, laid out the Janssen Park residential community in the Hyde Park district, and built Fairmount Park in Independence; built the Kansas City and Independence Air Line Railroad; erected over one hundred homes in different areas of the Midwest; built an office building and hotel in Mexico City; located Procter & Gamble’s manufacturing plant in Kansas City; started the Port Arthur Rice Farm, bought land and founded scores of towns south and southwest of Kansas City; created the Bethany School in Kansas City’s West Bottoms; and was a major financial contributor to the building of the First Church of Christ, Scientist in Kansas City. Amazingly, the above represents but a condensed list of his business, promotional, and philanthropic accomplishments. Stilwell and his wife left Kansas City in 1913 and moved to New York City, where they resided for the rest of their lives. There he wrote twenty novels, a number of nonfiction books, hymns, poems, and plays. Some of his books, Cannibals of Finance in particular, dealt with his perception of the deceit and 52 V i s i o n a c c o m p l i s h e d

dishonesty of the Wall Street money trusts. Some outlined his larger world views, like Universal Peace, in which he denounced war on ethical and economic grounds and urged Europe and North America to avoid it at all costs. Others, like Live and Grow Young, explored his interest in the world of spirits. Unfortunately, this last book and his other writings involving popular spiritualism have led a number of Stilwell chroniclers to place undue importance on the subject. Stilwell, in his own writing, stated that he was “not a spiritualist.” If anything, it was his religion—not any ethereal communication with fanciful apparitions—that provided Stilwell his moral, ethical, and professional compass. That religion, the Church of Christ, Scientist, disavowed the legitimacy of popular spiritualism. His later writings should be viewed in the context of a man who only a few years before lost not one but two railroads; had his non-rail businesses taken from him by his arch-nemesis, John W. Gates; and suffered a serious injury. For a man, who by all accounts possessed a prodigious ego, the loss of both his businesses and his health had to have been extremely difficult. That his writings about the “spiritual world” won him a measure of celebrity provided him some degree of comfort and pleasure as Stilwell enjoyed being recognized. While the precise reasons for writing about spiritual advisers and nightly visitors will remain forever a mystery, giving the subject undue importance does Stilwell’s legacy an injustice. He was a good, honest, ethical, and complex man, a visionary who, from practically nothing, built a railroad that was destined for greatness. While much of his writing is rambling, self-justifying, and repetitive, there are moments, as in the passage appearing in Cannibals of Finance, in which he pays homage to Kansas City, when he displays a sensibility that marked him as profoundly more sensitive than the great majority of his business contemporaries: If my business life is now ended, and notwithstanding the fact that my home is now in New York, where my ancestors worked unmolested for the building of that state, I shall always think of you, my dear Kansas City, and still watch you from afar. You will be a great city, far greater than you now dream of. The wealth of the wonderful Missouri Valley will flow through your gates, and pay tribute to your banks, merchants and manufacturers. Often in the October of life, with its struggles nearly over, I shall think of the October days of harvest of my dearly loved West. I shall hope that your barns are filled to overflowing with the grains of the field, that on the pastures of your blessed land the herds are numerous, and your future bright. S t i l w e l l’ s F i n a l Y e a r s 53

Though records of Stilwell’s estate are mostly nonexistent, it has been suggested that at the time of his death on September 26, 1928, his net worth was one thousand dollars. If true, it would be perfectly indicative of his lifelong philosophy that everything he did was to build something of great importance and not the accumulation of personal wealth. On October 9, thirteen days after Arthur Stilwell’s death, Jennie, his beloved wife of forty-nine years, got up in the morning, put on her best formal dress, scribbled a brief note saying she wanted to be closer to her Arthur, and stepped out of the window of their twelfth-floor West End apartment.

54 V i s i o n a c c o m p l i s h e d

The Dawn of a New Century Brings Prosperity

7

An oft-repeated aphorism is that good luck is the product of preparation and hard work. While there is a measure of truth to that, sometimes good luck, and its evil sibling bad luck, is just that—luck. Sometimes luck simply happens and has nothing to do with hard work or preparation. During the last few years of the nineteenth century, KCS had certainly experienced its share of bad luck, often in the form of storms and washouts leading to extensive track closures that weighed on the new railroad’s financial health. But happily, soon after the old century gave way to the new, the KCS’s fortunes improved dramatically from bad to very, very good.

Spindletop Spindletop Hill, formed by an underground salt dome, was located fifteen miles south of Beaumont. In 1899, people began to note that the dome had begun to expand and push upward, leading some geologists to speculate that there might be oil deposits underneath the dome. Wanting to investigate further, in October 1900, a group of Pennsylvania oilmen contracted an Austrian-born engineer, Anthony F. Lucas, to do exploratory drilling. On January 10, 1901, mud began to bubble out from Lucas’s drilling hole. Within minutes, the mud began surging upward, forcing workers to flee the immediate area. A short time later, natural gas escaped followed by a gusher of oil shooting some two hundred feet into the air. More than fifty thousand barrels of oil escaped from “Lucas No. 1” over the next nine days, covering the area in a heavy black glaze. It was a transformative event for Texas and Louisiana, for the United States, and for the railroads serving the area, including KCS. Within two years, Spindletop was 55

producing 23 percent of all US petroleum output. Major petroleum companies—Standard Oil, Gulf, Texaco, and Humble, to name a few—grew from the discovery. Nearly two-thirds of the oil from the twelve hundred wells were transported by rail. Though lacking the geographical reach of some others, KCS did move oil north through Shreveport. Moreover, the company also profited handsomely through its ownership of the Port Arthur ship canal and terminal that Stilwell had conceived of and then built. By 1902, petroleum had become the largest commodity moving on the canal, far outpacing the next two, grain and lumber. Growth came so fast that it soon threatened to overwhelm the capacity of the canal. Realizing this, KCS, with help from the petroleum industry, lobbied for the US government to assume control of the canal. On June 19, 1906, President Theodore Roosevelt signed the bill doing just that. Under federal control, the canal was dredged to make it deeper and wider, extending to Beaumont. KCS retained ownership of the lucrative terminal at Port Arthur. While many rail enthusiasts have concentrated on Stilwell’s decision to forgo building to Galveston as being almost divinely inspirational given the deadly hurricane of 1900, perhaps the greatest long-term significance of his decision was that it meant that the railroad was built through an area that was to become awash with oil. Sadly, he was no longer with the railroad and so did not get to enjoy the fruits of his decision. The importance of Spindletop to KCS were immense. Revenues generated from the discovery of oil deposits almost singlehandedly transformed a chronically cash-strapped company into a profitable one. It allowed management to use free cash to acquire additional rail segments, rebuild and repair extensive segments of track, and add desperately needed locomotive power and rolling stock. Petroleum helped propel the company’s profitability from 1901 through the years of the Great Depression.

A Different Kind of Leadership After Arthur Stilwell was forced out, KCS was for the better part of the next forty years controlled by New York financial interests. With that change, the railroad took on a different persona shaped in large part by an executive management that shared the New York investors’ demand for a more structured, disciplined, tightly run, profit-driven company.

56 V i s i o n a c c o m p l i s h e d

This was not at all a bad thing. Stilwell, the visionary promoter, had left behind a railroad in disarray. Its track was in poor condition, it lacked adequate locomotive power and rolling stock, and it had no defined strategic plan. Stilwell had been masterful in keeping his railroad alive, but for all his creativity and resourcefulness, he lacked the financial discipline and railroad marketing expertise to create a sustainable operation. His obsession with getting to the Gulf overwhelmed any practical awareness that his ambitious dream was built on a fragile foundation. The new owners of KCS could not have been more different from its founder. For them, profitability was everything. They owned the railroad not to benefit midwestern farmers or develop rural communities in southcentral states, but to maximize the railroad’s earnings potential. They were in it for the money, which meant having tough, competent businessmen running the operation. Two such men would exert vast influence over KCS’s operations for the next thirty years. Both were respected by hard-driving financiers, many of whom were associated with the rail titans of the Gilded Age. They were all about bottom-line profitability; given the sorry state of the railroad, bringing that mindset to the company’s operations was precisely the right attitude at the time. Neither man discarded the railroad’s corporate culture, but both reshaped it by integrating a greater emphasis on financial practicality into every aspect of its operations and strategic planning. The two men, Leonor Loree and Harvey Couch, were in large part responsible for transforming an adolescent railroad into an established, professionally run company.

Leonor Fresnel Loree Leonor Loree was born on April 23, 1858 in Fulton City, Illinois. For a man of his era, he was exceptionally well educated, earning bachelor’s and master of science degrees, as well as obtaining civil engineering and doctor of law diplomas from Rutgers University. He then topped off his academic résumé by adding a doctor of engineering degree from Rensselaer Polytechnic Institute. His passion was railroads, and during his career he served as president of the Baltimore and Ohio Railroad and the Delaware and Hudson Railway. He also served as chair of the Missouri-Kansas-Texas Railroad (Katy) and of KCS from 1907 through 1936. His rail experience also included a two-year stint with the US Army Corps of Engineers, which deployed him to Mexico

T h e D a w n o f a N e w C e n t u r y B r i n g s P r o s p e r i t y 57

to work on the Mexican National Railroad. Loree was also the author of an 820-page book, Railroad Freight Transportation, recognized as a historically significant book covering all aspects of rail operations. A 1933 profile article in the New Yorker described Loree as “[s]haggy and elephantine, with quick, amused eyes and lumbering, soft-footed walk of a bear.” It went on to state that “a friend observed that Loree’s real place is in the Museum of Natural History,” and that in mannerisms and actions he seemed “a survivor from Wall Street’s Pleistocene Age, a reminder that there was a time when Jay Gould and Jubilee Fisk ran the Erie from the Manhattan Opera House and John W. Gates drank the Steel Corporation into existence.” The article chronicled that during the time he served as president of the Delaware and Hudson, his office was “a profusion of nymph’s heads, festoons of fruit and fat dimpled cherubs. There are sunburst crystal chandeliers, a mantelpiece with carved lions’ heads, wall niches full of cockle shells, and windows with stained glass borders.” One of Loree’s “Rules for Success” was “Be Audacious”; by all accounts, he successfully practiced what he preached. Despite his idiosyncrasies, Loree was a man passionate about railroad operations and the development of efficiently consolidated railroad networks. He was an ardent proponent of larger and heavier locomotives to improve speeds, longer train lengths, and greater tonnage. He also advocated more efficient yards. All this he brought to KCS.

“A Helluva of a Way to Run a Railroad” Loree’s association with KCS dates back to 1906 when an angry contingent of east coast KCS creditors contracted him to inspect the system for the purpose of making far-reaching recommendations on upgrading every aspect of the operation. The investors felt that the railroad’s physical state was best described as no more than “two streaks of rust, its engines lost steam, the men were disheartened and the stations were shacks.” After inspecting the network, Loree did not disagree. After a thorough review he stated his impression of KCS: “This is a helluva of a way to run a railroad.” From consultant to a brief period as president to board chair, Loree oversaw the complete overhaul of KCS using Job Edson, KCS president from 1905 to 1927, as his main lieutenant. Within three years, the railroad’s infrastructure had improved and was in better shape than it had ever been. In all

58 V i s i o n a c c o m p l i s h e d

fairness, Loree had something Arthur Stilwell never had: money to improve the railroad’s infrastructure. Revenues from Spindletop continued to pour in. The new grain route from Kansas City to Port Arthur was a success despite reluctance from the MoPac, the IC, and the UP to interchange grain traffic with KCS, a holdover from the rate war initiated by Stilwell years before. With improved track conditions and better service, things were looking up. Now that the north–south route was in place and grain was flowing to the Gulf, seats on the Kansas City Board of Trade, which had been going for fifty dollars prior to the connection with Port Arthur, skyrocketed to $3,600. Kansas and Nebraska farmers saw immediate additional profits of eighty cents an acre. Ironically, the actions of the profit-driven managers who had taken over KCS’s operations fulfilled one of Stilwell’s motivations for building the railroad—namely, to improve the financial condition of midwestern farmers. The railroad’s improved operations also helped propel Kansas City into becoming for a time the world’s largest wholesale lumber market. The revenues from these commodities allowed KCS to continue to strengthen its infrastructure, improve service, and become a viable competitor to the established railroads in the Midwest. Loree was very much involved in the railroad “merger mania” that surfaced in the 1920s. A plan set forth by eastern railroad owners and financiers called for the consolidation of eastern and midwestern railroads into four conglomerates. In 1925, Loree proposed a fifth: a trunk line running from New York to Kansas City and from Canada to Mexico. His plan was eventually blocked by the Interstate Commerce Commission (ICC). A few years later, he put forth another consolidation plan, this time to combine the Katy, the St. Louis Southwestern Railway (Cotton Belt), and KCS. Despite his concerted efforts and influence on Wall Street, this plan, too, failed to gain approval, thwarted in good part by opposition from the IC and other midwestern railroads. It was probably best that the deal fell through, as the Great Depression would have put huge financial strain on a new company formed by the merging of three railroads. Loree had a strikingly long tenure at KCS. His three-decade run marked a mostly successful period in the company’s history, especially considering it included the depression years. He achieved practically all he sought to attain and left the railroad in far better shape than the one he first inspected thirty-two years earlier. Leonor Loree died in 1940, two years after retiring from the KCS board of directors.

T h e D a w n o f a N e w C e n t u r y B r i n g s P r o s p e r i t y 59

Harvey C. Couch Every bit as instrumental in bringing major change to the KCS system as Loree was Harvey Couch, who shared the same entrepreneurial instincts as Arthur Stilwell, if not his personality. Couch was the personification of America’s self-made man, raising himself up from the humblest of beginnings to eventually becoming a man of great success, influence, and wealth. Unlike Stilwell, he was a calculating businessman who curried favor with powerful east coast financial interests. Born in 1877 in the tiny town of Calhoun, Arkansas, Couch was the eldest of six. From a young age working long hours on the family’s small cotton farm, he attended school only two months out of the year, a situation not unusual for children of farmers at the time. Eventually, his father’s ill health forced the sale of the farm, and the family had to relocate to find employment. Leaving Calhoun and his farm duties did afford Couch, for the first time, the opportunity to attend school on a nine-month-per-year basis, but his foray into a more traditional academic setting did not prove to be a success. Shy, withdrawn, and feeling terribly out of place, Couch soon announced his intention to drop out. This seeming failure was to mark a turning point in his life. His teacher wrote on the blackboard, “A quitter never wins and a winner never quits,” and followed that up by telling his student, “Men like you have built empires.” Couch took the statements to heart, and they became the foundation of a lifelong compulsion to succeed. The teacher who provided the encouragement, Pat Neff, proved to be no slouch himself, as he eventually became governor of Texas and then president of Baylor University. As it turned out, Neff was only temporarily successful in to extending Couch’s academic career. Though Couch agreed to remain in school, his stay was short lived. Two years later he left while still in his midteens, feeling his family had greater need of his wage-earning support than he had love of scholarship. After a series of low-paying jobs, he landed a position with the Post Office’s Railway Mail Service, where he became head clerk on the St. Louis Southwestern Railway. According to Couch, one day during a water stop he witnessed a construction crew raising a utility pole. His first thought was that they were putting up telegraph lines, but he was soon informed that the pole was for use in a telephone system. While watching the crew put up the pole, he thought, Why could he not develop telephone service for rural communities? This 60 V i s i o n a c c o m p l i s h e d

would have been but an idle thought for most people, but for Harvey Couch it led to the start of his business career. At the tender age of twenty-one, with scarcely a penny to his name, he formed a telephone company in 1898. By 1903, his company had fifteen miles of telephone line in Louisiana. By 1910, his North Louisiana Telephone Company had strung more than fifteen hundred miles of line, serving fifty exchanges in four states. In 1911, now thirty-four years old, he sold the company to the Southwestern Bell Telephone Company (SBC), earning a personal profit of well over $1 million. It was only the beginning of his ascent. Couch took his telephone distribution experience and used it to develop an interconnected electric utility system. He started by providing twentyfour-hour electric service to two Arkansas towns: Malvern and Arkadelphia. Soon his company, the Arkansas Power and Light Company (AP&L), was expanding throughout the state. As the demand for electric power increased, Couch built dams on the Ouachita River, which in turn formed three lakes and produced inexpensive electric power. The cheap energy helped lure industrial plants to Arkansas, including the International Paper Company. Sixteen years after its formation, AP&L had three thousand miles of line serving cities and towns in sixty-three of the state’s seventy-five counties. Decades later, AP&L became part of a utility conglomerate that was to become the Entergy Corporation.

The Louisiana and Arkansas Railway Couch was successful. He was rich. And he remained driven. While money and influence were important to him, like Stilwell, he was a builder of companies, and he was not yet finished. He had acquired a love of railroads while working for the Railway Mail Service and decided that he wanted to return to the industry, this time not as a laborer but as an owner. On the lookout for opportunities, he discovered that two railroads, the Louisiana and Arkansas Railway and the Louisiana Navigation and Railway Company, might be available. The owners of these companies had recently died, and it appeared the families might be interested in selling. His next move was to call on his relationship with a group of investors who had partnered with him in his prior ventures and had profited handsomely by doing so. Like Leonor Loree, Harvey Couch was respected by major New York money interests. Using his contacts, he quickly formed a syndicate of investors and, in July 1928, organized a Delaware corporation, T h e D a w n o f a N e w C e n t u r y B r i n g s P r o s p e r i t y 61

The Louisiana and Arkansas Railroad (L&A), founded by Harvey Couch, was merged into the KCS rail system in 1939. The L&A provided KCS a route between New Orleans and Dallas.

the Louisiana and Arkansas Railway Company (L&A), which promptly purchased the two railroads for the sum of $27 million. Under Couch’s guidance, the combined railroad improved its track network and facilities, purchased locomotives and rolling stock, and acquired short lines that complemented the system while shedding underutilized track segments. By 1939, the L&A consisted of a line running between Dallas and New Orleans, with branch lines between Alexandria, Louisiana, and Hope, Arkansas, and between the Louisiana towns of Minden and Shreveport. While overseeing the rationalization and revitalization of the L&A, Couch became interested in adding a third railroad to the mix, the Kansas City Southern Railway. What ensued was a takeover contest of sorts, though it was never referred to as such—at least not formally. Couch and his New York syndicate began buying KCS’s stock in 1935; by February 1937, Couch controlled enough of the company’s equity to get himself elected to KCS’s board of directors. It should again be noted that New York investors had exerted dominant control over the company since the period that Stilwell was pushed out, and these investors firmly supported Harvey Couch. A few months after joining the board, Couch became chair of the board’s executive committee, replacing Leonor Loree who had retired from the 62 V i s i o n a c c o m p l i s h e d

board. During this transitional period, Charles Johnston maintained his position as president; however, two years later he resigned after a falling-out with Couch, who took on the title of president of the railroad. With Couch’s influential management and board presence, it was only a matter of time before there would be a consolidation of the two railroads. The only question was which railroad, KCS or the L&A, would emerge as the lead company. While details of the negotiations are largely nonexistent, one has to think that KCS’s larger size and greater market presence were key to it becoming the dominant railroad in the combination; however, Couch and his L&A executive team did assume most of the key executive management positions. Harvey Couch became chair of both boards; his brother, C. P. “Pete” Couch, was elected to the KCS board and became president of both KCS and the L&A. After the consolidation was formalized on October 20, 1939, another individual was elected to the KCS board, though little was made of it at the time. He was not an L&A employee, but rather a thirty-year veteran of the KCS. In a very short time, this little-known southerner would usher in an era that would forever change the company.

T h e D a w n o f a N e w C e n t u r y B r i n g s P r o s p e r i t y 63

William N. Deramus II

8

An Era Begins

During his time as chair of KCS, Harvey Couch benefited from having the full support of his powerful East Coast investor syndicate, which he used effectively to exert control over both the KCS and L&A executive teams. Although Couch wielded near-total influence over the two boards, he never lost investors’ support or admiration, nor did he suffer any notable business missteps. What eventually did take a toll was ill health. In May 1939, after the ICC had approved the consolidation of KCS and the L&A, Couch acknowledged that years of stress, travel, and long hours weighed heavily on his health and were forcing him to step back from the day-to-day management of the railroad. Using his considerable influence with the two railroad boards, he was able to get his younger brother, C. P. “Pete” Couch, elected to the boards of KCS and the L&A, as well as becoming president of the two railroads. Harvey Couch remained chair of both. Eight months later, the elder Couch, though battling severe influenza, unwisely insisted on keeping with his plan to attend the Democratic National Convention in Chicago and then travel on to Baltimore and Washington, DC. During his stay in DC, Couch suffered a heart attack, the severity of which compelled him to relinquish his public utility responsibilities and his chairmanships of KCS and the L&A and retire to his Couchwood vacation retreat near Hot Springs, Arkansas. Only a matter of months later, on July 30, 1941, Harvey Couch died at the age of sixty-three. Couch without question deserves his place as a pathbreaking American business figure during the first half of the twentieth century. The telephone and electric companies he created grew to become major components of hugely successful systems. His building of the L&A, and adding it to the KCS system, substantially enhanced the value of the combined network 65

and increased the railroads’ stature within the industry. His public service achievements were also notable. Tabbed by President Herbert Hoover to be one of seven directors of the Reconstruction Finance Corporation (RFC), Couch led the efforts to finance public works programs after the Great Depression. In that capacity, he was instrumental in developing three large-scale projects: the San Francisco–Oakland Bay Bridge; the waterworks systems of Pasadena, California; and the Colorado River Aqueduct to Los Angeles. The RFC became the precursor to President Franklin Roosevelt’s public works programs under the New Deal. Harvey Couch’s tenure as chair, like Leonor Loree’s before him, propelled KCS’s growth. Although KCS was still not a major player in the industry, neither was it just a regional operation. Loree’s principal contribution had been the upgrade of the company’s physical plant. He had inherited a railroad that had mostly earned the sobriquet “the Haywire” in the early years of its existence. During his years as director, Loree did much to lessen the validity of the slur. Harvey Couch’s lasting contribution is the inclusion of the L&A into the network. The transaction provided KCS with expanded access to southern markets and to Dallas, both of which became increasingly important to the company in the decades ahead.

The Kansas City “Coup” When Arthur Stilwell and E. L. Martin first imagined a belt line railroad, the banking community of Kansas City was still in its infancy. In fact, it was hardly even a proper city, as it was not until 1889 that it was incorporated under the name “City of Kansas City.” Previously, its legal name had been the “City of Kansas.” With Kansas City still very much a work in progress, Stilwell had been forced to lean on East Coast contacts to give birth to his railroad venture. As its construction progressed, he was compelled to make frequent trips to Europe and other US commercial centers to obtain additional financing. Stilwell did have local business friends and investors, but the Kansas City group fell far short of being a major contributor to his railroad. But in the mid-1890s, Kansas City was flush with ambitious men desiring growth for their city, and no one person was more integral to this spirit than William T. Kemper. Born in Gallatin, Missouri, in 1866, Kemper realized at a young age that rural Missouri would not offer the wealth of personal growth opportunities that he desired. Kansas City provided the perfect 66 V i s i o n a c c o m p l i s h e d

vehicle. It was very much a midwestern community, and Kemper was very much a midwesterner. The city, like Kemper, wanted to grow. The two were a perfect match. Kemper needed Kansas City, and before long, Kansas City needed William Kemper. He and his wife, Charlotte, had moved to the city in 1893. Kemper gained experience from working with his father-in-law, Rufus Crosby, a successful cattleman and head of the Valley Falls Bank of Deposit in Valley Falls, Kansas. Eventually, young Kemper became a grain trader and soon formed the Kemper Grain Company. During his early days in Kansas City, he worked alongside another commodity trader, John Truman, father of the future president of the United States. Kemper and Harry Truman formed a close relationship that lasted throughout their lives. In 1906, Kemper was recruited to head an affiliate of the National Bank of Commerce. He eventually assumed ownership of the bank, which became the Commerce Trust Company. Along the way, Kemper became an acquaintance of Arthur Stilwell, which in a roundabout way led to him eventually becoming a receiver when Stilwell’s Kansas City, Mexico, and Orient Railroad went into receivership. As part of the receivership arrangement, Kemper received fifteen thousand shares of KCM&O stock. Kemper successfully navigated the railroad through two receiverships before finally selling KCM&O assets to the Atchison, Topeka, and Santa Fe in 1928—but not before making a fortune. As a major owner of the railroad, he benefited handsomely from the discovery of oil deposits along its right-of-way. As the years passed, William Kemper’s wealth grew, but not more than his devotion to Kansas City. His passion for the city was passed along to his family until the names Kansas City and Kemper were inseparably bound. Even when a schism developed in the family, both factions remained steadfastly committed to the community. One of William’s sons, R. Crosby Kemper, engineered the growth of the City National Bank, which eventually became UMB Bank. The elder Kemper’s son, James M. Kemper, took control of Commerce Trust Company, which in time became Commerce Bancshares. Both sons and their respective families were enthusiastic in their support of every aspect of Kansas City life: from banking, to taking leadership roles in area business development, to involvement in local and state politics, to supporting education, to underwriting the city’s arts and culture. It was, therefore, not surprising that a Kemper was to play an important role in the next chapter of KCS’s history. Having a railroad of reasonable size W i l l i a m N . D e r a m u s I I 67

and commercial significance headquartered in Kansas City was seen as a definite plus for a city with aspirations of becoming a prominent midwestern commercial and cultural center. However, while the railroad was headquartered in Kansas City, KCS’s identity as a midwestern company had been diluted by the outsized influence of its East Coast investors. This rankled some within the Kansas City business elite who wished for KCS to be a larger presence in the city’s business community. A sizable segment of the local business community, certainly including the Kempers, believed it was in the long-term best interest of Kansas City if the railroad were to reestablish its midwestern roots. By the early 1940s, with Harvey Couch gone, a select group of Kansas City’s business elite, led by R. Crosby Kemper, who sat on KCS’s board of directors, moved to bring the railroad back home. Pete Couch had worked alongside his brother from the days of the North Louisiana Telephone Company and was an able executive, but he did not evoke the same reverential admiration and support as his elder brother had. Kemper and his group saw an opportunity and approached the Couch investor syndicate with a proposal to buy them out. Acknowledging that they had enjoyed a good run and were less confident as to the railroad’s future, the investors agreed to sell. The Kemper group aggressively accumulated KCS’s publicly traded shares until they controlled 47 percent. The group then reached an accord with the same Dutch syndicate that had been Stilwell’s benefactor during the construction of the KCP&G. The Dutch holdings represented 20 percent of the outstanding KCS shares. It was not a coincidence that with the change in KCS’s shareholder profile, the composition of the board of directors also changed. In 1941, there were ten New Yorkers on the KCS board and only three from Kansas City. By 1944, there was considerably more balance with eight New Yorkers, seven Kansas Citians, and two from Shreveport. By 1945, there were six from New York, seven from Kansas City, and two from Shreveport. Also, Kansas Citians dominated the executive committee four to two. Unsurprisingly, as the composition of the board changed, so did that of executive management. The board first removed Pete Couch as president of KCS and the L&A and replaced him with William N. Deramus II. Couch was initially allowed to remain chair of the two companies, but his days were clearly numbered. His number came on April 4, 1944, when Deramus replaced him as chair of the board.

68 V i s i o n a c c o m p l i s h e d

KCS was once again run by people with midwestern and Kansas City sensibilities. The change had practical implications. The “change in control” renewed and reinforced the railroad’s earliest mission to provide efficient rail service connecting the Midwest to important US and foreign markets. But probably more importantly, the bond created when the relationship between KCS and the city’s business community was reestablished was to become crucial during a future crisis, when the railroad’s independence was thrown into doubt.

William N. Deramus II The name of William N. Deramus II first appeared on the KCS payroll on November 9, 1909. For the next eight decades, there would be a Deramus employed at the company. Deramus was born in Cooper, Alabama, on March 25, 1888. Like many children who grew up in rural America, his formal education ended early. Shortly before his fourteenth birthday, having just completed eighth grade, he left school to take a job tending the switch lamps and keeping the local Cooper train station clean and orderly. For this he was paid four dollars a month. A year later, his railroad career took on a more concrete form when he joined the Louisville and Nashville Railroad. From there he moved on to the Atlantic Coast Railroad and then to the Southern Railway where, at age twenty, he became a dispatcher in Memphis, Tennessee. His next and last stop was KCS, which he joined as a telegraph operator. Shortly thereafter, he was promoted to dispatcher and then chief dispatcher. Promotions came in rapid succession; soon he was named superintendent of car service and, from there, superintendent of the Southern Division. A few years later, Deramus II was elected general manager, then vice president and general manager, and then executive vice president. In 1941, he was elected president of KCS and, shortly after, president of the L&A as well. In 1944, he was elected president and chair of the board of both railroads.

KCS Becomes an Early Adopter of Technology First and foremost, Deramus II was a railroader. During his fifty-six years at KCS, he spent the great majority of his time away from his Kansas City office out on the rails. He knew the railroad backward and forward, and it was said

W i l l i a m N . D e r a m u s I I 69

that he could tell exactly where he was on the system simply by listening to the sound of the wheels on the track. His number-one commitment was to improve his railroad’s physical plant; to that end, he continued Leonor Loree’s dedication to rebuilding and upgrading KCS’s tracks, bridges, and terminals. His maintenance projects were funded in great part by the healthy revenues generated during World War II from transporting troops and military equipment to points around the system and hauling the railroad’s solid grain and forest product traffic. KCS also benefited from the wartime excess profits tax, which provided railroads the incentive of financing capital projects at very attractive interest rates. Deramus II’s reconstruction of the railroad’s infrastructure included the replacement of 75 percent of the ties on KCS and 95 percent of the ties on the L&A; replacement of 85-pound and 100-pound rail with 127-pound rail on hundreds of heavily used miles; and installation of block signals between Kansas City and Shreveport and between Baton Rouge and New Orleans. In addition, curves were straightened, grades reduced, and passing tracks lengthened. He oversaw the construction of a new yard facility in Shreveport that became the railroad’s hub and was named Deramus Yard in 1956 in his honor. He also had a diesel shop constructed in Pittsburg, Kansas, and new shop facilities built in Shreveport. Additionally, he was the driving force behind KCS being one of the first railroads to use diesel locomotives in freight transportation. At the same time that he oversaw conventional railroad activities, he also incorporated emerging new technologies into the company’s daily operations. Deramus II was particularly adroit at transferring technology developed during World War II to his railroad. He bought large surplus wartime radio equipment, which led to KCS employing the use of microwave signals to control large segments of its rail systems from a central location. Under his direction, KCS became an early proponent of computer technology. Soon after the end of World War II, he also acquired surplus computer equipment from the military and then engaged the services of Univac technicians to integrate the technology into rail operations. KCS became the first railroad to computerize car and revenue accounting functions. All this he did without one day of formal education in computer technology.

70 V i s i o n a c c o m p l i s h e d

Luxury Passenger Service Regular passenger service first appeared on the system on April 6, 1897. In the teeth of an early spring blizzard, a Kansas City, Pittsburg, and Gulf train left Kansas City’s Grand Central Station at Second and Wyandotte Streets with passengers headed for Port Arthur. In the following decades, service expanded between Kansas City and the Gulf. While the equipment and customer service gradually improved, it remained rustic at times, as evidenced by a passenger’s account of her trip to New Orleans on the “Flying Crow.” “Our train conductor shot a 40-pound wild turkey from a mounting on the engine, and we all enjoyed it the next day for dinner.” Rustic or not, the Flying Crow, advertised as operating on a route “as straight as a crow flies,” became widely popular. The real jewel, though, was to become the Southern Belle. The Belle had actually been inaugurated under Harvey Couch in 1940, though service was sporadic. Advertisements for the service promoted the route between Kansas City and New Orleans, boasting a travel time of twenty-one and a half hours. Its existence became a symbol of the consolidation of the KCS and the L&A, as it ran on the tracks of both railroads. It was really under Deramus II that the Southern Belle assumed true luxury status in 1950. It was advertised as “Streamlined Hospitality.” A song was composed in its honor that included the verse “Southern Belle, you’re the thrill . . . that can make my heart stand still.” KCS even staged a contest in which eighteen-year-old Margaret Landry of Baton Rouge was crowned “Miss Southern Belle.” All this was certainly a far cry from shooting turkeys from the top of a locomotive. By 1949, the Southern Belle consisted of chair cars, four bedroom and four roomette Pullman cars, a dining and tavern/lounge car, an observation car, and a baggage/mail/dormitory car. By 1951, the train’s locomotive power was fully dieselized. While cultures are largely the products of the individuals whose lives and leadership qualities shape over time the identities of their organizations or countries, there are also instances when inantimate objects can come to serve as symbols of strength and pride—the statue of the charging bull on Wall Street, or the majestic Lady Liberty at Ellis Island, for instance. Not

W i l l i a m N . D e r a m u s I I 71

Under William Deramus II, the railroad’s passenger service was upgraded. The Southern Belle, which operated between Kansas City and New Orleans, came to symbolize KCS’s growth as a significant railroad serving the south-central region.

only did the Southern Belle become a symbol of the railroad’s financial strength in the 1940s and 1950s, it became a source of pride for KCS employees. It shouted out that the scrappy but little-recognized rail line had come of age and was now a legitimate railroad, a special railroad. The Belle spoke to the success of a company that could provide elegant service. While Deramus II was a gruff railroader who ran away from excessive promotion, he appreciated the importance of the Southern Belle as a positive, visually recognizable symbol of his company’s growing prominence.

Storm Clouds Approach Benefiting from World War II traffic and the lack of any significant modal competition, KCS generally prospered during the early years of Deramus II’s time as chief executive officer. Revenues were steady, if less than spectacular. With the help of tax benefits, the railroad had the funds to invest in its physical plant. But by the early 1950s, economic winds were shifting. First came the repeal of the wartime excess profits tax and other tax benefits, which, along with sharply declining revenues, forced KCS to reduce its capital spending and take a knife to its track maintenance program. To the severe detriment of its physical plant, over the next twenty years the company was repeatedly forced to slash its track and facilities budgets. Between 1957 and 1962, KCS cut its maintenance-of-way headcount by 61 percent, its rail replacement program virtually ceased, and cross-tie replacement fell to a rate of less than 2 percent in ten out of fourteen years between 1956 and 1970. This amounted to a ticking time bomb. The root cause of declining revenues was of grave concern; the problem was not confined to KCS but had spread throughout the entire rail industry. The crisis was in good part a result of the nation’s infatuation with motor vehicles of all sorts. As Americans moved to the suburbs, families grew increasingly dependent on automobiles for personal transport and trucks for the movement of goods. Consequently, motor vehicles required roads, and the US government accommodated that need to an extent greater than anyone could ever have imagined. While serving as Supreme Commander of Allied Forces during World War II, Dwight D. Eisenhower gained an appreciation of the “Reichsautobahn” system, the first iteration of what was to become Germany’s Autobahn highway network. The Reichsautobahn was a component of Germany’s W i l l i a m N . D e r a m u s I I 73

national defense system. Eisenhower recognized the importance of providing key ground transport routes for military supplies and troop movements in case of emergency or foreign invasion. While the building of roads had continued since the days of the Ford Model T, the United States lacked an integrated system of highways. As the thirty-fourth president, Dwight Eisenhower made it his top priority to oversee the construction of just such a system. Eisenhower’s National System of Interstate and Defense Highways Act of 1956 established the blueprint for the US interstate highway system. The construction of a vast network of modern highways began that year and continued on into the following century. During the heaviest years of construction from 1956 to 1995, the US interstate highway system grew from 2,100 to 41,500 miles. The interstate highway network brought enormous economic and social change. Its contribution to the country’s quality of life was, and still is, immeasurable. Today it is impossible to conceive of a United States without its vast highway network. On the other hand, its creation delivered a nearfatal blow to a central component of the country’s transportation infrastructure and economy: namely, its railroad industry. No single commercial entity benefited more from the highway construction program than the trucking industry. It was handed, basically at no cost, an interconnected national highway system, the essential component of its infrastructure for serving key markets in all the forty-eight contiguous states. Not only were truckers given a beautiful, state-of-the-art highway system paid for by US taxpayers, but the government willingly took on the responsibility for funding its maintenance. So, it was hardly a surprise when shippers, to the greatest extent possible, took their products off trains and put them onto trucks. And why not: trucks could reach their destinations faster, provide door-to-door service, and were cheaper. Whereas railroad rates were highly regulated and generally expensive, trucking companies were free to price based on cost and market demand. Railroad rates were controlled by the ICC, which had been established by the US Congress in 1887 to protect against monopolistic abuses that had arisen during the period of heavy rail expansion. Under ICC regulations, which were strengthened a decade later with the passage of the Hepburn and Mann Elkins Acts, individual railroads lacked the freedom to deviate from regulated pricing or freely enter into contracts with shippers. If the regulated price to move a commodity from Kansas City to Dallas was $500, no railroad 74 V i s i o n a c c o m p l i s h e d

had any option but to charge that amount no matter what their cost was to haul the load. Trucks could, and did, adjust prices based on service costs and demand. Not only had the trucking industry been provided its transportation network, which was maintained at the government’s expense; it had nearly total pricing freedom. Conversely, railroads had to allocate vast sums to maintain their rail networks while having precious little control over pricing. It was not a level playing field and defied any sense of fair modal competition. Adding salt to the wound, the US government had provided considerable financial support to inland water operators, who paid no charges for the use of federally provided inland, coastal and Great Lakes waterways. Over a fifty-year period, the percentage of intercity freight handled by inland waterway carriers grew from a minuscule 1 percent to 10 percent of the total market. The elimination of tax incentives that encouraged infrastructure improvements, the loss of market share to trucks and inland water carriers, and unfairly restrictive rail regulations combined to make railroads look outdated and—at least for the transport of a wide range of commodities— obsolete. In little more than a decade, the perception of railroads being at the core of the nation’s growth and prosperity had been replaced in the minds of most Americans by an image of an industry that was little more than a tired relic of the nineteenth century. The average American loved cars and airplanes; shippers preferred trucks. As railroads watched their markets shrink they were faced with the somber realization that they had no means to effectively fight back. Their only option was to drastically cut their operating and maintenance budgets year after year, not to compete, but to survive. By the time the 1960s rolled around, KCS was under tremendous financial pressure. Capital for system maintenance was drying up. Revenue growth, where there was any growth at all, was unimpressive. The entire rail industry was in severe pain; KCS was edging ever closer to falling into a death spiral. For KCS, business as usual was not an option if it had any hope of surviving. Change—radical change—was its only hope. Enter William N. Deramus III.

W i l l i a m N . D e r a m u s I I 75

William N. Deramus III

9

The time-worn adage “The apple never falls far from the tree,” is particularly appropriate when describing William N. Deramus III. “WND III,” “the Hat,” and “the Old Man” were just a few of the nicknames given to the boss by his colleagues, though seldom were they uttered within earshot of the man himself. It would not be inaccurate to describe Deramus III as a supersized replica of his father. In a company and industry replete with colorful figures, Deramus III took a back seat to no one. William N. Deramus III was born on December 10, 1915, in Pittsburg, Kansas. Unlike his father, young Bill Deramus enjoyed the advantage of an excellent education that included a degree from the University of Michigan in 1936 and a law degree from Harvard Law School in 1939. If the family had any hope that Deramus III would use his Ivy League degree to pursue a legal career, that hope quickly went up in smoke when he took an unassuming job as a railroad apprentice on the Wabash Railroad. Not long after the United States entered World War II, the young Deramus enlisted in the army. He served with distinction, reaching the rank of captain. During his service years, he gained practical, hands-on railroad experience during his involvement in the construction and operation of the Ledo Road in India, and with the Allied forces’ rail operations in Burma. Returning home after the war, the Deramus name helped him to be chosen as president of the Chicago Great Western Railway (CGW) in 1949, where he had as much success as possible turning a moribund system into a reasonably profitable one. Despite scant business growth opportunities, under Deramus’s tight reins in 1956, the CGW posted a record profit of $3.4 million. Word of his accomplishment traveled fast, and it was not long before

77

a desperate group of Katy investors convinced him to become president of the struggling railroad. The investors had every right to be panicked, for the Katy was in deplorable shape. According to the respected transportation writer, Fred Frailey: The realities Deramus faced at the Chicago Great Western and Katy were daunting. CGW was caught in the middle of a vastly overbuilt railroad network in the Midwest and would never, ever be more than a marginal railroad. In that dire situation, Deramus did about what you’d expect, which was rub every penny until it shown. The Katy was in even worse shape, beaten to bits by a half-decade drought that sapped its wheat-growing region. The controlling shareholder, Pennroad Corp., was beside itself, and its chairman went to Bill Deramus Jr. for advice. Why, he said, you’d do worse than hire my son, and they did, forgetting to tell the younger Deramus that when he took office on January 1, 1957, the Katy had already booked the revenues budgeted for January and February as 1956 income. The house of cards we called the Katy was about to tumble down.

With the railroad cannonballing toward bankruptcy, there was no question that drastic action was necessary. Displaying an iron will and an uncompromising determination to do whatever he felt was necessary, he immediately trimmed payroll, ordered the reduction of telephone use, and cut recordkeeping expenses. Three months into his tenure, he acted with ruthless abandon when during the middle of the night he ordered a crew of outside movers to clear out offices of Katy employees at its St. Louis facility. Unsuspecting employees reported to work the next day only to find an armored security officer standing before darkened, totally empty offices. Tersely printed notices advised the 115 displaced workers that they were out of jobs unless they reported to work some five hundred miles away in Denison, Texas, within forty-eight hours. Similarly, a week before, also without notice, Deramus had reduced the Katy workforce in Parsons, Kansas, from thirteen hundred to eight hundred. During his four years at the Katy, he managed against formidable odds to keep the railroad operating, but some of his actions were harsh, bordering on cruel. The toll on morale was high, but if Deramus cared, he never showed it. It was not an enjoyable time for Katy employees or, one must imagine, for Deramus either. Thus, when in 1961 his father asked him to be his replacement as president of KCS, Deramus III jumped at the opportunity. His time at the CGW and the Katy had taught him, doubtless to a fault, how to run a barebones rail 78 V i s i o n a c c o m p l i s h e d

operation. For better or worse, the lessons learned at the two railroads were to become ingrained in his managerial philosophy. One criticism that can be legitimately leveled at Deramus III was that he refused to face up to the deterioration of KCS’s physical plant, due in great part to his relentless cost cutting, until the system broke down. In fairness, he faced persistent revenue and cash flow challenges that necessitated fiscal restraint, but his stubborn adherence to the same kind of draconian slashing of operating and capital expense cost that he had done at the CGW and the Katy would lead to serious problems at KCS.

A Man of Few Words Deramus was an enigma to those who worked for him. How could a shy, retiring man of very few words be described at the same time as larger than life? But the truth was that he was both shy and larger than life. Cemented into the memories of those who worked beside him, or as closely as he would allow, is the image of “the Old Man” sitting at his desk six days a week, his unfashionable old railroad hat frequently atop his head, and a lit cigarette perpetually between two fingers. Hardly the image of a charismatic leader. Though a man of few words, those that he uttered in his rough, cigarette-hardened voice were seldom challenged. He was gruff, crusty, socially awkward, and uncompromisingly tough. At the same time, he could also be hugely generous, supportive of his friends and loyal colleagues, and sometimes almost childlike in expressing his caring for those experiencing physical or mental illness or pain or for those suffering social injustice or economic disadvantage. His philanthropy was motivated not by any desire for public acknowledgment but by sincere caring and empathy. He asked for only one thing in return: that neither he nor his company be given credit for his acts of kindness or generosity. His avoidance of the spotlight bordered on the pathological. A story is told about a “presentation” he gave at a testimonial dinner held in his honor in Kansas City. After a lineup of people spoke admiringly of his many contributions to the city’s business community and his support of a wide range of social welfare programs, he was invited to say a few words. Stepping up to the microphone, he said, “This has gone on for too long and I don’t give speeches.” With that, he stepped away from the podium and left. The evening was over, but in his own way he had made his statement: actions speak louder than words, and he did not particularly care what people thought of him. W i l l i a m N . D e r a m u s I I I 79

The executive photo in the 1974 KCSI Annual Report, shows the publicity-averse William N. Deramus III looking away from the camera towards KCSI’s president and chief operating officer, Irv Hockaday. Though possessing vastly different personalities and management styles, the two close colleagues and friends managed the company through a complex period in the 1970s.

Under Deramus III, KCS’s annual meetings became legendary in an almost comical way. It was as though every year he strove to set a new record for brevity. If the meeting went on for more than ten minutes, the company’s officers nervously sensed their boss’s mounting discomfort. It was not that he was hiding anything; rather, he felt that these required meetings were just window dressing and a colossal waste of time that could be better spent doing real work. He was known to leave annual meetings before they ended, a definite breach of corporate etiquette. To use his own words, he didn’t give a damn. He had real work to do, and for him talking about previous year’s achievements was a waste of time and not real work. Those people who worked with him, a number of whom went on to carve out impressive business careers, all agreed that Deramus III was brilliant. As Irv Hockaday, who served as a top executive at KCS before becoming president and chief executive officer of Hallmark Cards Inc., noted, Deramus was able to see connections between two seemingly disparate things that others could not. It is this particular attribute that, more than anything, resulted in his being able to create a wildly diversified company and, in doing so, help save the railroad. When the younger Deramus walked into his position at KCS on his father’s coattails, he was met with a situation that, while not yet as desperate as he had encountered at the CGW and Katy, had the potential of spiraling out of control. Unfortunately, it once again appeared his only move was to cut, cut, cut. And he did. Over the last decade, his father had pretty much done everything he could to keep the railroad at least marginally profitable. Besides introducing new technologies that brought greater efficiencies to train operations, business management, and accounting functions, he had even taken a tentative step into exploring diversification when he and his son, who was still president of the Katy at the time, collaborated on a joint study regarding the feasibility of using the rights-of-way of the CGW, Katy, and KCS to create a propane distribution network. The study would eventually lead to the formation of the Mid-America Pipeline Company (MAPCO), which became a successful energy company and in which KCS was a prominent investor. But by 1961, Deramus II had run out of ideas, and the constant struggle to compete in an environment with the cards stacked against the rail industry had taken a toll both physically and mentally. He hoped that his son could find a way to keep KCS viable within a shrinking rail marketplace.

W i l l i a m N . D e r a m u s I I I 81

KCSI If Deramus II had the feeling that change might be necessary, Deramus III was certain of it. For the latter, it was as obvious as this: KCS could either make radical changes to its corporate structure or muddle along and wait for fate to take its course. Even some of the largest railroads, like the Santa Fe (SF) and UP that still had healthy cash reserves, felt the need to diversify. For them, however, diversification primarily took the form of pouring railroad-generated funds into energy and mineral operations sited on properties they were given as land grants in the 1860s. It was not only the large railroads that responded to the impossible competitive environment. The C&NW’s Ben W. Heineman was an early advocate of rail diversification. After becoming chair in 1956, Heineman undertook the same kind of draconian cost cutting as Deramus III was to do at KCS. While the cuts helped to an extent, Heineman realized that ultimately cost cutting, no matter how severe, could alone not save the railroad. Thus, he became the driving force behind a series of diversification that eventually led to the creation of Northwest Industries in 1968, a holding company that held not only the C&NW but also chemical companies and Lone Star Steel, among others. The diversification Heineman started continued after his tenure, and in 1989 a new holding company, Chicago and North Western Holdings Corporation, was founded. Its subsidiaries included 400 Freight Services Inc., Douglas Dynamics, and Global One, a highly automated double-stack facility located near downtown Chicago. Similarly, the IC actively responded to competitive challenges by forming a holding company in 1962, concentrating primarily on investments in the areas of real estate development, industrial goods, and consumer products. Since it appeared that the future of US business was going to be largely driven by those companies that were able to compete without the shackles of oppressive regulations, Deramus III was determined to transform KCS into one of those companies. Without the rich land resources of the larger railroads, Deramus set out to create and invest in largely unregulated, or loosely regulated, companies that had reasonable growth potential. For two decades, Deramus III had demonstrated a passion for railroading and an unswerving determination to keep his railroads solvent even under the harshest conditions. Even so, it appeared that not long after joining KCS, he had begun to give up on the railroad industry—not railroading and certainly not his railroad, but the industry that was being strangled to death. To 82 V i s i o n a c c o m p l i s h e d

that end, on January 29, 1962, Kansas City Southern Industries Inc. (KCSI) was organized as a diversified holding company. The Kansas City Southern Railway Company (KCSR) became its first subsidiary. Having set on a course of action, Deramus III was a man on a mission. The holding company that he established was ultimately responsible for the creation or acquisition of over one hundred nonrail companies. What an amazing ride it would turn out to be. While sometimes messy and with an abundance of missteps and failures, KCSI ultimately succeeded to an extent far beyond anyone’s imagination—except perhaps that of William N. Deramus III.

W i l l i a m N . D e r a m u s I I I 83

The KCSI Years

10

One chapter cannot approach doing justice to the story of KCSI. With its cast of colorful, creative characters, successful and semisuccessful companies, and more than a few head-scratching entrepreneurial oddities that never quite made it, KCSI deserves a full history of its own. Still, no history of the Kansas City Southern Railway can ignore the contribution of KCSI to the railroad’s survival and ultimate success. The diverse collection of companies that came to compose KCSI reflected Deramus III’s vision, brilliance, mental agility, unconventional wisdom, and a total absence of fear of making mistakes. His thumbprint was on every aspect of the organization. With so many companies and varied investments, it would be natural to assume that within KCSI existed a committee of highranking executives who reviewed the practicality of investment opportunities. Such an assumption would be incorrect. When asked about the composition of an investment committee, Irv Hockaday, Tom McDonnell, Bob Druten, and Bill Skelley—who had all worked for Deramus at KCSI and went on to have successful careers—for a moment cast blank stares before answering that there had been no committee. It was all Bill Deramus who, especially in the early years, selected what companies and what industries KCSI would pursue. He told his people what KCSI was going to acquire, create, or invest in and then expected they would get it done. Those who worked at KCSI understood that while from the outside some of the investment decisions appeared random, even haphazard, almost all were made with the sound, if sometimes unconventional, reasoning of Bill

85

Deramus. Even some of KCSI’s failures were the result of Deramus being too far ahead of his time in that he actually saw opportunities that proved to be too far in the future to be successful in the 1960s and 1970s. The breadth of KCSI holdings was astounding. There were mutual funds, insurance companies, pharmaceutical research firms, drug research and development laboratories specializing in both human and animal drug research, data processing and financial accounting systems companies, real estate companies, television and radio stations, an airline, a florist, an advertising agency, and even a traveling carnival ride company, just to name a few. And behind all this was a man sitting in his office at Eleventh and Wyandotte Streets, William Deramus III. Was he eccentric? Without question. Brilliant? If not, he lived right next door to brilliance. His interests were as diverse as the companies he invested in. Even the brightest people who worked for him—and there more than a few at KCSI—say without the slightest hesitation that Deramus was always the smartest guy in the room, though he seemed to go out of his way not to show it. He was maddening and authoritarian, to be sure; still, those in his inner circle agreed that he was one of the most unique individuals they ever encountered. The mission of KCSI was to provide investors with a set of appealing investment ideas, particularly in industries demonstrating high growth potential. The regulatory environment in which KCSR was operating in the 1960s did not suggest a bright future for the railroad. It was Deramus’s hope that by becoming an attractive investment, KCSI’s equity would increase in value, which, among other positives, would allow KCSR time to work through a difficult period. In his eyes, KCSI had been born out of necessity. Railroads are dependent on capital goods business cycles. Well-run railroads can manage economic cycles, but when excessive regulations are imposed, the prospects for sustained profitability shrink to practically nothing. For precisely this reason, Deramus was determined to find or create companies neither at the mercy of fast-changing business cycles nor bound by restrictive regulations. He set a course for KCSI to invest in three industries: communications, pharmaceutical and health care, and financial services. That all three would become major engines of growth in global economies is testament to his vision and to, as Irv Hockaday observed, Deramus’s ability to see things most others could not.

86 V i s i o n a c c o m p l i s h e d

Communications Deramus was fascinated by technology, perhaps in part reflecting his father’s early adoption of computer technology after World War II. While Deramus III had an intuitive comfort level with computers and emerging microwave communications, his gift was mostly an appreciation of what technology could mean for business and society in coming years. He and his father had brought computer technology to their railroad; now Deramus III sought to expand his experience with communication technology beyond being just an adopter to being a provider of communication services to businesses and the general public. In 1965, KCSI established the Mid-American Television Company, which purchased television stations in Peoria and LaSalle, Illinois, and in Jefferson City and Sedalia, Missouri. The company also purchased a radio station in Jefferson City. Deramus recognized that by the 1960s, television had become the predominant method of mass communications in the US. Anyone alive and old enough to turn on a television remembers being transfixed by the coverage of President John F. Kennedy’s assassination on November 22, 1963. For days the nation remained glued to the TV coverage, which even included live coverage of the fatal shooting of the assassin, Lee Harvey Oswald. The nation, and much of the western world, watched in horror, amazement, and grief from moments after the assassination to the burial at Arlington National Cemetery. Television had already gained popularity, but the Kennedy tragedy took the medium to a whole new level of social significance in America. Television was replacing radio as the leading means of bringing national and local news to the public, as well as reporting stories of local politics, civic events, education, and human interest. Deramus was also cognizant of how television was playing into the nation’s passion for major sports by increasingly providing live coverage of sporting events. One other thing he appreciated: the financial value of television stations tended to appreciate handsomely, making them relatively safe, attractive investments. The growing popularity of television also appeared to make the industry resistant to national economic downturns. This appeared to be confirmed in the 1970s when during a period of economic doldrums, labeled “stagflation,” television experienced an increase in advertising revenue. New research revealed that during times of economic downturn, people stayed at home

T h e K C S I Y e a r s 87

more and watched television, which in turn translated to higher advertising revenues. Deramus took note that in the average American home, the television was on more than six hours a day. Given that he wanted to invest in companies that, unlike railroads, were impervious to economic cycles, television was a natural. In time, KCSI’s involvement in communications evolved beyond ownership of television stations to exploring advances and opportunities in sophisticated, state-of-the-art communications technology. To pursue this, LDX Group Inc. was formed in 1983 as a holding company, consolidating the communications interests of KCSI and Telecom Engineering, an international communications consulting firm. LDX Group was established to respond to market opportunities resulting from emerging communications technology and the divestiture of the Bell telephone system from AT&T. LDX Group formed separate subsidiaries to serve different markets. LDX Inc. was a long-distance telephone resale company providing discount service to business and residential subscribers. It bought transmission facilities from interchange carriers like AT&T and Western Union at bulk rates and then resold long-distance rates at a lower cost than the larger providers. LDX served the St. Louis and Kansas City areas. LDX Network operated a sixteen-hundred-mile microwave relay transmission system along KCSR, serving the railroad. LDX Group was also involved in the developmental stage of cellular radio technology designed to make it possible to send out and receive voice and data using portable telephones. KCSI grasped the attractiveness of cellular for its capital and labor advantages over traditional “hardwired” landline telephone service. Deramus’s communications investments were on the front edge of what was to be a totally new world of mass communications. In July 1987, LDX Network combined its regional fiber-optic network with the national network of Williams Telecommunications Company, forming a new company, Williams Telecommunications Group Inc. (WTG). LDX Group kept a 19 percent interest in the new company. By 1988, WTG was one of three transcontinental fiber-optic systems. The combination with Williams marked the final major communications-related transaction undertaken by KCSI. Deramus and his KCSI executives had done well by making a modest investment in a few television stations and eventually turning it into partial ownership of one of the nation’s largest fiber-optic networks. By the time the deal with Williams

88 V i s i o n a c c o m p l i s h e d

Telecommunications was announced, KCSI was already involved in two other emerging industries and decided to step away from its pursuit of stillevolving communications opportunities. KCSI had played its hand well and prospered. It was time to move on to other ventures.

Pharmaceuticals and Health Care Services Starting in the 1980s, KCSI turned considerable attention to growth opportunities in the pharmaceutical and health care services industries. In 1984, Martec Pharmaceutical was incorporated for the purpose of developing and marketing both generic and innovative pharmaceutical products. Martec’s inventory of products consisted of prescription drugs that were marketed to wholesale drug companies, independent pharmacies, and drug chains. The company’s primary business strategy was to acquire the marketing and developmental rights for innovative compounds from established European and Asian pharmaceutical companies. Concurrently, KCSI got involved in developing and marketing veterinary products. In 1984, Midcon Labs was incorporated. Like Martec, Midcon Labs sought to develop and market prescription drugs, though its principal emphasis was in producing injectable products for swine, horse, beef, dairy, and poultry markets. Martec and Midcon Labs never reached the level of success that had been hoped for. Their managements were solid as were their market opportunities. But pharmaceutical development is a long, expensive process with a high failure rate. It takes considerable time to produce a successful product and get regulatory approval, and getting the rights to sell a prescription drug as a generic is also a long and complex ordeal. The final rewards may be spectacular, but the costs to get there are high. KCSI did not have the financial wherewithal to pour vast amounts of money into the two companies. Thus, with modest investments came lukewarm returns. Still, the fact that KCSI had pursued the effort again displayed an awareness of an industry on the brink of astronomical growth. It was just not the right fit for KCSI. Fortunately, the same cannot be said for KCSI’s Argus Health Systems Inc. (Argus), founded in 1983. Argus was not only innovative; it addressed a number of health care services problems that had risen with the rapid growth and changes in health care administration. The brilliance of Argus was that it was both a health services and financial company. It reflected

T h e K C S I Y e a r s 89

KCSI’s interest in pharmaceutical and health care expansion and its position as a leading proponent of the integration of advanced data processing and accounting applications to companies in a wide range of different industries. Argus became a subsidiary of one of KCSI’s primary companies, DST Systems, which made perfect sense as its mission paralleled DST’s own. Argus was established to provide desperately needed management services to health care providers. By 1980, pharmacies and health care companies were being overwhelmed by data processing challenges brought on by the expansive growth of the health care industry. Argus addressed a broad spectrum of their needs. Early on, its two prime data service areas were in the processing of prescription claims and in the management of clinical data. It furnished administrative services for drug plans operated by providers such as Health Maintenance Organizations (HMOs), Preferred Provider Organizations (PPOs), pharmacy administrative services organizations, and other managed health care operations. Argus introduced a pharmacy network system that was a recordkeeping, pharmacy payment, database, and administrative system for prescription drug benefit programs. The system provided a means for its customers to focus on drug program cost containment and utilization review, which incorporated a reporting system covering physicians’ prescribing patterns, drug interactions, and potentially conflicting drug therapies. It also developed a system to support the research of new drugs by providing users a flexible database entry system as well as a database for collection and analysis of clinical trial data in preparation of new drug applications to be submitted to the US Food and Drug Administration. Given the challenges of maintaining accurate recordkeeping and database management in health care services, it was no wonder that Argus was a success. Much of what has become standard practice in pharmaceutical and health care records management dates back to the development of Argus in the 1980s. Argus management was also proficient in staying abreast of changes in the industry and refining their product offerings, accordingly.

Financial Services While KCSI’s forays into communications and health care were innovative and, in some cases, quite profitable, it is in the realm of financial services where the holding company struck gold. Though its entry into financial

90 V i s i o n a c c o m p l i s h e d

services was as much due to chance as advanced planning, in time an integrated strategy evolved that drove KCSI’s investment decisions. The strategy called for building a presence in three interconnected areas of financial services: • Product technology • Product distribution • Product creation These three areas fed each other, and over the course of three decades, KCSI utilized their interdependence to create an exceptionally successful enterprise. KCSI eventually earned a reputation as primarily a holding company with a collection of financial services firms that just happened to own a railroad as well.

Product Technology: The Birth of DST The very first acquisition made after the launch of KCSI in 1962 had been the purchase of Television Shares Management, a Chicago-based mutual fund management company. Renamed Supervised Investor Services (SIS) in 1963, it marked KCSI’s formal entry into financial services and introduced the holding company’s executives to John Hawkinson, the head of SIS and a legendary figure in the growth of the mutual fund industry. Mutual funds had enjoyed a period of expansive growth in the 1960s, but with the growth came problems. Simply stated, the recordkeeping, database, and accounting systems employed by mutual fund companies were woefully inadequate to keep up with the volume of business the funds were experiencing. SIS was no exception, as John Hawkinson confessed to Deramus. Business was being severely restricted, even lost, by the failure of SIS and the rest of the industry to provide timely and accurate records of transactions to mutual fund investors. Deramus told Hawkinson that maybe KCSI could help and then went on to explain that KCSR had been an early adopter of computer technology and had developed computer programs to buttress the railroad’s accounting systems. Soon after the meeting, Deramus put KCSI’s Ray Bammes and his team in touch with SIS, and history was made. The combined KCSI-SIS team adapted the KCSR accounting systems to meet mutual fund applications. The work became the basis for back-office accounting systems for

T h e K C S I Y e a r s 91

nearly all mutual fund companies. KCSI helped SIS flourish and, in 1970, sold it to Kemperco, the holding company for Kemper Insurance, with KCSI maintaining a majority position. SIS became Kemper Financial and continued to enjoy strong growth in assets after the transition. Building on the experience of developing the accounting and records management system for SIS, as well as seeing the possibility of taking the prototype and adapting it to meet the needs of other mutual fund and financial services companies, KCSI incorporated Data Systance Inc. in 1968. In time, the name Data Systance was shortened to DST Systems Inc. (DST). Little more than a vague idea in the mid-1960s, DST had by the 1980s become the brightest star in KCSI’s drive to own a diverse collection of growth-oriented business. During its greatest run, 80 percent of DST’s revenues were derived from recordkeeping services for mutual funds and other financial services institutions. Services included data processing and shareholder accounting systems designed specifically for the mutual fund industry. KCSI owned 87 percent of DST.

Tom McDonnell What cannot be overstated is the influence of Tom McDonnell on the expansion and success of DST and its product offerings. While the company got off to an unorthodox start using railroad technology to solve a problem for SIS, it is possible that DST would have ended up being little more than a nice story to amuse people at cocktail parties if not for the presence of Tom McDonnell. McDonnell was a Kansas City native who stayed in his hometown to earn a bachelor’s degree in business from Rockhurst College. He then traveled east to obtain an MBA from the University of Pennsylvania’s Wharton School of Business. He was ambitious, brimming with confidence, and ready to jump headfirst into the corporate world. He loved Kansas City but was perfectly willing to relocate for an appealing opportunity at a recognized company. To that end, he had lined up an interview at a prominent company in the mid-Atlantic region. But before leaving for his appointment, McDonnell’s aunt, who worked for the chief executive officer of Kansas City Power & Light, suggested he meet William Deramus at KCS. McDonnell thought “Why not?” If nothing more, it would be good practice for his upcoming interview.

92 V i s i o n a c c o m p l i s h e d

The meeting was a curious one, but then meetings with Deramus III often were. McDonnell left not sure what to make of Deramus, but he had done his research and saw that the holding company appeared to be committed to growth, and its ownership of the railroad seemed to provide a solid base. Still, he did not expend much mental energy on the meeting or the company, as he felt a larger opportunity awaited him on the East Coast. A few days later, while in the shower, McDonnell heard the telephone ringing. Not expecting an important call, he did not scramble to answer the phone. But it rang and rang. Finally, still wet and wrapped in a towel, he answered the call to hear a gravelly voice ask, “What took you so long to get to the phone?” That was pretty much the extent of Deramus III’s job offer. McDonnell had no idea what his job would be, nor his job title or salary. Things did not come into sharper focus when he was dispatched to find the individual to whom he was to report only to discover his new boss had absolutely no knowledge of the new hire. In a sense, he was thrown into the deep end of the pool to either sink or swim, and that proved to be the kind of challenge in which, time and time again, Tom McDonnell would thrive. The unorthodox start to his KCSI career did not faze him in the least, but it was not long before people realized that few things fazed Tom McDonnell. Something or someone might anger him or bemuse him, he might be challenged or intrigued, he might be bored, he might be charming and friendly or crusty and sarcastic, but he was very rarely fazed. After a brief apprenticeship on the railroad, he moved more formally into the financial services section of the holding company. He might have left the railroad, but his career took off like a runaway freight train. Working alongside Ray Bammes, McDonnell became an immediate presence at DST. He learned the business from the ground up, from the sublime to the ridiculous. He would not only have to determine what the noncommunicative Deramus III wanted DST to become; he also had to learn the mutual fund industry inside and out, as well as banking, insurance, and custodial account trading. At the same time, he was responsible for selecting carpeting and overseeing its installation in their new office space, in addition to getting desks, tables, and chairs. One day he would be meeting a big-name money manager; the next he would be negotiating a contract for office coffee machines. There was, however, one constant in all this: he threw himself totally into every task, great or small, and he did everything well.

T h e K C S I Y e a r s 93

Tom McDonnell was the force that grew DST from being a nice little idea and niche player into being the nation’s largest mutual fund services firm. While not quite a rag-to-riches story, success was definitely not handed to him on a silver platter but was earned through hard work, intelligence, and a bold spirit. The same words used to describe McDonnell—smart, brash, fearless, innovative, entrepreneurial, hard charging, confrontational, tough but compassionate, demanding but caring and generous—all fit within the larger framework of KCS’s corporate culture. And like KCS’s most notable leaders, he not only embodied the spirit of the company; he also refined it and gave it new forms of expression. McDonnell became CEO of DST in 1984 and quickly surrounded himself with smart and capable people. For years, it was Tom McDonnell who propelled DST; he was the person most responsible for forming joint ventures and partnerships to extend DST’s market reach far beyond the company’s earliest dreams. Although DST was smaller and less well funded than its competitors in a rapidly developing business space, McDonnell pushed it to move faster and with greater agility. He eventually made DST the numberone company serving the back-office accounting needs of mutual funds and other financial services companies. Nothing could have provided better evidence of DST’s value in satisfying KCSI’s objective of finding and developing companies immune to drastic stock market upheavals or general economic downturns than the firm’s reaction to the Black Monday crash of October 19, 1987. The crisis hit markets around the world, beginning in Hong Kong before spreading to Europe and then the US. For the day, the Dow Jones Industrial Average dropped 22.6 percent. A number of factors were ascribed to the crash. A breakdown of unity within OPEC months earlier had resulted in a 50 percent drop in oil prices, causing panic in the energy sector. Causing further tremors, armed hostilities had broken out between the US and Iran when the Iranians had fired on two US ships, which brought a retaliatory US strike on an Iranian oil platform. Thus, the markets were already jittery when a downturn and selling pushed the indexes down to a point where computer-programmed trading appeared to take over, resulting in the blind selling of stocks around the world. Given it being bound so tightly to the mutual fund industry, one might assume that DST might have felt some of the pain of Black Monday. It did not. The beauty of DST’s business model was that the company was paid for every mutual fund transaction regardless of whether it was a buy or sell 94 V i s i o n a c c o m p l i s h e d

order. In the case of the crash, the volume of transactions, overwhelmingly sell orders, was extremely high despite the drop in asset levels. Adding to the high volumes was the fact that mutual fund companies had developed a vast portfolio of diversified funds that ranged from high-risk growth to low-risk stability, and there was considerable movement among funds as the market crashed. But for DST, everything qualified as a transaction; every transaction, no matter whether it was a buy or sell, meant DST was paid. This is exactly the kind of protection from business cycles and stock market traumas that Deramus had sought when he had launched KCSI. One of McDonnell’s traits was his ability to take a single entity and expand it. Like his boss, Bill Deramus, he saw connections from one thing to something else much larger in scope that others failed to see. In McDonnell’s case, DST alone would have been considered a success that he could have ridden for years and retired a wealthy man. But for him, riding out the string was not an option. Wealth was nice, but what motivated McDonnell was the creative, entrepreneurial challenge of building something even grander, something others had not done. In 1972, DST’s association with Kemper Financial resulted in co-ownership of Investors Fiduciary Trust Company, a joint venture that provided specialized banking, data processing, and trust and custodial facilities to mutual funds. In 1973, DST entered into a joint venture with State Street Bank, which led to the formation of Boston Financial Data Services, combining banking, custodial facilities, and State Street’s customer base with DST’s data processing products and recordkeeping capabilities. DST also entered into a joint venture with Monarch Capital Corporation to create Vantage Computer Systems Inc. (Vantage), to provide proprietary recordkeeping services to insurance companies with special emphasis on the insurance industry’s expanding offerings of investment products. In 1983, DST signed a joint venture arrangement with Vantage to form TPA Associates, which provided DST access to a universal life insurance processing system, giving it an entry into that industry. Though DST’s creation sparked a conversation between William Deramus and John Hawkinson, in its fullest iteration it was the product of Tom McDonnell’s intelligence and determination. He was also a major proponent of Argus and supported its growth, and along the way he made DST a major player in the real estate development in Kansas City. McDonnell helped rejuvenate the city’s downtown, leading to the attraction of technology and research startups as well as a vibrant arts community. Similar to the other T h e K C S I Y e a r s 95

leading lights of KCS’s history, Tom McDonnell was both very much his own man and being a true son of the company he joined in 1969.

Product Distribution In 1979, KCSI took a major step in adding a product distribution component to its arsenal of financial services companies. With its acquisition of the Pioneer Western Corporation, KCSI had direct ownership of a life insurance and mutual fund financial services company, which had a talented and motivated distribution workforce that sold investment products directly to the public. While Pioneer Western was to play an important role in KCSI’s promotion of mutual funds, the initial rationale behind the acquisition was that while railroads were extremely capital intensive, insurance companies were not, and the holding company wanted greater balance between the two in its portfolio of businesses. The acquisition was a good one. Within five years of the purchase, Pioneer Western’s earnings had increased by more than 240 percent, and its sales force had grown by 50 percent. Through its two subsidiaries, Western Reserve Life Assurance Company of Ohio and Western Reserve Financial Services Inc., Pioneer Western marketed various life insurance and investment products. When KCSI made the acquisition, Pioneer Western was already acknowledged as an industry leader in the coordinated marketing of life insurance protection and mutual funds. This was based on the company’s philosophy that policyholders should be able to purchase term insurance and at the same time build significant wealth through investments in mutual funds. In a few years, with the support of KCSI, Pioneer Western would have another product to distribute to great effect.

Product Creation With all due respect to Martec and Midcon Labs, both established in 1984, the major addition to KCSI’s portfolio that year was its acquisition of a portion of Janus Capital Corporation for $11 million. A year later, KCSI increased its ownership in the firm, with the purchase of an additional 1.6 million shares. KCSI had already established a foothold in the area of financial services technology with DST, and in 1979, it had broadened its product distribution

96 V i s i o n a c c o m p l i s h e d

exposure by acquiring Pioneer Western. With Janus, KCSI found exactly what it had been looking for in the area of product creation. Janus would prove more than just a home run for the holding company; it was to be a grand slam. Tom McDonnell had become acquainted with Janus through DST. He was impressed by its management and was intrigued by its corporate culture, which was in some ways the Rocky Mountains version of KCS’s own culture, though targeted expressly for the mutual fund industry. McDonnell urged others at KCSI to take a serious look at the still relatively small company, and it was not long before there was general consensus that Janus would be a good fit for what the holding company wanted in its financial services portfolio. Janus was still small enough to be affordable and had already made a name for itself as an innovative, free-thinking mutual fund company concentrating on investments in growth-oriented technology firms. With little money, Tom Bailey had founded Janus in 1969. His decision to locate his little company in Denver, Colorado, was not a matter of chance or convenience but deliberate. Bailey, displaying the same unconventional disposition that had characterized earlier KCS leaders, wanted his firm to be free from the conventions of Wall Street and have the freedom to think and act outside the box. At the time of its acquisition by KCSI, the Janus family of no-load mutual funds had $470 million in assets under management. Noload funds had become an attractive investment option in part because they were sold directly from mutual fund companies to investors with no fees or commissions charged for their purchase. Bailey felt comfortable with KCSI taking an ownership position in Janus, as the culture of the two companies worked well together and, more importantly, his portfolio managers had total control of investment decisions and suffered no interference from the holding company. He also liked the fact that Pioneer Western was under the KCSI corporate umbrella; although Janus was strictly a no-load mutual fund company, Pioneer Western, with its twelve hundred registered representatives, sold load funds for which service fees were charged to clients. Under KCSI, Janus and Pioneer Western collaborated in the development of IDEX Corporation’s family of mutual funds. As load funds, the IDEX products were marketed and sold by Pioneer Western’s agents, brokers, financial planners, and investment advisers, but management of the funds themselves, including all the investment decisions, was under Janus. It was a unique collaboration between a no-load mutual fund

T h e K C S I Y e a r s 97

company and one that distributed load funds. It proved to be quite successful and provided Janus a connection to a different investor class. From $470 million in 1984, Janus assets under management grew steadily as it remained steadfast in its investment strategy. By 1997, when KCSI first floated the idea that it was considering separating its financial services subsidiaries from its transportation segment, Janus was generating 85 percent of its parent company’s operating profit. It ranked in the top echelon of the nation’s mutual fund families, and assets under management had grown to $166 billion with four million client accounts. Then it really took off. By the year 2000, Janus shareholder accounts had climbed to six million, and assets under management had risen to $330 billion. It was the top-selling mutual fund group in both 1999 and 2000. Along the way, KCSI had acquired a smaller fund family, the Berger Funds, which had been founded by William Berger, a major name in the industry in the 1980s. The Berger Funds never experienced the same kind of growth trajectory as Janus, both a result of its investment decisions and shifts in market conditions. Still, the Berger Funds helped establish KCSI’s credentials within the mutual fund industry and added to the company’s product creation capabilities. Janus Capital’s phenomenal run became KCSI’s final success. In truth, the holding company as it was now constituted had mostly outrun its usefulness. By the last years of the 1990s, KCSR’s financial prospects and regulatory status had improved. At the same time, many within the financial services companies of KCSI, as well as a sizable universe of investors and stock analysts, wanted the less regulated businesses freed from the constraints of the “old technology” that the railroad seemingly represented. Both sides, transportation and financial services, wanted an amicable divorce; they got one in July 2000 when the financial services segment was spun off into a new holding company, Stilwell Financial. KCSR represented the primary subsidiary in a new transportation holding company named KCS. The 1990s had been a wild, wonderful ride for KCSI. The continued maturation of DST, Argus, and Pioneer Western, along with the meteoric rise of Janus, had led to KCSI garnering widespread respect within the financial community. In hindsight, it was probably naive to have ever thought that the holding company’s nontransportation businesses would deliver any kind of meaningful cash flow directly to the railroad. The companies KCSI founded and

98 V i s i o n a c c o m p l i s h e d

acquired needed to use internally generated cash to fund their own growth, and KCSI had to show good financial performance to attract and maintain investors. Overall, that was accomplished and as a result it served the railroad well. KCSI enjoyed years of excellent stock appreciation, especially in the 1990s, and kept investors satisfied with the returns. What was not generally appreciated was the extent to which KCSR had benefited the financial services companies and KCSI. Many investors felt more comfortable putting money into a stock driven by growth-oriented companies, knowing their investments were partially backstopped by a brick-and-mortar railroad. KCSR might not have been a direct contributor to KCSI’s stock price appreciation in the 1990s, but the fact that it was very hard to kill a railroad gave investors confidence that they could gamble on growth while still knowing that the holding company had a solid foundation. In a way, they could have their cake and eat it too. Who could ever have predicted what was to occur after the July 2000 Stilwell Financial spin-off? The financial world suddenly turned upside down. By December 2000, Janus shares had fallen 28 percent, more than double the S&P 500’s overall decline. Through October and November, it had shed more than $1 billion a day in assets under management. Janus assets fell another $90 billion in 2001. Janus was a victim of the market plunge of Nasdaq tech stocks that had soared in value in the 1990s. Tech stocks had dominated many of Janus’s portfolios and when market forces shifted, Janus Capital suffered the consequences. By the summer of 2002, assets for Janus, which had peaked at $330 billion, had fallen to less than $200 billion, prompting Landon Rowland, who had departed KCSI to become the chief executive officer of Stilwell Financial, to say in an interview printed in the Denver Post, “We were carried away by our confidence that we knew something our predecessors did not.” Stilwell Financial could not withstand Janus’s precipitous drop in assets under management. By January 1, 2003, Stilwell Financial was dissolved, and its financial services companies merged into Janus, under the name Janus Capital Group Inc. Ironically, while all this was happening, railroad stocks were coming to life. The breakup of KCSI in 2000 and the subsequent failure of Stilwell Financial cannot diminish the accomplishments of the holding company over its four-decade run. While some might argue that KCSI never provided KCSR with any tangible support, an argument can be made that it saved the

T h e K C S I Y e a r s 99

railroad by providing an attractive investment opportunity from the period 1962 to 2000. It can also be argued that the complexity of KCSI’s structure helped protect the railroad’s independence. Beyond the stock price appreciation, there were perceived complications with the “unbundling” of KCSR from the holding company if there was to be a hostile takeover attempt. To do so would have been possible, but the process would have been messy, and few felt it was worth the effort to try. KCSI had given the railroad just what Deramus III had hoped it would—time. And when the legacy of KCSI is written, that will be one of its greatest contributions.

100 V i s i o n a c c o m p l i s h e d

Years of Turmoil

11

1960–1979

If the KCSI holding company had been showing promise of growth by 1970, KCSR certainly was not. The inequitable competitive landscape caused by crippling regulations had worn down the rail industry. Slashing budgets became an annual exercise. The process of developing annual earnings forecasts varied little from one railroad to another. Finance teams would develop an earnings estimate that it felt would be the minimum acceptable to the company’s shareholders. The marketing and sales teams would provide revenue estimates for each commodity group. Operations would determine how much it would cost to serve customers and provide necessary track system maintenance and upgrades. Every year after the departments submitted their estimates, the final budget would have to be adjusted to reflect the harsh reality that rail rates were forced to remain the same even though carloadings were declining. The discussion inevitably came to the conclusion that expense and capital budgets must again be cut to allow for even the possibility of marginal earnings growth. Deramus III was all too familiar with the process—so familiar that it became part of his operational DNA. At both the CGW and Katy, Deramus did not take a scalpel so much as a butcher knife to the budgets, and he had carried the practice to KCSR. Did he cut maintenance budgets too much during the 1960s and early 1970s? Yes. Did he have an alternative? Probably not—certainly not a good one. His railroad was in full survival mode. With no business opportunities of consequence on the horizon, he had only one option: cut costs.

101

An Industry in Decline The US railroads’ share of intercity freight was in free fall, going from 75 percent in the 1920s to 35 percent by 1978. During the years from 1950 to 1982, the 112 percent increase in intercity freight ton-miles was not remotely close to being evenly distributed among modes of transportation. Rail ton-miles increased by only 36 percent, while truck ton-miles grew by 190 percent and inland water carriers increased 452 percent. In 1947, railroads had handled three times as much tonnage as trucks; by 1980, trucks carried 50 percent more tonnage than the railroads. The dire economic impact of this shift had become dreadfully clear. Between 1967 and 1980, there were eleven major railroad bankruptcies. The Penn Central fell in 1970, followed by several other northeastern rails, including the Erie Lackawanna, the Lehigh Valley, and the Reading and Central of New Jersey. By 1976, the Rock Island and the Milwaukee had reached the steps of bankruptcy courts. During the 1970s, bankrupt railroads accounted for more than 21 percent of the nation’s rail mileage. The problem was not just bankruptcies. By 1976, more than forty-seven thousand miles of track had to be operated at reduced speed because of unsafe conditions. Railroads had deferred billions of dollars in maintenance. The situation on the ground had become so startlingly bad that “standing derailments,” defined as a stationary rail car derailing because of poorly maintained track, became part of railroad lexicon. It is hardly any wonder that a generation of Americans viewed railroads as dinosaurs, relics of a bygone era. Between 1970 and 1979, the rail industry’s return on investment averaged 2 percent, and it continued to decline, falling to 1 percent in 1979. The rate of return had been falling for decades, having averaged 4.1 percent in the 1940s, 3.7 percent in the 1950s, and 2.8 percent in the 1960s.

KCSR’s Woes Increase Other than unloading KCSR in a fire sale, Deramus III really had no alternative but to continue making cuts across the board. Still, it is hard to imagine anyone within the company having any doubt but that the annual cost cutting would eventually lead to serious problems, and it did. Track and bridge conditions deteriorated to an extent that many in the company’s engineering

102 V i s i o n a c c o m p l i s h e d

department lost sleep worrying about the possibility—some thought probability—of a catastrophic accident. Cheap scrap rail, rather than continuous welded rail, was being used to replace broken-down, worn-out track. In one instance, the first train that ran over newly laid cheap replacement rail tore up the track before derailing. Insufficient quantities of ballast were put down; and for a time, a lowercost, lesser-quality chat product was used in place of quality ballast, which only exacerbated problems. Among other things, ballast allows water to permeate downward, thereby helping keep the tracks above water during heavy rains. The chat material actually kept the water from being absorbed and thus caused flooding when it could have been avoided. Publicly, the company claimed that the ponds of water over portions of its track were due to underground springs. Many within maintenance-of-way knew otherwise. The company’s tie replacement program languished, and similar to the ballast alternative, the company experimented using inexpensive replacement ties, with similarly dismal consequences. Rail grinding, an essential process for extending the life of heavily used track, was halted. So was track lubrication, an important process used to reduce friction between steel wheels and steel rails. Railroads can get away with deferred maintenance for a year, maybe a bit longer, but eventually there is no escaping the negative impacts. The track system’s problems were further compounded by KCSR doubling down on its long-held practice of running heavy trains, a strategy that Deramus had employed at CGW. Throughout most of the 1960s and into the early 1970s, KCSR was committed to consolidating its trains, making them longer and heavier. This was done to reduce crew costs and, for a time at least, lessen the overall expense per ton of freight. The downside was that the added weight only increased track failures and derailments. The company’s declining financial condition led to another blow, this one inflicting a psychological stab to the heart of employees. After three successive years of losses in its passenger train service totaling over $7.2 million, and with no hope of a turnaround, Deramus III made the decision to terminate the Flying Crow and Southern Belle passenger train service. It had to be a painful decision, as only a couple of years earlier he had commissioned the rebuilding of the Southern Belle’s passenger equipment. Deramus III knew that he could not afford the luxury of sentimentality; the era of regularly scheduled passenger rail service was over. A new day

Y e a r s o f T u r m o i l 103

had come in which the public preferred automobiles and airplanes to trains. The end came on an evening in the spring of 1969, when the Southern Belle rumbled into Kansas City’s Union Station for the last time as a passenger train. The KCSR family was left with a heavy heart as well as the question whether the loss of this beloved symbol of the company’s success and prosperity portended worse things to come. It was not long before it appeared that their worst fears might be realized.

Lee National Irv Hockaday was still a recent recruit to KCSI’s legal department in 1969 when he was informed that Lee National Corporation had filed a Form 13D with the Securities and Exchange Commission (SEC), a legal requirement for a company that had acquired at least 5 percent of another company’s stock. In a short time, Lee’s ownership of KCSI’s equity had grown to over 22 percent. Lee National was a later iteration of the Lee Tire and Rubber Company, which had been founded in Pennsylvania in 1912. For half a century, Lee Tire had been a solid, profitable, and respected company. But by the early 1960s it had fallen on difficult times and ultimately fell under the control of a New York group that was interested in having a platform from which to seek out and pursue undervalued companies. The company’s name was changed to Lee National Corporation. Frank Levien, previously a New York City–based attorney, became the firm’s CEO, and Alvin Dworman, a prominent New York real estate investor, became his chief lieutenant. KCSI had caught their attention. The railroad was struggling, but Levien and Dworman assumed that KCSR, like other large and medium-sized railroads, had a bountiful portfolio of attractive property assets. Furthermore, KCSI’s nonrail companies were still in their infancies with more promise than performance. The two speculators felt, not unreasonably, that there was far more value in KCSI than the current stock price suggested. Levien and Dworman came at KCSI with guns firing, employing all manner of means to wrest control of the company from the existing management. KCSI’s board of directors dug in their heels and affirmed its strong support of management and the company’s strategic plan to unlock the corporation’s potential. The confrontation grew increasingly hostile, with Lee National threatening lawsuits against the directors, Deramus III and Hockaday. The

104 V i s i o n a c c o m p l i s h e d

aggressors managed to get a couple of their people added to the KCSI board, Frank Levien being one of them. Deramus III’s decision to let his young lawyer, Hockaday, direct the company’s defense proved to be the right one. Remaining calm in an increasingly contentious standoff, Hockaday developed a possible strategy for resolving the crisis. After spending many hours with the Lee National people, he surmised that Levien and Dworman would consider abandoning their takeover attempt in exchange for real estate and cash. His hunch was correct. After accompanying the two New Yorkers on a tour of the company’s properties, Hockaday structured a deal in which KCSI was able to reclaim Lee National’s 22 percent ownership with land being the primary payment. The crisis was thus averted. But KCSI management barely had time to catch its breath before a strategic misstep raised the ire of ICC commissioners. The problem involved one of KCSI’s subsidiaries, the Howe Coal Company. It is actually a cautionary tale of when a deal sounds too good to be true, it probably is.

The Howe Coal Fiasco The story’s roots go back to the years immediately after the Civil War with the emergence of Oklahoma coal mining operations, which were pretty much the product of one man, J. J. McAlester. A promoter and near-mythical figure in Oklahoma history, McAlester married into the Choctaw Nation so as to gain legal access to coal deposits in Indian Territory. He promoted the idea of having railroads haul local Oklahoma coal to midwestern and south-central destinations. From the late 1860s to the early 1890s, the business produced steady profits for mine owners. Then serious problems arose. From the outset there had been a number of challenges associated with Oklahoma coal mining. First, the coal seams tended to be thin, and the deposits were smallish with layers of other elements on either side. Second, because the coal seams were surrounded by layers of other materials, extraction of the coal was complex and thus costly to mine. And, third, the mining of the coal was often frighteningly dangerous due to the presence of natural gas deposits above, below, or to the sides of the coal deposits. Starting in the 1890s, a series of explosions and exposure to toxic chemicals resulted in alarmingly high death tolls at Oklahoma mines. The combination of these factors put a damper on Oklahoma coal,

Y e a r s o f T u r m o i l 105

and while some mines managed to survive, Oklahoma coal became only a modest contributor to the nation’s coal supplies. The above factors made it all the more surprising that KCSI entered into a major investment in the Howe Coal Company, which necessitated the issuance of $13.5 million of preferred stock to help finance the operation. But it did, and the reason it did was that a group representing Japanese steel mills had expressed interest in purchasing Oklahoma metallurgical coal to fire their mills. The Japanese agreed to purchase “millions of tons of coal” per year from Howe beginning in 1967 for a minimum period of ten years. KCSR would transport the coal from Howe to Port Arthur; from there the coal would be shipped through the Panama Canal and then on to Japan. KCSI incurred considerable expense beyond its initial investment in the Howe Coal Company. KCSR was responsible for providing the coal cars. In an effort to maximize efficiency and profitability, the cars it built were humongous 150-ton, six-axle behemoths, considerably larger and heavier than the standard 100-ton, four-axle cars used by the industry to move coal. Given the suspect condition of KCSR’s track, the decision to build extralarge and heavy cars was an example of putting dreams of extraordinary profits over sound judgment. The costs associated with the Howe business opportunity did not end with the coal cars. A coal handling facility was required at Port Arthur; the large cars had to have specially designed coal unloaders to get the coal from the railcars onto conveyors that would carry it to a ship. Still, with an agreement to move millions of tons of coal for at least a decade, the outsized expenses were deemed acceptable. The first public disclosure that perhaps not all was going according to plan was a note in KCSI’s 1970 annual report that pointed to “production difficulties which have been prevalent during the mine’s development stage.” The company remained confident that the problems could be worked out; however, it soon became apparent that the optimism was misplaced, the challenges were simply too great to overcome, the coal extraction was slow and expensive, and the quantity was well below the amounts agreed on in the contract. The Japanese had sufficient cause to walk away from their contract with KCSI, and that is exactly what they did. The Howe fiasco was the result of a desperate company, KCSR, making an ill-conceived gamble, which KCSI bought into. Neither had done the kind of comprehensive due diligence that the expenditures called for. Not only was there ample history showing that the extraction of Oklahoma coal was 106 V i s i o n a c c o m p l i s h e d

problematic, the costs association with the transportation of the coal and the construction of a coal handling facility were expenses that KCSR and KCSI could ill afford in the late 1960s and early 1970s. But desperation and the hope of a big win had triumphed over sound judgment. The final return on KCSI’s substantial investment? One coal train. And, to add insult to injury, that one phenomenally heavy train derailed and caused considerable track damage.

The ICC’s Complaint While embarrassing, the Howe coal project could have been excused as an unfortunate mistake by KCSI pursuing one of a host of business opportunities during its period of business expansion. Some work out; others do not. Unfortunately, the Howe fiasco caught the attention of the ICC, as did the company’s recently negotiated settlement with Lee National. As an adjunct to its industry-wide investigation of railroad diversification conducted in 1971, the ICC’s Bureau of Enforcement proposed a special investigation into KCSI’s activities, suggesting that the holding company was expending the bulk of its energies in diversification ventures while ignoring the needs of the railway. The ICC alleged, “If there has not been a deliberate policy to deprive the railroad of its non-operating assets and to drain off its operating revenues, management, in pursuit of its independent enterprises, has been so indifferent to the financial well-being of the railroad company as to accomplish the same result.” The ICC went on to list what it saw as the most blatant of the company’s mismanagement. It accused KCSI of wasting $9 million in the spin-off of its Baton Rouge development project and the transfer of most of the rail carrier’s $44 million of nonrail assets to the holding company. Also, there was the use of $9 million of the railroad’s cash in the purchase of Howe Coal Company, an investment that led to a $15.4 million write-off when the coal company became unprofitable. The ICC rebuke was the last thing KCSI needed. It was bad enough that the railroad was struggling; now the specter of possible management malfeasance also hung over the holding company. Ironically, what KCSI’s management had tried to achieve was precisely the opposite of what the ICC’s allegations implied. Having assessed the overly restrictive regulatory environment to which not only KCSR but the entire rail industry was subject, KCSI had striven to create a profitable, Y e a r s o f T u r m o i l 107

diversified holding company that could provide investors with attractive returns and thereby give the railroad time to improve its situation. And the progress KCSI had made indeed showed promise. True, the Howe Coal Company venture was a colossal mistake. But from its very first days, KCS had never shied away from being aggressive for fear of taking a misstep. KCSI had experienced failures, but on balance, its success rate was laudable if not exceptional. Additionally, the most resourceful executives at KCSR and KCSI had traditionally been creative and unafraid to extend their mandates beyond conventional business practices. In a sense, the Howe coal project was an example of this and ultimately proved to be a good example of the company’s resourcefulness. Because the transport of coal from Howe to Japan did not materialize, the oversized coal unloader built at Port Arthur first looked like it would be a painful monument to an embarrassing operational and financial failure. But rather than retreat in defeat, management sought alternative uses for the facility and succeeded in developing one that was to become of lasting financial value. The coal unloader became the genesis of what was to become the Pabtex facility, which was reengineered to move petroleum coke from KCSR railcars onto ships. It did not take long for the business to generate healthy revenues with excellent margins. When viewed from the perspective of the revenues that Pabtex would bring to KCSR over many decades, the $15.4 million writeoff proved inconsequential. Moreover, the gigantic coal cars built to carry Howe coal were eventually repurposed for the hauling of wood chips, which also became a sustained, profitable line of business. Irv Hockaday, who by 1971 had become president of KCSI, smoothly managed the ICC complaints, arguing that the property, primarily in Baton Rouge, that was given to Lee National as part of the settlement agreement could be viewed as a positive for KCSR. Not only would KCSI and KCSR remain independent, now it would be Lee National who would develop the property that eventually would result in line-haul revenue for KCSR. The original plan had KCSI developing the property. Thus, the transaction would save the company developmental costs while still providing revenue opportunities. Eventually, the ICC investigations came to nothing, and no sanctions were declared. Nevertheless, KCSR’s management felt shell shocked and feared what might come next. The answer was nothing good.

108 V i s i o n a c c o m p l i s h e d

The Month the Trains Stopped Moving: Tom Carter to the Rescue The ICC storm clouds gradually dissipated, but that did not free the railroad from its misery. As Robert Dreiling states in his history, “The railroad finally busted in 1972.” Years before, Deramus III had been asked a question about deferred maintenance to which he replied, “I don’t know what deferred maintenance is. Deferred compared to what?” Years of underfunding track maintenance and rehabilitation gave him his answer in December 1972 when a series of derailments essentially shut down the railroad for a month. The shutdown was more than a slap in the face. It was huge embarrassment to the proud William Deramus and forced him to accept that he could no longer avoid deploying considerable personnel resources and money to correct the catastrophic collapse of KCSR’s rail infrastructure and train service. To clean up the mess and get the system up and running with a degree of efficiency, safety, and reliability, he leaned on his trusted colleague, Tom Carter. Born in Dallas, Texas, in 1921, Carter had attended Southern Methodist University, earning a bachelor of science degree in civil engineering in 1944. Later he was to add a master’s degree in engineering management from the University of Kansas. The relationship between Tom Carter and Deramus III dated back to the years the latter was CEO of the Katy, where Carter did a masterful job of keeping the trains running despite being handed paltry budgets. In Deramus’s mind, Carter was the perfect person to do the same at KCSR. But this time, the greater complexity of the system and its degraded condition necessitated Carter getting greater authority and a lot more capital dollars than he ever had while at the Katy. He received the authority on August 1, 1973, when he was named president of KCSR. While most of the railroad’s departments now reported to him, there was no doubt that the bulk of his time and attention would be focused on the railroad’s operations. Then, a few months later, he received the budget when the board of directors allocated $75 million to the rebuild, which would be deployed over a three-year period. It was a generous sum for a corporation not exactly flush with money, but really not enough. One board director, Rome Blair, who years before had served as general manager in KCSR’s operations department, was heard to say that $76 million was not nearly enough to get the job

Y e a r s o f T u r m o i l 109

done. Nor was three years enough time to rebuild the system, but Carter would just have to overcome the obstacles of too little money and too little time. One of the first matters that had to be dealt with was the staggering number of expensive derailments on the system. During the month of January 1974 alone, there was a total of forty-one main line derailments, costing KCSR $1.8 million. One month! Especially troubling, and expensive, were the frequent derailments of long, heavy trains traversing Rich Mountain. The problem confounded KCSR’s train service personnel who insisted that the consists of the trains conformed to accepted industry practice, and in fact they did. But still the derailments occurred with shocking regularity. Carter took on the challenge himself to identify the cause of the derailments and then develop a solution, neither of which could be done while sitting at his desk in Kansas City. He went to each derailment, inspected every mile of track, and spent far too many nights in backwater motels thinking through the problems. Finally, it came to him, and in true KCS style, his solution bordered on the unconventional. Conventional railroading practice dictated that slave units should be placed near the rear of trains. Slave units are remote-controlled units that provide additional power to locomotives pulling trains over mountainous terrains. It makes sense to place them near the back end to provide a push to the train climbing a steep incline—unless the train also encounters sharp curves in the process. Suddenly, it dawned on Carter that the slave units were literally pushing cars off the tracks during the curves. Having diagnosed the problem, Carter utilized his engineering training to redesign the car consists and place the slave units throughout the trains so that they did more pulling than pushing. Veteran railroaders were dubious of Carter’s somewhat unconventional remedy, but they were quickly won over when the number of derailments on mountainous terrain dropped off immediately after implementation. Railroad historian and writer Fred Frailey thoroughly detailed the enormity of the problems that confronted Carter in his excellent two-part account, which appeared in Trains magazine in August and September 1979. The detail in which Frailey describes the railroad’s plight leaves one wondering how Carter and his teams could have possibly accomplished so much within such a condensed time frame to address the enormity of the problems.

110 V i s i o n a c c o m p l i s h e d

Frailey wrote that under Carter, ties were replaced at the almost unheardof rate of nearly 6 percent per year. Fifty miles, sometimes more, of mostly welded rail was laid annually, and the equivalent of seventy 6,500-ton trainloads of ballast was unloaded each year. Confronted by both budget and supply issues, Carter chose to use a high-grade, but less expensive and more available, chat product for ballast rather than the preferred slag. It was not as good as the standard slag ballast in that it did not drain particularly well after heavy rains, but it was an improvement over what was there, or not there, at the time. The track was not the only thing in need of a complete overhaul; KCSR’s train service was in shambles and was begging for a near-total redesign. Since the time of Leonor Loree, KCSR had been running long, heavy trains to maximize revenues per train while reducing expenses by running one long train rather than two shorter ones. Carter managed to convince Deramus to back off this philosophy, demonstrating to him that the heavier trains were actually costing the railroad higher expenses due to their higher rates of derailments that caused extensive track damage and because their excessive weight reduced the life of rail track. Under Carter, shorter trains, and more of them, were put into service. He and his operations team brought greater sophistication to the positioning of cars in blocks, something that KCSR had paid little attention to previously, which had resulted in trains spending too much time in terminals while the switching of cars was performed, one by one among multiple trains. Then Carter called for the reduction of train speeds throughout much of the network. While reduced speeds necessitated reworking train schedules and resulted in additional crew costs, the lower speed reduced derailments and the severity of those that did occur. Most importantly, when all facets were considered, these measures actually resulted in greater overall cost reductions. At the end of the three years Carter was given to fix the system, with a budget that realistically should have been three times higher, was KCSR’s physical condition in perfect shape in 1976? No, not even close. But it was acceptable—actually, more than acceptable. And, if its train service was not yet quite operating at the level of its major railroad peers, Carter had reduced the gap substantially. Given KCSR’s condition in December 1972, when the trains had stopped running, what Carter and his team had accomplished was remarkable.

Y e a r s o f T u r m o i l 111

Despite the holding company’s own cash issues, the KCSI board continued to support the railroad rebuild beyond its $75 million allotment. It loaned KCSR about $5 million, it deferred payment of additional money owed to it by the railroad, and it arranged a $5 million line of credit for KCSR with its banks. So that the railroad could conserve cash, KCSI suspended the railroad’s contribution to the holding company, money that was needed to pay dividends to shareholders. To keep shareholders reasonably content while dividends were suspended, the board of directors devised a plan by which stock was distributed to them in a successful oil-drilling company KCSI owned. The move kept most shareholders on-board while the railroad recreated itself. The response of KCSI to its railroad’s emergency marked another time that Irv Hockaday’s leadership and intelligence served the company extremely well. His support of and belief in KCSR shines through in a quote that Fred Frailey used at the end of his two-part article: “I’m not about to let us lay off on maintenance to hype the earnings. Some of our stockholders ask me that all the time. ‘Golly,’ they say, ‘it will be great when you ease off the maintenance programs,’ and I reply, ‘If that’s what you expect, then sell the stock—we’ll buy it.’” KCSR’s employees pitched in as well. True to form, Deramus called on company managers to cut expenses by a combined $250,000 a month. One manager within the operations department cut his section’s budget alone by $308,000 per month. Employees throughout the railroad came up with cash saving ideas, from streamlining floor cleaning to cutting fuel consumption, to rechecking waybill computations. The end result was monthly expense reductions that dwarfed the monthly cuts that Deramus requested. It was yet another example of the “indomitable spirit” of KCS that Robert Dreiling chronicled in his history of the company. There was a reason that the KCSR had given Carter only three years to rebuild the railroad, and that will be discussed shortly. But given that he met the abbreviated schedule, it is surprising that he never fully received the credit he deserved. A number of executives, within both the railroad and the holding company, recognized what he had accomplished and remained loyal Carter supporters and friends, even after his retirement and all the way until his death in 2019. But some within the railroad, even some within operations, were less enthusiastic. Though somewhat unfair given the circumstances, their criticisms were understandable. The early to mid-1970s were tough years for 112 V i s i o n a c c o m p l i s h e d

KCSR employees forced to work, day in and day out, in a difficult environment. They did their jobs, they supported the compromises that Carter forced them to make, and they witnessed firsthand what they felt were serious deviations from accepted railroad practice, and all these served to shape their perspectives. For many, unfortunately, Tom Carter symbolized KCSR’s shortcomings when, in reality, he represented its character and strength. One thing is for sure: without his contributions, the railroad’s recovery a few years later would not have happened.

Finally, Light at the End of the Tunnel So dense had been the gloom that hung over KCSR during much of the 1970s, it had been nearly impossible to recognize that the seeds of the railroad’s rebirth had been sown during the decade. First, the company was awarded a coal contract, which will be discussed in the next chapter. Not only was this contract a financial windfall for KCSR, it proved to be historic, as it radically changed the relationship between electric utilities and railroads. What the coal contract did to provide for long-term revenue growth, the Railroad Revitalization and Regulatory Reform Act of 1976 did to instill hope within industry that, finally, the federal government had begun to acknowledge the inequities in the nation’s freight transportation marketplace. The “4R Act,” as the legislation became known, salvaged the still viable freight operations of the bankrupt Penn Central and other failed and failing rail lines in the northeast, mid-Atlantic and midwestern regions through the creation of Conrail. It also established the basic outline of regulatory reform in the railroad industry. Among the act’s proposals were the following: Balance the needs of carriers, shippers, and the public. Foster competition among all carriers by railroads and other modes of transportation. Permit railroads greater freedom to raise or lower rates for rail services in competitive markets. Promote the establishment of railroad rate structures that are more sensitive to changes in the level of seasonal, regional, and shipper demand. The 1976 legislation was a breath of fresh air for the railroads. In addition to the above, it also stipulated that contract rates could be set for transactions involving an investment of more than $1 million, something that had not previously been an option for railroads and shippers. Y e a r s o f T u r m o i l 113

But just as surely as the sun sets in the west, bureaucracies are hard to rein in once they become entrenched. The ICC, which had exerted dictatorial control over the railroads for nearly a century, viewed the 4R Act as a serious threat to its authority and strongly opposed it. The act’s provisions had been written over the objections of several ICC commissioners, and as a result of the ICC’s bureaucratic inertia, the legislation had little initial impact on the way the rail industry functioned. What developed was a contest between a recalcitrant federal agency and growing congressional momentum for regulatory reform. The proponents for reform in Congress got additional ammunition from a report produced by the Department of Transportation in 1978 entitled “A Prospectus for Change in the Freight Railroad Industry.” The report was an exhaustive 165-page study that detailed the myriad problems and inequities faced by the industry. The study made the case that without substantial regulatory changes, the nation’s freight rail system would continue to deteriorate. Among the report’s most telling points was the contention that while the ICC had been created to regulate the rail industry when its monopoly status had led to widespread abuses, that monopoly no longer existed. Regulations that had been established as instruments of public policy were now having a damaging effect on the public good. The report went on to point out that the ICC continued to make decisions based on the railroads having nominal market competition from other modes of transportation, namely trucks and inland water carriers. In other words, while the ICC was declaring that railroads still controlled the freight market, the reality was railroads were no longer the dominant transportation mode. After almost two decades of regulatory oppression, change appeared to be on the way. The push for meaningful rail regulatory reform provided hope that the 1980s might bring positive change to KCSR and the rail industry.

114 V i s i o n a c c o m p l i s h e d

Recovery

12

The difference between success and disaster at times can be razor thin. Such was the case for KCSI and KCSR in the 1980s.

Staggers to the Rescue The decade got off to an excellent start with two major developments originating in the 1970s. As discussed in the previous chapter, momentum for meaningful rail reform had taken hold in Congress in the mid-1970s. Once the movement for reform caught on, there was no stopping it; in the fall of 1980, President Jimmy Carter signed a landmark piece of legislation that passed through both the House of Representatives and the Senate with overwhelming support. The Staggers Rail Act of 1980, named for its sponsor, Congressman Harley O. Staggers, was destined to have a greater-than-imagined impact on the railroad industry. It proved to be a textbook example of how deregulation, if done properly, can spur economic growth. Among the legislation’s provisions were the following: A rail carrier could establish any rate for a rail service unless the ICC was to determine that there was no effective competition. Rail shippers and rail carriers would be allowed to establish contracts subject to no effective ICC review unless it was determined that the contract would interfere with the rail carrier’s ability to provide common carrier service. (Common carrier obligation refers to the statutory duty of railroads to provide transportation or service on reasonable request. A railroad may not refuse to provide service merely because it would be inconvenient or unprofitable. Since the act’s inception in 1980, there has never been an instance of a rail contract interfering with a railroad’s common carrier obligation.) 115

The scope of ICC’s authority to control rates to prevent discrimination among shippers was substantially curtailed. Industry-wide rate increases were to be phased out. Staggers proved to be a monumentally successful piece of legislation, benefiting railroads and shippers alike. Over the ten-year period after passage, the railroads ended their multidecade loss of market share to truckers, profits for the rails began to recover, and rail rates generally declined. According to the Association of American Railroads (AAR), Staggers resulted in a 45 percent reduction in average rail rates and the increase in rail prosperity over time allowed the industry to reinvest more than $635 billion in their systems over the twenty-five-year period after Staggers became law. In addition, return on net investment also increased: 4.4 percent in the 1980s, 7.0 percent in the 1990s, and 9.6 percent from 2000 to 2015. In light of all of this, it is curious that KCSR had fought to prevent the Staggers Act from being passed. Why? The simplest explanation might be best summed up by the saying “Better the devil you know than the devil you don’t.” Like other railroads, KCSR had suffered under the weight of unfair regulatory constraints, including inflexible rate making. But the company felt that, as restrictive as the constraints were, Staggers could make it nearly impossible for KCSR—a smaller railroad with challenging terrains and heavily dependent on interchange traffic—to compete with larger railroads that had longer routes and fewer interchanges with other carriers, on a more openly competitive rate-making playing field. Under the rate-making system established after the passage of the Interstate Commerce Act in 1887, if two railroads served the same shipper, each railroad was bound by law to charge the same set price. As a result, shippers mostly divided their business between the two, feeling that it gave them a measure of protection from one rail carrier providing inadequate service. Under Staggers, each railroad was free to set its own contract prices with individual shippers. KCSR management worried that the big railroads, with their larger financial war chests and more expansive service territories, could charge significantly lower rates and take greater market share. KCSR also acknowledged, at least internally, that it probably was not prepared to operate in a competitive market. Through no fault of their own, generations of its salesforce were not salespeople in the truest sense, but rather were order-takers and customer service representatives. As there were few rate negotiations in a fixed-rate system, the sales personnel lacked

116 V i s i o n a c c o m p l i s h e d

experience in negotiations, costing, and the design of rate packages that served the interests of both the shipper and the railroad. KCSR felt ill prepared and disadvantaged. So, while acknowledging the faults of an overregulated system, KCSR feared that Staggers could worsen the situation for smaller railroads forced to compete with the giants. For years, KCSR had been in full survival mode. Nothing illustrates this better than the fact that to reduce KCSR’s operating expenses, its major departments had been turned into subsidiaries of KCSI. For instance, KCSR’s marketing department became the subsidiary Transmark. Things had reached a point where Transmark employees were tasked with selling decorative oil lamps, ashtrays, and ceramic dog and cat statuaries. It is a credit to the loyalty and commitment to KCSR that they took on these bizarre assignments without serious complaint, but one could understand how, under the circumstances, management may have lacked confidence in the sales force’s ability to effectively negotiate rate packages in a less regulated environment. As it turned out, KCSR had overestimated the problem. It was true that its salespeople lacked competitive rate-making experience, but so did those at other railroads. Everyone had a steep learning curve. And, more importantly, shippers by and large remained wary of handing over the lion’s share of their business to a single railroad for fear they would become beholden to that single carrier. Also, as Staggers was to radically change the dynamic between railroads and shippers, it was inevitable that it would take time to be fully implemented. Thus, the railroads had more time to prepare their employees to manage the new competitive landscape than they initially feared. Furthermore, what KCSR lacked in size and pricing flexibility, it made up for with being more approachable and customer-friendly than its peers. Entering into contracts for smaller-volume business was sometimes viewed by larger railroads as causing more problems than they were worth. KCSR, on the other hand, viewed the marketplace from a different perspective. A small contract that might barely move the needle for a larger railroad could be significant for KCSR. As such, its marketing and sales and operations employees were more willing to try to accommodate the entirety of its customer base regardless of size. When it came down to it, KCSR had always been a niche player that put a high premium on customer service built on trust and the willingness to

R e c o v e r y 117

adapt to the individual needs of its shippers. That did not change with the passage of Staggers. KCSR was not always the lowest bidder, but often it was judged a viable option when all factors were considered. So, despite a good bit of initial hand-wringing, the Staggers Rail Act became a key component to KCSR’s turnaround in the 1980s, just as it was for the entire rail industry.

The Contract That Saved the Railroad As important as Staggers was, the primary savior of KCSR was not a piece of federal legislation but coal. Not only did a two-page coal deal signed by the company in 1974 kick-start the revitalization of the railroad, it also reshaped the way railroads and electric utility companies would work together in the future. There would not have been a 1974 coal deal without Michael F. McClain, certainly one of the most important, if less recognized, figures in KCS’s history. Mike McClain was born on March 27, 1929. One of five children, his early childhood years were spent in the Rosedale and then Argentine sections of Kansas City, Kansas. Fittingly, both were railroad neighborhoods. At a young age, he joined KCSR and eventually worked his way up to senior vice president of marketing. For all but a few years he took off in the late 1980s, Mike never left the company until he retired in the mid-1990s. Mike took it on himself to learn intimately every mile of rail on the system and every interchange with other railroads. He also committed to knowing and befriending as many of KCSR’s customers as possible. One of those customers was John Turk. In 1974, Turk was president of the Southwestern Electric Power Company (SWEPCO). John and Mike became close friends and ultimately the architects of a truly historic coal deal. Both were consummate company men, 100 percent loyal to their respective companies. Both knew their companies inside and out. Both were men of character who adhered to rigid ethical standards. And they trusted each other implicitly. The SWEPCO contract would prove to be a deal negotiated not by teams of lawyers but by two men supported by a very small group of trusted associates. At the time, SWEPCO was almost entirely dependent on natural gas as a fuel source for the generation of electricity. In 1969, the company had approached Exxon, its primary natural gas supplier, seeking to sign a 118 V i s i o n a c c o m p l i s h e d

contract that would have Exxon furnish natural gas to one of SWEPCO’s Texas generating units. Exxon told SWEPCO that a long-term gas contract was not possible. This in turn signaled to SWEPCO executives that changes were in the wind. The company eventually got its natural gas supplied to its Texas plant from another company, but at a price nearly four times higher than what it had formerly paid. Natural gas prices were rising due to increased demand for electricity in the south-central and southwestern regions of the United States. SWEPCO was experiencing a 9.3 percent compounded annual growth rate in demand, which meant that additional electric generating capacity was needed. The company had already been exploring alternative fuel options. Oil was one option, but political unrest in the Middle East was resulting in higher prices and supply uncertainty. Natural gas prices were similarly being influenced by international discord. The two most viable options were nuclear and coal. SWEPCO conducted an exhaustive study suggesting that in many ways, nuclear was the preferable energy choice. However, obtaining commercial operating licenses for nuclear power plants was becoming a political minefield, as intense pressure was being put on politicians to halt the expansion of nuclear power generation. While SWEPCO believed that nuclear power was safe, it felt that it was virtually impossible to project when a nuclear plant might go online. Thus, almost by default, coal was selected as the best fuel choice for the generation of electricity going forward. Soon after making that decision, SWEPCO announced its intention to build two coal-fired facilities: one near Carson, Texas, and another near Gentry, Arkansas. In July 1972, SWEPCO entered into a contact with the coal company, AMAX, to supply coal from the Powder River Basin (PRB) in Wyoming. Once that was accomplished, the utility company turned to negotiating a deal to transport the coal to the plants. The transportation details were to be worked out by three companies: SWEPCO, KCSI, and Burlington Northern (BN). BN would move the coal from the PRB to Kansas City, where it would be handed off to KCSR. According to a high-ranking SWEPCO official, while all the parties involved acted professionally, it was the two close friends, Mike McClain and John Turk, who drove the deal and enabled the negotiations to move along rapidly. There was no posturing, no initial outrageous requests or demands— only a commitment to get a fair deal done expeditiously. And what a deal it ended up being: a twenty-five-year agreement in which BN-KCSR would deliver a minimum of 1,650,000 tons of coal per year to R e c o v e r y 119

each of the four generating units: three at the Welsh power plant in Texas and one at the Flint Creek plant in Arkansas. That amounted to a minimum of 6,600,000 tons of coal per year. The first Welsh unit was scheduled to open in late 1977 and the Flint Creek unit in 1978. The third and fourth units would open in 1980 and 1982, respectively. The deal was unprecedented. While railroads had been transporting coal for over a hundred years, the dynamics of the business were much different from this one. Traditionally, utilities that used coal to generate electricity located their power plants near coal mines; thus, the transport of the coal was mostly short haul. In this case, the Welsh plant was nearly fifteen hundred miles away from the PRB, and Flint Creek was more than one thousand miles away. This was to be the first long-distance movement of coal using dedicated unit trains. It was groundbreaking. Heretofore, there had been no accepted industry practice as to who would own the car fleet that would be used to service a coal contract. SWEPCO decided that it wanted to have control of the cars to guarantee availability, so it placed an initial order of nearly fourteen hundred cars. That decision led to the accepted norm going forward that in most contracts, the utilities would supply the rolling stock. Amazingly, the twenty-five-year deal with over 6,600,000 tons of coal to be delivered annually was finalized by a two-page Letter of Understanding with a short tariff attached. The largest and most important transaction in KCSR history was essentially a handshake deal between business professionals who respected, trusted, and liked each other. Arthur Stilwell would have definitely approved. This was the way he had envisioned his railroad doing business. A retired SWEPCO vice president, Les Delahanty, observed, “The magnitude of the deal was difficult to imagine. SWEPCO planned to recreate itself from a mid-sized utility almost totally reliant upon natural gas for its generating units to one where western coal would supply 65% of its fuel requirements between 1976 and 1983.” The significance of the deal to KCSR was even greater. Stated bluntly, the SWEPCO coal deal saved the company. In 1976, the year before the first Welsh unit went online, KCSI’s transportation revenues totaled $149.6 million. In 1979, with both a Welsh unit and a Flint Creek unit, transportation revenues had risen to $224.8 million. By 1984, with all four units in operation, revenues had increased to $347.0 million, a 143 percent increase in a nine-year period. 120 V i s i o n a c c o m p l i s h e d

Not Only SWEPCO Sparked the Recovery Of course, not every dollar of revenue growth was attributable to SWEPCO. In the immediate years that followed, KCSR—again led by Mike McClain— struck deals with other utilities to deliver PRB coal to power plants, including those owned by Kansas City Power & Light, Empire, and Texas Utilities. It was not just the company’s coal business that grew during the 1970s and 1980s. KCSR’s agriculture traffic increased as the railroad steadily moved far greater volumes of corn to southern poultry producers, and Mike McClain was at the center of the growth. His close relationship with Bo Pilgrim, one of the founders of the poultry producer Pilgrim’s Pride, helped lead to new contracts. Soon, KCSR served over thirty poultry producers in the southcentral states, including not only Pilgrim’s but also other emerging industry giants such as Tyson and Perdue. The time was perfect for the growth of KCSR’s poultry business. By 1985, the consumption of chicken had surpassed pork; by 1992, chicken was well on the way to surpassing red meat. Grain became a core, stable commodity for KCSR, as the chickens ate every day no matter how good or bad the harvest or how high or low the price of corn. McClain also concentrated on forming relationships with lumber and paper mills. Increasingly, contractors were using pine for home construction, and the south was rich with pine forests. The area became the home of a number of state-of-the-art paper and lumber mills. But, in the final analysis, it was coal that led to KCSR’s financial turnaround, and the SWEPCO agreement started it all. Without the combination of KCSR’s president Tom Carter and Mike McClain, it would not have happened. Carter had been handed, to again borrow Bob Dreiling’s term, a “busted” railroad. McClain faced a shrinking customer base that was producing revenues barely adequate to maintain basic business functions. It would be hard to imagine a bleaker picture. It had the appearance of a company about to fall into a death spiral. Carter and McClain turned everything around. Given their success one would think that the two would be forever linked together for what they accomplished for their railroad, but that never proved to be the case. The likeliest reason was probably their very different personalities. Carter was a reserved southerner. Though out of necessity he could be a tough taskmaster who demanded loyalty, mostly he remained the consummate team player, loyal almost to a fault to his boss, Deramus III. McClain was a proud, stubborn Irishman who at times could be a bit R e c o v e r y 121

of a lone wolf. While he was devoted to KCSR and its customers, he was at his best when he was able to work with minimal interference from others. He hated office politics and when asked to play that game, the results were usually less than satisfying. Although Carter, while president of KCSR, had authority over most of the railroad’s departments, in the 1970s his primary attention was on its operations. McClain’s total attention was centered on marketing and sales; everything else was an inconvenience. It has been said that when a railroad’s operations and marketing and sales departments get along well, something is wrong. While the conflicts that tend to arise with regularity between the two key areas can be maddening, the tensions often lead to a better balance between train service and sales. In this case, Carter and McClain did not agree on everything, but both were smart enough to understand that they were tied at the hip and needed each other. Carter was wise enough to understand that Mike McClain knew how to get a deal done and was also knowledgeable enough about operations not to agree to any service agreements that the railroad could not handle. Carter also knew that McClain was on the cusp of pulling off one of the most significant business deals in railroad industry history. Thus, he gave Mike the space he needed. And McClain knew full well that if Carter and his operations team were not able to get the railroad running efficiently, there would be no SWEPCO contract, and ultimately that might mean the eventual end of KCSR. So, he supported Carter even when he wanted more service capacity than he was provided. While these two very different men worked separately from one another, their goals were intertwined. When Carter was able to deliver the service and McClain the coal contract, railroad history was made, and KCSR had a future.

KCSI Sets Its Sights on a Major Acquisition In 1983, the Atchison, Topeka, and Santa Fe (Santa Fe, SF) announced its intention to acquire the SP, which would make it the dominant railroad in the western United States. Their decision was based on the supposition that the ICC would not block the merger, as the agency had previously signaled that it did not believe that size necessarily reduced competition. The SF was confident that the merger would gain rapid approval—so confident,

122 V i s i o n a c c o m p l i s h e d

in fact, that it had begun repainting locomotives reflecting the combination. More meaningfully, the SF had formed a holding company, Santa Fe Southern Pacific (SFSP), with SP put in trust pending final ICC approval of the merger. Their confidence proved to be misplaced. The merger process stalled, as opposition to it increased. Then on June 30, 1987, the ICC rendered its decision, denying the merger application of the SF and the SP, claiming that the railroads ran parallel systems and would indeed reduce competition in the west. The holding company was ordered to sell one or both of the railroads within two years. It was expected that the decision would set off a bidding war. Rail insiders felt the most likely suitor would be Norfolk Southern (NS), which would result in a single-line transcontinental railroad. As it turned out, NS did not bid, but two other entities did. KCSI was the first to jump into the fray with an offer to buy SP for a little more than $2 billion, including the assumption of over $800 million of SP debt. It was a daring move for a company whose railroad had been flirting with insolvency just a few years before. The difference in size of the two rails was daunting. SP had over twenty-six thousand employees; KCSR had less than three thousand. SP operated over 11,600 miles of track, while KCSR ran over 1,600 miles. To a number of observers, KCSI’s proposal seemed audacious. The bid was primarily the brainchild of Landon H. Rowland, who had become KCSI’s chief operating officer. It was Rowland’s contention that the railroad industry was on the brink of major consolidation, and if KCSI’s rail franchise did not expand, it would eventually suffer significant loss of market share. It was not an ill-conceived assumption. Still, it was questionable whether the company had the financial or managerial wherewithal to effectively manage the integration if it was able to win the prize. The second bid came from Denver-based Rio Grande Industries; at about $1.8 billion, it was a bit lower than KCSI’s. Rio Grande Industries was a holding company controlled by its principal owner, Philip Anschutz. Its only rail property was the Denver Rio Grande Western Railroad, which operated between Denver and Salt Lake City. But the real force behind the bid was not the smallish regional railroad itself but its owner, Phil Anschutz. Anschutz had amassed a fortune in oil, real estate, telecommunications, and entertainment. With a net worth of over $12 billion, he was listed as one

R e c o v e r y 123

of the hundred largest landowners in the United States. He had purchased Rio Grande Industries in 1984. While somewhat reclusive and almost never agreeing to be interviewed, he wielded enormous power, especially in the western states. Anschutz’s political clout and stature within financial markets were determinative factors in SFSP’s acceptance of the Rio Grande Industries bid over the KCSI offer in late December 1987. KCSI reacted immediately, petitioning the ICC to overturn the deal on the basis of its belief that its offer was higher and that KCSR offered significantly greater synergies with SP than the Rio Grande Railroad—both valid points. But KCSI had a problem that was getting in the way of its long-shot effort to convince the ICC to overturn the SF–Rio Grande Industries deal. A very big problem, as it turned out.

The ETSI Lawsuit In 1973, after the Arab oil embargo caused energy prices to spike, a group of companies formed Energy Transportation Systems Inc. (ETSI) for the express purpose of building a pipeline that would carry crushed coal from Wyoming to coal-burning electric power plants in Arkansas. Some of the companies in the partnership wielded considerable power and influence, including Bechtel, Lehman Brothers Kuhn Loeb, United Energy Resources, and Atlantic Richfield. The ETSI project was to be the largest and most ambitious of several coal pipeline projects envisioned in the 1970s. The concept behind the multiple planned projects was that the coal would be crushed, then mixed with water to create a slurry, and moved via pipeline to its destination. At the power plants, the coal slurry would be dried and then burned to create electricity. In the pipeline, the slurry would move along at the slow speed of four miles an hour. Some proponents of the scheme pointed to significant transportation cost savings; whereas railroads, they claimed, charged $11.80 per ton of coal from the PRB, the pipelines would deliver coal for about $7.00 per ton. Other projections pegged the rail transport costs at $9.10 per ton and the pipeline at $6.50. When one considers how precious water resources are in the western states, it is a wonder that the coal slurry concept ever received the degree of support it did. To carry the crushed coal through a pipeline would take huge quantities of water. In the case of the ETSI pipeline project, to carry the

124 V i s i o n a c c o m p l i s h e d

thirty-seven million tons of coal needed annually would necessitate 20,000 acre-feet of water. An acre-foot of water is enough to cover an acre of land one foot deep, which equates to 326,000 gallons. The ETSI pipeline would require 326,000 gallons of water multiplied by 20,000—a very big number that would put extraordinary demand on the chronically limited Western water resources. Despite the enormous water requirement, a number of coal slurry projects, including ETSI’s, gained traction with various state governmental officials, especially those that stood to sign lucrative contracts to supply water. This was a potential emerging new business with almost no history. In fact, there was only one active coal slurry pipeline: the 273-mile Black Mesa line, opened in 1969, which moved about five million tons of coal annually from Arizona’s Black Mesa Mine to the Mojave power plant in Nevada. The ETSI pipeline would source the coal from the PRB and move it over one thousand miles from Gillette, Wyoming, to Arkansas, totally dwarfing the Black Mesa coal slurry pipeline. The western railroads saw the slurry pipelines as a serious threat to their coal franchises and vigorously fought their construction. The projected route of the ETSI pipeline had it crossing railroad lines at sixty-five different locations. The railroads fought them on every crossing. Lacking state or federal eminent domain authority, ETSI had to fight the railroads in court sixty-five times. It won every case, but the judicial process was slow and expensive, running on for about ten years, and exacted a heavy toll on ETSI’s financial resources. Then in the early 1980s, ETSI suffered a mortal blow when it lost out to the Chicago and North Western (CN&W) on a contract to move coal from the PRB to an Arkansas Light & Power plant. It never recovered from the loss, and the company fortunes declined. The ETSI pipeline project died a slow death with the end finally coming in 1984, the victim of railroad obstructions, falling energy prices in the 1980s, and growing concerns over western water resources. The failed project had cost ETSI $145 million. But the end of the ETSI project did not mean that the crisis was over for the railroads. Seeking to recover its losses, ETSI sued five railroads, including KCS, SFSP, and BN, charging them with collusion and restraint of trade. The courts seemed sympathetic. On Monday, April 11, 1988, the Federal District Court in Sioux Falls, South Dakota, found KCSI guilty of restraint of trade. The jury awarded

R e c o v e r y 125

the State of South Dakota $200 million in antitrust damages, which under antitrust law would almost certainly be trebled. The state was also awarded an alternative recovery of $200 million for interference with contractual relations and $44.2 million in punitive and other damages against KCSI. The company’s potential liability totaled $844.2 million. One analyst who followed KCSI stated that the company would be in “serious, serious trouble” if the verdict was upheld. “For a company of this size, it is nothing less than a staggering amount. . . . It’s dynamite.” The court decision effectively ended any hope KCSI ever had to get the ICC to void the deal allowing Rio Grande Industries to buy the SP. While Landon Rowland put on a stoic face after the South Dakota court decision, pointing out that KCSI was still the highest bidder for the SP, he admitted the timing of the ETSI court decision was “awkward.” It was more than just awkward: it put a knife through the heart of KCSI’s bid. As an equity analyst with First Kansas City Securities noted, “Any time a jury awards two-thirds of your net worth, you have a significant problem on your hands.” Almost simultaneous to the court verdict and jury award, the ICC denied KCSI’s bid to overturn the deal between Rio Grande Industries and SP and formally approved the SP sale. It is impossible to know if KCSI could have stopped the sale of SP to Rio Grande Industries under any scenario, but the company had no legitimate shot of succeeding with the specter of an $844 million antitrust judgment hanging over it. For the second time in its history—the first being in the 1920s when Leonor Loree had pursued the Cotton Belt—KCS had failed in its attempt to acquire the SP. In both cases, it could be said the company was probably fortunate to have lost out. Loree’s plan to put together three railroads would have seriously compromised the company’s financial health during the Great Depression. Similarly, not only would a successful acquisition in the 1980s have drained the company’s financial resources, KCSR did not have the managerial depth of talent to integrate the two rail operations. Given that in the mid-1990s, UP was to be nearly brought to its knees after it ultimately acquired the SP, it is hard to imagine a scenario in which KCSR could have managed the task in the 1980s. Sometimes it is best not to get what you think you need. KCSI had no time to feel sorry for itself over the failed acquisition, as it still had to deal with its potentially crushing legal jeopardy. To that end, the company sought to limit the possible damage by coming to a settlement with ETSI. Three other railroads did the same. KCSI agreed to pay 126 V i s i o n a c c o m p l i s h e d

ETSI $82 million to settle: $32 million using available cash and $50 million from loans taken out from two banks, using the railroad’s rolling stock as collateral. SF, the one railroad that chose not to settle ETSI’s lawsuit and fought the case in court, paid a hefty price for its decision. In March 1989, a federal court in Los Angeles found the railroad guilty of conspiracy and the jury awarded $345 million to ETSI, which automatically was tripled under antitrust law to $1.04 billion. A year later, SF reached a settlement paying out $350 million. For KCSI, reaching the $82 million settlement did not mark the end of the serious threat to the company. ETSI had not been the primary entity in the court decision that resulted in a potential $844 million liability for the company. It was the State of South Dakota, which had already won a decision against KCSI in federal court. South Dakota had entered into a contractual arrangement with ETSI to provide water for the slurry project. That the ETSI project was canceled in part due to KCSI’s opposition meant that South Dakota had lost a very lucrative contract. The situation was so dire for KCSI that outside attorneys had drafted bankruptcy papers in the eventuality that the judgment was not overturned. One former KCSI director related the story that his wife had asked him why he appeared so distressed after an emergency meeting of the board of directors. He told her that if things went badly, it could cost them their life savings, their cars, their house—everything. The good news was that there was legal precedence that gave the company a reason to be hopeful. With excellent outside counsel, KCSI appealed the decision. A little more than a year later in June 1989, the United States Court of Appeals for the Eighth District in St. Louis, Missouri ruled that South Dakota had no standing to assert federal antitrust action. The original decision and jury verdict were overturned. KCSI’s stock gained $8.75 the day after the decision. The company had survived—bloodied to be sure, but alive. The $82 million settlement to ETSI hit the company hard, forcing it to mortgage its rolling stock to help raise the settlement cash payout. But, most importantly, the railroad had survived.

Another Unwanted Caller Surfaces If the attempted acquisition of a major railroad and defending itself in the aftermath of a potentially devastating court decision were not enough, R e c o v e r y 127

KCSI’s management also found itself confronted by an unsolicited bid to buy the company. Howard Kaskel was known to be a resolutely private man. He was also an extremely wealthy one, listed in 1986 by Forbes magazine as one of the world’s four hundred richest people. His family had built the Doral Hotel chain, which included three hotels in New York City and a hotel and country club in Miami. Kaskel’s construction company had built or rehabilitated apartment houses, office buildings, restaurants, bowling alleys, and hotels in Miami, Boston, and Chicago. But the primary base of the Kaskel construction empire was New York City, where the family built approximately seventeen thousand apartments, many of them in the city’s most affluent neighborhoods. He was successful in pretty much everything he took on, even horse racing. His thoroughbred, Sir Henry Lewis, won the Irish Derby in June 1987. He was a man accustomed to winning. Like the individuals who controlled Lee National in the 1970s, Howard Kaskel did not come across as a person particularly interested in owning a railroad; it was KCSI’s nonrail subsidiaries that held his greatest interest. According to an associate, the real estate and construction mogul saw “Kansas City Southern as an attractive investment opportunity and a company that is undervalued.” In August 1987, an SEC filing disclosed that Kaskel had amassed a 7.9 percent ownership stake in KCSI. Kaskel and a wealthy cadre of investors he had assembled continued purchasing shares in the company over the next seven months, reaching an 11.3 percent ownership level. Not known as a corporate raider, Kaskel expressed an interest in some kind of “friendly” transaction with KCSI’s management and directors. But the board of directors rebuffed his overtures. In March 1988, the situation grew more contentious when Kaskel’s group offered sixty dollars a share to acquire KCSI in its entirety, both railroad and nonrail subsidiaries. In a letter to KCSI’s chair, Landon Rowland, Kaskel threatened a proxy fight if the board did not act on the offer by April 4. In his letter he said that his offer represented a “substantial premium” over the $46.25 price the stock had closed at end of the previous week of trading. He further stated that over the past eight months, he had suggested “various ways” that the company could maximize its value to shareholders, but the company had rejected each of his suggestions.

128 V i s i o n a c c o m p l i s h e d

“After careful review of our options,” he continued, “we have concluded that it would be desirable for us to acquire Kansas City Southern.” He added that he was prepared to meet “promptly” with KCSI directors to negotiate mutually desirable and beneficial arrangements. Speculation within the analyst community was that Kaskel’s primary interest was not with the railroad but with KCSI’s financial services companies, particularly DST. An analyst at Solomon Brothers felt Kaskel’s bid was low, and the company stock value was more in the $67 or $68 range, with DST alone worth $23 or $24. An analyst at Kidder, Peabody & Company felt that KCSI’s management would fight the unsolicited overture. It seemed that KCSI was in for an ugly proxy fight, But it did not happen, thanks to a good friend and the connectivity of Kansas City’s business community. Irv Hockaday had left KCSI in 1983 to join Hallmark Cards Inc., the greeting card company founded by Donald Hall. Headquartered in Kansas City, the company from its inception had been the epitome of a good corporate citizen. Two years after leaving KCSI, Hockaday become Hallmark’s president and chief executive officer. When he learned of Kaskel’s group’s bid for KCSI, he contacted Don Hall and suggested that Hallmark act as a white knight by taking a significant position in the company. Hall, the consummate Kansas City business leader, immediately agreed and Hallmark acquired a sizable block (six hundred thousand shares) of KCSI. With the solid backing of Hallmark, which with the purchase now had 1.04 million KCSI shares, or 10.2 percent of total shares outstanding, the threat to KCSI was quelled. The Kaskel group made money on their investment but in the end did not get what they had originally sought. The resolution to this threat says much about Irv Hockaday’s loyalty to his former company and to his mentor, William Deramus III. It also is a testament to Don Hall’s commitment to Kansas City and its business community. The support of Hallmark reflected the fraternity of Kansas City businesses, a group that KCS had joined in the early 1940s when R. Crosby Kemper led a group of local business leaders and investors in taking primary control of KCS out of the hands of New York investors. Happily, for Hallmark, as more than one executive of that company related, the purchase of

R e c o v e r y 129

KCSI stock ended up being one of the best investments that the company ever made. It was the very definition of a win-win.

The End of an Era There is a negative connotation associated with the statement “He died at his desk,” as it suggests that the person failed to live his life to the fullest. On November 15, 1989, William N. Deramus III was found slumped over at his desk in his office at 114 West Eleventh Street. In this case, rather than lamenting the site of his passing, it was generally acknowledged that if “the Hat” could have chosen the place where he would take his final breath, it would have been right there at his desk. Deramus III was not defined by his job, but like most successful executives, he defined his job. He had taken control of a troubled railroad, and by the time of his passing, KCSR was once again in reasonably good financial shape. But more than that, he imagined and then created an expansive, multidimensional conglomerate that he not only ran but directed its entry into widely divergent businesses and industries. It was through his company, and mostly at his desk, that he defined himself not only as a creative, innovative, and progressive business leader but also as a supporter of social causes and a champion of those less fortunate. In the case of Deramus III, his desk and his office provided a better picture of the man than his words ever did. It was said that the furniture in his office appeared to be the leftovers after everyone else had finished decorating. Everything in the office was covered with stacks of books on art, history, wild animals, science, sociology, and much more. He stubbornly resisted notoriety. He hated having public praise lavished on him. Friends said that his generosity usually carried only one condition: keep your mouth shut about where the gift came from. He was crusty and sometimes profane. Sometimes, too, when circumstances compelled, he made hard decisions without considering the impact they would have on his employees and their families. His actions, done out of financial necessity, often came across as overly harsh, even cruel. But at other times, his loyalty and sincere if painfully awkward kindness would shine through to those around him. What made him unique was that he possessed all these traits in equal measure. His many acts of kindness were not motivated by vainglory: he did not try to soften his image as a fierce businessman, nor did he ever promote himself as tough with a heart of gold. 130 V i s i o n a c c o m p l i s h e d

In the end, William Deramus III was a powerful creative force and a complex human being. He ran his company and his life from his desk, wearing his hat, smoking his cigarette. The end of the 1980s also marked the end of the eighty-one-year Deramus era, when the last in the line of leaders, William Deramus IV, retired from his position as president of KCSR. It was not a perfect span by any means. Under the leadership of both Deramus II and Deramus III, there were highs and lows. Both were men of vision who were willing to do whatever was necessary to keep the railroad afloat. It was not always pretty, but in the end, they succeeded in doing what few could have accomplished. In a few years, their company, KCS, would reach heights of success that not even they could have foreseen. Neither one lived to see that day, but both were major contributors to Stilwell’s vision being accomplished.

R e c o v e r y 131

The Great Contraction

13

Consolidation in the 1990s

The Staggers Act had breathed new life into a moribund industry. Rails recovered market share, return on net investment reversed a multidecade negative trend, and reinvestment in rail infrastructure increased. Furthermore, shippers’ rail transport costs mostly eased as a result of the adoption of market-based pricing. But Staggers was not a magic wand able to erase all the industry’s ills. Despite reclaiming some of the freight market that had been lost, rail supply still far exceeded market demand. That realization had driven Landon Rowland to pursue the ill-fated attempt to acquire SP. KCSI had sought to be on the right side of the wave of consolidations that company executives, as well as industry professionals, felt was inevitable. In 1980, there were thirty-five Class I railroads in the United States—a number that was viewed as unsustainable, and indeed it was. By the end of 1995, thirty-five shrank to seven; by 2010, the number had been reduced to five. The industry had entered a period of substantial change, and Rowland decided that KCSR needed a leader with no preconceptions as to how the railroad should operate in the emerging new competitive landscape. Rowland had been elevated to chief executive officer of the holding company in 1987. His sharp legal mind, his intelligence, his wide range of interests from the sophisticated to the very common, his ambition, and his quirky, slightly off-center personality had all appealed to Deramus III. But while Deramus had handed over the day-to-day management, he still occupied his office and thus had remained the major force at company headquarters. That changed only with his passing in November 1989. His absence left two men, Landon Rowland and Tom McDonnell, the principal figures at KCSI—Rowland by virtue of his title and McDonnell because of his close 133

relationship with Deramus and his track record of success. The two had vastly different personalities and worldviews; there would prove to be no close collaboration between them. But, while McDonnell felt a deep responsibility to the holding company, he was committed to devoting the lion’s share of his energy into developing DST into a vibrant company, and he felt that there was much more to be accomplished there. As a result, Rowland became more than just KCSI’s chief executive in name; he became its leader. While he maintained an active role in the management of KCSI’s financial services, Landon Rowland was smart enough to initially give McDonnell space and so focused his attention on the railroad. Deramus III’s son, William Deramus IV, had served as KCSR’s president since 1986 and was acknowledged by most to be a capable railroad professional. But questions of his management style, along with personality conflicts with Rowland and other company executives, had dogged him and suggested that his tenure as president might not last long. Sure enough, Deramus IV left KCSR in 1990, thus ending over eighty years of Deramus family association with KCS. Landon Rowland’s effort to acquire SP had laid bare not only his ambition but also his belief that KCSR’s long-term survival as an independent railroad likely depended on extending its franchise. Frustrated in the acquisition effort, Rowland set out to find the right individual to guide KCSR through an evolving competitive landscape. There was no shortage of viable candidates with the railroad experience to run KCSR; however, Rowland shied away from old-school rail executives. He believed that KCSR needed someone who had experienced success in running a company that had transitioned from being highly regulated to one operating in a more open, market-based competitive environment. Individuals with that skill set were few and far between, but Rowland felt he had discovered the perfect candidate. George W. Edwards had no background in railroading. His reputation had been made as an electric utility executive, where he had gained national recognition for his ability to work cooperatively with customers, regulators, and elected officials at local, state, and federal levels. A charismatic leader, he became a hot property after orchestrating a successful campaign to secure a commercial operating license in 1990 for the Seabrook Station nuclear power generating plant, located not far from the major population center of Boston. It had been a stunning achievement given the massive nationwide opposition to nuclear power in the wake of the 1979 accident at Three Mile Island in Pennsylvania and the 1986 disaster in Chernobyl, Russia. 134 V i s i o n a c c o m p l i s h e d

At age fifty-one, Edwards’s ability to inspire employees and work with outside groups with wide-ranging agendas made him a seemingly perfect fit for KCSR. Moreover, the fact that he had also achieved much of his reputation while guiding a company, United Illuminating (UI), from being bound by heavy regulation to one operating in a significantly less regulated environment was seen by Rowland as a huge plus. Edwards had another point in his favor. UI, like KCSR, was a relatively small company surrounded by much larger ones, but also like KCSR, it did not see itself as insignificant, nor did it act like a small company. In addition, no one had ever accused Edwards of thinking or acting small. Desiring the opportunity to ply his entrepreneurial talents in a totally new setting, he readily accepted the offer to become KCSR’s president and chief executive officer and joined the company in March 1991. It took him little time to gain the support of the railroad’s employees, not just its management but people throughout the company. George Edwards possessed a mesmerizing personality. An Arkansas native, he had a pleasant, engaging way of interacting with people and excelled at gaining support through one-on-one interaction with employees at all levels and in all departments. He made people feel good about themselves and want to help him. What increased his appeal was that while employees and outsiders responded to his calm, smooth demeanor, they also knew he was tough, a Vietnam combat veteran. He might not be a railroad man, but he was without question a leader. Less than a year into his tenure, Edwards convened an offsite strategic planning meeting for KCSR executives and midlevel managers and set a goal for the railroad to increase its contribution to KCSI by 10 percent annually. Everyone who attended the conference recognized that the only way KCSR could hope to meet that lofty goal would be through expansion. The network, as it was constituted at the time, simply did not offer the market opportunities to achieve, let alone sustain, growth of that magnitude. “It was obvious if we continued in our existing posture we couldn’t meet our target for increasing net income,” Edwards told a Traffic World reporter. “You can only cut costs so far. You can only benefit from crew-consist agreements for so long. So, we decided that we had to expand.” There was no question in Landon Rowland’s mind that he had landed the perfect man to reshape KCSR. Expansion was the one thing that the railroad had not experienced since the L&A merger in 1939. Under Edwards, that changed quickly though at T h e G r e a t C o n t r a c t i o n 135

first modestly. In April 1992, the company announced the acquisition of the thirty-two-mile Graysonia, Nashville, and Ashdown Railroad (GN&A). Though a very small operation, the GN&A provided access to grain shippers, thus adding supply stability to KCSR’s growing business with poultry producers. A month later, an agreement was reached with SF allowing KCSR to purchase ninety miles of track and an eighty-acre intermodal yard (Zacha Junction), giving it direct access into Dallas, Texas. During the same general timeframe, Pabtex Inc., KCSI’s transportation division’s subsidiary located in Port Arthur, acquired an additional 530 acres of land adjacent to its bulkhandling facility for petroleum coke and coal. The acquisition gave the company a total of 20,000 feet of deep-water frontage and 1,025 acres of land to develop additional port operations.

The MidSouth Acquisition A little more than three months later, in September 1992, KCSR announced a more significant strategic move, stating its intention to purchase the MidSouth Corporation and its 1,200-mile railroad for $219.2 million in cash, plus the assumption of $150 million of MidSouth’s debt. The primary strategic appeal of the MidSouth was its 327-mile straight-line corridor between Shreveport and Meridian, Mississippi. KCSR would now own a small but significant section of the most direct rail corridor connecting Southern California to the southeast Atlantic coast. Prior to acquiring the MidSouth, KCSR’s intermodal franchise had languished by reason of size and geography. It was also limited by the conventional rule of thumb that routes under five hundred miles were not conducive to intermodal transport being financially viable. Over time and with the ability of railroads to dramatically reduce operating costs through efficiencies, the mileage for intermodal to be deemed profitable was reduced, but in 1992, five hundred miles or more was still the standard. Prior to the MidSouth acquisition, KCSR possessed neither a rail corridor of sufficient length nor one that linked multiple attractive commercial markets. Although the route from Shreveport to Meridian was well under five hundred miles, it constituted an important bridge between two large Class I carriers: SF and NS. Thus, the MidSouth was an important three-hundred-mile straightline segment of a major transcontinental intermodal corridor. Traffic on

136 V i s i o n a c c o m p l i s h e d

The first significant expansion to KCS’s rail system in fifty-five years was the acquisition of the MidSouth railroad in 1994. The MidSouth provided KCS a segment of the fastest rail corridor connecting southern California and the southeastern Atlantic coast.

the corridor grew and while KCSR’s revenue per container was modest, the margins were favorable due to extremely low operating costs. The appeal of the MidSouth was broader than just its potential for intermodal growth. The acquisition immediately added approximately 150,000 carloads annually of lumber and pulp and four paper mills to the seven already being served by KCSR. According to Edwards, all these expansions had been discussed and approved during the February 1992 strategic meeting. “We figured that we would do it over a three- or four-year period. We did it in a year. Things just fell into place.”

A Sudden Shift in Thinking: KCSR Is Put Up for Sale The acquisition of the MidSouth was good for KCSR. It was a good deal in the 1990s and would become an even better deal in the early 2000s when KCS and NS would strike a joint venture deal in which NS acquired a 30

T h e G r e a t C o n t r a c t i o n 137

percent stake in the “Meridian Speedway,” the corridor between Meridian and Shreveport. However, in the grand scheme of things, the MidSouth acquisition fell well short of being a game changer. It was a strategically nice addition, but it did not make KCSR significantly more relevant in the North American logistics network. Post-Staggers, KCSI watched as mergers and acquisitions, at first relatively minor in scale, began to redraw the US rail map. In 1980, BN had acquired the St. Louis–San Francisco Railway (Frisco). In 1982, the UP purchase of the MoPac had been approved. In 1988, the MoPac purchased the Katy, bringing it under the UP umbrella. In 1990, the Canadian Pacific (CP) had taken control of the Soo Line. And in 1994, the UP had acquired a minority position in the CN&W. Observing the acceleration of the acquisition activity, KCSI management concluded that the efforts to bolster KCSR’s position as a strong, independent Class I railroad had likely fallen short of providing the franchise with a protective shield if the trickle of consolidations became a tsunami. At the same time, KCSI management felt that the recent expansions on the railroad had made KCSR a more valuable and desirable property. Plus, the holding company was maturing and Wall Street increasingly viewed KCSI as primarily a financial services company. So, all things considered, even while still integrating the MidSouth into its rail system, KCSI signaled to the industry that it might be open to an acquisition of KCSR. All the US Class I railroads, plus the two major Canadian rails, took looks. There was some interest, particularly from SF and BN. KCSR would fit seamlessly into either railroad, and it was unlikely that an acquisition of KCSR would face difficult regulatory obstacles. As the process evolved, internally it was felt that BN was the front-runner although word began to filter through KCSR executive management that there might be a BNSF-KCSR combination. It was not long before KCSI and KCSR executives became confident that an announcement was imminent. Furthermore, within KCSR an assumption took root that its executive management would play a central role in the operation of the combined railroads, as BN’s CEO Gerry Grinstein was not a railroader but a former airline executive and probably nearing retirement. At least one part of the internal speculation proved to be correct; an announcement was imminent, but it was not the one that KCSI and KCSR management had been expecting. On June 30, 1994, BN and SF surprised the rail world by announcing their intention to merge— with no mention of KCSR. 138 V i s i o n a c c o m p l i s h e d

The truth was both BN and SF had come to the same conclusion that acquiring KCSR would not provide either with markedly greater market presence. Rather than making a nice but not particularly notable acquisition, the managements of BN and SF had opted for making a bold move that, if approved, would challenge UP’s supremacy in the West. Ironically, both carriers suggested that it was their initial interest in acquiring KCSR that proved to be the catalyst for their coming together and crafting the BN-SF merger. Being a cause of the deal was no consolation to KCSR, as the company felt left out in the cold. BN and SF gave some initial consideration to adding KCSR to the merger but ultimately decided that the additional regulatory scrutiny that would result by adding a third railroad might lead to having to make concessions to appease shippers and that the benefits of bringing KCSR to the party were not worth that risk. The dramatic turn of events effectively marked the end of George Edwards’s run at KCSR. KCSI’s board of directors and some within the ranks of executive management, including Landon Rowland, felt Edwards had been outmaneuvered by BN and SF executives. Whether that was true or not, it was undeniable that he and others at KCSR and KCSI had seriously overestimated the railroad’s value. Someone had to take the fall for the embarrassing errors in judgment, and that person was to be George Edwards.

The Illinois Central Mistake Acting in what certainly looked like desperation, KCSR—with Edwards pushed to the sidelines—scrambled to find a partner. After a whirlwind courtship, on July 19, 1994, only three weeks after the BN and SF debacle, the announcement was made that KCSR was to be purchased by the IC in a stock deal valued at $1.63 billion. The announcement also stated that IC’s president and chief executive officer, E. Hunter Harrison, would assume that position for the combined railroads. The IC possessed a long and storied history. As one of the earliest Class I railroads, the IC’s existence dated back to 1850 when President Millard F. Fillmore signed a land grant for its construction. Upon its completion in 1856, the IC was the largest railroad in the world. A decade later it had grown even larger, extending its track into Iowa. In the 1870s and 1880s, the IC further lengthened its network, reaching New Orleans to the south, T h e G r e a t C o n t r a c t i o n 139

Louisville to the east, and into Wisconsin and South Dakota to the west. Its growth continued into the twentieth century; by 1980, the IC operated over 8,366 miles of track. Then in the late 1980s, post-Staggers railroads began to shed underutilized routes, leading the IC to spin off most of its east–west and redundant north–south lines. By the time the plan to acquire KCSR was announced, the IC had reduced its track network to 2,717 miles, marginally less than KCSR’s 2,733 miles. From day one, both the financial markets and transportation industry professionals were unimpressed with the deal. An analyst at Kidder, Peabody & Company observed, “KCS is going for less than its management wanted, and Illinois Central is at the high end of what it wanted to pay.” Upon the release of the announcement, whereas it would have been reasonable to believe the KCSI’s stock price would rise, it actually plunged by $2.50. The IC’s stock price dropped by $0.88. It did not get any better: over the next three months, IC stock declined more than $3.00. The two railroads pitched the idea that the combination would create value by providing IC with greater access to forest products facilities and poultry producers and would add impressively to its chemical and petroleum products franchise. The pitch did not sell. As one transportation consultant stated, “The synergies and cost savings that one might anticipate from a merger just aren’t there. Their parallel route systems are too far apart to merge.” No one was buying the value enhancement of merging one north– south railroad with its track running east of the Mississippi River with another north–south railroad whose track ran west of the Mississippi River. The financial markets smelled more desperation than opportunity in the proposed combination. Whatever little momentum the deal had when first announced quickly withered away. Finally on October 25, 1994, only three months after its announcement, the transaction was terminated. KCSI had played its hand and had lost. The failure to get a deal done lessened the perceived value of the railroad in the eyes of investors, competitors, and even shippers. Doubts surfaced about the quality of KCSR’s management. Even before the transaction was scrapped, an analyst made the unflattering comment: “IC is going to send a SWAT team over to the KCS and try to drive efficiencies there.” It was not the sort of remark to inspire confidence in a company’s management. KCSI’s plan to sell off the railroad had backfired badly and even within headquarters there were legitimate concerns about KCSR’s future.

140 V i s i o n a c c o m p l i s h e d

Consolidation Mania, 1990s Style KCSI’s ham-fisted efforts to sell its railroad had done real harm to the company’s public image, but an image problem was not the only threat now facing KCSR. No one in the rail industry had for one second doubted that UP would react aggressively to the late June announcement by BN and SF. Long the unquestioned dominant western railroad, it was unthinkable that UP would sit idly by and watch its market supremacy challenged. The industry did not have to wait long for UP’s response. After reviewing its options for a few months, on November 11, 1994, UP announced that it was making a counteroffer to buy SF. UP’s bid set off a very public, very hostile confrontation among the management and boards of the three railroads. SF’s board of directors quickly rejected UP’s initial bid as being too low and refused to meet with UP to discuss any change in terms. For a few months the hostilities made regular front-page news in major US newspapers. On January 31, 1995, sensing absolutely no leeway in SF’s position, UP threw in the towel and ended its acquisition effort. Eight months later, the BN-SF merger received regulatory approval. For KCSR, UP’s failure to derail the BN-SF merger was in some ways worse than if UP had been able to supplant BN as the acquirer. If it had been successful, perhaps BN would have revisited the idea of acquiring KCSR. But UP’s inability to reconfigure the outcome left it angry and more determined than ever to maintain its elite status. There was no way that UP would turn its attention toward KCSR. It had to make a grander statement than that, and there was worry in Kansas City that it could spell further trouble for the railroad in the future. Halfway through a decade that had begun with so much promise, KCSR had lost its focus. While there had been earlier takeover attempts and serious challenges to the company, this was the first time that it had put itself up for sale. The good news was that it was not sold. The bad news was that KCSR was left shaken and without a defined strategic direction. On top of that, its management had lost credibility, which in some cases was fair and in others, not. But fair or unfair, it was a serious problem that could not be ignored. KCSR’s situation had not risen to the level of disaster. However, if anyone in 1995 was foolish enough to predict that this battered and demoralized midsized railroad would become one of the most exciting growth companies in the transportation industry by the end of the decade, that person would have been labeled stark raving mad and delusional. But that person would have been right. T h e G r e a t C o n t r a c t i o n 141

A Change at the Top

14

The Haverty Era Begins

After failing to engineer a merger of its railroad with another Class I carrier, KCSI management was forced to admit that the drastic alteration of its strategic plan for KCSR had been seriously ill advised. Only four years earlier, George Edwards had been brought in to pursue growth. But after some early success—the most notable being the purchase of the MidSouth—the railroad had floundered under his executive team’s management. Yes, the problems at KCSR had grown serious enough to warrant change, but KCSI’s decision to jettison the railroad had been wrongheaded and had backfired catastrophically. The plan had been ill conceived, its execution inept. The bungled sale—coupled with a serious degradation in the railroad’s network fluidity due in part to management’s preoccupation with its possible acquisition—not only damaged KCSR’s reputation in the industry; it also left the railroad’s employees demoralized and its management confused and indecisive. KCSI was forced to go back to the drawing board to develop a new strategic plan for its transportation division. The first question, while obvious, was nonetheless devilishly hard to answer: Exactly what did the holding company want to do with its railroad? For the time being, selling it seemed out of the question. Three options were given serious consideration. The first was to petition the ICC requesting that KCSR be included in the BN-SF merger. As noted earlier, BN and SF had briefly considered the inclusion of KCSR in their merger but had concluded that the risk of additional conditions being put on the merger’s approval outweighed any possible benefit. Petitioning the ICC also held little appeal to KCSI; it reeked of desperation.

143

A second option, too, garnered faint support, as it would do little more than replace high-level executive management and reorganize the operations department. Simply put, this plan would buy time for the railroad to improve operational performance, rehabilitate its image at least partially, and achieve marginal profitability. But what would be the endgame with this strategy? It would hardly enhance KCSR’s strategic position within the railroad industry. This approach seemed to be little more than a stopgap measure that allowed KCSR to muddle along and hope for the day when a larger railroad would swallow it up. Given the company’s recent humiliations, no one felt confident about KCSR becoming an alluring takeover candidate anytime soon. The third option was to restart the effort that had been initiated with the hiring of George Edwards. Instead of selling it, what if KCSI attempted to reignite efforts to grow it? Perhaps the expansion initiatives had been abandoned too quickly, the result not of the initial strategy’s failure but due to a poorly thought-out plan to execute a quick sale of the railroad. Maybe, just maybe, it was worth trying to give expansion another chance and, this time, give it a longer runway. The first two options were unappealing and gathered no support among KCSI and KCSR executives. None suggested that a passive response to the railroad’s present state would result in a positive outcome. On the other hand, bold declarations about pursuing growth are one thing; backing them up with practical strategies and flawless execution would be quite another. If the third option was going to be seriously considered, KCSR did not just need a new strategic plan; it needed a tough, relentless leader to direct it. Also, the hiring of George Edwards had exposed the problems inherent in hiring a CEO who lacked on-the-ground railroad experience. He had known the electric utility industry down cold but was an outsider to the rail industry. When he was hired, it was hoped that his outsider status would bring a fresh perspective, and initially, it had. But in the end, identifying growth opportunities that could fit into KCSR’s overall profile, and negotiating good commercial contracts and productive marketing agreements were more than could be expected from someone unfamiliar with the dynamics of the rail industry. KCSR needed an individual who knew railroading inside and out and who was experienced in thinking and acting strategically within a larger transportation context. It required someone with vision who also possessed the creativity, fortitude, and passion to turn that vision, step by step, into reality. And, if all that was not enough to give ulcers to any executive 144 V i s i o n a c c o m p l i s h e d

recruiter tasked with finding candidates, the individual also had to have the ability to accomplish everything without the benefit of vast corporate financial resources to carry out his plans.

Michael R. Haverty Mike Haverty was a fourth-generation railroader whose great-grandfather, Thomas William Haverty, had emigrated from Ireland in 1860 and settled in Atchison, Kansas, in 1865. Soon after arriving, the young Irishman joined the Atchison and Pike’s Peak Railroad, which eventually became the Central Branch of the UP and eventually the MoPac, where he became a bridge and building laborer before eventually working his way up to foreman. Mike’s grandfather, Thomas William Haverty Jr., and then his father, Harold Joseph, followed in the elder Haverty’s footsteps by also joining the MoPac, becoming conductors. It was only natural, then, that on June 11, 1963, his nineteenth birthday, Mike joined the MoPac—“the family railroad”—as a brakeman-switchman. As was often the case with descendants of those who had immigrated to the United States to forge a better life for themselves and their families, Mike was urged to aim higher, which in his case meant getting a college education. He was strongly encouraged to do so, both by his father and by his boss at MoPac, Ab Rees Sr. Taking their advice, he enrolled at the University of Southwestern Louisiana on a football scholarship. Because of both his family’s history with the railroad and his own tireless work ethic, Mike was invited back to the MoPac during the summers to earn the money necessary for him to stay in school. During his last summer before graduating, he worked sixteen-hour days as a brakeman-switchman. But that summer, Mike had a new partner who more than compensated for his long, exhausting workdays. His new wife, Marlys, not only got him through that long, hot summer but also was to become his greatest pillar of support throughout his entire career. Soon after graduating and working as a switchman for the Rock Island Railroad in Des Moines, Mike was offered the opportunity to participate in MoPac’s highly respected Management Training Program. Over time, this program had produced an impressive list of graduates who would eventually rise to positions of influence within the US rail industry. There had been little doubt that Mike was on a path toward having a distinguished career with MoPac. A C h a n g e a t t h e T o p 145

As it turned out Mike’s ambitions took him in another direction. In 1970, he made the startling decision to accept the position of trainmaster in San Bernardino, California, for the SF—thus ending 105 years that a Haverty had worked for MoPac and its predecessors. He realized that stepping out of his comfort zone would be a challenge, but he was confident that he could climb the corporate ladder at SF faster than he could at MoPac, which already had a host of quality young railroaders in midlevel management positions. The decision turned out to be the right one; over the next nineteen years, Haverty steadily progressed up the chain of command in the operations department, all the way to the top. On June 1, 1989, he was named president and chief operating officer of SF, the youngest president since the election of William Barstow Strong to that position one hundred years earlier. It would have been perfectly reasonable for anyone to conclude that Haverty, at the age of forty-four, had reached the pinnacle of his career. Actually, at the time, he probably would not have disagreed. His goal had always been to run a railroad and he had succeeded. And not just any railroad: it was the historic SF. That was the good news. The bad news was that Haverty had not exactly fallen into a bed of roses. In 1989, SF was not feeling particularly good about itself. The decade had been a brutal one for the company. It was still struggling to adapt to a deregulated operating environment with its traffic dominated by the less profitable intermodal business. Then there was the ICC’s denial of its acquisition of SP in 1987 and the ETSI mess. At the time of Haverty’s elevation to president of the railroad, SF was desperately trying to right itself from the two serious calamities. The failed merger had forced SF to execute a very aggressive $4.8 billion leveraged recapitalization after a huge cash payout to shareholders to protect itself against the possibility that a corporate raider might attempt a takeover in light of its weakened strategic position. SF had been heavily leveraged even before the ETSI coal slurry pipeline judgment that ultimately was settled at a cost of $350 million. By 1989, SF was 90 percent leveraged in its debt-to-total-capital ratio, its average intermodal margins were less than 10 percent, and the revenue impact of the loss of a major automotive contract was about to kick in. That contract alone would cost SF 10 percent of its total annual revenue. In his very first communication to employees upon taking day-to-day control over the railroad, Haverty let employees know that there would be 146 V i s i o n a c c o m p l i s h e d

changes. “I intend to do everything in my power to help guide our railroad through this continuing difficult period,” he wrote. He also provided a hint that he was not a fan of conventional thinking. “Since we haven’t been all that successful doing things the old ways, that leads us to a continuing program of trying to do things in innovative ways.” He presented his foremost principle of communication: “You may not always like what I say, but you know that I generally ‘tell it like it is,’” a trait he tied to his working-class Kansan roots. He remained true to his word during his tenure as SF’s president. He helped develop and execute the implementation of a restructuring plan that eliminated layers of management, consolidated operating divisions, closed facilities, sold off underutilized assets, and eliminated four thousand positions. He was also instrumental in the creation of groundbreaking labor agreements with the United Transportation Union and Brotherhood of Locomotive Engineers that reduced crew size, lengthened distances crews could operate trains, and changed pay structures. These agreements resulted in improved labor productivity and cost savings not just for SF but eventually for all US Class I railroads. However, it also earned him the enmity of other Class I executives, as, prior to reaching agreements with the unions, he had directed SF to drop out of national negotiations. He was branded a maverick by much of the rail industry. Meant as an insult, Haverty wore the label with pride. As impressive as these accomplishments were, it was actually another agreement that Haverty engineered that transformed the transportation industry and earned him his place as one of the railroad industry’s greatest innovators.

The Handshake that Changed Two Industries The story’s origin dates back to 1981, almost a full eight years before Haverty became SF’s president. At the time, Haverty was a student in the executive MBA program at the University of Chicago. As part of a marketing course, he wrote a paper exploring the idea of a joint venture involving a railroad and a trucking company. Eight years later, newly chosen to run the operations of SF, Haverty decided to take the theoretical concept he had laid out in his graduate school paper and bring it to a real-life application. It was a radical idea because railroads and trucking companies were fierce competitors, but this venture would demonstrate Haverty’s openness to A C h a n g e a t t h e T o p 147

exploring unconventional strategies in the attempt to develop expanded service options and generate revenue growth. It was also indicative of an ability to move projects along from concept to reality. It is rare when the same individual who can think outside the box also possesses the discipline to take their ideas and bring them into actual practice. Like Arthur Stilwell, Mike Haverty had that ability. The story unfolds when Haverty invited J. B. Hunt, the legendary trucking magnate and founder of J. B. Hunt Transport Services Inc., to ride with him from Chicago to Kansas City on business cars coupled to the rear of a Los Angeles–bound intermodal train pulled by freshly painted SF Warbonnet locomotives. Unbeknownst to Hunt, Haverty had arranged for one of Hunt’s company trailers to be put on a rail flatcar that was coupled right ahead of the business cars so that J. B. and his entourage could step out on the business car platform and view how smoothly it was riding at top speed. They were not long out of Corwith Terminal in Chicago when the train began traveling at high speed. As the guests looked out the window of the business car, Mike made sure that Hunt took note of the cars and trucks snarled in huge traffic jams on Interstate 55. Passing Galesburg, Illinois, J. B. reached out his hand to Haverty and said, “Haverty, we’ve got a deal.” Thus, the first-ever intermodal deal between a major truckload carrier and a Class I railroad was consummated by a handshake. As Haverty later recounted, SF earned $30 million in intermodal revenues before the lawyers had finished the written contract. Today, there is a large, signed photo of J. B. Hunt and Mike Haverty in the lobby of the Hunt company headquarters in Lowell, Arkansas, memorializing this transformative transportation agreement.

Haverty Looks South It was in 1991 when Haverty first became intrigued with developments south of the border in Mexico. His introduction to the country came while he attended a conference in Acapulco at which three people spoke: Carla Hills (United States), Jaime Serra Puche (Mexico), and Michael Wilson (Canada). The three became the primary negotiators of the North American Free Trade Agreement (NAFTA). Haverty witnessed firsthand not only their enthusiasm over the concept of a pathbreaking trilateral agreement but also the excitement of government officials and business leaders in attendance from the three countries.

148 V i s i o n a c c o m p l i s h e d

He left the conference convinced that Mexico was on the cusp of impressive economic expansion but that it needed to partner with other major North American countries for it to become reality. Alone, Mexico lacked the financial strength and infrastructure to become a major manufacturing hub; it needed to partner with the United States and Canada. The meeting also brought home to Haverty the realization that the North American continent was undergoing a seismic economic shift. Starting in the middle decades of the nineteenth century and extending to the final twenty-five years of the twentieth century, economic growth on the continent had generally run along an east–west axis. Railroads had both benefited from and encouraged this east–west growth pattern. Haverty realized that the pattern was shifting and it was likely that in the coming decades, the most dramatic growth would swing north–south. He was by no means alone in thinking this. Economists had already drawn the same conclusion, and they had the numbers to back it up; percentage growth was ramping up at a faster rate north and south than it was east and west. Sociologists were also noting early shifts in population, which conformed to changes in economic growth patterns. Population trends shifted as more and more manufacturing plants relocated to the south and southwest. Haverty’s interest had now become more practical than academic. Already gaining a reputation as a strategic thinker, he started to formulate in his mind ways in which railroads might participate in this changing economic and societal landscape. And, if anything was for sure, once Mike Haverty’s mind went to work, it did not shut down. However, a sudden development in his professional career was about to put any ideas involving Mexico on the back burner.

Another Career Change It was not long after traveling to Mexico that Haverty rather abruptly left SF. His leaving might have seemed sudden, but it had been contemplated for some time. As SF continued to shed many of its diversified companies to concentrate on its core transportation business, the divisions of authority between Mike Haverty and the company’s chief executive officer, Rob Krebs, became increasingly blurred. The two strong-willed, hands-on leaders were frequently getting in each other’s way. Both came to agree that having two dominant personalities running one railroad was neither necessary

A C h a n g e a t t h e T o p 149

nor advisable over the long run. Haverty concluded that it was time for him to move on; on June 4, 1991, only two years after being named president and chief operating officer, he resigned. For the first time in his worklife, Mike Haverty was unemployed and out of the railroad business.

Haverty Corp He might have left his executive position at a major railroad, but he had no intention of disappearing from the scene. Haverty had become a prominent figure in the transportation industry, and because of that he did not lack for offers to join transportation companies both within and outside the rail industry. But none felt right to him. Feeling constrained at SF, the last thing he wanted to do was to put himself into another position that would fail to satisfy his desire to build something special, big, and strategically unique. So rather than settling for a job that would provide wealth but little satisfaction, he decided to form a transportation consulting and investment company, Haverty Corp. Because of the contacts he had made over the years, the company was soon on solid financial footing. Still, there was a sense that Haverty Corp was primarily a vehicle by which Mike could remain engaged and relevant in the transportation industry. But that being said, the time spent building up Haverty Corp proved to be invaluable in preparing him for the challenges that laid ahead. Haverty Corp had barely opened for business when J. B. Hunt asked Mike to join him on a trip to Mexico. For Hunt, Mike Haverty was the perfect adviser. He liked and trusted him and recognized his ability to think strategically. Hunt, like Haverty, had come to feel that Mexico had vast economic potential. He also knew that while trucking’s share of the intercity Mexican freight market was over 85 percent, the cross-border movement of trailers and containers was clumsy and inefficient. Thus, he was intrigued with the idea of forming a joint US-Mexican trucking company that could specialize in moving freight between the two countries. Hunt had become acquainted with the chair of the Mexican company, Grupo Transportación Marítima Mexicana (TMM), who shared a similar desire to participate in emerging cross-border trade opportunities. Hunt asked Haverty to join him in discussions with the Mexican firm with the intention of putting together a trucking partnership. While Haverty did join Hunt in Mexico and participated in discussions involving the start-up of a joint venture, his consultations did not result 150 V i s i o n a c c o m p l i s h e d

in Haverty Corp taking a financial or managerial position in the venture, which proved fortunate as the undertaking was unsuccessful mostly due to a lack of a cohesive business arrangement between J. B. Hunt and TMM. Nonetheless, for Haverty the experience had been valuable in that it added to his knowledge of the state of Mexico’s transportation system, its most promising commercial and industrial centers, the country’s culture, and the complexities of putting together joint US-Mexican companies. And, last but certainly not least, the experience introduced him to TMM’s colorful chair, José “Pepe” Serrano, a man who was soon destined to play a prominent a role in KCS’s expansion plans.

Haverty’s Interest in Mexico Grows Mike Haverty’s interest in Mexico took a more tangible form when, through his corporation, he invested in the South Orient Railroad, which runs from San Angelo Junction to Presidio, Texas. The South Orient had been part of Arthur Stilwell’s grand plan to build the KCM&O from Kansas City to the western coast of Mexico. Haverty saw the US portion of the South Orient as the key segment in a plan he was developing to create a cross-border intermodal network. He and a group of investors he recruited sought to develop a rail corridor through acquisitions and trackage rights agreements that would operate from Fort Worth to Presidio, where it would connect with the Mexican National Railway (MNR), which would provide access to the industrial center of Chihuahua. The effort to form a cohesive group proved unsuccessful. “I learned that trying to get multiple railroad executives to work together and stay on the same page was harder than herding cats,” Haverty later related while chuckling at his own naivety at that time. What it did display was Haverty’s ability to see possible combinations that can take a single idea and through strategic partnerships form something much larger and more ambitious. It was a precursor of something much grander in scale that was soon to come.

Kansas City Southern Comes Calling Although Haverty’s ambitious South Orient cross-border intermodal dream did not materialize, the effort introduced him to KCSI’s chief executive officer, Landon Rowland. It just so happened that Rowland and his most trusted A C h a n g e a t t h e T o p 151

railroad adviser, Senior Vice President of Marketing Mike McClain, had also been monitoring developments in Mexico. Their interest was piqued by Haverty’s vision of developing an efficient rail network between the United States and Mexico. Haverty’s plan comported well with Rowland’s desire to reignite KCSR’s expansion efforts in the wake of its failure to become part of another railroad. For the next couple of years, Haverty’s meetings with Rowland were mostly informational. Landon Rowland had an unquenchable thirst for information on a wide variety of subjects. One subject he found especially compelling was possible changes developing in Mexico’s transportation system. And, as evidenced by his earlier failed attempt to buy SP, Rowland was not afraid of taking risks; in fact, sometimes the more unconventional the risk, the better. Both the potential and the risk of an investment in Mexico intrigued him. While intellectually gifted and able to absorb information and concepts quickly, he was not a career railroader and he began using Haverty to fill in gaps in his transportation knowledge base. He became enamored of Haverty’s knowledge of trade patterns and how transportation networks, particularly railroads, were structured in ways to address shippers’ needs. Thus, it was not surprising that during the fourth quarter of 1994, when Rowland and others at the company were confronted with what to do with KCSR that Mike Haverty’s name surfaced repeatedly. By early 1995, Rowland was convinced that Haverty had the necessary attributes to tackle the daunting job of reenergizing KCSR, reestablishing its sense of pride, and redefining its strategic direction. Having become familiar with his ability to imagine rail corridors assembled through acquisitions and alliances, Rowland felt that if anyone could get KCSR going again, it was Mike Haverty. He also appreciated Haverty’s belief that expansion did not necessarily demand acquisition but could also be achieved through partnerships and strategic alliances. For a company without abundant financial resources, this was particularly important. By the winter of 1995, Rowland, Mike McClain, and KCSI’s chair, Paul Henson, had begun an active recruitment campaign. In February 1995, Henson traveled to Haverty Corp’s office in Lisle, Illinois, and offered Haverty the positions of president and chief executive officer of KCSR and executive vice president of KCSI, as well as a seat on the board of directors of KCSI. Haverty wanted the job. He missed running a railroad. He was also fixated on KCSR’s north–south orientation, which fit well with his beliefs about 152 V i s i o n a c c o m p l i s h e d

emerging economic growth patterns. He saw untapped potential for KCSR that other rail executives did not. On the other hand, he had been put off by the holding company’s recent efforts to sell the railroad and flatly told the KCSI group, “I’m really not into selling stuff.” Before accepting their invitation to join KCSR, he asked for two assurances. One, that he would not be asked to sell KCSR; and two, that KCSI would be open to pursuing some kind of railroad investment in Mexico. Both demands were readily accepted. On May 15, 1995, Mike Haverty joined KCSR.

A C h a n g e a t t h e T o p 153

Growth on the Fast Track

15

1995–2000

Mike Haverty knew full well that he was stepping into a tough job, but he had no way of knowing exactly how tough it was going to be. Years later, he would say if he had any idea of what he was getting himself into, he would have told Paul Henson and Landon Rowland, “Thanks but no thanks.” Of course, he would not have actually said that at all. There was no way that Mike Haverty would have let a few challenges, no matter how daunting, keep him from pursuing his ambition to create something truly unique in the railroad industry. Precisely what his vision was for KCS had not yet been formulated when he arrived at Eleventh and Wyandotte Streets. He knew he wanted KCSR to remain independent. He knew he wanted to investigate possibilities in Mexico. He knew of a few small railroads that might be available for purchase. And he knew that he had to try to negotiate marketing agreements with other railroads so that KCSR could extend its market reach. But nothing in May 1995 was definite. Haverty did not see that as a problem for he felt he had a little time to develop a cohesive plan. On that point, he could not have been more mistaken. Time, as it turned out, was the one thing he did not have.

A Very Rude Awakening Less than a month into the job, UP received ICC regulatory approval to complete its acquisition of the CN&W, which it had filed for in 1994. While this was not great news for KCSR, because the grain that the CN&W had interchanged to KCSR at Kansas City would now move on UP, it was not unexpected and paled in comparison to the shock that came a few months 155

later on August 4. UP, having been thwarted in its attempt to snatch SF from BN during the acquisition battle, announced its intention to purchase SP. The hits kept coming when only a couple of weeks later, the ICC gave its final blessing to the BN-SF merger. Four months in and Haverty had to feel like the walls were closing in fast on his railroad. Being virtually surrounded by two giant railroads would strike a serious blow to KCSR’s chances of long-term survival. Its total revenues in 1995 had been $502 million. An internal study prepared for management estimated that approximately 25 percent of that revenue base was at risk due to the consolidations. Without sources of new revenue, it was unrealistic to think that KCSR could exist indefinitely as an independent Class I railroad. Other railroad executives and some within the Wall Street analyst community felt KCSR’s demise was only a matter of time. Haverty himself was not confident that KCSR could survive as an independent Class I railroad unless it was able to obtain strategic concessions from the proposed western railroad megamergers, and succeed in the pursuit of a couple of modest but strategic acquisitions. He was fixated on growing KCSR’s market reach and doing it quickly. Expansion into Mexico stood out as the potential grand prize, but it was unclear what form that opportunity might take, if there would even be an opportunity at all, or when it might occur. The only thing Haverty had at that moment was Paul Henson’s and Landon Rowland’s assurances that KCSI was committed to investigating expansion into Mexico. Putting aside Mexico for the time being, Haverty set his sights on pursuing a plan that, if achieved, would partially compensate for the revenues that KCSR stood to lose due to BNSF and the UP-SP combination, if it was approved. His plan involved some minor acquisitions plus the signing of marketing and trackage rights agreements with other carriers. It would be a patchwork quilt, but if created shrewdly, it might work.

A Sudden Unexpected Partnership Changes Everything Literally the very day Haverty started his KCSR career, the Kingsley Group, a consulting firm contracted by TMM, paid him a visit. The Mexican government had for some time been signaling its interest in developing some sort of privatization plan involving its railroad system. While there were still no concrete plans or timetable in place, TMM’s chair, Pepe Serrano, was desperate to partner with a western US Class I railroad in preparation 156 V i s i o n a c c o m p l i s h e d

for the announcement of a privatization plan. He had previously approached UP and BNSF, but executives at both companies had shown no inclination to get involved in a joint venture with TMM. Through his association with J. B. Hunt, Serrano knew Mike Haverty and was aware of his interest in Mexico’s freight transportation potential. In fact, in 1993, using Hunt as an intermediary, Serrano had informally floated the idea of Haverty moving to Mexico to run a railroad if an opportunity developed. The idea did not float for long, as Haverty, through Hunt, expressed his disinterest. But Serrano had later been made aware of Haverty’s continued desire to pursue a Mexican investment by Mike McClain, whom Landon Rowland had sent to Mexico by in 1994. While there, McClain had met with Serrano and the Kingsley Group consultants and relayed KCSI’s interest in a Mexican business venture as well as mentioning the holding company’s desire to hire Mike Haverty to run KCSR. So, on Haverty’s very first day on the job, Serrano had members of the Kingsley Group in Kansas City presenting a verbal proposal for TMM and KCS to begin working out a joint venture agreement. While KCSI-KCSR had not been Serrano’s first choice as a partner, it was his only option, and at least the railroad now had a CEO who was intrigued with the idea of expansion into Mexico. The main problem with KCSR was that its lines terminated hundreds of miles north of the Mexican border, but Serrano’s team had come up with a plan for at least partially addressing the shortcoming. KCS could invest in the Texas Mexican Railway (Tex-Mex), a 154-mile railroad that ran between Corpus Christi and Laredo and was fully owned by TMM. While the Tex-Mex did not connect with KCSR, it had one extremely important feature: it owned the US portion of the International Bridge, the primary rail gateway between the United States and Mexico. TMM had purchased the Tex-Mex in 1992 as part of Serrano’s plan to bid on a railroad concession if the Mexican government decided to privatize its rail system. By 1995, the Mexican legislature was getting close to approving such a plan for Mexico’s state-owned railroad network. The specifics had not been completely formalized, so the details were still sketchy, but parties interested in participating in the process were beginning to mobilize. Haverty was very much interested in TMM’s proposal, which aligned well with his vision for KCSR’s expansion. But it was his first day at KCSR, after all, and he felt he needed time to evaluate the state of his railroad before jumping into a plan of this magnitude. His caution was justified, as the more he learned of KCSR’s problems, the more overwhelmed he felt by G r o w t h o n t h e F a s t T r a c k 157

the immediate job before him. Service was terrible, and minimal investment had been made in rail infrastructure, equipment, and information technology over the two-year period that the railroad had been up for sale. The MidSouth had never been adequately integrated into KCSR; the operating unions were hostile to changes being made; and morale was low as a good percentage of KCSR’s management and contract employees felt their railroad, and probably their jobs, might soon disappear. Some within the ranks distrusted Haverty, thinking he had been brought in to carry out what his predecessor had failed to do, namely sell the railroad. Haverty felt addressing these issues should be given priority over a joint venture arrangement with TMM. But then everything changed with the UP-SP announcement and the approval by the BN-SF merger. If the UP-SP merger was approved, it was possible that UP and BNSF could control as much as 90 percent of rail traffic west of the Mississippi, which would put KCSR in an extremely perilous position. Haverty felt certain that between UP’s chair, former US secretary of transportation Drew Lewis, and Phil Anschutz, owner of the SP, the merger would ultimately be approved. Given this situation, he decided there was no alternative but to move Serrano’s offer to the front burner. KCS would enter into a joint venture agreement with TMM to co-own the TexMex and investigate opportunities for expansion into Mexico. To the rest of the transportation world, KCS’s partial ownership of the Tex-Mex—a railroad to which KCSR did not even connect—made no sense and was nothing more than just a wild shot in the dark. It hardly seemed like the first phase of an intricate plan that included contesting the UP-SP merger. Still, Haverty felt that if enough pressure was put on the ICC, maybe KCS would get some form of concession that would allow the two railroads to connect, thus creating a single-line railroad from Kansas City to the Mexican border. It might be a long shot, but Haverty felt KCSR had nothing to lose by going for it, and Landon Rowland agreed. Rather than standing on the sidelines it was at least better to go down fighting if it came to that. Because part of Haverty’s developing plan to gain a connection to the Tex-Mex was to mount an aggressive attack on the UP-SP merger application, he preferred not to have to file a case with the ICC for KCS to gain majority ownership of the Tex-Mex, which Serrano had offered. Instead, Haverty opted for a 49 percent position to ensure that KCSI was not seen as the controlling partner, thus eliminating the need to file a case with the ICC. 158 V i s i o n a c c o m p l i s h e d

Haverty later learned that KCS could have taken a 50 percent position in the Tex-Mex and still not have been required to file a case with the ICC, as it would not have been considered the controlling shareholder. Taking a minority interest would come back to haunt Haverty and KCS, as the relationship between the partners began to sour. Years later, Haverty occasionally joked how impressed members of the transportation community and Wall Street analysts were with KCS’s response to the megamergers that threatened its viability—namely, its purchase in late 1995 of 49 percent of a 154-mile railroad in south Texas with which it did not connect. “We really showed them that KCS meant business,” he would say with a grin. If he was grinning later, the rest of the railroad industry was laughing out loud at the time of the Tex-Mex deal. How could this floundering railroad ever think it made sense to try to counter what the giant railroads were doing in the west by taking a minority interest in a small railroad to which it did not even connect? On the surface it looked foolish and, worse, desperate. But Haverty saw something that conventional railroaders failed to grasp. Still, even Haverty would admit it was a gamble that would only make sense if KCSR and the Tex-Mex were allowed to connect in some way. But events would come to show that this seemingly nonsensical investment would be the first step in the accomplishment of Arthur Stilwell’s final dream of forming a single-line railroad from the heartland of America to the Pacific coast of Mexico.

The Tex-Mex The Tex-Mex story originated in Corpus Christi, Texas, a town that was established as a trading post in 1839. South Texas ranchers would bring hides and tallow, a fatty substance used to make candles and soap, to the trading post and exchange them for hardware and manufactured items used for farming. From Corpus Christi, the hides and tallow would be carted by horses to the Rio Grande, where they would be transported by steamboats to destinations along the south Gulf Coast. In 1870, a group of Corpus Christi merchants began clamoring for a railroad to be built in the belief that a railroad would give them a leg up on the competitors in Brownsville and Rockport. It took nearly two years to organize, but in 1873 a charter was granted to build the Corpus Christi and Rio Grande Railroad Company. The project G r o w t h o n t h e F a s t T r a c k 159

essentially died before it ever got off the ground due to the Panic of 1873, which dried up bank financing. That would probably have been the end of the story if not for the creativity and determination of one Uriah Lott. Like Stilwell, he was a transplant from upstate New York. Lott had moved from Albany to south Texas in 1866 to work as a shipping agent for the King and Kenedy steamship line. After a short stay there, he moved to the up-andcoming town of Corpus Christi, where he first took a job as an agent for Singer Sewing Machines before landing a sales position a short time later at the Aetna Insurance Company. Though his career was progressing reasonably well, he yearned for an even greater challenge, and he definitely got more than he asked for when in 1875, he agreed to become the president of the still-nonexistent Corpus Christi and Rio Grande Railroad. On the day he took the reins of the railroad company, the venture had a grand total of $39,000 in cash and $161,000 in promissory notes. Not in the least deterred by its lack of funds, Lott got the company organized, and on November 26, 1876, he ceremoniously drove in the first spike marking the beginning of construction. The spike, which had been gilded for the occasion, was stolen a few hours after the ceremony, hardly an auspicious start for Lott’s venture. By 1877, Lott had overseen the construction of twenty-five miles of track when serious money problems threatened to put an end to his plan. But, again like Arthur Stilwell, Uriah Lott was a master promoter. Using most of his dwindling cash, he purchased a locomotive, which he had refurbished and christened Corpus Christi. The locomotive pulled a few cars that Lott would rent out to entertainment-starved south Texans. The charter trips brought in just enough money to continue to pay his laborers and give him time to pursue investors, which he did and was reasonably successful in getting people to put money into his project. By the end of 1879, fifty-five miles of track had been laid. At that point, Lott called for a pause in construction as he tried to entice Laredo town officials to offer financial incentives to build the railroad to that city rather than to Eagle Pass, another town along the Rio Grande. What he got instead was an unhappy surprise when the rail titan, Jay Gould, announced his intention to extend one of his railroads, the International and Great Northern, to Laredo and his willingness to do so without any financial assistance from the city. Lott was loath to let Gould undercut him and scrambled madly to acquire additional funding. Out of the blue, he was presented with a startling offer. Mexico’s president Porfirio Díaz had long viewed Laredo as the rightful 160 V i s i o n a c c o m p l i s h e d

northern terminus of the Ferrocarriles Nacionales de México (MNR) and as such had granted a concession to two Americans, Civil War hero general William Jackson Palmer and James Sullivan, to build the MNR from Mexico City to the US border at Laredo. Palmer and Sullivan were desperate to buy the Corpus Christi and Rio Grande. General Palmer had already begun construction of the Denver and Rio Grande southward with the intention of having a railroad line from Denver into central Mexico. The Corpus Christi and Rio Grande would fit perfectly into their planned system. What made them all the more eager to do a deal was that if Jay Gould got to Laredo first, he would block their entry into the city which would eliminate any possibility of a connection with the MNR. So, Palmer made a generous offer, and Lott rushed to New York to finalize the sale. On June 30, 1881, the Texas Legislature granted the new owners a charter for what would be called the Texas Mexican Railway Company. After the transaction, the last 102 miles of construction moved along rapidly. The laying of track was carried out in both directions, and by the fall of 1881, the route between Corpus Christi and Laredo was completed. Though small in size, the Tex-Mex was operated by men open to embracing change and innovation. In 1895, the railroad’s original iron rails were pulled up and replaced with steel. In 1906, the railroad switched from using mesquite logs for fuel to coal and then in 1920 began utilizing oil-burning engines. In 1939, the Tex-Mex made railroad history by converting its entire locomotive fleet to diesel electric, thus becoming the first railroad in the United States to become 100 percent dieselized. If nothing else, the culture and spirit of the Tex-Mex were a perfect complement to KCSR’s.

The Campaign to Derail the UP-SP Merger Besides the proposed UP-SP merger posing a serious threat to KCSR’s survival, it also offered an opportunity of sorts. If rail shippers and ICC commissioners could be convinced that the merger would be harmful to shippers and threaten the well-being of another US Class I rail competitor, maybe KCSR could gain its needed connection with the Tex-Mex. With that as its goal, the company prepared an all-out campaign to convince regulators, shippers, and federal and state elected officials of the potential negative impacts of a UP-SP merger. One of the fundamental claims G r o w t h o n t h e F a s t T r a c k 161

One statement shared by Mike Haverty’s friends, admirers, and foes was that KCS would not have survived if not for his strategic vision and relentless determination.

KCSR would make was that the merger would eliminate competition for over $1.65 billion in annual revenue and for that reason alone should be denied by the ICC. Supporting this argument was that in 1986, the ICC had denied SF its merger with SP due to its potentially negative competitive impact and that traffic base had represented $921 million, just a bit over half of what would be the UP-SP merger impact on competition. The recently approved BN-SF merger represented only a $165 million impact, a mere fraction of the potential UP-SP threat. KCSR also referred to studies that found that a reduction of rail competitors from three to two often led to significantly higher freight rates. Nearly $4 billion of the nation’s rail traffic would be subject to the three-to-two reduction in rail competition in this case. Not stopping there, KCSR attacked the settlement agreement crafted by UP and BNSF that would have UP-SP divest 335 miles of track and grant 7,000 miles of trackage rights to BNSF. For that, BNSF would drop its opposition to the proposed merger. KCSR’s argument was that trackage rights provided only modest competitive protection and were almost never competitive over long distances. KCSR called the settlement a sham; in no way would it preserve true competition in the affected markets, but it would allow UP and BNSF to essentially form a duopoly in the western United States, as well as control all traffic coming in and out of Mexico. In its arguments to what is now the Surface Transportation Board (STB), the regulatory body that in December 1995 had replaced the ICC as the agency with rail oversight, KCSR did not hide from the fact that it had entered into the partnership with TMM for the express purpose of both pursuing cross-border freight business and exploring the opportunity of an investment in a Mexican-based railroad. Without the STB acting to preserve competition, either through forced divestiture or through meaningful trackage rights, shippers and railroads on both sides of the border would be disadvantaged. KCSR argued that the easiest, most practical, and effective solution would be to allow it to connect directly to the Tex-Mex at Corpus Christi, thus providing a third-rail competitor for cross-border traffic. Many within the transportation industry, particularly much of the US Class I establishment, scoffed at KCSR’s protests. Opposing arguments were made that KCSR was only interested in helping itself and that its “solutions” would only interfere with the massive efficiencies that the UP-SP merger would offer shippers. Some claimed that with the seven thousand miles of

G r o w t h o n t h e F a s t T r a c k 163

trackage rights it would receive postmerger, BNSF would become an effective, if not equal, competitor to UP-SP. Compared to UP, SP, and BNSF, KCS had a limited voice in Washington, DC. It was truly a David-versus-Goliath struggle. In terms of money, size, and influence, KCS was totally out of its league, but it had one thing going for it: its arguments made sense, and they resonated with people representing a number of different constituencies. The Department of Justice’s antitrust division came out in opposition to the merger, and while it had no official regulatory authority in the case, its voice did carry some weight. Major shipper groups, too, opposed the merger. While that was hardly surprising in the case of the National Industrial Transportation League (NITL), who as a matter of course viewed almost all mergers within the transportation industry as anticompetitive, a sizable number of prominent shippers were reaching a boiling point. In their minds enough was enough; regulators should balance competitive interests with what seemed to be their predilection for supporting large-scale mergers made in the name of operational efficiency— which in some cases proved not to be all that efficient, particularly in their early stages. The protest was further aided by companies that themselves had significant clout in Washington, like Dow Chemical, Shell Petroleum, and Vista Chemical, each expressing concern that the UP-SP merger would have a materially negative financial impact on their Gulf region facilities. Despite the mounting opposition, Haverty grew certain that the STB was not inclined to deny the merger. Not only was UP’s influence in Washington, DC, substantial, it would be difficult to turn down this consolidation so soon after approving that of BN and SF. Plus, the trackage rights agreement with BNSF presented the appearance, if not the reality, of a significant compromise that would preserve competition while promoting greater operational efficiencies. Finally, on September 11, 1996, the STB did what regulatory agencies sometimes do: it landed on safe ground by granting approval of the UP-SP merger, but with conditions. The board found that the great bulk of the competitive issues had been addressed by the negotiated resolutions reached by BNSF and UP and that the Commissioners decision largely supported tworail competition. However, in a nod to KCSR, the STB granted the Tex-Mex trackage rights over the combined UP-SP network between Corpus Christi, Robstown, and Beaumont, giving it a circuitous connection to KCSR. The most comprehensive solution to the competitive issues caused by the merger would have been the forced divestiture of a rail line that would 164 V i s i o n a c c o m p l i s h e d

have given KCSR and the Tex-Mex a more direct and efficient connection. However, doing so would have detracted from the value of the UP-SP combination, and the STB was not about to go down that road. KCSR would have to live with half a loaf. The good news was that the KCSR would survive to fight another day. No one broke out the champagne in Kansas City after the STB decision but there was definitely a sigh of relief. While far from perfect, the trackage rights compromise was enough to allow the dream of an expansion into Mexico to live on. The timing of the STB decision ended up being perfect. Mexico’s Secretariat of Infrastructure, Communications, and Transportation (SCT) was putting the final touches on the guidelines for the bidding process to privatize the national rail system, and the Mexican legislature was on board with the initiative. Now that KCSR and the Tex-Mex connected, in the eyes of the SCT, the KCS-TMM partnership would now be considered a legitimate bidder. In that sense, at least, the STB’s granting of the trackage rights to the Tex-Mex could be considered a victory of sorts.

Gateway Western Haverty’s vision for KCSR was in no way a one-act play. Mexico might be the centerpiece of his vision, but it did not stand alone. His plan was to make KCSR a competitor in diverse markets and to move ahead on that front he undertook a number of seemingly disparate projects. Prior to joining KCSR, Mike Haverty had sat on the board of the Gateway Western Railway Company (GWWR). The railroad’s history dates back prior to the Civil War, but it was not until 1878, under the ownership of the Chicago and Alton Railroad, that service originated between Kansas City and St. Louis, and then Kansas City and Springfield, Illinois. The service options gained little commercial success through the years 1947–1972 under a number of different operators, which included the Alton Railroad and the Gulf, Mobile and Ohio Railroad, and the Illinois Central Gulf Railroad from 1972 to 1987. In 1987, the service became part of the Chicago, Missouri, and Western Railway, but when that railroad entered bankruptcy in 1989, SF arranged for a New York investment firm to purchase the Kansas City to St. Louis line, thus creating the GWWR. SF routed considerable intermodal traffic over the route until its merger with BN in 1995, rendering the GWWR line no longer necessary. Haverty oversaw the acquisition of the GWWR by KCSR on May 5, 1997. The purchase was not about immediately buying additional revenues and G r o w t h o n t h e F a s t T r a c k 165

adding customers, as the GWWR lacked both. What Haverty saw was not only potential for growth on the line but also its long-term value as a strategic connection to other railroads. The GWWR not only connected to CSX at East St. Louis, but it also connected to the IC, which in 1999 had merged with Canadian National (CN), at Springfield, Illinois, and East St. Louis. The GWWR also had a branch line that went from Alton, Illinois, to Jacksonville, Illinois, where it connected to BNSF. The railroad also had good access to fertile grain territory in the area. It took more than fifteen years, and only after major upgrades were made to the line. But eventually Haverty’s acquisition was justified, and fifteen years in the railroad industry is a mere blip in time. With the GWWR track in much-improved condition, a major grain trading company, Barlett, built a grain elevator at Jacksonville, Illinois, which would provide KCS its largest single-line haul from the United States to central Mexico. Beginning as a modest, underutilized segment of KCSR’s system, the GWWR had become a strategically significant component of the railroad’s growth.

Marketing Agreements In addition to acquisitions, Haverty knew that to extend into new markets, the railroad had to pursue more strategic marketing arrangements with others. In 1997, he had negotiated a haulage agreement with the Iowa and Minnesota Rail Link (IMRL), whereby KCSR sent locomotives and cars to the Quad Cities or to grain elevators on the Northern Iowa branch line over the IMRL at a specified cost. It gave KCSR access to important grain territory without having to make a capital investment. Beginning in 1998, Mike Haverty and Paul Tellier, chair and chief executive officer of CN, began discussions as to how the two companies might work together on promoting traffic between their railroads in the United States, as well as taking advantage of NAFTA by marketing traffic between Canada and Mexico. CN had just purchased the IC, giving it excellent connections with KCSR at Jackson, Mississippi, and Springfield, Illinois. The KCSR and CN soon entered into a fifteen-year joint marketing agreement, which provided for a haulage agreement on intermodal-automotive traffic that allowed KCSR to serve Memphis and Chicago, and for CN to serve Dallas and Fort Worth (through Wiley, Texas) and also Kansas City. Additionally, it provided greater access for both companies to chemical and petroleum facilities along the Gulf Coast between Baton Rouge and 166 V i s i o n a c c o m p l i s h e d

New Orleans, Louisiana. Finally, it promoted growth of rail traffic between Canada and Mexico over the two railroads’ systems. Once implemented, the two top executives and their marketing teams met quarterly to review how the venture was progressing and what new opportunities there were for new business. Along with the developments discussed above, another venture landed on the doorstep. This one was totally outside the scope of anything ever imagined by anyone at KCS prior to Mike Haverty. During the interview process, leading up to his becoming CEO of the railroad, Haverty had told Landon Rowland and Paul Henson that he was a builder, not a seller. They did not fully appreciate what KCSI-KCSR and they were in for. But they were about to find out.

G r o w t h o n t h e F a s t T r a c k 167

The Panama Canal Railway Company

16

From its earliest days, the KCS rail system had been put together as something resembling a checkerboard. Still, there had been a vision behind the majority of its strategic moves, and that was to create an efficient rail route from the Midwest to the Gulf of Mexico. Even the acquisition of the MidSouth, which provided KCSR an east–west corridor, also had given the railroad greater access to the south. The company had held steadfast to its north–south North American railroad orientation. At various times, especially after forming its partnership with Grupo TMM, KCSR had been approached by groups representing Europe, Africa, Asia, and South America with proposals for the company to invest in or purchase foreign railroads. The proposals were quickly rejected on the grounds that they fell outside KCSR’s vision. So, what on earth led KCS to think that investing in a 47.5-mile railroad across the Isthmus of Panama adjacent to the Panama Canal would fit within its vision? Putting that question aside for a moment, few railroads have as fascinating a history as the Panama Canal Railroad. Its construction began in 1850 and was completed in January 1855. It is a story of engineering brilliance, on the one hand, and horrific, nightmarish construction conditions leading to thousands of deaths, on the other. The primary purpose for its construction was to provide another route for people desiring to travel from the East Coast of the United States to the West, a large number of them anxious to be part of the California gold rush. The plan was for travelers to travel by ship to Colón on Panama’s east coast and then travel by rail to Panama City, where they could board a ship to California.

169

In his book Brave Companions: Portraits in History, American historian David McCullough included an essay, “Steam Road to El Dorado,” about the building of the original Panama Railroad, chronicling both the engineering and construction design brilliance and the abject misery of the laborers brought to Panama from Columbia, West Indies, Ireland, Wales, France, Italy, and China as well as slaves from a number of African countries. No one tells the story better than McCullough. It is a portrait of a small railroad that holds a major place in railroad history. Upon completion, the railroad proved to be a financial success. Despite paying exorbitant fees for tickets, few travelers complained given the luxury of a short train trip from one ocean to another rather than traversing over other longer routes. For a time in the 1860s, the Panama Railroad had the highest stock price on the New York exchange, trading as high as $335 per share. But the fortunes of the Panama Railroad declined in 1888 when the French Canal Company went bankrupt and then collapsed after its failure to build the Panama Canal. By the time the US government gained control of the railroad with its purchase of all the property rights from the French in 1904, the Panama Railroad had fallen into near-total disrepair. The United States oversaw the relocation and rebuilding of the railroad from 1906 to 1914, a necessary undertaking as the railroad was critical to the construction of the canal. While never reclaiming the financial status it had in 1860, the railroad provided transportation for Panamanians and US military personnel assigned to military bases located in the Canal Zone. Regrettably, the railroad again declined precipitously after 1979 when the United States turned over ownership to Panama in advance of handing over full control of the canal and Canal Zone to the Panamanian government on December 31, 1999. By the time KCS entered the picture, the Panama Canal Railroad was a shell of its former self, and that is an overgenerous description given the state of its track and equipment.

Haverty Travels to Panama As it happened, Mike Haverty’s involvement with the Panama Railroad predated his joining KCS. Business at Haverty Corp. was growing nicely when he took a phone call from a friend, Mike Lanigan, president of MiJack Products Inc. (Mi-Jack), a privately owned international provider of 170 V i s i o n a c c o m p l i s h e d

intermodal equipment and industrial cranes as well as a contract operator of intermodal terminals for major railroads throughout North America. Haverty had a long relationship with the Lanigans, the family who owned the company, dating back to his days at SF. Lanigan explained to Haverty that Mi-Jack had a small investment in an equipment distribution terminal at the Port of Balboa in Panama City. Trusting Haverty’s strategic expertise and rail operating experience, Mike Lanigan asked him to evaluate the practicality of an investment in the Panama Railroad. Haverty was not particularly interested, but Lanigan and Mi-Jack’s sales representative for Latin America, Dario Benedetti, kept leaning on him to visit Panama and take a look at the railroad, as there was speculation that the Panamanian government was seriously considering privatizing it. Lanigan suggested that the Panama Railroad might be an interesting project for a Haverty Corp. investment. In no uncertain terms, Haverty declared his lack of interest. Panama’s longtime dictator, Manuel Noriega, had been recently ousted from power and the country was struggling to regain its footing under a new government. The government was also still adjusting to the US military exiting the Canal Zone, where its presence had been a stabilizing influence for decades. Investing in a speculative project in an unsettled nation seemed the very definition of high risk and one that held no interest for Haverty. But Mike Lanigan stubbornly persisted and eventually figured out a way to get Haverty to at least take a look at the railroad. Mi-Jack had made an investment in a port operation in Buenos Aires, Argentina, and in February 1994, Lanigan convinced Haverty to travel there to evaluate the feasibility of building an intermodal terminal at the port. As part of the deal, Haverty would stop in Panama while traveling back to the United States. So, in March 1994, Haverty made his first trip ever to Panama. He was anything but charmed by his first impressions of the country. What was most disturbing were the soldiers standing on street corners wearing bulletproof vests and armed with machine guns. Neither did his first glimpse of the railroad warm his heart. Never in all his days riding trains had he ever seen an active railroad in such bad shape, and he had seen some bad ones. The Panama Railroad still operated minimal freight service though its passenger service had been discontinued years before. Against his better judgment, he agreed to ride a train across the isthmus. Joined by Dario Benedetti, he boarded a train at Colón on the Atlantic Ocean side. Actually, it was hard to call it a train, as T h e P a n a m a C a n a l R a i l w a y C o m p a n y 171

its consist was composed entirely of a GP diesel locomotive and one flat car carrying commercial equipment. He mentioned to Dario that this was the first one-car freight train he’d ever seen. He was soon to see a second one traveling in the opposite direction. Business was obviously not booming on the railroad. Despite the train’s diminutive size, Haverty and Benedetti shared the cab of the locomotive with five crew members, though what most of them were doing remained a mystery. Even while traveling at speeds less than ten miles per hour, Haverty worried that the train would derail, as the rail ties were totally deteriorated and the bolts were broken in the rail joints, causing the rails to bounce up and down as the locomotive passed over them. As the train sped up to what Haverty calculated to be around twenty miles per hour, he saw wide grins on the faces of the crew, clearly expecting the crazy Americans to yell, “¡No más!” at any second. The locomotive was dipping and wobbling, and Haverty grew seriously concerned that it might derail and topple over sideways and fall into a culvert. Dario Benedetti appeared to be enjoying the ride and said it was like being on a roller-coaster, to which Haverty leaned over and told him that it was a good thing Dario Benedetti did not know anything about railroads, for if he did, he would jump off this “expletive” locomotive right now. The grin on Benedetti’s face disappeared. The trip took over four hours to cover the 47.5 miles from Colón to Balboa. Haverty did not complain about the slow transit, as he was just happy to still be alive. Once safely off the train, Haverty was ready to rush to the airport and get on the next plane to the States, where he would file a report to the Lanigans, the gist of it being, “Are you kidding me? Not on your life should you spend one penny on this death trap!” But he did not go directly to the airport. While Haverty was eating dinner at the hotel, his thoughts traveled back to his days at SF when he commuted by train from his home in Naperville to Chicago’s Union Station. He remembered being impressed with the simplicity and efficiency of the rail service, a push-pull operation that could be controlled from either end. The train would run back and forth between the city and the suburbs. Why, he wondered, could not the same type of system be implemented for moving freight from the port on one side of Panama to the port on the other? Container trains could travel back and forth across the isthmus, not like traditional intermodal service in the United States, but more like a conveyor belt–type operation. It would not be built to compete with ship traffic through the canal, as trains simply could not move the thousands of containers a ship 172 V i s i o n a c c o m p l i s h e d

could. But trains could move 100–110 forty-foot ocean containers on flat cars. It would be a boutique operation that would supplement freight service and help ocean shipping companies reduce their canal costs. During his visit, he had watched ships transit the canal and drop off and pick up containers at the port on the Atlantic side near Colón. Ships traveling along the west coast of the Americas dropped off containers they had picked up en route that were destined to the east coast of the Americas while also picking up containers destined to ports on their routes. In similar fashion, ships traveling the eastern coast of the Americas transited the canal and dropped off containers destined for the western coastal ports and picked up containers destined for ports along their routes. The Atlantic operation reminded Haverty of a railroad switching yard. He reasoned that if the Port of Balboa received major upgrades on the Pacific side, container ships traversing up and down the eastern and western coasts of the Americas could drop off containers on either coast of Panama and have the railroad provide transit across the isthmus. Haverty was also informed by a young ocean company executive, Tom Kenna, that container ships would sometimes arrive at a Panama port exceeding the weight restrictions for vessels transiting the canal, and up to two hundred containers would have to be offloaded and taken by truck across Panama. Kenna added that some refrigerated containers might be quarantined from moving on vessels via the canal and would have to move from one coast to the other by land. Theoretically, ocean carriers could save time and money, as well as improve ship utilization, if they used the railroad to move the containers across the isthmus as they would no longer have to queue up for hours to get into the canal, take approximately nine hours to transit it, pay canal fees per container, and then dock at Colón to load and offload containers. Instead, they would be able to just drop their containers off on their north and south trips on the Atlantic or Pacific side, and the railroad would carry them on intermodal container trains on a one-hour trip across Panama. The rail intermodal terminals could be right next to the port terminals so that trucks could quickly dray the containers back and forth between the ocean and rail terminals. Another benefit would be that containers to and from the Colón Free Trade Zone—the second largest port in the world—could travel by train. Additionally, perishable products moving in refrigerated containers, such as bananas from Chile heading to New York City, could reach their destinations as much as two days earlier if they crossed Panama by rail rather T h e P a n a m a C a n a l R a i l w a y C o m p a n y 173

than on a ship via the canal. On top of all this, the highway system across the isthmus was in poor shape and overused in the mid-1990s, often taking trucks a full day to go from one coast to the other, compared to one hour on a high-speed intermodal train. So Haverty’s report to Mi-Jack ended up being less negative than he had originally thought it would be. Nonetheless, as his report pointed out, the capital cost of rebuilding the track and upgrading the locomotive power and rolling stock would be high. He recommended that, since a fifty-year concession was being contemplated by the Panamanian government, the right-of-way be completely rebuilt with welded rail, concrete ties, and granite ballast to guarantee that the track infrastructure would last the lifetime of the concession without future major investment. He proposed that the system be constructed to handle double-stacked intermodal trains that could hit seventy miles per hour. He estimated that the total capital cost for the rebuild, including track, locomotives, double-stack cars, and intermodal terminals on each side, would be in the neighborhood of $80 million. Haverty’s report was favorably received by the Mi-Jack hierarchy and was forwarded on to the Panama government in April 1994 through an influential Panamanian associated with Mi-Jack, Bolo Aleman. Initially, the proposal went nowhere, as Panama was preoccupied with contracting for the building of a new port at Balboa, as well as planning for the takeover of the canal in less than five years. The privatization of its dilapidated 47.5-mile railroad was not a priority. In the meantime, Mike Haverty’s life had changed dramatically with his selection to head KCSR, which required that he shut down his consulting company, Haverty Corp. Not surprisingly, Panama dimmed to a distant memory for him.

The Plan is Resurrected As it turned out, the Panama project did not lay dormant for long. Immediately on the heels of the visit by the Grupo TMM contingent on Haverty’s first day at KCSR, Mike Lanigan called to discuss Panama. Haverty was happy to take the call. It was not that the Panama Railroad fell within his strategic vision of KCSR; it really did not. But Haverty wanted to show both people within the company and outsiders on Wall Street and the transportation community that he intended to be proactive, that he would not be tied to conventional thinking, and that KCSR was definitely not for sale. While not sure the project would ever get off the ground, Haverty received the 174 V i s i o n a c c o m p l i s h e d

complete support of the board chair, Paul Henson, and Landon Rowland to pursue a fifty-fifty ownership venture between KCSI and Mi-Jack for the purpose of gaining control of the Panama Railroad. In the year since the original proposal from Mi-Jack and Haverty Corp. had been submitted and mostly ignored, the Panamanian government had strengthened its commitment to making the country a global shipping hub with the canal, naturally, its central feature. A new state-of-the-art port facility on the Pacific side would complement the MIT terminal on the Atlantic side, as well as planned expansion at Colón. Though only partially grasping its potential, government officials now viewed a rebuilt railroad as an added inducement for maritime shippers to expand their exposure to the Canal Zone. Thus, in 1995 the Panama government officially announced its desire to offer a twenty-five-year concession with the right to renew for another twenty-five years, at virtually no upfront cost to a group willing and able to finance the rebuilding of the railroad and then manage its operation. KCSR and Mi-Jack made a formidable team. KCSR, as a Class I railroad, and Mi-Jack as a world leader in operating intermodal terminals, had all the experience and talents needed to rebuild and operate a hybrid intermodal rail operation. It also helped that the partners already had a finished proposal. Finally, the two companies had the credibility to attract financial backing to take on the project. The International Finance Corporation (IFC), a member of the World Bank Group, became an enthusiastic financial investor in the proposed railroad. Still, the process of finalizing the privatization process and awarding the concession dragged on and on; it was not until 1999 that KCSR and Mi-Jack were notified that they had won. But there was a problem, and it was serious enough to possibly kill the rail project before it even got off the ground. The government had awarded the right-of-way to the concessionaires but provided no land for intermodal or support facilities necessary to make a truly operative intermodal railroad. Instead, all of the surrounding land had been granted to Hutchison Port Terminals as part of their winning bid on the Port of Balboa. Under this arrangement there would be no point in taking on the project. Dario Benedetti and Bolo Alemán immediately sprang into action, lobbying for the concession to include land adjacent to the track. It took a year, but their persistence succeeded in getting the government to add land to the rail concession. In retrospect, all the delays proved to be a blessing in disguise for KCSR and Mi-Jack, as Hutchison had fallen behind in the planning and construction of the Balboa terminal. If the railroad had been able to keep to its original T h e P a n a m a C a n a l R a i l w a y C o m p a n y 175

construction timetable, the rebuilt line would have been ready for operation well before the opening of the port. It would have been a railroad without any freight to haul.

Rebuilding the Railroad With the amended concession document officially granted, serious construction planning began. It had already been determined that none of the materials needed for the rebuild was available locally. The welded rail would come from Canada, the granite ballast from Nova Scotia, and the concrete ties from Colombia. A Dallas-based engineering design firm had confirmed that Haverty’s $80 million estimate for the project was realistic, though Haverty himself had begun to have second thoughts and was worried about possible cost overruns. Concerns aside, construction planning moved ahead. During the planning phase, Haverty asked the partnership team to consider changing the name of the railroad from the Panama Railroad to the Panama Canal Railway Company (PCRC) to better identify its location and association with canal transport. Haverty also wanted the company logo to be a combination of the previous railroad shield with the KCSR logo and painted in traditional KCSR colors. Mike Lanigan and Mi-Jack liked the concepts and agreed to go ahead with the changes. After the concession had been awarded to the KCS/Mi-Jack partners, Dario Benedetti had been named as acting president of the PCRC, but the appointment was to be only a temporary one while the early stages of planning for the rebuild project were developed. As the date for beginning construction approached, it was crucial to find someone with solid railroad and managerial experience to oversee all aspects of the project. In early 1999, Mike Lanigan had called Haverty and told him that he knew someone who might be the type of individual they needed. David L. Starling began his professional career in 1971 as a clerk on the Frisco. He worked his way through the operating ranks of the Frisco and had become its general superintendent of transportation right before the railroad was swallowed up by BN in November 1980. Starling’s next job was superintendent of BN’s Chicago Terminal Division, a complex assignment due to the amount of interchanging with multiple railroads in Chicago, the busiest rail operations city in the United States. The job was further complicated by

176 V i s i o n a c c o m p l i s h e d

having to coordinate freight activities with heavy commuter traffic between downtown Chicago and its suburbs. It was during this period when Dave Starling and Mike Haverty first met. After a successful stint in Chicago, Starling made a major career move leaving BN to join Mi-Jack Products in 1984. There he assumed a lead role in the formation of a terminal operating company, In-Terminal Services (ITS), which contracted with US railroads to operate their intermodal terminals. He and Haverty, who by this time had joined the SF, again worked together after SF contracted ITS to operate its major intermodal terminals. Starling soon rose to become the head of ITS for Mi-Jack. Then, Starling made yet another career change, this one even more surprising than leaving BN for Mi-Jack. In 1988, he left ITS to join American President Lines (APL) working out of Atlanta. There he was to hold a number of positions in APL’s Stacktrain operations, including being responsible for the utilization of double-stack trains to move auto parts from Detroit to Mexico for General Motors, Ford, and Chrysler. Then, still within APL, he made yet another surprising move, accepting the position of managing director of the ocean company’s Philippines operations. His move to maritime shipping was a radical departure from his railroad background, but Starling thrived in his new environment. His success led to his promotion to vice president for central Asia, responsible for Hong Kong, the People’s Republic of China, and the Republic of China in 1995. He and his family remained in Hong Kong until 1999, at which time he was scheduled to be transferred to Oakland, California. Mike Lanigan, who had remained in contact with Starling, sensed that Dave was less than thrilled with the Oakland assignment. His suspicion led Lanigan to call Haverty and discuss the possibility of convincing Dave Starling to take on the role of president of the reimagined Panama Railroad. The more they talked about it, the more convinced they were that he was the perfect person for the job. They could think of no other person who had Starling’s railroad, intermodal, and ocean shipping experience. Plus, they knew him, liked him, and respected his managerial abilities. They offered him the job. Always ready for a new challenge and eager to blend his ocean shipping and railroad experience, Starling accepted. At about the same time Starling signed on, the bids came back from contractors to rebuild the railroad, including intermodal and support facilities. The quotes confirmed Haverty’s fears of higher costs, and the estimates did

T h e P a n a m a C a n a l R a i l w a y C o m p a n y 177

not even include suspected cost overruns but best-case scenario construction expenses. Based on the criteria that the Dallas engineering firm had established, the lowest bid came in 50 percent higher than Haverty’s original $80 million estimate, the amount that had been budgeted for the project. The mood of the KCS and Mi-Jack teams plummeted on hearing the news. Having persevered through five years of delays, and working through miles of red tape, it was like a punch in the gut that the project might go up in smoke at this late stage. There was no way that the PCRC investors would underwrite the additional projected costs, especially as the $80 million estimate had already been considered high given the speculative nature of the rail project. An emergency meeting was scheduled in Kansas City in the hope of figuring out a way to salvage the project. It did not look promising. The mood in the room was somber. Jack Lanigan Sr., patriarch of the family and founder of Mi-Jack, was present, as were his sons. Dave Starling was there, along with other key KCS and Mi-Jack personnel. Of course, Mike Haverty was there and a guest of Mike’s, Cecil Clair Hutchinson, founder of Neosho Construction Company out of Topeka, Kansas. Haverty and Ab Rees Jr., son of Mike’s early boss on the MoPac and now vice president of operations at KCSR, had known Hutchinson for decades. The MoPac had been Neosho’s first significant rail customer. Hutchinson’s company had bid on the PCRC rebuild and had actually come in with the lowest bid, but even that was still 50 percent higher than Haverty’s original estimate. Mike Haverty wanted Hutchinson there because he trusted him and knew the latter would give him straight answers. Before the meeting in the board room convened, Haverty asked Hutchinson to first speak privately with him in his office. Mike shut the door and flat-out asked his friend why Neosho’s bid was so high. Hutchinson responded by pointing out that there were three major issues he had with the bid package. First, the construction contract had been written in such a way that the construction company was responsible for all of the liability, and there were severe financial penalties for not meeting deadlines. Hutchinson told Mike that Neosho—and all the other bidders, for that matter—had done little or no work in foreign countries and none in a country like Panama, which had only a few years earlier been controlled by a ruthless, corrupt dictator. For that reason, all the bidders had padded their estimates to protect themselves. Second, the Dallas engineering firm

178 V i s i o n a c c o m p l i s h e d

had written in a provision that required the construction company to cut the existing subgrade down six inches on the right-of-way across the entire isthmus and then rebuild it. C. C. said that this would not only cost millions of dollars in equipment, material, and labor and slow down the rebuild but in fact severely disturb the railroad subgrade that had been in place for decades, with some going back to the original 1855 construction. That, he said, would be a major mistake. Third, Hutchinson felt that the Dallas engineering firm KCSR had selected had too much control over the project, plus its fees for overseeing the project were too high. His advice was that the construction company hired should control the engineering and the Dallas firm’s contract should be terminated. Haverty said he would be willing to relieve the contractor of virtually all liability except gross negligence and have PCRC underwrite it. He also trusted Hutchinson’s opinion regarding the subgrade not being disturbed. Finally, Haverty said that PCRC would be agreeable to eliminating the Dallas engineering firm and letting the contractor do the engineering and provide its own oversight. He then asked Hutchinson if PCRC agreed to the three points would Neosho take on the job at the originally budgeted estimate of $80 million. After a short back-and-forth discussion, Hutchinson agreed to the terms, and the two shook hands and said they had a deal. Haverty and Hutchinson walked back into the corporate boardroom, where they quickly turned the frowns into smiles and relief. The project was given the green light to proceed. The scene had the faint echo of the moment in 1887 when against the odds Arthur Stilwell had saved the Kansas City Belt project and, in effect, had given birth to the KCS. Construction moved along smoothly. Not disturbing the subgrade proved to be a great decision as a motor vehicle could operate over it at seventy miles per hour once the track was removed. With Neosho in control of construction, members of the PCRC team were able to turn their attention to acquiring equipment. Mike Haverty had decided that PCRC would use F40PH (Freight-Passenger-Head End) locomotives that Amtrak was retiring and putting up for sale. For PCRC’s push-pull operations, a locomotive would be located at each end of the train. The locomotives would be painted in the traditional KCS Southern Belle paint scheme. As it turned out, the F40PH locomotives were not only good for freight and passenger service. Because they had generators to supply electricity for passenger service, the

T h e P a n a m a C a n a l R a i l w a y C o m p a n y 179

Jointly owned by KCS and Mi-Jack Products Inc., the Panama Canal Railway Company (PCRC) began commercial operation in 1998, providing another option for ocean shippers moving containers between the Atlantic and Pacific Oceans.

railroad’s mechanical team was able to string electric cables along the articulated double-stack containers freight cars from the locomotive generator so that refrigerated containers could be moved by rail across the isthmus. It was decided that the PCRC should invest in bulkhead five-pack doublestack articulated container cars that were being phased out in the United States, gradually being replaced by lighter weight double-stack cars. It was felt that since the container trains in Panama would be relatively short and would not encounter significant grades or curves over the short forty-sevenmile run, the extra weight would not be an issue. Knowing that the retired bulkhead cars were likely to be scrapped, the price the PCRC negotiated was reasonable. Eighteen bulkhead five-pack cars were ordered. The cars presented another benefit in that their design prevented container doors from being opened during transit. This meant that Panama’s customs office allowed the containers to be moved in-bond across the isthmus without having to clear customs. This resulted in a significant savings of time, effort,

180 V i s i o n a c c o m p l i s h e d

labor, and expense and gave the PCRC another advantage over trucks, which required customs clearance on every load. The concession agreement included terms requiring the operation of passenger service even though, while under government control, passenger service had been abandoned years earlier due to deteriorated equipment and unsafe track conditions. Like most railroaders, Mike Haverty loved passenger trains, but as a freight railroad executive, he was not excited about the prospect of trying to cover the costs of running passenger service. His dilemma was that Panamanian government officials, and even some of the PCRC team, were nostalgic when it came to the bygone days of passenger service. He was frequently reminded that Hall of Fame Major League baseball player, Rod Carew, had been born on a Panama Railroad passenger train. Dario Benedetti was a supporter of passenger service, as was Bolo Alemán. Both put pressure on Dave Starling, who was agreeable but wanted the PCRC to be in control of the service. Haverty was skeptical, thinking that PCRC control was a bad idea and was inclined to contract out the passenger service to an operator who would furnish the cars and provide the passenger services, including food and drinks. To that end, Haverty contacted Tom Rader of Colorado Railcar, a company known for operating outstanding service for the Alaska Railroad. Haverty, Mike Lanigan, and Dave Starling met with Rader at his Colorado office to discuss PCRC passenger service and broached the possibility of outsourcing the business to Colorado Railcar. The meeting did not go exactly the way Mike Haverty thought it would, and in this case that was a good thing. Rader disclosed that the possibility of a PCRC passenger service was the talk of the passenger service industry and that he was convinced that it could be financially successful. His recommendation was that PCRC should operate its own passenger service. While he would be glad to operate it for PCRC, he thought outsourcing would be a mistake and a missed opportunity. The three PCRC representatives found his straightforward honesty refreshing and reassuring. Starling was happy, as was Lanigan, to have PCRC maintain control. And, with his fears eased, Haverty got on board too. That meant the next step was to get equipment. Willis Kilpatrick had worked for Mike Haverty at SF and had been responsible for rebuilding that railroad’s business car fleet. He had followed Mike to KCSR, where he had put together the company’s Southern Belle business

T h e P a n a m a C a n a l R a i l w a y C o m p a n y 181

train. Willis was assigned the job of finding cars for the PCRC passenger service. He found five coach cars manufactured by the Budd Company in 1952 that were formerly part of the Pennsylvania Railroad fleet. He also located a 1937 Pullman Standard car that had been converted to a dome car by SP in 1955. While they all required major rehabilitation, the cars were perfect for passenger service between Panama City and Colón. The interiors of the cars were designed and decorated in a Panamainspired, traditional fashion. At first it was planned to have the exterior painted in KCSR Southern Belle colors; red, yellow, and deep, dark green, with the green being the primary color. But dark green seemed wrong for Panama’s hot, humid climate. The decision was made to reverse the color scheme making the cars primarily yellow and trimmed in red and black. The passenger service proved to be an immediate success and helped ingratiate the PCRC with the Panamanian people. While owned by two US companies, somehow the PCRC passenger service seemed quintessentially Panamanian. There could not have been a better person selected to oversee the construction and then the day-to-day management of PCRC than Dave Starling proved to be. He possessed all the skills and experience necessary—railroad operations, intermodal terminal operations and transport, and maritime shipping. He was also familiar with working in foreign countries and dealing with diverse social and business cultures. One of Starling’s first accomplishments was hiring Thomas Kenna to be vice president of marketing. There is a striking similarity between Arthur Stilwell’s recruitment of the Dutch coffee merchant John de Geoijen and Starling’s hiring of Tom Kenna. Both de Geoijen and Kenna were young and already successful. Neither was looking for a new job, certainly not one at a fledgling railroad company with questionable prospects. Both went to their respective lunches without an inkling what was in store for them. If they had, odds are that they would have declined the invitation. But both went, and they left with new careers, working for upstart railroads. On November 27, 2001, the PCRC opened for business. The freightmoving side of the operation was not an immediate success, but that was less because of the railroad itself and more because a good portion of the expanded canal infrastructure was not yet completed. For the first couple of years, the PCRC’s most successful business was not moving containers but people. There were two aspects to its passenger service. A commuter train was inaugurated and was a hit from its first day of operation. The train took 182 V i s i o n a c c o m p l i s h e d

commuters from Panama City in the morning and returned them from the eastern coastal port of Colón in the late afternoon. It was a fully subscribed business. The PCRC also ran excursion trains for passengers of cruise ships that stopped in Panama. It, too, was a wildly successful venture. Once most of the supporting canal infrastructure was in place, the PCRC’s freight business began to grow and soon became the railroad’s dominant business segment. So efficient was the railroad and so low were its operating costs, the PCRC was able to attain operating ratios in the midto low forties. The business was so successful that in 2003, KCS and Mi-Jack bought out the IFC’s equity position, which meant all the earnings of the PCRC became pure profit to the two companies and generated significant cash returns for both. Mike Haverty, the Lanigans, Dave Starling, Dario Benedetti, Bolo Alemán, Tom Kenna, and a number of key people from both KCS and MiJack had pulled off the rebirth of one of the world’s most truly most amazing railroads. Given the human cost of its original construction in the 1850s, it would have been a shame if the railroad had ceased to exist. But it did not. It was brought back to life by people who appreciated its heritage. It is entirely fitting that the world’s first transcontinental railroad lives on and thrives. While PCRC did not conform to KCS’s north–south North American orientation and business strategy, it did show that like Stilwell and Deramus III before him, Mike Haverty could see opportunities that most others could not. PCRC was a success for Haverty, but neither it nor any of his earlier achievements compared to the challenge, and the opportunity, before him.

T h e P a n a m a C a n a l R a i l w a y C o m p a n y 183

The Birth of Mexico’s Railroad System

17

From a bird’s-eye view, the development of the United States is by and large a story of expansion. From a small passel of colonies along the northeastern and southeastern coasts, generations of Americans gradually moved westward, first to the Midwest and then on to the Far West and Southwest. From the mid-nineteenth century onward, railroads played an increasingly important role in the westward migration. Mexico’s development as a modern nation-state was more one of contraction, partially the result of losing half of its original territories to the United States in the Mexican-American War of 1846. But contraction for Mexico also meant its struggle to assimilate people from disparate and often isolated areas into a unified modern nation with a common set of laws and values. But here, too, railroads played a significant role. A strong argument can be made that no single technology or industry was more influential in the creation of the unified nation-state of Mexico than the development of its interconnected rail system.

Mexico’s First “Transportation Corridor” The first appearance of anything resembling a unified government entity in Mexico dates back to 1427 with the alliance of three city states located in and around the Valley of Mexico. Despite its limited territorial reach, the Aztec Empire was to have a major influence on the formation of Mexico’s culture, arts, value system, and government; that influence is still present throughout modern Mexico. It is fitting, then, that the Aztecs were responsible for the

185

development of Mexico’s first transportation corridor. True, calling what they formed a transportation corridor is a stretch, but the two-hundredmile path they carved between a settlement on the Atlantic Ocean—today’s Veracruz—and the Aztec capital of Tenochtitlán—now Mexico City—was to become, some four hundred years later, roughly the route of Mexico’s first railroad. After Hernán Cortés conquered the Aztecs in 1521 and claimed the land for Spain, the path, which Spaniards named “El Camino Real,” served as the invasion route used by conquistadors to plunder Tenochtitlán. Over time, the El Camino Real extended northward from Tenochtitlán toward what is today the Mexico-US border and became an active trade route.

Mexico’s Early Attempts to Build a Railroad Mexico did not declare its independence from Spain until 1821, and sadly the next fifty years were dominated by debilitating periods of political instability leading to forty-nine different administrations holding power. Not surprisingly, Mexico’s multidecade political infighting and governmental chaos, coupled with external attacks from the United States and France on the country’s sovereignty, forestalled the building of the nation’s infrastructure, including the development of a rail system desperately needed for the country’s economic growth. The first attempt to build a railroad dates back to 1837 when a concession was granted to Francisco Arrillaga, a wealthy Spanish-born merchant who sought to build a railroad between Veracruz and Mexico City, roughly along the route of the El Camino Real. As a result of insufficient funding and continuous government turmoil, not one segment of track nor a single tie was laid down under Arrillaga’s concession. Twenty years later, a grant was provided to a Mexican aristocrat, Antonio Escandón, to build a rail line along a route similar to the earlier concession. Unfortunately, Mexico was still in a state of constant political conflict, which again doomed any chance of procuring financial backing. In 1864, during the French intervention into Mexican affairs, Escandón was forced to sell his concession to the government of Maximilian, a Hapsburg who the French had installed as emperor of Mexico. Maximilian in turn granted it to a British company, the Imperial Railway Company, which built a 264-mile rail corridor from Veracruz to Mexico City. It was inaugurated on January 1, 1873, during the administration of Mexican president Sebastián Lerdo de Tejada. 186 V i s i o n a c c o m p l i s h e d

The Porfiriato While the first Mexican railroad went into operation during President Lardo’s regime, the true father of Mexico’s rail system was to become his successor, General Porfirio Díaz. Under the banner of the Revolution of Tuxtepec in 1876, Díaz grabbed control of the central government and established a dictatorship, which lasted thirty-five years. The Díaz dictatorship would be labeled by historians as the Porfiriato. Porfirio Díaz was to become one of the most significant and controversial figures in Mexican history. Condemned by his adversaries as a ruthless despot in the same mold as Cortés, Santa Ana, and Maximilian, there is no denying that he and the Porfiriato were the forces behind Mexico’s widespread economic growth in the last decades of the nineteenth century. His ambitious infrastructure construction programs, savvy financial management, and commitment to law and order served to gain Mexico legitimacy in the eyes of foreign nations. During his rule, propelled by expanded exports, Mexico’s economy flourished. The country’s mining and agricultural sectors thrived, and Mexico also experienced desperately needed expansion of its steam, water, and electric power capacity. However, the centerpiece of his ambitious economic development program was the building of a national rail network. His success in accomplishing this objective was stunning. When Díaz assumed control in 1876, Mexico had only 397 miles of rail track, and 114 mules were used to set trains in motion. In eight years, the rail network had expanded to 3,559 miles, and steam engines had replaced animal power. By 1889, the system had grown to 7,559 miles, and when he was forced to flee Mexico in 1911, the country’s rail network was composed of nearly 17,000 miles of main line track. The construction of the railroad system—both passenger and freight— was the means by which Díaz sought to modernize Mexico. He envisioned Mexico’s railroads as a means to link agricultural areas to urban markets and ports, as well as to forge a modern, civilized country with a citizenry gaining a sense of national identity. Boosters emphasized the importance of the government’s rail projects in bringing a civilizing aspect to Mexico, promoting national unity, increasing commerce, and even changing the racial composition of the populace. Additionally, the Mexican rail system would allow for the rapid deployment of troops across the nation. Railroads were clearly the backbone of the Díaz regime’s mantra of “order and progress.” T h e B i r t h o f M e x i c o ’ s R a i l r o a d S y s t e m 187

While there was widespread public support for rail construction, Díaz did not have clear sailing in Mexico’s Congress of the Union. Opponents of his regime saw rail development as another instrument for the rich—especially wealthy Americans—to exploit Mexico for their own advantage. This was the heart of the criticism of Díaz’s aggressive rail construction program. They had no argument with the idea of integrated rail system but feared that the large-scale American investment in the rail system posed a threat to Mexico’s sovereignty. Those who challenged Díaz’s rail development strategy wanted a more homegrown approach in which native Mexican companies would fund, build, and operate the railroad companies. Frustrated by the political wrangling, Díaz pushed a law through the Congress of the Union that gave the executive branch full control over the granting and revising of railroad concessions. In an attempt to placate his adversaries, he agreed to a number of concessions, including that any foreign owners of Mexican railroads would have to hand over their concession rights to Mexico after ninety-nine years, and the foreign owners must consider their railroads as Mexican and subject to the nation’s laws. While these concessions did little to appease his opponents, they were significant in that they were to reappear a hundred years later during the formalization of Mexico’s rail privatization plan.

Mexico’s Rail System under the Porfiriato As noted earlier, the first rail corridor running from Veracruz to Mexico City, after nearly four decades of delays, was finally inaugurated in 1873, three years prior to the beginning of Díaz’s regime. Named the Mexican Railway, it was primarily a passenger service and proved to be immensely popular, especially with foreign travelers. Leaving Mexico City, trains would descend 3,937 feet over a distance of twenty-five miles. The breathtaking drop in elevation offered passengers dramatic changes in scenery from orange groves and coffee plantations with snow-covered volcanoes in the background, to tropical jungles as they approached the Atlantic coast. The rugged topography and sharp descents had pitted engineers and builders in a fierce battle against nature, but when completed, they offered passengers startlingly beautiful vistas, as well as a very exciting train ride. The other three of Mexico’s four major rail corridors were built during the Porfiriato, with two of them financed and controlled by US interests. Only the Mexican Railway was completed prior to Díaz’s rule. 188 V i s i o n a c c o m p l i s h e d

The Interoceanic Railway The only railroad not to be built and owned by Americans during the Díaz regime was the Interoceanic Railway, which began operations in 1891. As its name suggests, the original plan for the corridor was much more ambitious than the final product ended up being. As originally envisioned, the railroad was to operate from Veracruz on the Atlantic side to Acapulco on the Pacific. The Mexican and British promoters financing the rail concession were never able to accomplish their grand plan due to funding problems and lack of widespread political support. When completed, the Interoceanic, owned by British interests, roughly paralleled the Mexican Railway running from Mexico City to Veracruz. While the Interoceanic Railway’s route was somewhat different, passing through Texcoco and Puebla, like the Mexican Railway it relied on an impressive array of bridges, tunnels, and viaducts to navigate sharp descents.

The Mexican Central Railroad Of all the major railroad projects undertaken during Mexico’s ambitious building period, the Mexican Central Railroad (Ferrocarril Central Mexicano) was the largest, extending 1,240 miles from Mexico City to El Paso, Texas. It also included two secondary lines, one to Guadalajara and another to Tampico. Altogether, the Mexican Central had 3,100 miles of track, about 25 percent of what was to become the entire Mexican rail grid. It also carried the most freight, approximately 30 percent of the total. The Mexican Central trains leaving Mexico City to El Paso cut through the middle of the country, crossing ten states: México, Hidalgo, Querétaro, Guanajuato, Jalisco, Aguascalientes, Zacatecas, Coahuila, Durango, and Chihuahua. The railroad was incorporated in Massachusetts in 1880 by the same group of Boston financiers who controlled the SF. When the line opened in 1884, it connected with three railroads—the SP, the Texas and Pacific, and the SF—at the US border in El Paso. Because of its ownership, the Mexican Central essentially became the extension of the SF in Mexico. One of the unintended consequences of rail construction during the Díaz years was the use of the railroads for many Mexicans seeking to emigrate to the United States in search of jobs and a better quality of life. That had never been the intention behind the building of the system. Actually, the intent T h e B i r t h o f M e x i c o ’ s R a i l r o a d S y s t e m 189

had been quite the opposite. The rail system was to be a means for moving laborers to regions within Mexico that were developing economically. A secondary objective was for the rail system to ultimately create a more homogeneous mix of cultures and economic diversity. But many, despairing of the opportunities in their native country under the oppressive Díaz dictatorship, utilized Mexico’s railroads to cross the border into the United States, and the Mexican Central became the primary rail line used by those who sought opportunities farther north.

The Mexican National Railway The third major railroad constructed during the late nineteenth and early twentieth centuries was the Ferrocarriles Nacionales de México (Mexican National Railway [MNR]). The MNR provided the shortest route between Mexico City and the United States at Laredo, Texas. The corridor to Laredo measured 1,054 miles and included three branch lines. The MNR concession was granted to William Palmer and James Sullivan, the same Americans who had acquired the Texas Mexican Railway from Alexander Lott in 1883. The Palmer-Sullivan company began construction of the MNR in 1880 and inaugurated the line in 1888 on reaching San Luis Potosí. The railroad passed through San Luis Potosí, Coahuila, and Nuevo León, through the Valley of Mexico, and into the Valley of Toluca. After running through Celaya, San Miguel de Allende, and San Luis Potosí, the MNR cut through the deserts of the Sierra Madre and into the town of Saltillo. Further on, the appearance of textile factories and grain mills were the first indicators of the railroad’s entry into Monterrey. From there it was a relatively short haul to the US border at Laredo. The MNR added a Gulf of Mexico connection in 1905 through a branch line running from Monterrey to Matamoros, a city located a few miles west of the Gulf and across the Rio Grande from the city of Brownsville, Texas. Brownsville was the largest city in the lower Rio Grande Valley and is situated 272 miles from San Antonio, 352 miles from Houston, and 517 miles from Dallas. The city’s proximity to Matamoros provided an important link between eastern Mexico and large Texas markets. A second MNR branch line included a cutoff from Mexico City through Querétaro to Celaya. Together, the Mexican Central and Mexican National railroads controlled over half of the total trunk miles in Mexico and operated the only lines between Mexico City and the United States. In little more than a 190 V i s i o n a c c o m p l i s h e d

quarter century, Mexico had gone from being a country with an isolated population to having a well-designed rail grid that moved people and goods throughout much of the country as well as providing greater and more efficient access to US markets. Díaz had accomplished his vision of a Mexican railroad grid. The system was designed to bring together the nation’s population and link manufacturing and agricultural centers to markets and ports throughout much of the country. It was also instrumental in the Porfirian efforts to forge a modern, civilized citizenry and a national identity. Before the railroads were built, Mexico had been segregated with its indigenous peoples mostly populating rural areas, while the urban centers were mostly the habitats of wealthier Spanish elite. The railroads, more than any other single entity, served to break through this demographic by offering rural people greater access to the benefits and economic opportunities of urban life.

“Poor Mexico, So Far from God, So Close to the United States” Any satisfaction Díaz may have felt in the near-completion of the rail system was short lived. By the turn of the century, social and unrest, which had been building through much of the 1890s, was reaching a boiling point. To oversimplify a complex situation, Díaz had two problems. First, dictators seldom engender deep feelings of affection from those they rule. The longer the autocrats grasp power, the more hostilities fester, grow, and spread. After two decades under Díaz’s harsh, sometimes brutal reign, a large portion of the Mexican populace were demanding to be heard and called for fundamental changes in their central government. Second, Díaz had turned to foreign investors, primarily wealthy Americans, to provide the lion’s share of the funding for his infrastructure construction program. Railroads, mining and petroleum companies were among those funded, owned, and operated by foreign interests, and the majority of the investors and owners were American. A wide swath of Mexicans labeled Díaz as “pro-American,” and that was a problem as suspicion and distrust of American interests ran deep. Fifty years after the MexicanAmerican War, concern remained that the United States was still a threat to Mexico sovereignty. The progressive Mexican press was increasingly publishing articles and editorials stating that rather than bringing greater economic independence to Mexico, the railroads were facilitating the penetration of the United States T h e B i r t h o f M e x i c o ’ s R a i l r o a d S y s t e m 191

into areas of the economy that were placing Mexico increasingly under the financial control of its northern neighbor. In addition, journalists argued that while the foreigners were lining their pockets with money, they discriminated against Mexican labor. There was some truth to this accusation: approximately 70 percent of locomotive engineers and 86 percent of conductors were foreigners, mostly American. Mexicans were almost universally relegated to low-paying, manual rail labor. Journalists hammered away at the message that while the rich got richer, Mexicans did the work and got the scraps. Fearing the anger over railroad ownership was threatening to migrate to other industries and pose a serious threat to his hold on power, Díaz opted to make a move that would demonstrate his responsiveness to the public’s discontent: he directed his highly respected secretary of finance, José Yves Limantour, to develop a strategy to bring the majority of Mexican railroads under national control. Following through on the directive, in 1902, Limantour began to purchase and nationalize the country’s major foreign-owned railroads, using the argument that unnecessary and costly trunk line construction by the Mexican Central and Mexican National railroads had wasted much-needed capital and done little to integrate vast regions of the country, thereby undermining national interests. In 1903, Limantour began purchasing the controlling interests in major rail stocks. Díaz had come to believe, perhaps correctly, that the real source of the unhappiness of the Mexican public with the railroad system was the undue influence of the United States. This was certainly a factor in the Mexican government taking control of the railroad system and leading to Porfirio Díaz’s declaration “Poor Mexico, so far from God, so close to the United States.” The anti-American sentiment was clearly evidenced by the fact that the partial nationalization of the country’s railroads was confined to those owned by US interests and did not include ownership by Great Britain. By 1909, Limantour had formed the National Railways of Mexico, which now controlled two-thirds of Mexico’s network. With the nationalization of a majority of the system, the Díaz government, in a further attempt to appease its critics, announced plans to establish fifteen schools to provide Mexican rail workers professional training that would encourage elevation to higher-ranking jobs. The government also decreed that Spanish, not English, would be the official language of railway

192 V i s i o n a c c o m p l i s h e d

service. All this was a fairly transparent attempt to quell the growing nationalism that was taking hold throughout Mexico. Whatever the motivation for the government’s actions, they did not work. The partial nationalization of the system had little to no effect in dispelling the public’s anger with his authoritarian regime. After more than three decades living under a brutal dictatorship, Mexicans had cried out for much broader change then just an adjustment in rail ownership. Rather, the displeasure with Mexico’s railroads was but one aspect of what had become a widespread outrage over the exploitation and poor treatment of workers and disgust with the huge disparity in the quality of life between the rich and the poor. A desire was growing for a more democratic form of government. A nationalized railroad alone was not going to satisfy the desire for freedom and greater equality. Finally, on November 20, 1910, the tensions that had been mounting for a decade erupted and the Mexican Revolution began. In 1911, Díaz resigned his presidency after more than three decades of rule and left Mexico to spend his final years in Paris.

The Revolution’s Impact on the Railroads The Mexican Revolution did a lot more harm than good to the country’s railroads. Seriously underfunded, rail operations and maintenance suffered. The long and bloody conflict caused attention to be diverted to more immediate issues than the country’s transportation system. Insufficient capital directed toward the rail network—a problem that would plague the industry throughout the twentieth century—resulted in the serious degradation of the railroad infrastructure. But, in one sense, as painful and problematic as the nationalization of the railroads was, and as debilitating the revolution was to orderly rail operations, together the two provided the basis for the formation of a true Mexican railroad culture. Prior to 1909, while Mexicans mostly appreciated the benefits of having a modern rail system, the fact that it was owned and operated by “outsiders” lessened the public’s pride in its existence. Mexicans used the system and benefited by and large from it, but it was not truly theirs. Their muted positive feelings toward the railroads were legitimate; it really had not been their system, but one owned by foreign interests.

T h e B i r t h o f M e x i c o ’ s R a i l r o a d S y s t e m 193

While historians disagree as to the benefits that came from the revolution, the prolonged conflict provided Mexicans a greater sense of national identity than at any time since the country’s independence from Spain. A similar statement can be made regarding Mexican rail workers after nationalization. In the years after 1909, a true rail culture began to grow from the ground up. As the years progressed, Mexican nationals controlled all aspects of rail operations and held jobs at every level. This new rail culture developed independent of American, British, French, and German interests. Understandably, this was liberating for Mexican rail workers and gave them a greater sense of dignity, purpose and responsibility. If not for the eight-decade period of national ownership of the rail system, it is highly likely Mexico’s successful privatization of its rail network in the mid-1990s would not have been possible. The nation’s rail system had become a truly Mexican system only after it was nationalized and the Porfirians were ousted from power. The responsibility of ownership allowed railroad operators and much of the general public to recognize and objectively react to the systems faults and shortcomings. No longer could the railroads’ problems be attributed to the callousness of foreign employees or the greed of foreign owners. The railroad system’s problems were their problems and the responsibility for addressing the system’s faults was also theirs. Hence, when privatization was proposed in the 1990s, the idea was not met with a debilitating backlash of negativity over the possibility of renewed foreign involvement. Why? Because no matter who might be involved in the ownership structure going forward, the system was now, and always would be, Mexican.

194 V i s i o n a c c o m p l i s h e d

The Game Changer

18

While the Mexican Revolution was for the most part fought from 1910 to 1920, the period of revolutionary zeal and social reform extended over multiple decades. After 1920, Mexican leaders redirected the passions and fervor that sparked the revolution into the formation of laws and public policy. The civil war had arisen out of a demand for human rights, a more equitable distribution of wealth, and greater control over the country’s industries and, by extension, the nation’s economy. In a sense, the less complex phase of the country’s desire for substantive change was the physical combat. The more nuanced undertaking was the transformation of revolutionary passion into laws, social programs, and economic policy. This second phase was the form the Mexican Revolution took in the 1920s and 1930s. The 1920s were difficult years. The revolution had cost the lives of many of the country’s young men, not only exacting a horrible toll on families but also seriously depleting Mexico’s available workforce. It is hard to energize a nation’s manufacturing base when the labor force is not large enough to fill the jobs. Adding to the problem was the impact of the Great Depression on the country. Still very dependent on the United States, Mexico was hit hard, even more than other Latin and South American countries. Still, even in the midst of severe economic distress, a progression of Mexico’s prominent political figures who had remained faithful to the spirit of the revolution sought to institute reforms that would touch nearly every aspect of the nation’s political, social, and cultural life. Of these leaders none was more committed to profound social and economic reform than was Lázaro Cárdenas, who served as Mexico’s president from 1934 to 1940. Of indigenous origin, Cárdenas was truly a “man of the people,” a tireless, passionate, relentless reformer. 195

The boldest initiative Cárdenas undertook—and the one that would have the greatest long-term economic, political, and social ramifications—was the nationalization of Mexico’s petroleum industry and the formation of the government-controlled Petróleos Mexicanos (Pemex) in 1938. Cárdenas did not stop there; that same year, he also completed the nationalization of Mexico’s rail system, forming Ferrocarriles Nacionales de México, which he placed under what he called a “workers’ administration.” In addition to its rail system (including railcar manufacturing) and the petroleum industry, almost all of Mexican industries were nationalized under Cárdenas, including mining, electric power generation, seafood processing, sugar refining, fertilizer production, primary petrochemicals, iron and steel manufacturing, automobile production, telephone operations, airline services, banking, street and road construction and maintenance, and the processing and distribution of basic consumer goods. Under Cárdenas, the nation moved toward an economic policy that encouraged domestic ownership of manufacturing, over which the central government would exert considerable control. This would replace the nation’s reliance on foreign investment, especially that from the United States. Agrarian reforms, the nationalization of industries, the nurturing of labor unions, large-scale government investment in infrastructure, upgrades to its education system and a host of government-supported social programs propelled an impressive economic turnaround, great enough for the period from 1940 to 1970 to be labeled “the Mexican Miracle.” Statistics supported the label. During this thirty-year period, as Mexico’s population doubled, its gross national product increased sixfold, and the economy grew at a rate over 6 percent annually. Nationalization seemed like a miracle indeed. Until it no longer did.

The Crash While the status of Mexico’s middle class had improved considerably during the “miracle” years, people in large parts of the country still suffered from extreme poverty, poor education, insufficient health care, and nonexistent or unreliable utilities. But to its credit, Mexico’s government had remained faithful in its support of a wide range of programs and was spending vast sums of money attempting to address the country’s social and infrastructural deficiencies. 196 V i s i o n a c c o m p l i s h e d

It was an ambitious goal, but one for which the government felt it had not only the public support but also the financial resources to underwrite. Its plan for continuing to fund social reforms was directly tied to Mexico’s vast crude oil fields, fortuitously discovered at precisely the same time that international oil prices were skyrocketing and interest rates were low, even negative. This dynamic allowed Mexico to borrow heavily from international capital markets to invest in its state-owned oil company Pemex, which in turn provided the government with the tax-generated income needed to support its social welfare agenda. This strategy resulted in a tremendous increase in spending, but as Mexico had become the world’s fourth largest oil exporter, it seemed that the country could afford it. Then suddenly, almost overnight, global energy markets collapsed; almost as quickly, so did the Mexican economy. Beginning in 1981, oil prices began an unrelenting downward plunge that led interest rates to shoot upward from near zero to double digits. Mexico was hit broadside and, by 1982, was forced to suspend payments on foreign debt, devalue the peso, and rationalize its banking system. Just like that, the country was thrown into an economic tailspin. Mexico no longer had the financial resources to continue its ambitious social programs. Worse still, it could no longer support its nationalized industries, which after years of government support had become badly managed, criminally inefficient, and totally unprepared to cope with a reeling economic environment of high interest rates and inflationary pressures. It became brutally apparent that this was not a situation in which the government could hunker down, remain steadfast to its core economic policies, and weather the storm. Change—drastic change—was necessary. A new economic plan had to be implemented. In short order, the nationalistic-inspired economic policy promoting domestic ownership was replaced by the near opposite. From 1988 to 1994, Mexico privatized nearly all of its state-supported companies. Its telephone company, TelMex, went from being a government monopoly to a private monopoly. The nation’s banking system was also privatized. One by one, in rapid succession, Mexico’s businesses fell under the control of private owners. This change also represented a retreat from the country’s bias against trade, and Mexico’s political leaders deserve credit for how rapidly they transformed the country from being a grudging trade partner to becoming one of the most ambitious, forward-thinking free-trade countries in the T h e G a m e C h a n g e r 197

world. Mexico was all of a sudden open for business. From the mid-1990s to the end of 2005, Mexico signed twelve pro-trade agreements with fortyfour countries. Not only did Mexico sign treaties with its Latin and South American neighbors, free-trade deals were also forged with China, the European Union, Israel, Ireland, Norway, Switzerland, and Japan, among others. Then of course, there was NAFTA, which was approved by the three North American countries in 1994. The multiple trade deals, along with an international economic rescue package crafted by President George H. W. Bush and signed by President Bill Clinton, helped to kickstart Mexico’s economy.

Rail Privatization For anyone who had been paying attention to Mexico’s sudden shift in economic policy and to the state of its railroad system, it was not a question whether the system would be privatized, but when it would happen and what form it would take. By the late 1980s, the nationalized FNM was running at successively higher operating deficits annually. In 1989, the operating deficit totaled $449 million; in 1990, $549 million; and by 1992, $552 million, representing 37 percent of its operating budget. Moreover, the poor condition of its locomotives and freight cars, coupled with its deplorable service, had resulted in railroads’ share of the freight market falling to 9 percent, about half of what it had been only a decade earlier. KCSI’s Landon Rowland gave a talk to a Kansas City historical society in the mid-1990s at which he noted that the company first got wind of Mexico’s intention to privatize its rail system from an executive of one of its large customers. The initial information suggested that the entire system might be sold to a single buyer. Rowland deployed Mike McClain to Mexico to investigate. McClain soon discovered that rail privatization was definitely in the cards but that the information the company had received was not entirely accurate. There would be no single owner of the entire Mexican system. Mexico’s president Carlos Salinas had directed the SCT to develop a privatization plan for the rail system. The SCT adopted three guiding principles to use in designing a plan that would drive competition and provide incentives for potential concessionaires: 1.  The allowance of parallel tracks 2. The creation of alternative routes from ports and borders to key markets 3.  The designation of trackage rights along defined segments of track 198 V i s i o n a c c o m p l i s h e d

The service territories of the rail concessions would be developed considering a combination of geographic divisions and freight markets. The design of the service territories would consider the maximization of intramodal competition while also offering the highest return for the government. No one concession would be granted sole access to a selected set of major cities, industrial areas, or key ports. In other words, the intent was to establish routes or corridors in which traffic levels would be sufficiently high for two operations to be competitively maintained. The SCT also established that the concessions would be for fifty years with the option for an additional fifty-year extension. The operator would have exclusivity of its system for a thirty-year period, at which time alterations to the concession agreement could be made under certain conditions. In an effort to provide a level of support for native Mexican businesses and conscious of the need to maintain Mexican identity within the reengineered rail system, the majority owner of each of the concessions had to be a domestic Mexican company. The SCT settled on a plan to create four separate rail concessions, which very much resembled the service territories of the rail companies developed during the rule of Porfirio Díaz. The North-East Line would connect Laredo and Brownsville, Texas, to Monterrey and Mexico City. The twenty-five hundred miles of track would also connect Mexico City to the Gulf of Mexico Port of Veracruz and to the Pacific Ocean at the Port of Lázaro Cárdenas. It would also link the Port of Tampico on the Gulf to Aguascalientes via San Luis Potosí. The Pacific-North Line would connect Mexico City to Eagle Pass and El Paso, Texas; Nogales, Arizona; and Calexico, California. It would also connect to the Gulf ports of Tampico and Veracruz and the Pacific ports of Guaymas, Mazatlán, and Manzanillo. The South-East Line would operate between Mexico City and the Yucatán peninsula. Finally, the Terminal Railroad (Valley of Mexico) would operate in the Mexico City area and be jointly owned by the three other concession owners and a government entity that could also operate an urban passenger line. Almost all of the concession documents were prepared during the presidency of Carlos Salinas, but by the time that the bidding process was about to begin, Ernesto Zedillo (1994–2000) had become Mexico’s president, and Carlos Ruiz had been selected to be the head of the SCT.

T h e G a m e C h a n g e r 199

KCS Studies Its Options It was shortly after Mike Haverty joined KCSR in July 1994, when Carlos Ruiz sent Emilio Sacristán, an emissary of the Mexican government, to Kansas City to meet with Haverty and Landon Rowland. It was no secret that KCSI was contemplating the utilization of its partnership with TMM for a purpose far grander than just an investment in the Tex-Mex Railway. KCS needed a Mexican partner if it was to participate in the concession process, and that partner would be Grupo TMM. From the outset, it was a marriage of convenience devoid of love. Sacristán invited Rowland, Haverty, and their spouses to take a trip on a private rail car from Chihuahua to Los Mochis (Port of Topolabampo) through the Copper Canyon. The route was not chosen by chance. Not only was the scenery spectacular, the route over which the party traveled was over the one that Arthur Stilwell had attempted to build as part of his Kansas City, Mexico, and Orient Railroad. Sacristán’s objective was to entice as many US rail companies as possible into the concession sweepstakes, as competition would inevitably mean higher bids and a larger payday for Mexico. According to Haverty, the rail trip with Emilio Sacristán marked the turning point for KCS from interest to active participation.

KCS Leans toward Bidding on the Pacific-North Concession Having bought into the game, the next step for KCS and TMM was to undertake a thorough due diligence of the property they would bid on. Initially, the concession targeted was not the North-East Line but the PacificNorth. It was not that the partners were blind to the fact that the North-East Line was the superior property and that it was a better geographic fit. Still, KCS executives felt there was little to no chance that UP would let anyone but itself win the North-East concession. During the decades following the nationalization of the rail system, UP had become the dominant US railroad doing business in Mexico, and its primary interchange point was Laredo, Texas. With this history and a bountiful financial war chest, UP was the hands-down favorite to win the most prized concession. It just did not seem to make any sense for KCS to enter into a battle that it would surely lose; thus, KCS convinced TMM to concentrate on winning the Pacific-North concession.

200 V i s i o n a c c o m p l i s h e d

But there was one very large problem with that idea: the Pacific-North line did not go to Laredo. The Pacific-North’s US gateways would be in western Texas, Arizona, and California—areas that neither KCSR nor the Tex-Mex came anywhere close to touching. It was absurd to think that if UP won the North-East concession that it would be agreeable to providing the Pacific-North trackage rights so that it could interchange with the Tex-Mex at Laredo. There was no reason why it should. So TMM and KCS petitioned the SCT to include in the concession documents a provision that would permit the owner of the Pacific-North concession to be guaranteed trackage rights between Monterrey and Nuevo Laredo so that rail traffic could move between western Mexico and the primary US-Mexico gateway at Laredo, Texas, where it would be able to interchange with either the UP or the Tex-Mex. The argument was that doing so would spur competition, one of the goals of the privatization process. The SCT denied the request. There were a couple of logical reasons behind the denial. The SCT had already determined that the North-East Line would be the first concession put out to bid, and it feared that the forced trackage rights provision would lessen its value in the eyes of prospective bidders. The second probable reason for rejection was that the SCT wanted the KCS-TMM partnership to bid against the UP group for the North-East Line, not because the partnership was favored by the government but to drive up the bidding. If the SCT had rejected the trackage rights proposal to get KCS-TMM into a bidding war with UP, it got its wish. Since pursuing the Pacific-North concession without trackage rights over a segment of the North-East Line so that it could connect with the Tex-Mex made no sense, the partnership’s duediligence team concentrated its energies on studying the North-East Line, which served the areas representing 70 percent of Mexico’s gross national product and, of course, connected with the Tex-Mex at Laredo. During its first days the team dutifully went about its business, but with little expectation that their work would lead to a bid, much less a successful one. The group had two primary tasks: evaluate the state of the North-East Line’s physical infrastructure, including track, terminals, office facilities, locomotives and rolling stock, and study the existing freight markets, both in the areas directly served by the North-East Line and Mexican markets outside the parameter of the concession. The due-diligence team was also tasked with preparing a detailed estimate of the potential growth of the

T h e G a m e C h a n g e r 201

freight market particularly in light of the expectation of expanded NAFTAdriven cross-border trade. As expected, the findings were a mix of good and bad. On the positive side, what surprised the group the most was the superb condition of much of the main line track, which matched the quality of US Class I railroads and was superior to long stretches of KCSR’s. In truth, it was not all that surprising. Creating and maintaining good track had fit nicely into the model that had driven most of the economic decisions during the years of Mexico’s nationalized industries. The government encouraged its railroads to contract with steel companies to forge steel rails, cement companies to make rail ties and bridge supports, and stone companies to provide ballast. One nationalized industry would help another and so on. While all this led to cronyism, overspending, and poor productivity, it at least resulted in a generally well-constructed and well-maintained main line track network. The team also found that there were a sufficient number of sidings and that the spacing between them was generally good. The problem was that they were not long enough to handle long trains, as Mexico’s train lengths were typically shorter than those in the United States. The shorter lengths were a factor of weak traffic demand and labor rules that limited the number of locomotives allowed per train. Fewer locomotives per train meant shorter train lengths, which in turn meant more train starts and the hiring of additional labor. The system’s terminal, maintenance, and office facilities were found to be unsatisfactory and would need major renovations and upgrades. For the most part, the KCS-TMM team felt that many of the infrastructure improvements could be phased in over time with the exception of the central operations center in Monterrey, which needed immediate attention, as it would be the hub of the railroad’s operations, marketing, and finance. The condition of the railroad’s locomotives and freight cars was another problem. The locomotive fleet was old, underpowered, poorly maintained, and unreliable. The railcar fleet was ancient, decrepit, and for the most part worthy of one huge bad-order designation. A complete upgrade was needed and it would not be cheap. On the marketing side, the situation also told two different stories. On the negative side, over the last fifteen years the Mexican rail system had lost over half of its business to trucks due to poor service, lack of security, and failure to be price-competitive. Only 9 percent of Mexico’s freight traffic moved by rail, compared to over 30 percent in the United States. The good news was 202 V i s i o n a c c o m p l i s h e d

that shippers claimed that they would return to the railroad in a heartbeat if the service and security improved. It was believed that those two things alone, if provided, could bring back a good portion of the lost traffic even if rail rates remained higher than those of trucks. But what excited the partners the most was Mexico’s business growth potential. The North-East Line served the core of the emerging manufacturing hub that would serve North America, South America, and Asia. Between automotive manufacturing, iron and steel production, agriculture products, electronics, petroleum production, and the manufacture of every imaginable kind of consumer household good, Mexico’s potential economic growth was off the charts. The market analysis boosted the energy of the due-diligence team. The potential growth along the North-East Line dwarfed anything else on the continent. No longer was the group just “working through the process.” Still with scant feelings of optimism that victory was within reach, the KCSTMM partnership was more positive than ever that this was a battle worth fighting. The partnership did have some things working in its favor. TMM was an established, well-known, and generally respected company in Mexico with good contacts with government officials. Its chair, José “Pepe” Serrano, was a member of the prominent Segovia family, and social status meant a great deal to Mexico’s political and business elites. In addition, the leaders of the two companies, Serrano and Landon Rowland, were not afraid to take financial risks when they saw enticing opportunities. Though by nature more fiscally conservative than those two, Mike Haverty—probably more than anyone else connected to the project— understood the enormous financial opportunity implicit in a rail service that could connect the industrial heartland of Mexico to all major commercial markets in the United States and Canada. Thus, he joined Serrano and Rowland in the belief that the potential of the North-East concession justified an aggressive bid. The company’s contacts at its key primary bank, Morgan Stanley, agreed. Nelson Walsh was KCS’s direct contact; he and his boss, Jim Runde, supported the contention of Rowland and Haverty that the company should put together a meaningful offer for the concession. By early 1996, KCSI and TMM had begun the arduous work of drafting an investment contract in preparation of making a bid for the concession. The two companies had to work through myriad contentious issues involving the T h e G a m e C h a n g e r 203

rights of their respective ownership positions. Haverty called his longtime friend Jim Slattery, a lawyer at the Washington, DC, law firm Wiley, Rein & Fielding, and asked him to have the firm’s international lawyers review the working document. Slattery, a native Kansan and former US congressman, got the firm engaged in the review, and the result was that significant alterations were made to the draft, which helped KCS’s in-house counsel, Jay Nadlman, protect KCS’s legal position in the final contract. During this time there was another figure, one who remained quietly in the background. That person’s experience and extensive background in doing business in Mexico was instrumental in convincing the SCT to add one extremely important clause to the agreement that became crucial to the concession’s value. A banker by profession, Max Blanton, born in Panama, had been involved in a multitude of business transactions in Latin and South America. By the mid-1990s, he was serving as a key adviser to Nelson Walsh at Morgan Stanley. Max convinced the KCS-TMM partners that it was essential to add to the documents the stipulation that the concession owners would have the right to set trackage rights rates based on a calculation of what had been paid for the concession. So important was this clause that it became a make-or-break point in KCS’s decision whether or not to go forward with the bid process. While the SCT had rejected the KCS-TMM request for a Monterrey-to-Nuevo Laredo trackage rights provision for the Pacific-North concession, the Mexican regulators from the very beginning had included the concept of trackage rights as one of their guiding principles for the drafting of the original concession documents. The SCT wanted a level of competition among the Mexican railroads and trackage rights would be one way to assure that occurred. However, what Max Blanton feared was that if KCS-TMM failed to tie the cost of the concession to the setting of trackage rights rates, the SCT could at a future date arbitrarily impose low trackage rights rates to promote aggressive head-to-head competition. Such a situation would not only cost KCSTMM business within their concession territory; it would also significantly reduce the value of their investment. KCS executives, especially, felt it was vitally important to get this issue resolved at the outset. All parties involved in the bidding process knew that at some future date the owners of the North-East and Pacific-North concessions would have to negotiate an extensive set of trackage rights agreements,

204 V i s i o n a c c o m p l i s h e d

and the best way that the eventual owners could protect the value of their concessions was to have some semblance of guidelines for determining rates for another railroad using their tracks based on the value of the concession segments. This was a much bigger issue for KCS than it was for UP. If KCS-TMM were to win the North-East Line and there were no guidelines for determining trackage rights rates, what would stop the UP from investing in the less expensive Pacific-North line and then demanding low trackage rights rates over the North-East Line? Theoretically, that could give UP access to every US-Mexico gateway, a situation that would hurt KCS-TMM and also be far less than ideal for Mexican and US shippers who would be captive to neartotal monopolistic pricing. Max Blanton strongly recommended that KCS and TMM demand the adoption of the same method used in the United States for setting trackage rights, a method recognized and approved by the STB in which trackage rights rates are directly linked to the value of the corridor involved. What the KCS-TMM partners would be asking for was for the SCT to adopt the same framework, which was exactly what the partners did. The SCT, already leaning heavily on the advice and support of the STB while preparing the original concession documents, acquiesced by agreeing that the amount paid for the concession be considered in the calculation for setting trackage rights rates. It was an important victory. While arguments could still arise over a corridor’s value, this provision went a long way toward protecting the owners from being forced to accept low, arbitrarily set, rates. Naturally, the SCT’s desire to have KCS-TMM engaged in the bidding process was an additional inducement for including the trackage rights provision in the concession document. It seemed a small price for the SCT to pay, but the ramifications were huge for KCS and TMM. With hundreds of items to review, it was entirely possible that this issue could have been overlooked by the partners if not for Max Blanton, and KCS and TMM would have eventually paid dearly for their oversight.

How the Impossible Became Possible After completing its due diligence, the KCS-TMM team felt that the abundant market opportunities coupled with improved service would allow the North-East Line to regain 16 to 18 percent of the freight traffic in its service

T h e G a m e C h a n g e r 205

area and those numbers alone, even without extraordinary cross-border trade growth, supported an aggressive bid. It was now up to the company executives to get the firm backing of their boards of directors. For Pepe Serrano, this was pretty much just a formality, as he controlled over 90 percent of the voting shares of the TMM board. On the KCSI side, it was up to Landon Rowland and Mike Haverty to convince their directors that this was the proverbial “once in a lifetime” opportunity that could transform KCSR from being considered an afterthought by the major railroads—more of a regional line than a true Class I—into a key partner in an emerging North American north–south supply chain. With the acquisition of the North-East Line, KCSR would shift from being a company in imminent danger of losing as much as 25 percent of its revenues to the large railroads surrounding it, to becoming part of the fastest-growing rail network in North America. It was up to KCSI’s chief financial officer, Joe Monello, and the Morgan Stanley bankers to explain to the board how the company would finance its share of the investment and the short- and long-term financial returns that they might expect. All parties performed their parts flawlessly, and the board demonstrated its support by authorizing up to $2 billion for a bid to win Mexico’s crown jewel railroad. The board’s action was done with the highest level of secrecy. No financial analysts, journalists, or transportation professionals ever in their wildest dreams imagined that KCSI and TMM could make a bid anywhere in the vicinity of $1 billion, let alone $2 billion, but that actually played to the partners’ benefit. Better that the general feeling remain that while KCSI and KCSR could talk big, they were all hat and no spurs—at best a second- or third-rate threat to UP. It was in the partners’ best interest that no one else in the industry and financial world thought KCS-TMM had even a glimmer of a chance to win Mexico’s most valuable rail concession. Rumor had it that there could be as many as five bidders for the NorthEast Line. Grupo México, a mining company owned by one of the richest men in Mexico, Germán Larrea, appeared interested. UP had put together a partnership with Empresas ICA, Mexico’s largest construction company, and SBC. It was thought that Genessee & Wyoming was also exploring the possibility of extending their universe of short-line rail holdings into Mexico. The one western railroad curiously absent, or at least out of the public eye, was BNSF. Many in the transportation world felt BNSF could be a 206 V i s i o n a c c o m p l i s h e d

legitimate threat to UP taking the top prize. While it lacked a connection at Laredo, it was felt that this could be corrected, maybe even by purchasing the Tex-Mex. And, if BNSF was reluctant to engage in another bidding war with UP, there was always the Pacific-North Line, which in good part had been built by SF in the nineteenth century. BNSF could interchange directly with that concession. Maybe it was the memory of having SF’s Mexican railroad expropriated by the government in 1938, or maybe BNSF’s management was concentrating its full attention on merging its two railroads into one, but there seemed to be no interest being expressed in Fort Worth for the bid process. But that did not stop widespread speculation that a last-minute bid from BNSF could well be forthcoming. Then, all of a sudden, the slight glimmer of hope the KCS-TMM partners had of pulling off an upset began to shine just a little bit brighter. First, UP executives were clearly preoccupied with attaining regulatory approval of their merger with SP, and the process proved to be rockier than had been anticipated. Mike Haverty had stirred the pot; his well-considered, outspoken critique of the merger application had helped mobilize shippers and shipper organizations that were opposed to the combination. UP had remained confident that the merger would gain approval, but its executives could not for a second take anything for granted. They did not want to be forced to divest any of their lines, most certainly not to KCS. The UP-SP merger was the top priority in Omaha. The Mexican concession, while significant, was secondary. It was also possible that UP management felt it did not need to be totally engaged. UP had been a dominant transportation force in Mexico for decades and was certainly the odds-on favorite to win the concession. UP’s competition did not appear particularly threatening, certainly not KCS. UP had the customers, the contacts with Mexico-based shippers, the decades of experience dealing with the complexities of doing business in Mexico, and solid relations with government officials at all levels in multiple agencies. Everything seemed to be in place; maybe not having management’s lasersharp attention was not that serious a problem. But then, as Thanksgiving 1996 approached, a crack appeared in UP’s joint venture partnership when SBC abruptly dropped out of the partnership. Their reason for doing so was never publicly disclosed, but it is likely that consolidation activities within the telecom industry demanded management’s attention more than a possible railroad investment in Mexico. SBC’s T h e G a m e C h a n g e r 207

decision to back out was both a financial and psychological setback for the partnership. For UP executive management, it added another problem to a plate already full of frustratingly complex issues. It also boosted the growing optimism of KCS and TMM. All of a sudden, executives in Kansas City and Mexico City were projecting their chance of victory in the fifty-fifty range, even if still no one else in the transportation industry did. Something happened at UP over the Thanksgiving holiday. A fleet of UP corporate aircraft traveled down to Mexico and then shortly thereafter flew back. This suggested that executives held some last-minute high-level meetings at which some serious decisions were made. The bids were due to be submitted to the Mexican government soon after the Thanksgiving weekend, so it was initially thought the meetings might be nothing more than signing off on the bid. But why were so many corporate jets needed for a mere signoff? There was another possibility. A rumor was circulating that certain Mexican officials had gotten wind that the KCS-TMM partnership had put together a much higher bid than anyone had expected, something in the neighborhood of $1 billion. If this was true, how should UP react? Everything at the time was only speculation and still is today. However, KCS and TMM suspected that if UP-Empresas ICA determined that a substantially higher bid would be needed to secure winning the concession, it could pose a serious problem for UP. With its vast wealth, superb credit ratings, extraordinary banking relationships, and myriad Wall Street contacts, committing significantly more money to the bid package would not have been a serious financial problem for UP. But the same might not have been true for its partner. Empresas ICA had no interest or experience in operating a railroad and would gladly have ceded that responsibility to UP. What the construction company likely found more appealing, besides sharing in the profits generated from the rail venture, was the likelihood of obtaining lucrative construction contracts related to the necessary upgrading of the new railroads track and facilities infrastructure. But now as the majority owner, if it were to contribute 51 percent of a much higher bid, the financial calculus would be dramatically altered—and most definitely not in Empresas ICA’s favor. If, then, it balked at the idea of increasing their bid, UP would be stymied. The terms that the SCT had established for the bid process clearly stipulated that a Mexican company had to be the majority partner in any bid for one of the rail concessions. With SBC gone, that meant the UP could be no 208 V i s i o n a c c o m p l i s h e d

more than a 49 percent owner and its financial contribution would have to reflect that. TMM executives, especially, doubted that Empresas ICA had the stomach to invest a good deal more into what some still believed a speculative venture, and there was considerable thought in both Kansas City and Mexico City that UP’s Thanksgiving holiday trip to Mexico might well have been related to this dilemma. The worst-case scenario for UP—that their partnership bid would not win the North-East concession—had to have begun to look not all that bad. Even in defeat, UP would still have over 90 percent of the freight traffic coming in and out of Mexico over Laredo. Comparatively, the Tex-Mex would be no better than a secondary option; it, and KCSR, did not have UP’s vast rail network into the western and midwestern US markets. Plus, UP had long-standing contracts and relationships with Mexican shippers that made it unlikely there would be significant loss of business to the new KCS-TMM entity. True, losing the bid would mean that UP would not gain any revenues for the rail movements within Mexico over the North-East Line. But over time, adjustments could be made to contracts, making the US portion of the business the most lucrative part of the whole long-haul package. Moreover, UP would avoid the significant cost of bringing the Mexican railroad up to US operating standards, a responsibility that would fall directly on its shoulders rather than its partner’s. In addition, it would avoid the difficult job of creating a new Mexican railroad company that would meld seamlessly into their US operations. Given that UP was just in the initial phase of consolidating SP into its system, the thought of taking on two integrations at the same time—with one involving a railroad operating in another country—must have made a number of rail executives in Omaha uncomfortable. From this perspective, losing the Mexican revenues did not seem a very high price to pay. In the long run, even without the concession, UP’s Mexican business was secure. So as KCS and TMM put the final touches on their bid package, there was reason for the partners to be optimistic. An eleventh-hour surprise was always possible, but the team felt it had done all that it could. That alone was a source of some satisfaction. The bids were submitted to the SCT a few days after Thanksgiving and the winner was to be announced on December 6. An indication of KCS’s growing confidence was that it brought to Mexico City a reasonably large contingent of people. It was not huge, but joining Landon Rowland, Mike T h e G a m e C h a n g e r 209

Haverty, and Joe Monello were employees from sales and marketing, operations, communications, government affairs, investor relations, finance and accounting, and legal. As day turned into night, one could see the tension etched into the faces of the KCS people waiting for the announcement. The smiles seemed a bit forced, the expressions showing more bravado than confidence. One could sense doubt, a fear of possibly a very nasty, crushing surprise. It had happened to the company before. Too many times, actually, beginning when Arthur Stilwell had seemingly saved his railroad from receivership only to see his deal evaporate with the untimely death of his benefactor, George Pullman. Then three-quarters of a century later, KCS had put together the highest offer to buy the SP, only to see the deal go to a lower bidder. And in 1994, there was the embarrassing surprise at the hands of BN and SF. Then there was the realization that UP had always been KCSR’s chief adversary. With UP’s money and influence, and ambivalent feelings at best toward Mike Haverty, was this not a perfect moment to suffer another crushing blow? KCS had a little too much experience with snatching defeat from the jaws of victory to feel confident in these last few hours. Maybe bringing a contingent of people from Kansas City to Mexico City was not such a great idea after all. After what seemed like an eternity, the formal announcement was made. This time, there was no nasty surprise: the KCS-TMM partnership had won the North-East Line concession! Tension instantaneously turned into jubilation. The impossible had happened. Even though it was now official, it was still hard to believe. The transportation and financial worlds were stunned, not only that KCS was the victor but also by the size of the KCSR-TMM bid and the margin of victory. The KCS-TMM bid of $1.4 billion dwarfed the others. The next highest was not UP’s but that of Grupo México at $545 million. The UPEmpresas ICA bid was $527 million. According to SCT officials, two other prospective bidders had withdrawn their offers without explanation. Any embarrassment among the KCS contingent that the partnership’s bid had been excessive was quickly brushed away by three realizations. First, if the rumors of KCS-TMM’s bid in the $1 billion range had actually gotten out, and UP decided not to respond by increasing its financial commitment, it made sense that UP’s final bid would be low just to make the KCS-TMM bid look reckless and foolish. Second, the team had done its due diligence and felt very comfortable that the business case was solid and justified the 210 V i s i o n a c c o m p l i s h e d

$1.4 billion bid. The partnership was paying a high price, but it was confident that the bid reflected the value of the concession. Third and most important, KCS had won. The psychological impact of that was beyond calculation. KCSR, which until the very moment of the announcement had been considered by more than one self-proclaimed expert all but a dead railroad, barely moving, could now dream of a future in which it could become a formidable player in the North American logistics and supply chain. It was heady stuff for a company that only two years earlier had tried desperately to sell itself, and it could not even do that successfully. The feeling of complete and utter joy among the KCS people in Mexico City that night is impossible to describe. It was a multilevel high. Everyone felt a deep sense of personal achievement. Everyone’s contribution to the joint effort, whether large or small, was significant and necessary. It is one thing to know you have done your best, but it is a totally different thing to know you have done your best and won. Everyone in the KCS contingent had every right to feel great pride in themselves both individually and collectively. Then there was also the feeling of satisfaction that winning the bid for the Mexican rail concession meant that Arthur Stilwell’s dream of a railroad from Kansas City into Mexico had been realized. The KCS delegation in Mexico City felt an overwhelming sense of pride in knowing that they had played a role in realizing Stilwell’s vision. The celebration carried on long into the night. The next morning, bleary eyed but still happy, a number of KCS people met for breakfast in the hotel dining room. To a person, everyone was reading the initial press accounts and financial analysts’ write-ups. While there continued to be smiles around the table, there also appeared a recognition that this major victory was by no means an end unto itself. The path ahead would be long, difficult, and at times perilous, though no one could have imagined exactly how perilous it would eventually become. Some analysts immediately suggested that it was no slam dunk that KCS could get the funding to cover their portion of the $1.4 billion. Their opinions may have been colored by people in Mexico and the United States with vested interests in there being another victor and harboring a hope that financial markets would see the bid as reckless and deny KCS the funding necessary for it to remain a partner. But KCS and Morgan Stanley had done their work. With investors looking for ways to play NAFTA and Mexico’s economic potential, KCSI, with T h e G a m e C h a n g e r 211

its diversified companies, was a relatively safe way to get into an emerging market investment. With Morgan Stanley leading the issue, KCSI entered the market to sell two bonds totaling $475 million, plus a $594 million bank loan. Morgan Stanley had earlier arranged a bridge loan of $400 million when KCS and KCS and TFM submitted the initial acquisition proposal that required a fully financed bid. If anyone had any lingering thoughts of the deal falling through, those thoughts were dispelled within minutes as the offering was 2.5 times oversubscribed. Before turning to the next chapter of the Mexico saga, two items that would continue to directly connect the Mexican government financially to the North-East concession bear mentioning. First, as an enticement to prospective bidders, the government had included in the concession documents a provision that entitled the newly created rail entity to receive a value-added tax (VAT) refund. The concession papers spelled out in detail the particulars related to filing for the refund. The second item was that the government had decided to temporarily maintain a 20 percent ownership stake in the North-East concession. It wrote into the documents a put option, which gave it the right to monetize its ownership share within a two-year period after the commencement of commercial operation. While for reasons of simplicity, this narrative will continue to refer to TMM being a 51 percent owner of the concession and KCS a 49 percent owner, during the time that the Mexican government held its position, the effective ownership level of each was 40.8 percent and 39.2 percent, respectively. Both items would financially impact KCS and TMM. In the case of the VAT, any refund would be split proportionally between the owners. Similarly, when the Mexican government decided to put their 20 percent position to the partners, the financial obligation to pay would also be split proportionally. Neither of these items caused one moment of concern for the partners celebrating their victory that night of December 6, 1996, in Mexico City. But that would change.

212 V i s i o n a c c o m p l i s h e d

From KCSI to KCS; from TFM to KCSM

19

Considering the amount of planning, strategizing, politicking, due diligence, and sleepless nights that had gone into the campaign to win Mexico’s most valued rail concession, it would seem impossible that the next stages could be more complicated and fraught with tension than the bid process, but that proved to be the case. It had been understood, certainly by KCS at least, that getting the new railroad company up and running was going to be a complex and grueling job, but no one could have predicted that the process would also be replete with power struggles, distrust, deceit, plots, and subplots. Relationships of any kind, no matter whether personal or business, often begin with feelings of exuberance and near-boundless optimism, only to evolve into something quite different. Nothing can put a chill in a partnership more than cold, hard reality. Solid relationships usually manage to work through obstacles. Strong partnerships may come out looking different, but they survive. Flawed partnerships usually do not; in the case of KCS and TMM, partnership cracks had already appeared during the bid process. It did not take long for those cracks to become deep fissures. The unraveling began only a few days after the concession had been awarded and involved the naming of their jointly owned railroad. KCS agreed with TMM that the railroad should have a name that connected it to Mexico, but it rankled the US executives that TMM insisted on a name that was a near-mirror image of its own. Was it mere coincidence that the name TMM proposed, Transportación Ferroviaria Mexicana (TFM), had a similar ring to its own? KCS people certainly did not think so. It appeared to them like the majority owner wanted it clear that the subsidiary was clearly theirs. 213

A public spat over the name would have provided the Mexican media rich fodder with which to criticize the partnership, and KCS would likely not have fared well in the press accounts. So, KCS acquiesced to TMM’s choice of name for the railroad. However, Mike Haverty dug in his heels and insisted that the locomotives of the railroad be painted in the same color scheme as KCSR’s and that the lettering on the sides of the engines be in the same style as the US railroad’s. TMM agreed to this, but the early tiff foreshadowed a future in which every step in the process of getting TFM up and running, no matter how large or small, would be replete with drama and expose the deepening fractures in the partnership. The next issue involved the selection of a location for TFM’s headquarters. As with naming of the new railroad, negotiations began in agreement only to soon descend into acrimony. The partners agreed that TFM’s headquarters should be in Mexico City. Besides being the seat of Mexico’s government and location of the SCT, Mexico City was the location of many of the country’s prominent companies and subsidiaries of major US and other foreign firms. It made sense for TFM to be there, and it was also logical that TFM’s newly appointed president, former TMM executive Mario Mohar, should be located in Mexico City along with the railroad’s legal and government affairs staff and a small contingent of sales and marketing personnel. But when TMM suggested TFM be located in TMM’s headquarters, KCS reacted with strong disapproval. Being located in TMM’s headquarters building would place the new company completely in the shadow of its majority owner. It would be extremely difficult—impossible, really—for TFM management to maintain even a semblance of independence in a physical environment where the executives of its majority owner had desks a few feet down the hall while KCS executives were two thousand miles away. Already its name was strikingly similar to one of its owners; now its offices would be in the headquarters of that same owner? KCS felt that letting this happen would in effect be ceding full control of TFM to TMM. The issue rose to the highest ranks of both KCSI and KCSR. Mike Haverty, with the support of KCSI’s chair Paul Henson and CEO Landon Rowland, insisted that TFM be situated in a building separate from TMM, and preferably not in one nearby. KCS wanted the location to be on the west side of Mexico City along the highway to Toluca, as the airport in Toluca would be the one most frequently used by Kansas City–based

214 V i s i o n a c c o m p l i s h e d

executives flying in for meetings with TMM and TFM. This time KCS prevailed and TFM’s offices were located on the west side of Mexico City and remained there until 2005. However, neither partner walked away happy from the headquarters debate. The honeymoon was over; the collegiality between the partners after their unlikely victory only months earlier was gone, never to return. There was one point on which there was no disagreement and that was where TFM’s operations center should be located; only Monterrey, the hub of the railroad, made sense. KCS insisted that not only operations personnel but also the bulk of TFM’s sales and marketing should be housed there. Information technology (IT) and finance and accounting personnel should be located there as well. TMM wanted the finance and accounting department to be situated near them in Mexico City, but KCS again prevailed, arguing that it made no sense to separate that group from the rest of the principal departments. Some debate was had over who would have primary control of IT and whose operations and revenue management platform should be used. The truth was it hardly mattered; both KCSR’s and TMM’s systems were woefully outdated. As a stopgap until a more robust computer platform could be designed, the partners agreed to utilize the North-East Line’s ancient system, which was a slimmed-down version of UP’s Transportation Control System. The problem with that, in addition to being slow and functionally limited, was that having historical North-East Line customer and pricing data stored in Omaha by a subsidiary of UP was hardly ideal for a company that supposedly sought to interchange considerable freight with the TexMex at Laredo. If UP gained access to historical pricing data, such information could provide UP with a competitive advantage. No doubt cognizant of already having a superior competitive position in Mexico, UP decided accommodation was preferable to confrontation, and thus UP Technology worked out an agreement with the partners that provided for the privacy of the historical records stored at UP’s Omaha facility. Back in December 1996, right after being awarded the concession, the partners had boldly announced their intention to have TFM in full control of commercial rail operations by the summer of 1997. It was an ambitious goal given the enormity of what had to be done. As only one of the partners possessed railroad operating expertise, the responsibility for managing TFM’s start-up fell largely on the shoulders of KCSR. Being thinly staffed itself,

F r o m K C S I t o K C S ; f r o m T F M t o K C S M 215

KCSR could only afford to provide a handful of Kansas City–based personnel to the effort of getting TFM up and running, which led Mike Haverty to call on a number of his associates from his pre-KCS days to step in. Chris Aadnessen was named vice president of operations. Earlier in his career, Aadnessen had been an operating executive on the Western Pacific before it was folded into UP. He later joined the Kingsley Group, a respected transportation consulting firm. His railroad knowledge and experience, management skills, and calm-but-firm demeanor made him a perfect fit to work with and guide the Mexican workforce. While talented, the workforce needed a great deal of training if TFM was to approach US rail standards. Bill Lyman was selected to serve as vice president of transportation at TFM. Lyman had worked for Haverty at SF; like Aadnessen, he not only had an impressive background but also had a quiet and even temperament—again, an ideal quality for working with the TFM team. Two other former Haverty associates, Doug Sizemore and George Woodward, were brought on as consultants. Woodward possessed a wealth of useful data on historical trade patterns between the United States and Mexico, knowledge that would be invaluable in developing TFM’s sales and marketing strategies. Sizemore was a proven operations professional. The team had six months to put together a functioning railroad operation. The main line track was in good shape; however, everything else was an entirely different story. The locomotives and rolling stock were in deplorable condition. In the short term, TFM would have to make the best with what it had, bolstered by whatever KCSR could contribute and what equipment was available and affordable to be leased. There would have to be significant capital spending on equipment, but new locomotives and railcars would not be available for the summer kickoff. The labor issue proved to be more complicated than KCS had been led to believe. In developing the rail privatization process, the Mexican government had recognized that it would be unwise to make it the responsibility of the concession winners to negotiate large-scale workforce reductions and labor rule changes with the Mexican Transportation Workers Union. So daunting was the challenge of doing so, it might have limited the pool of bidders and would surely have reduced the price bidders would be willing to pay. Realizing it was in its own best interest, the government had declared it would take the lead in negotiating a set of new contracts with the rail union. Given what KCS rail veterans knew from long experience with labor negotiations, it came as a surprise, albeit a happy one, when Mexican government 216 V i s i o n a c c o m p l i s h e d

officials and top TMM executives reported that a new rail agreement had been quickly hammered out. Used to contentious management–union negotiations that often extended out for years, the KCS contingent had been startled that in an amazingly short period of time, Mexico’s rail union had agreed to massive labor force reductions in the neighborhood of 20 percent, meaningful changes to work rules, reduced crew size requirements, elimination of cabooses, and the closure of many unnecessary and poorly maintained yards and offices. In return, the Mexican government assumed responsibility for statutory severance payouts. Changes that might have taken a decade to accomplish in the United States were accomplished in a few months. At least, that was what appeared to be the case. The reality turned out to be something quite different. KCS had no representation in the negotiations. TMM claimed that the head of the Mexican Transportation Workers Union felt that the presence of US personnel in the meetings would slow things down and was unnecessary. KCS was assured by TMM representatives that everything had proceeded smoothly and to TFM’s great benefit. The first indications that all might not be what had been relayed to KCSR appeared in Monterrey, both inside the office and out in the yard. During the spring of 1997, while the North-East Line was still operating under government control, operations personnel from KCSR made regular visits to Monterrey to observe the progress being made toward an on-time start-up. What they found was a troubling lack of engagement from a large segment of the workers there. For four weeks in a row, KCS personnel looked out at the yard to see the same loaded train sitting idle while groups of union workers roamed aimlessly around the yard. Others wandered the halls, doing nothing but interfering with those who were trying their best to get TFM ready for commercial operation. There was no evidence that large-scale work rule changes or labor reductions were imminent. As troubling as these scenes were, the KCSR operations people mostly kept their criticisms to themselves. When they did bring them up, they were assured by their TMM and TFM counterparts that the process was playing out as planned. Given the overwhelming number of issues to be dealt with to meet the scheduled start-up date, the KCSR representatives decided it was best to accept the assurances at face value. The process of just trying to create an operation that at least approximated that of a US railroad was more than a full-time job. The last thing they needed was to spark a union confrontation that could delay the opening and sour the relationship between KCS and the F r o m K C S I t o K C S ; f r o m T F M t o K C S M 217

In June 1997, Transportación Ferroviaria Mexicana, S.A. de C.V. (TFM), jointly owned by KCS and TMM, began commercial operation and quickly became the most efficient freight rail service between the United States and Mexico.

Mexican government before TFM was even operational. So, the team put aside their labor concerns and plowed forward. Despite a long list of challenges, TFM began commercial operation on June 20, 1997, as had been planned. From a classic operations perspective, it was hardly a thing of beauty, certainly not smooth and efficient, and definitely not up to US Class I standards. Still, in six months TFM had gone from being nothing more than a name to being a functioning railroad. While its service was not stellar, it was superior to what had previously existed. The success of the TFM launch earned KCSR managers a measure of respect from Mexican train service personnel. Prior to the start-up, many of the workers quietly questioned the authority of the KCS team. There were no major conflicts and directions were mostly accepted, but there was an undercurrent of resentment and less-than-total buy-in to the training. Workers listened and were outwardly respectful, but their countenances suggested that they felt they already knew all they had to know about train operations. But when the trains started rolling under TFM control, it was clear that train and yard crews, as well as office personnel, were grateful, if sometimes a bit grudgingly, for the guidance and the assistance they received from US 218 V i s i o n a c c o m p l i s h e d

managers. The experienced railroaders guided them step by step through the first few days and weeks, and gradually confidence and pride replaced the initial confusion and uncertainty. Given the success of the launch, it was reasonable to hope that as TFM fell into a steady daily rhythm, the earlier animosity between the two partners would give way to a more cooperative spirit. That did not happen. Tensions surfaced as it became clear that KCSR executives and operating personnel had not received the full, unvarnished truth regarding the state of the rail union contract, particularly regarding employment levels. One example pretty much confirmed KCSR’s worst fears when an executive observed eight laborers working a switch, which under even the most generous of work rules would constitute an egregious misuse of labor. If this had been an isolated case, it could have been dealt with quietly. But it was not an isolated case; it was the norm. There were still too many workers wandering around the yards and company facilities doing little or no work. This was a problem and KCSR management saw it as a potentially serious one that went beyond the impact a bloated employee base would have on productivity and profitability. KCSR had publicly highlighted the impressive labor concessions agreed to by the Mexican Transportation Workers Union. Now, witnessing something totally at odds to what they had been told raised concerns among KCS executives that they had unknowingly provided the public misleading, perhaps false information. As KCS was a public company, this situation was intolerable and demanded immediate action. In no uncertain terms, Mike Haverty told Pepe Serrano that since KCSR had been barred from the negotiations with Mexican government officials and the union, TMM had to fix the problem and do it immediately. Neither the KCSR demand nor the TMM’s reaction was collegial; however, Serrano understood that the situation could blow up and damage not only KCS but also TMM and TFM. TMM did reengage with government and union officials; necessary changes were made, though reluctantly, to better align reality with what was being said publicly. While the labor problem was mostly resolved, the episode was yet another dagger to the heart of the partnership. Unfortunately, it had also tarnished for a time the relationship between KCSR and the head of the Mexican rail union. Despite the acrimonious brushups between its owners and the long list of operational shortcomings and infrastructure deficiencies, TFM was a success. The potential business opportunity was everything that KCS’s due diligence had suggested and more. Despite some disappointment that F r o m K C S I t o K C S ; f r o m T F M t o K C S M 219

the lack of adequate equipment and infrastructure meant that intermodal growth would lag initial projections, TFM’s owners were overjoyed with the greater-than-expected carload business. Even prior to TFM’s start-up, KCS had boasted to prospective investors and trade media that KCS, with its new US-Mexico rail service, had the opportunity to become North America’s fastest-growing rail system. It did not take long for the facts to start backing up the boasts. In the last couple of years of the 1990s, while Class I rail carloads in the United States were growing at a 3 percent clip, TFM carloads were averaging 12 percent annual growth. Except for a few stubborn skeptics, it was apparent that KCS’s great gamble—first investing in the little Tex-Mex and then taking the plunge into Mexico—had paid off handsomely. The company was no longer just an afterthought in the transportation industry. KCSR had caught people’s attention. Though still cash constrained, the railroad was now considered a legitimate participant in North American transportation and KCSI, its holding company, an exciting, growth-oriented investment opportunity.

Tensions Approach the Boiling Point The early success of TFM did nothing to improve the relationship between KCSR and TMM. If anything, it did the opposite. The partners did not trust each other. Personality clashes, cultural differences, disputes related to majority-minority status, and business and professional ethics conflicts all played into the erosion of trust. Still, as difficult as it would have been to keep the two companies working together indefinitely, it is possible that enlightened self-interest might have kept the partnership intact longer if not for one huge unsolvable problem: the KCS-TMM business model was fatally flawed. The flaw was not the fault of either partner but the result of a partnership that had been formed out of necessity rather than sound business strategy. The core problem was that while both wanted TFM to be successful, each company defined its success differently. For Mike Haverty, TFM, together with the Tex-Mex and KCSR, provided the opportunity for KCSR to have something it never had in its one-hundred-year history: revenues from longhaul traffic. Before TFM, KCSR’s average length of haul was less than five hundred miles. In addition, while KCSR either originated or terminated over 75 percent of its business, only a small percentage of the traffic was

220 V i s i o n a c c o m p l i s h e d

single-line haul. KCSR was primarily a short- and medium-haul railroad that interchanged with all the larger Class I carriers. Its short lengths of haul put limits on KCSR’s profitability. A combined TFM, Tex-Mex, and KCSR system would still mostly feed the railroads serving major markets. But instead of interchanging after a 300mile haul, the hauls could be 1,500, 2,000, and even 2,500 miles. Revenues and profitability would soar, and the operating ratios of all three railroads would improve. This was Haverty’s vision for success, and he felt strongly that the partnership should move in this direction. He wanted the combined system to provide shippers a legitimate competitive option to UP and reduce that railroad’s near monopoly of the traffic moving over the Laredo crossing. TMM did not see things the same way. The structural flaw at the heart of the business model was that it provided no incentive for TMM to buy into the KCS/Haverty vision. Except for the rather nominal amount it would receive from the Tex-Mex contribution, TMM would not benefit from freight moving north of the border on KCSR’s track. Worse still, in the eyes of TMM, working with KCSR would damage its good relationship with UP, and UP was TFM’s primary interchange partner. TMM was not comfortable with buying into a strategy that could push UP away from using the Laredo gateway. UP’s network and access to major markets were hugely larger than KCSR’s, which for TMM made UP a more attractive interchange partner for TFM than Tex-Mex–KCSR. There was no incentive for TMM to upset the status quo, as while KCS owned 49 percent of TFM, TMM owned zero percent of KCSR. Thus, while KCS benefited from the revenues of the TexMex and TFM, TMM received no direct financial benefit from increased business on KCSR. The small profit TMM would earn from increased traffic from Tex-Mex certainly would not justify damaging its relationship with UP. The schism between the two partners extended beyond financial issues. There was also the human factor. While TMM saw KCSR executives, particularly Mike Haverty, as combative, its relationship with UP was collegial with none of the sharp edges of a strained partnership. UP interchanging traffic with TFM at Laredo meant money to TMM without the hassles related to majority-minority status, long-term business objectives, or cultural or ethical differences. Put everything together—the distrust, personal animosities, and a flawed business model—and the result was a toxic partnership. It had taken less than a year of commercial operation for Haverty to realize that the only

F r o m K C S I t o K C S ; f r o m T F M t o K C S M 221

way that TFM would ever realize its true value was if it was fully owned and controlled by a single company. For a while it was unclear if Serrano felt the same. It was possible that the benefits of just being the majority owner were enough to compensate for the annoyance of having to put up with KCSR, for it had not taken long for it to become crystal clear that Haverty and KCSR executives could complain all they wanted, TMM was in the driver’s seat. As Mike Haverty often repeated, he had learned the hard way that it really did not matter if KCS owned 49 percent of TFM, 4.9 percent or .49 percent, TMM held the power. The partners were mostly able to hide their animosity from the public. What the partners were happy to share publicly was that both companies were benefiting from the concession. Though KCSR’s financial position was still a long way from where it ultimately had to be, it was improving, and its reputation within the transportation industry had been enhanced. KCS had created something unique: a single-line system linking Mexico’s manufacturing hub with interline connections to railroads serving every major North American market. Meanwhile, Pepe Serrano was leveraging the profits from TFM to expand TMM’s maritime shipping franchise, which was his company’s primary business line.

The KCSI Spin-Off KCSR’s parent company, KCSI, was also benefiting from TFM, though for it the benefit paled in comparison to the contribution it was receiving from its financial services investments. Mutual funds were on a historic roll in the United States and globally. One of the darlings of the industry was KCSI’s Janus Capital. From a small Denver-based family of funds, Janus had grown to be one of the giants, largely riding tech stocks to great heights. Its growth showed no signs of slowing down any time soon. In 1984, when KCSI began to move toward acquiring Janus, the mutual fund company had less than $500 million in assets under management. By the end of 1999, Janus had over $300 billion in assets. Investors were pouring money into Janus at record levels daily. The phenomenal growth of the mutual fund industry had also powered the impressive growth of another of KCSI subsidiary, DST. As the principal back-office processor of mutual fund accounts, DST was paid every time there was a mutual fund transaction, no matter whether it was for a buy or a

222 V i s i o n a c c o m p l i s h e d

sell. This was a dream scenario in an environment in which trading was hitting all-time highs. The money flowing in allowed the company to expand its operations and enter new markets diversifying its own portfolio of services. Between the excitement generated by KCSR-TFM and the extraordinary performance of its financial services division, KCSI stock had risen to record heights. It was KCSI’s success that led both the transportation and financial services divisions to agitate for its breakup. The reasons that had resulted in William Deramus III making his company-saving decision to create a diversified conglomerate were no longer relevant. The railroad industry had been freed from excessive regulation. While the “Railroad Renaissance”—a term often attributed to rail analyst Tony Hatch—was still a few years away, railroads had gotten through the worst of times and showed legitimate signs of renewed vitality. Mike Haverty and KCSR’s management had come to believe that while the railroad had benefited from KCSI’s cover in the past, in the future the holding company would be more of a hindrance than a help. While hardly flush with cash, KCSR was now ready and eager to make its own short- and long-range strategic decisions without interference from KCSI, which at times had objectives out of sync with those of the railroad. If the transportation services side was interested in gaining its independence, the financial services segment was desperate for it. In the dynamic world of mutual funds and related high growth-oriented businesses, railroads were viewed as “old technology.” To a new generation of financial services professionals, railroads were stable but boring. As investments, they had their place, but as capital-intensive companies, they were not viewed as engines of high growth. With price/earnings returns higher for financial companies than railroads it was understandable that Janus, Berger, DST, and the other companies on the financial services side wanted to soar unencumbered by the “shackles of an old tehnology.” There existed no animosity among the executives on either side of the holding company. KCSR management and its employees had benefited from KCSI’s stock performance and many on the financial services side felt an affection for the railroad and a respect for its history and culture. Tom McDonnell, DST’s chief executive officer and a disciple of Deramus III, never forgot the importance of his early connection to KCSR. Thus, the last years of KCSI were not beset by hostility or conflict. If anything, as KCSI

F r o m K C S I t o K C S ; f r o m T F M t o K C S M 223

entered the year 2000—a year that would see a major change in the holding company’s structure—feelings of excitement were mixed with nostalgia over the coming end of a forty-year adventure. On July 12, 2000, the financial services segment was spun off to shareholders. A new holding company, Stilwell Financial, was formed. Each KCSI shareholder of record received two shares of Stilwell Financial common stock for every one of KCSI that had been held. On the rail side, there was a reverse stock split in which shareholders of the former KCSI would receive one share of KCS stock (the new transportation services holding company) for every two shares of stock they had previously held. The reason for the one-for-two reverse split was an attempt to keep the railroad’s stock price as high as possible. At the time of the spin-off, the financial services segment represented 96.86 percent of the value of KCSI. That meant on a pure value basis, without a reverse split, the railroad stock would come out of the spin-off trading in the mid-single digits. The reverse split was intended to have the stock trading in the low double digits. The plan did not completely work as hoped. KCS stock came out of the chute trading at $5.38. A day after the spin-off, Mike Haverty and KCSR’s chief financial officer, Bob Berry, embarked on a cross-country roadshow to meet with institutional investment companies in an attempt to convince them to stay in the stock, buy more, or become new shareholders. At first, few seemed to see great advantage in supporting what appeared to be a fairly high-risk venture. While investors were intrigued with NAFTA, Mexico itself was a source of concern to many of them. Consequently, for a period of time, the stock languished in the single digits. Finally, in the fall of 2000, the stock began to recover, ending the year at $10.13. It was nothing to celebrate over, but at least it was a step in the right direction. But what if a shareholder had taken the Stilwell “dividend” received with the July 1, 2000, spin-off, reinvested it in the railroad, and then held it there until December 14, 2021? Some people did and, in so doing, earned a 44,000 percent return. Not bad for a railroad that a century earlier had been scornfully labeled “the Haywire.”

TMM in Crisis While all this was playing out in the United States, TMM was having its own adventure. It was not a happy one. With the start-up of TFM in June 1997, TMM had gone on an impressive roll. Money from the rail concession 224 V i s i o n a c c o m p l i s h e d

started pouring in, and TMM’s maritime shipping business was contributing healthy revenues as well. Financial institutions were more than willing to lend the company money, and Pepe Serrano was aggressive in going to the markets to finance the expansion of his maritime business. He seized the opportunity to buy two shipping lines: one Spanish, the other Colombian. At one point he even tried to convince KCS to join TMM in buying a Colombian railroad. Neither the opportunity to join TMM in another partnership arrangement nor the acquisition of a Colombian railroad appealed to Mike Haverty, who summarily dismissed the offer. The rejection did nothing to soothe the tensions between the two, but no matter. Serrano and TMM appeared to be riding a hot streak. And they were, until a TMM container ship docked in the Port of Manzanillo was found to be carrying a vast load of cocaine. The search had not been the result of either Mexican or US drug enforcement agencies having definitive evidence of possible involvement of TMM or Pepe Serrano in the movement of illicit drugs. Even so, the incident was an embarrassment and posed a serious problem to TMM—and by virtue of the partnership, for KCS as well. Under US law, if a US company is affiliated with a foreign company found guilty of being engaged in illegal drug trade, the US company, even if totally innocent or unaware of the illegal activity, is required to sever all involvement with that foreign company. The implications of this for KCS were, to say the very least, troubling. If Pepe Serrano or TMM were proven to be directly involved in the business of transporting illegal drugs, KCS would have to rid itself of its investment in the Tex-Mex and TFM. Under such a scenario, KCS would be lucky to get pennies on the dollar for its 49 percent interest in the joint venture. The blow to KCSR would be devastating to its reputation, growth prospects, and financial well-being. Fortunately, it never came to that. Investigations by both Mexican and US authorities failed to connect Serrano or TMM directly to Mexico’s drug trade. But, while absolved of any illegal drug activity, the discovery of drugs on TMM’s ships and the subsequent investigations did damage to Pepe Serrano’s reputation in Mexico, and to his company as well. The allegations had given reason for Mexican and US financial institutions to take a closer look at TMM’s finances. What they discovered was not good. TMM was overextended and bleeding cash. Their situation was made worse by an extended global slump in ocean shipping, the backbone of TMM’s business. Banks that had once been willing, even eager, to fund F r o m K C S I t o K C S ; f r o m T F M t o K C S M 225

Serrano’s expansion initiatives became leery of lending the company money. TMM was forced to shed its Spanish and Colombian shipping lines. Soon, the company had no alternative but to sell its fleet of container ships and concentrate solely on moving crude oil for Pemex on tankers. TMM’s exuberance of a few years earlier had been replaced by a desperate need for cash.

“Negotiations” Begin It was against this backdrop that Pepe Serrano and Mike Haverty met at the Michelangelo Hotel in New York City on January 27, 2002. At the meeting, Serrano agreed that Haverty was right: TFM should be owned by one company. He further agreed that with its rail operating expertise, KCS—not TMM—should be the owner. It was an amazing about face for Seranno considering that Haverty had suspected for some time that TMM had been plotting to take full control of the system. Negotiations to hammer out the particulars of a deal commenced soon after the New York meeting. However, one would be hard-pressed to describe what transpired over the next months as negotiations. TMM would lay out its conditions and KCS would summarily reject them. KCS would then counter with their proposals, which would be just as quickly dismissed by TMM. Pepe Serrano may have declared his willingness to sell his share of the Tex-Mex and TFM to KCS, but nothing in the discussions that followed suggested any interest in actually doing so. There was no give on either side, not totally surprising given the animosity between the principals and their companies. Tensions between Haverty and Serrano, which had been evident since 1996, hit rock bottom when Serrano, who had joined the KCS board after the original partnership between the companies had been signed, wrote a letter to his fellow directors advocating the dismissal of Haverty as KCSR’s chief executive officer. While the board quickly dismissed Serrano’s suggestion, the already-troubled relationship between the two grew into undisguised disdain. Their contempt for each other pervaded the negotiations and made any compromises next to impossible to imagine. For well over a year, the situation remained at a standstill. Then suddenly, and totally unexpectedly, in early April 2003, after fourteen months of fruitless exchanges, TMM signaled to KCS that it was prepared to, in substance, agree to KCS’s terms. From being dead in the water, the negotiations now moved at lightning speed, and on April 21, 2003, KCS

226 V i s i o n a c c o m p l i s h e d

and TMM signed an agreement to form a holding company, NAFTA Rail, headquartered in Kansas City and under the control of KCS. NAFTA Rail’s subsidiaries would include KCSR, TFM, and Mexrail, which was the holding company of Tex-Mex and the International Bridge at Laredo. TMM would receive $200 million and would also receive eighteen million shares of KCS equity. This was approximately 22 percent of the total shares outstanding, of which 20 percent would be voting shares and 2 percent would be subject to voting restrictions. In addition, TMM could receive an additional $100–$180 million as part of the VAT refund that TFM believed it was owed by the Mexican government under the terms of the concession agreement. The deal was structured as a merger. While the railroad would be under KCS control, TMM would have significant input into the selection of TFM’s management. Pepe Serrano and his nephew, Javier Segovia, would sit on NAFTA Rail’s board of directors. The Mexican press was not overjoyed with the announcement of the deal. An article in La Jornada focused on Serrano’s financial problems and claimed that his being up to his neck in debt was the reason for the sale. The article went on to predict that the deal would be approved as Serrano’s wife had a close relationship with the wife of President Vicente Fox, a testament to the power of social status in Mexico. El Universal claimed that calling the deal a merger was misleading. What really was happening, the article stated, was that a US company was buying a Mexican company and Mexico would no longer be the owner of its own railroad. The article claimed that this was just another bad thing to come to Mexico after ten years of NAFTA. The newspaper Reforma said that the sale of TFM meant that a US company would own the main railroad of the country with the strategic risks implicit in such a situation. The article went on to declare that the privatization plan had conceptualized strategic foreign investment, not foreign control. It, too, claimed the deal was the result of TMM’s desperate financial problems. It certainly seemed like TMM’s motivation to sell was the result of its dire financial needs, though future events suggested it was not quite so clear cut. Regardless of the motivation, there was a lot of work to be accomplished before the merger could be consummated. One major obstacle to overcome was that the majority owner of the concession had to be a Mexican company. If an exception was to be made it had to be approved by two Mexican government agencies: the Federal Competition Commission (COFECE) and the Foreign Investment Committee.

F r o m K C S I t o K C S ; f r o m T F M t o K C S M 227

TMM, with its high-level contacts within the Mexican government, took the lead role in seeking approval from the agencies. There was precedent for a US-based company gaining full ownership of a Mexican business, though the process in the case of a railroad concession was by no means straightforward. Still, with its contacts within the Mexican government, TMM expressed confidence that it could pave the way for KCS becoming the sole owner of TFM, minus the government’s 20 percent. KCS moved ahead with the process to gain the STB’s approval for its purchase of TMM’s ownership share of Mexrail. At the same time, KCS also worked with its bankers, with Morgan Stanley again being the lead bank, to obtain the financing necessary to complete the acquisition. The financing that made the most sense, given KCS’s credit rating and prevailing market conditions, was the offering of $200 million of Redeemable Cumulative Convertible Perpetual Preferred Stock. The net proceeds from the offering would be used to pay a portion of the purchase price for the controlling interest in TFM. If the acquisition was not completed, KCS would retain the cash from this financing for other corporate purposes. The financing went smoothly, and by May 2003, KCS had the funds in place to complete the acquisition.

VAT/Put Issues The acquisition agreement with TMM also had to consider two longstanding issues involving the Mexican government. As an inducement to get parties to bid on the North-East Line, the government had included in the concession documents a VAT refund provision. Mysteriously, the VAT provision had disappeared from later documents, and no VAT refund had ever been paid to TFM. However, TMM and KCS had copies of the original documentation and had already begun pressing the government to make good on the refund. Not surprisingly, this situation led to a legal battle with the government contending that it did not owe TFM a VAT refund and the partners saying it did, including interest and an inflation adjustment. By 2003, it was estimated that the VAT refund payment would be in the neighborhood of $800 million. The $100–$180 million payout to TMM in the acquisition agreement between KCS and TMM was conditional on TFM receiving the VAT refund payment. If and when there was a payout to TFM, TMM would receive a payment within the range noted in the acquisition agreement. 228 V i s i o n a c c o m p l i s h e d

The other major outstanding issue was related to TFM’s obligation to the Mexican government for a Put option on the government’s 20 percent ownership share of the concession. The original Put obligation stated that TFM, through its partners, must buy out the Mexican government’s ownership at a date set by the government within two years after the start-up of commercial operation. The two-year period had long passed, but due to a combination of delays caused by legal proceedings and the government’s willingness to give TFM more time to become financially stable, the government had not exercised the Put. The extra time had also allowed the value of the Put to increase and the Mexican government had recently declared its intention to start the Put process. This, too, had been considered in the preparation of the KCS-TMM acquisition agreement. Though the VAT/Put situation remained unresolved, the process leading up to closing on the NAFTA Rail appeared to be moving along as smoothly as could have been expected—in retrospect, maybe a little too smoothly. Then, in May 2003, about three months prior to the intended closing date of the acquisition, there came a hint that things might not be completely right. During the month, TMM defaulted on a $377 million obligation to its bondholders and other creditors, which led to TMM’s attempt to block its bondholders from exercising their legal rights in Mexico. Despite TMM’s pledge to meet its obligation to its bondholders and abide by its agreement to close the NAFTA Rail deal, Mike Haverty worried that a desperate TMM might be up to something. Still as the days passed, it seemed that his suspicions might be more a factor of his self-admitted paranoia than any fact-based concern. The process did seem to be moving toward a positive conclusion. KCS was assured by TMM that the approval of the two Mexican agencies, while not yet carved in stone, was in place leading TMM to declare that its board of directors would hold an August meeting to approve the acquisition transaction.

A Bit of Kabuki Theater Javier Segovia and Pepe Serrano assured KCS that the board meeting was really nothing but a perfunctory vote as Serrano, as chair of TMM’s board, had already pledged that as part of the acquisition agreement, he would recommend to the board members that they vote to approve the deal with KCS. Given that Serrano controlled over 90 percent of the voting shares of the TMM board, his vote would guarantee board approval. F r o m K C S I t o K C S ; f r o m T F M t o K C S M 229

Nevertheless, the board meeting raised Haverty’s antennae. He was aware that, by law, a company could not vote its shares on an acquisition without gaining prior written approval of the deal from the Mexican government. As of August, there still had been no formal approval announcement from the government. Members of KCS’s legal team, both external and internal, sought to convince Haverty that there was nothing to worry about. TMM claimed that the Mexican government had essentially already signed off on the transaction and would officially do so shortly after the TMM board vote. Counsel to KCS noted that the process had gone too far down the road, and the agreement was too ironclad, for there to be a last-minute surprise. On August 18, 2003, the TMM board gathered to vote on the transaction. The meeting began as orchestrated with Pepe Serrano recommending that the board approve the KCS/TMM transaction. Then the proceedings took a bizarre turn. After recommending the approval of the deal, Serrano called for the board vote. Serrano, with his controlling interest, voted “No” to the TMM approving the merger, thus killing the NAFTA Rail agreement. Afterward, with grim humor, KCS executives envisioned a scene in which Serrano stood at one podium as chief executive of TMM and recommended approval of the merger. Then Serrano hustled over to another podium, and as chair of the Grupo TMM board of directors, he voted the deal down. Any humor, even of the dark variety, was short lived and replaced by shock, frustration, embarrassment, and outrage. The TMM meeting had been an orchestrated farce meant to humiliate KCS. On one level, their staged production had succeeded. Over the past six years, largely because of its Mexican rail investment, KCS had gained the respect of transportation and logistics professionals, and its stock had become an interesting investment idea for growth-oriented investors. With TMM’s outrageous action, a good deal of that support evaporated. KCS stock did not crash but suffered a gradual, steady decline, losing about 14 percent of its value over the next forty days. KCS management was badly shaken not solely by the surprise, but that it had been the victim of a planned strategy to damage the company’s reputation. TMM’s carefully choreographed charade amounted to a declaration of war. The staged vote to reject the transaction could in no way be confused with a desire to return to a status quo situation in terms of the partnership. Whatever TMM had devised as a strategy going forward, its executives had no appreciation of the war they had set off. 230 V i s i o n a c c o m p l i s h e d

KCS Recovers Its Resolve Throughout its history, KCS had seldom backed away from a fight no matter what the odds. In Mike Haverty, the company had a leader with a take-noprisoners mentality, which was the perfect mindset to take into its public battle with TMM. In the immediate aftermath of the August 2003 debacle, Haverty could not be positive that KCS would eventually triumph, but on one point he was adamant: TMM would not walk away the winner. Vicente Corta, a partner at the law firm White & Case and KCS’s legal adviser in Mexico, summed up the company’s position: “After consulting with U.S. counsel, we have concluded that the contract between KCS and TMM to acquire Grupo TFM shares remains valid. We will pursue all legal means to protect KCS’ rights under that contract.” KCS had another thing in its favor: the acquisition agreement had been drafted under Delaware corporate law and included a provision for binding arbitration if there was a breakdown that could not be worked out amicably prior to the consummation of the transaction. On August 29, in accordance with the dispute resolution provisions of the acquisition agreement, KCS delivered to TMM a notice of dispute that triggered a sixty-day “informal” negotiation period between the partners. The sixty-day negotiation period was a procedural step more than anything else, as KCS did not believe for a second that TMM was about to negotiate in good faith. If no resolution was worked out within the period, KCS and TMM would then be subject to binding arbitration, which could extend another 120 days. Publicly, TMM presented an image of confidence that it would prevail in its plan to dismantle the acquisition agreement. It initiated a blistering attack painting KCS as an incompetently run company with deceitful management. It was clear that TMM had no intention of sitting down and talking to KCS. Only one meeting was held during the sixty-day informal negotiating period. Of all the adjectives that could be used to characterize the tenor of that single get-together, “amicable” was most assuredly not one of them. To this day, no one outside of the tight inner circle of TMM knows exactly what the company’s motivations were. At the time, transportation professionals, financial analysts, and journalists were all befuddled. TMM’s shareholders and bondholders were beyond befuddled; they were concerned and angry. TMM was playing a dangerous game with their money. There seemed to be a few possible explanations for TMM’s bizarre actions. One was that while negotiating with KCS, it had clandestinely been talking F r o m K C S I t o K C S ; f r o m T F M t o K C S M 231

with another prospective buyer of TMM’s ownership shares in TFM, and the negotiations with KCS were only to establish a base price for what the eventual buyer would have to pay. There was no evidence suggesting this had gone on, but at the time, suspicions were running high that this might be TMM’s game. Another possibility was linked to the ongoing VAT/Put issues between the Mexican government and TFM’s owners. KCS and TMM were engaged in a complicated legal process to settle the VAT dispute, which, hopefully, would be resolved with TFM receiving the refund. TMM led the legal charge, though KCS, in the person of Vicente Corta, was very much involved. While the Mexican legal process can be convoluted and, at certain levels, unpredictable, TMM was confident that ultimately the government would be forced to make good on its VAT commitment. Complicating the proceedings was what “making good” had come to mean in financial terms. With accrued interest and inflationary adjustments included, by the fall of 2003, the government was on the hook for a refund in the neighborhood of $1 billion. KCS management and its legal representatives were certain that TFM would never see a payment anywhere close to that amount. The assumption at KCS was that the Mexican government would find a way to free itself from a judgment of that magnitude. But TMM management and their legal representatives adamantly professed confidence that the full payment would be delivered to TFM. Adding to the complexity, and causing further animosity between the partners, was TMM’s claim that KCS was trying to grab the total $1 billion VAT refund for itself. The accusation was that KCS was conspiring with the Mexican government against TMM on the Put issue. The Mexican government was determined to Put its 20 percent ownership share to TFM and to that end had set a date of October 31, 2003, after which TFM would have sixty days to pay. The responsibility for covering the Put obligation would fall to the partners: 51 percent to be paid by TMM, 49 percent by KCS. The Put language stated that if one of the partners was unable to pay its share, the full obligation of the Put would fall to the other. On the brink of bankruptcy and with no chance of obtaining outside financing, there was no way that TMM could meet its obligation. Its creditors would surely have rebelled if it tried, and that almost certainly would have pushed the company into bankruptcy. To forestall paying the Put, TMM began a process intended to delay the government from proceeding

232 V i s i o n a c c o m p l i s h e d

by claiming that the government had not met the numerous procedural steps necessary to initiate the Put payment process and, in failing to do so, was not accurately calculating TFM’s true financial value. TMM filed suit in federal court. TMM was infuriated by KCS’s announcement that not only it was ready to meet its 49 percent obligation but also it had the financial wherewithal to cover the full amount of the Put if necessary. If this were to occur, TMM would forfeit its share of any VAT refund. TMM condemned KCS’s position, claiming that KCS’s intention to cover the Put was a betrayal of the partnership and represented a clear breach of the acquisition agreement, which included wording specific to the VAT and Put, and thus voided the contract. For its part, KCS contended it was doing nothing more than honoring the commitment it had made when signing the concession agreement; to do otherwise would jeopardize its position relative to both the concession and the acquisition agreement. What exactly did TMM hope to gain from its actions related to its Put obligation? At the top of the list was certainly a desire to protect its portion of the potential VAT refund. TMM’s 51 percent share on the $1 billion VAT refund would allow it to pay its share of the Put and still have about $180 million left over, which would give it greater negotiating flexibility with its bondholders and other creditors. This in turn leads to another possible reason that TMM had turned its back on its deal with KCS. Perhaps it felt, with close to $200 million in its pocket, it could restore its standing within the international financial community and somehow create a scenario in which TMM, not KCS, would become the 100 percent owner of TFM. It could then decide to run TFM itself, sell it outright to another railroad, or enter into a new partnership. Or perhaps TMM could renegotiate a much better deal for itself with KCS. It may very well have been the case that TMM felt its worst outcome was still selling its ownership shares to KCS but for substantially more money. TMM’s problem was that it needed a number of things to fall into place for it to have any chance of succeeding at whatever it had sought to accomplish. It needed its share of the VAT refund, and it needed to delay its Put obligation until after the VAT money was in its pocket. Finally, it had to get some indication that the dispute arbitration process would be sympathetic to TMM’s claims against KCS.

F r o m K C S I t o K C S ; f r o m T F M t o K C S M 233

The Tide Turns TMM would soon find out that a series of legal decisions were not supportive of their plan to slow down the VAT/Put process. Additionally, KCS had delivered a notice of dispute to TMM in late August 2003 and had also filed a complaint in the Delaware Court of Chancery seeking a preliminary injunction to preserve its full rights while KCS and TMM carried out the dispute resolution provisions provided for in the acquisition agreement. On October 22, 2003, Chancellor William B. Chandler III of the Delaware Court of Chancery, in a ruling from the bench, stated his intention to grant KCS’s motion seeking a preliminary injunction to preserve the status quo pending resolution of KCS’s dispute with TMM and TMM’s subsidiaries. In his ruling, which became official on November 4, Chandler stated he was issuing a written order enjoining TMM from taking any action in violation of the terms of the April 20, 2003, acquisition agreement pending resolution of the dispute between KCS and TMM. In accordance with the acquisition agreement provisions, if no resolution was reached after the sixty-day informal negotiation period that commenced on August 29, binding arbitration would begin in New York City and be governed under Delaware law and by the rules of the American Arbitration Association. The Delaware Court of Chancery’s ruling was a major victory for KCS. Chancellor Chandler’s opinion made it clear that any discussions in which TMM were to engage with any outside entity regarding possible TFM ownership or other matters pertaining to TFM, before the acquisition agreement expired on December 31, 2004, would constitute a breach of contract and be subject to legal action against the company. In other words, TMM risked serious legal jeopardy if it talked to any company about TFM ownership. The Delaware court ruling also assured KCS a fair and impartial ruling on the merits of its case through the binding arbitration process. The arbitration would be professional and held to the highest legal, professional, and ethical standards. Then on November 5, one day after the Delaware Court of Chancery’s official notification of the temporary injunction, TMM and KCS received notice that the Mexican Federal Court of the First Circuit was moving more quickly than anticipated regarding the VAT issue. The official decision did not come down until January 19, 2004. But when it did, it validated the

234 V i s i o n a c c o m p l i s h e d

claims of TFM and its owners by issuing a Special Certificate from the Mexican Federal Treasury in the amount of over $1 billion. Good news to be sure for cash-strapped TMM, but their joy proved to be extremely short lived. On the very next day, January 20, TFM was served with an official letter notifying it of the Mexican government’s findings and conclusions that the documentation provided by TFM in support of the VAT refund and depreciation of the concession title and assets reported in TFM’s 1997 tax returns did not comply with the formalities required by the applicable tax legislation. The government’s argument was suspect and there was a clear path for contesting it in court. Nevertheless, the government’s actions only served to further convince KCS management of what it already suspected: there was no way that Mexico was going to pay $1 billion out of its treasury. KCS’s position remained that the government would stall either until it was freed of its responsibility to pay the full VAT refund—or, more likely, until another option was conceived that would satisfy its obligation. It seemed obvious to KCS that another way had to be found to settle the VAT issue. By the spring of 2004, TMM had to be seriously reassessing its position regarding its rejection of the merger. The VAT/Put issues were still unresolved, and it was apparent, at least in terms of the VAT, no resolution could be expected soon. By 2004, the two began to be linked together and even referred to as “the VAT/Put issue.” Indeed, maybe linking the two made sense, and by doing so could possibly lead to a resolution. At the same time, the binding arbitration process, especially after the Delaware court’s grant of a temporary injunction to KCS, was not proceeding in the manner that TMM had expected. TMM had felt it could throw out enough accusations of KCS’s wrongdoing to convince the arbitrator that the acquisition agreement should be voided. TMM believed that that KCS would eventually decide that continuing to fight TMM in public battles that had now gone on for about a year was not worth the damage it was doing to its reputation. But TMM’s strategy, if that is what it could be called, had not borne any positive results. To the contrary, TMM’s wrists had been slapped by the Delaware Court of Chancery, which forbade it to do anything until after the arbitration ruling or the termination of the acquisition agreement contract at the end of 2004. And, even if the agreement did expire, where would that leave TMM? It would still have KCS as a partner, and if the partnership had

F r o m K C S I t o K C S ; f r o m T F M t o K C S M 235

been rocky before, it was hard to imagine what it would look like going forward. Plus, the whole world knowing that the partnership was toxic would cause serious problems for both companies. Its deteriorating financial condition, concerns over the VAT/Put disputes, and growing doubt over the outcome of binding arbitration had pushed TMM into a corner, and that finally led to a breakthrough in the impasse. With the state of its finances having reached a crisis point, TMM signaled to KCS that it was prepared to discuss a settlement. While no longer trusting anything that came out of TMM, KCS warily agreed to the overture. Rather than trying to settle everything with one agreement, KCS decided to start modestly by discussing a buyout of TMM’s ownership share of Mexrail. This would allow TMM to quickly receive a cash payout and thus keep its creditors at bay for a while longer. Negotiations were thus carried out along those lines. On August 15, 2004, KCS and TMM surprised the transportation world by announcing that they had reached a new agreement under which TFM would sell its 51 percent ownership of Mexrail to KCS for $32.7 million. The agreement also stated that KCS, on or before January 1, 2005, would repay TFM certain advances totaling approximately $9 million and assume TMM’s outstanding debt to TFM of about $400,000. Mexrail shares would be put into a voting trust pending STB approval of KCS’s petition to commonly control Mexrail, KCSR, and the Gateway Eastern Railway Company. Mike Haverty’s quote announcing the agreement left no doubt that something much bigger was in the works. “While the transaction does not have a direct impact on the pending TFM transaction, it is an important step forward. KCS has a valid contract with TMM to acquire TFM, and both KCS and TMM continue to work together to discharge their responsibilities under the contract. KCS still intends to acquire TFM.” In a press release dated November 29, 2004, KCS announced that the STB had approved KCS’s application to control the Tex-Mex and the US portion of the International Bridge at Laredo, Texas. The STB action allowed the controlling shares of Mexrail, which had been held in a voting trust, to be released to KCS. In the same release, KCS announced that counsel for TFM had been advised that the Fourth Collegial Tribunal for Administrative Matters for the First Circuit had sustained TFM’s complaint arising out of the failure of the Treasury of the Mexican Federation to adjust the VAT refund certificate issued to TFM to reflect interest and inflation. 236 V i s i o n a c c o m p l i s h e d

This was a major decision—a major victory, even. Still, it did not mean that TFM should expect a large check in the mail anytime soon. On the other hand, the decision did uphold TFM’s claim that it was legally entitled to a VAT refund. The Mexican government, through the SCT, continued to maintain that TFM had not properly supplied the required documentation in its 1997 tax filing, but there was no escaping the fact that a high Mexican court had concluded that the TFM claim of the refund was legal and justified. The Mexican government could not very well turn its back on its own legal system. Out of the public eye, two separate negotiations were now progressing rapidly. TMM had already concluded that really its only reasonable option was to strike a new deal with KCS. TMM’s bondholders had lost patience and the threat of drastic action had become real. They had been played off for some time by TMM’s claim that a VAT refund was coming relatively soon. It clearly was not, and the bondholders’ threats to bring the company down could no longer be ignored. TMM had to come up with money, and the fastest, cleanest, and really the only way to do that was through a new deal with KCS. While momentum had definitely swung in its direction, KCS was careful not to overplay its hand. While the desire to exact revenge was inviting, KCS did not want its hostile feelings toward TMM to jeopardize a deal that would give it full ownership of TFM. After the embarrassment of August 2003, KCS, more than ever, needed TFM and KCSR to be considered relevant in the transportation industry. It was one thing to want a pound of flesh after being publicly humiliated a year earlier. It was another to be reasonable and strike a new deal and get on with its future. KCS had its priorities in order. But there was one thing that for KCS was not negotiable. The agreement to form NAFTA Rail in 2003 had been a merger of two companies. While KCS would have been the dominant partner, TMM would not only have owned 22 percent of the company’s equity; it would also have had two seats on the board of directors and input into the management structure of TFM. That was not going to be the case in any new agreement—the board seats and any influence over management decisions were off the table. There would be no merger. KCS would only agree to buy out TMM and take full ownership. It would still pay a fair price, but TFM would become a subsidiary of KCS along with KCSR, Mexrail, and the other transportation holdings. There would be no NAFTA Rail. There would be no TMM involvement. F r o m K C S I t o K C S ; f r o m T F M t o K C S M 237

The VAT/PUT Swap Concurrently, high-level negotiations were taking place in Mexico City in an effort to resolve the VAT/Put issues. Now that TMM had resigned itself to forging a new TFM acquisition agreement with KCS, it no longer needed to hold out for a large VAT refund cash payout. Compensation could come through the new agreement. A breakthrough occurred when KCS’s legal representative, Vicente Corta, and Pepe Serrano were summoned to a private meeting with President Vicente Fox. Prior to the meeting, the parameters of a deal had already been hammered out during a series of meetings with high-level representatives of a number of Mexico’s federal agencies. The deal proposed would be in the form of a swap. TFM would relinquish its claim for a VAT refund. In return, the Mexican government would vacate the rights to its put and relinquish to TFM its 20 percent ownership. There would be no cash payment to any party under the settlement. President Fox stated his firm support for the swap, which was understandable considering the last thing he would want was to be the president who paid out $1 billion from Mexico’s treasury to a railroad owned by a US company. For KCS, a VAT/Put swap was the best possible outcome, given it never believed TFM would see a single peso of VAT refund money. Days after the meeting, Mexico’s Secretaries of Finance, SCT, and Public Function met and agreed that the swap should be consummated. This was another breakthrough; the SCT had previously not supported the swap concept, confident that ultimately the government could win the VAT controversy and also keep its Put to TFM. The parties began work on putting the agreement together, though cautioning the swap would not be officially completed until sometime in late in the year. With the guidelines for a final agreement in place, everyone was confident that the long, costly VAT/Put issue had been put to bed. Then on December 15, 2004, a joint press release from KCS and TMM announced that the boards of directors of both companies had agreed to the respective companies entering into an amended acquisition agreement. Under the new agreement, TMM would sell its 51 percent voting interest in TFM to KCS for $200 million in cash, 18 million shares of KCS common stock, $47 million in a two-year promissory note, and up to $110 million payable in a combination of cash and KCS common stock upon successful

238 V i s i o n a c c o m p l i s h e d

In 2005, KCS concluded its multiyear effort to buy out its Mexican partner’s position in TFM, thus becoming the sole owner of Mexico’s crown jewel rail concession. TFM was soon renamed Kansas City Southern de México (KCSM).

completion of the current proceedings related to the VAT claim and the Put with the Mexican government. There would be no NAFTA Rail and no TMM representation on the KCS board. Importantly, between the time of the announcement on December 16, 2004, and when the final transaction was to take place, KCS needed no further approvals from TMM’s board of directors. The TMM board had signed off on the amended acquisition agreement, and no additional input was needed from it. The deal became official on April 1, 2005. On that day, Mike Haverty stated, “TFM, Kansas City Southern Railway and the Texas Mexican Railway Company will now operate under common overall leadership, creating a seamless transportation system that spans the heart of North America.” On that day, too, Vicente Corta assumed the duties of TFM’s interim chief executive officer, a role he served with distinction but was happy to relinquish

F r o m K C S I t o K C S ; f r o m T F M t o K C S M 239

after an orderly transition to return to the practice of law for White & Case. Corta, a distinguished gentleman with a first-rate mind and wonderful sense of humor, held the respect of people on both sides of the border. In every conceivable way, this prominent Mexican lawyer reflected not only the best of his native country but also KCS. As Mike Haverty was to repeat countless times, without Vicente Corta, KCS would never have succeeded in acquiring the Mexican rail concession. On September 5, 2005, the VAT/Put swap became official, and wasting little time in putting its imprint on the ownership of the concession, on January 1, 2006, KCS changed the name of the railroad from TFM to Kansas City Southern de México, S.A. de C.V. (KCSM).

240 V i s i o n a c c o m p l i s h e d

KCS Turns a Page

20

Strangely enough, an argument can be made that on balance, the Great Recession, which began during the second half of 2007 and continued through the third quarter of 2009, ended up being a net positive for KCS. For all intents and purposes, from the time that George Edwards had become head of the railroad in 1991, through 2005, KCSR had run in high gear and was in an almost-constant state of change and tumult. The MidSouth acquisition, the fantasy of a BN-KCS transaction, the failed IC-KCS merger, the GWWR purchase, the investment in and rebuilding of the Panama Canal Railroad, the KCS-TMM partnership and Tex-Mex investment, the winning of the Mexican rail concession, the formation and start-up of TFM, the KCSI spin-off, the first agreement to buy out TMM, the drama surrounding the deal’s collapse, the second acquisition agreement that finally established KCS as the sole owner of KCSM, and finally the 2005 KCS-NS joint venture forming the Meridian Speedway—it was a lot for a medium-size company to digest in a ten-year period. Indeed, it was a lot for any company to process in such a short span of time. But just as an automobile’s engine will eventually break down if run at excessively high RPMs over a long period of time without proper maintenance, the same is true for humans pushed to their limits for years. By the later months of 2005, danger lights were flashing. After years of nonstop drama, pressure, and change, cracks had begun to appear throughout the company. KCS employees, especially management personnel, were close to running on empty. The most publicly visible breakdown came when the finance department missed the filing deadline for the company’s Form 10-K. KCS was forced to publicly disclose that during the preparation of the 2005 financial 241

statements, certain errors were identified in the calculation of the company’s deferred income tax balances that arose in the years prior to 2003. A material error was also identified in the 2005 income tax provision. These errors led to a material weakness, as disclosed to the SEC, in internal controls over financial reporting. KCS lacked sufficient personnel with adequate expertise in income tax accounting, effective reconciliation procedures related to income tax accounts, and sufficient oversight by management of the income tax accounting function. The errors resulted in KCS having to restate parts of its 2003 and 2005 financial statements. There were no bad guys in this story, as there was competence and commitment throughout the department’s ranks. But finance was the victim of neglect. It was not willful neglect, to be sure, but it was nonetheless present. The department was seriously understaffed: it needed personnel upgrades in key accounting, tax, and other areas, and it lacked the technological systems to support the company’s financial reporting efforts, to say nothing of providing useful financial data to other departments. The flow of information between departments was slow and often inaccurate. Finance personnel at all levels spent much of their time just trying to make sense of the numbers in front of them. This was a serious public embarrassment for KCS. But worse, investors had to wonder if the problems of the finance department were just the tip of the iceberg and if there might be serious problems running throughout the company.

“I Know a Guy You Should Talk To” While this situation was developing, Patrick Ottensmeyer was living in Lake Forest, Illinois, a northern suburb of Chicago; he had settled there while working for SF and then BNSF. Chicago had become home for the Ottensmeyer family after a period of multiple moves during the time he had advanced his investment banking career. Though he did not join SF until 1993, Ottensmeyer’s connection to the company dated back to 1987 when he served as lead banker during SF and SP’s $4.8 billion leveraged recapitalization. While that financial package was being put together, Pat met the man who was to become his mentor in the world of railroad finance, Dennis Springer. During his time at SF, Springer was widely acknowledged to be one of the leading lights in railroad finance. An intelligent and creative CFO, Springer 242 V i s i o n a c c o m p l i s h e d

was a central figure in SF surviving the dual disasters of the failed SF-SP merger and the ETSI pipeline lawsuit settlement. He crafted what became his company’s line of defense from any hostile takeover attempts, after SF and SP were forced to separate in 1978 by leading the restructuring of a massively leveraged holding company and sprawling conglomerate. The conglomerate at one time consisted of two Class I railroads, an oil and gas company, a refined pipeline products network, coal and natural gas resources, precious metals mining companies, and an extensive real estate portfolio. He performed this restructuring over an eight-year period through multiple refinancing at both the holding company and subsidiary levels, followed by IPOs of minority interests, in turn followed by tax-free spin-offs to SF-SP investors. Springer employed this model multiple times. After SP was sold, SF became a financially stable “pure play” railroad that was once again ready to assume a major role during railroad industry consolidation. Dennis Springer’s gift to KCS was that he hired Pat Ottensmeyer to work for him at SF and taught him everything he knew about railroad finance. The two were kindred spirits; both enjoyed the complexities of high-stakes financings and loved the railroad. During his time reporting to Springer, Ottensmeyer actually worked on the deal that would have provided the financing for a SF purchase of KCSR. After the BN-SF merger, Ottensmeyer became vice president of finance and treasurer of BNSF. His future at BNSF was secure. Rob Krebs, who became CEO of the merged companies, was a supporter. There was every reason to believe that Pat would play a central role in the finance department of BNSF for many years. The problem was that Ottensmeyer did not feel comfortable. “Somehow, when Santa Fe became part of a much larger company everything just seemed to slow down. I got the feeling that I’d get bored and frustrated with the bureaucracy.” Moving the family again was not appealing either. So rather than resettling in Fort Worth and working at a job that he feared would be neither professionally nor personally satisfying, he resigned and chose to remain in the Chicago area. Ottensmeyer’s early professional success had left him financially comfortable enough that he was in no hurry to jump into a new job just for the sake of a paycheck. He was certain that he did not want to return to investment banking. But other than that, he was unsure what he wanted to do next. He stayed active, investing in and working with a start-up company, taught finance classes at DePaul University, and spent time with his family. In prior years his professional responsibilities had necessitated long hours at work K C S T u r n s a P a g e 243

Patrick Ottensmeyer joined KCS in 2006 as the railroad’s executive vice president and chief financial officer, but that was only the beginning. A few years later, he became executive vice president of marketing and sales, then president in 2015, and finally, chief executive officer a year later.

and extensive travel; now what he wanted most was to devote more time to his three daughters. The next stage of his career, whatever that might end up being, could wait. Meanwhile at KCS, the financial reporting fiasco had left Mike Haverty with no alternative but to undertake a total restructuring and strengthening of his finance department, starting with the hiring of a strong chief financial officer with railroad experience. Having seen what Dennis Springer had accomplished at SF, Haverty’s first thought was to try and persuade him to join KCS. Though he respected Mike Haverty and felt KCS had real potential, after his long, illustrious career, retirement beckoned, and Dennis Springer was only too happy to yield to it. Without the slightest touch of regret, he turned down Mike’s offer but then added, “I know a guy you should talk to.” Little did Springer or Haverty know the impact that comment was destined to have on KCS’s future. As soon as Pat Ottensmeyer heard of the opening, he knew that this might be just the kind of opportunity that could pull him back into corporate life. He was already familiar with KCS based on his banking days and 244 V i s i o n a c c o m p l i s h e d

SF experiences. Without even having to review the company’s financials, he knew that it carried a heavy debt load, but compared to what SF had confronted, it seemed manageable. Like almost everyone else who had followed the company’s developments over the last few years, Ottensmeyer was intrigued by its Mexican rail investment and its prospects for business growth that were greater than the industry average. Then there was the company’s size, which was considerably smaller than the industry behemoths. To him, that meant two things. One, he would not have to deal with a bureaucracy. Two, he would have the opportunity to play a central role in its financial turnaround and growth, and he would likely be recognized for doing so. It seemed a perfect opportunity. Pat Ottensmeyer joined KCS in May 2006 as executive vice president and chief financial officer. He was given carte blanche to do whatever was necessary and spend whatever it took to turn the finance department around. He hit the ground running and brought in talent, who in turn brought in more talent. The department underwent an extensive reorganization. Working with his direct reports, Ottensmeyer began a long process of upgrading the financial data systems. Within six months, there were obvious improvements. Although far from perfect, overall, the department had resolved its reporting deficiencies and was operating more cohesively. Bringing in Pat Ottensmeyer had clearly been a good move and a sign that KCS had entered a new phase in which execution and performance efficiency, rather than a near-total preoccupation with survival, were the central objectives.

KCS Also Gets a New President No one was more aware than Mike Haverty that KCS was a work in progress. Even though finance had been the department with the most glaring deficiencies, operations, IT, and marketing and sales also needed major upgrades. Haverty was perceptive enough to realize he could not take on the development of the “new” KCS by himself. He needed a strong leader beside him, not a carbon copy of himself but someone who had his own set of strengths. A few years earlier, Haverty had asked Dave Starling, who he had actively supported to become PCRC’s president a few years earlier, to come to Kansas City and take on the position of president and chief operating officer. Dave had given it serious consideration but ultimately turned the offer down, primarily because he saw that Haverty was still very involved in both the K C S T u r n s a P a g e 245

day-to-day operations and the effort to integrate KCSM into the KCS system. Starling respected this but had felt at that point in time Mike Haverty should remain the sole, unquestioned leader of the company. So, Starling remained in Panama, and Haverty moved on to other candidates. But as 2007 ended, Haverty’s dissatisfaction with his company’s progress was growing stronger by the day. It was not the sudden decline in carloads and weakening revenues that bothered him, because those were obviously the result of weakening economic conditions. What really rankled him was the feeling that few within KCS really understood his vision of the company’s future. Pat Ottensmeyer got it, but he was still very new to KCS, and his hands were more than full with the finance department. Mike felt that the two key departments responsible for overall performance—operations and marketing and sales—were just not responding the way he felt they must. He had brought in established transportation people from larger organizations to address the problems in both departments, but it did not work out as he had hoped. Their failures were not due a lack of effort or competence but their inability to fit into KCS’s culture. KCS may have grown, but the core corporate culture still saw it as a scrappy company competing against larger railroads. KCS people did not want to be like the others in the industry. Yet Haverty had come to believe that some of his direct reports wanted to nudge the company’s personality more in the direction of the other Class I railroads. For those who were familiar with the myriad issues that had confronted KCS during the period 1994–2005, it was beyond debate that KCSR could not have survived as an independent Class I railroad if not for Mike Haverty. Haverty’s friends and staunchest allies were not the only people to understand he had saved KCSR. It was also the general belief of financial analysts, transportation professionals, journalists, and even his adversaries as well as those whom he had dealt with harshly or even fired. Mike Haverty not only had kept KCS independent but was also responsible for its expansion. Like Arthur Stilwell and William Deramus III, Michael Haverty was a visionary, strategic thinker, and builder. His primary motivation came from a burning ambition to be free of the constraints of conventional wisdom and build something unique, and he had accomplished that at KCS. But for him, the day-to-day management of a company was more a job than a passion. He desperately needed someone for whom the orderly, effective management of a complex, multidimensional organization was a challenge to be undertaken with the same passion that he had demonstrated in putting together KCSR 246 V i s i o n a c c o m p l i s h e d

One aspect of Mike Haverty’s campaign to strengthen KCS’s image was the redesign of the color scheme of the railroad’s locomotive and car fleet.

and KCSM. Haverty had made KCS a larger railroad; now he needed someone to run it in a way that was consistent with his vision and the company’s corporate culture. Fortunately for Haverty and KCS, Dave Starling was not only a shrewd and successful transportation executive, but he also had the ability to observe situations and decide whether he could step in and make a difference. If Haverty was a strategic thinker and builder, Starling was a creative, process-oriented planner. He was every bit as gifted and successful as Haverty had been in his areas of expertise. When Starling had turned down the KCS position a few years earlier, he knew Haverty was not yet prepared to cede authority; that was okay in Starling’s eyes. But now in 2008, he sensed that Mike was ready to step away from day-to-day management. Starling also knew that his disciple, Tom Kenna, was fully ready to succeed him as president of PCRC. Haverty had not considered reapproaching Starling, not out of stubbornness but respecting the situation for what he thought it was. But Pat Ottensmeyer had gotten wind that Dave would entertain another invitation to join KCS. At first Haverty was skeptical of the idea that Starling might have changed his mind, but after a brief call to Panama, he was surprised K C S T u r n s a P a g e 247

and pleased that this was in fact the case. A new offer was extended and this time it was accepted. On July 1, 2008, Dave Starling became president and chief operating officer of KCS. The agreement also broached the possibility of transition in a few years, as Haverty envisioned a time in which he would further relinquish executive management responsibilities. Behind Starling’s facade of a reserved, easygoing, polite southerner was an intelligent, competitive, results-driven businessman. Those who failed to notice were likely to suffer consequences. Starling was, in the most positive sense of the word, calculating. He thoroughly considered every action and directive and carefully thought out their consequences beforehand. Starling came to KCS with his eyes wide open. There were a number of problems demanding attention, and money to address them was tight. Only essential spending was allowed as company revenues were being decimated by an economic recession ransacking the vast majority of US companies. Dave Starling had also stepped into a situation in which the company resources, both financial and human, had been drained over the past decade and a half. The productivity of every department had fallen behind where it needed to be. Starling’s job was to fix things while cutting budgets. Although the two goals seemed mutually exclusive, that is exactly what he accomplished. Improbably, Starling was in a way helped by the recession, which brings us back to the opening sentence of this chapter. One of the problems with falling behind one’s competitors, a position in which KCS found itself in 2008, is that it is very hard to catch up, especially when the rest of the competition remains running at full speed. However, this is exactly where the Great Recession became almost a blessing in disguise for KCS. A company’s name or size did not matter; when the North American economy came to a screeching halt, nearly everyone went into a nosedive. Certainly, the railroads felt the pain. As painful as the business decline was, the recession bought KCS and Dave Starling time to strengthen its internal systems and improve its track and facilities infrastructure in the United States and Mexico. For a year and a half, KCS had the seeming luxury of not having to show outsized growth to Wall Street and investors. Growth was out of the question not just for KCS but for everybody. The recession gave the company the breathing space to address its internal deficiencies and prepare itself to be in a better position to compete when the economy improved. Starling took advantage of every day he was given to make sure that happened. 248 V i s i o n a c c o m p l i s h e d

He forced KCS managers to take zero-based budgeting seriously. Very seriously. KCS’s capital spend in 2008 was $576.5 million. In 2009, the first year he had control over the budget, KCS’s capital budget was slashed to $282.9 million. But Starling succeeded in convincing department heads that they were going to make KCS a better company, with him standing beside them and not over them. Also, these cuts, while hopefully temporary, were an essential step in the process. Without expressly stating it, Starling had reestablished a primary tenet of the company’s corporate culture: KCS employees can do more with less. Compared to other railroads, KCS had always been a modest spender, but that did not always translate into the company getting the best possible return on what it did spend. Starling led the effort for all departments to recalibrate how they spent their money: what was essential, what was important, what was nice to do but not necessary, what could be deferred, and what could be eliminated. It amounted to a cleansing exercise for the entire company. Introspection of this sort should be ongoing, but for years KCS managers had been beset by more immediate problems that took a majority of their attention. For once, KCS had the time to look inward rather than react to outside threats. And they now had the right person in charge to show them how to do it. While Starling had slashed capital spending, he committed more money to track projects than many financial analysts and large investors thought prudent during the recession. Starling understood their viewpoints but decided to take advantage of the limited earnings expectations for the company to make improvements. He rightly understood that no matter how much further he cut 2009 capital spending, corporate earnings were still not going to be pretty. The better play was to spend the limited dollars available to improve the network and be ready for the turnaround that both he and Haverty saw coming. Extensive segments of the network needed new rail, ties, and ballast. Track that was still in decent shape had to be ground and lubricated. At the same time, changes had to be made in the system control center to improve train scheduling. Starling looked at everything from the same perspective: improvements were given priority in terms of what would be their impact on handling growth in future traffic. Another area that cried out for serious attention was marketing and sales. Here the problems were a little more nuanced. Though conscious of the dire impact that the recession was having on business, Haverty and Starling were K C S T u r n s a P a g e 249

Dave Starling’s process-oriented management philosophy brought to KCS an operating discipline far beyond anything the railroad had experienced in its history, and that led to a run of exceptional operational and financial performance.

nonetheless frustrated by the department’s tepid reaction to the company’s expanded marketplace opportunities. No one expected revenues to be growing while businesses were pulling back their spending, but what bothered the two executives was that there seemed to be no urgency or desire for fundamental change in the way the department conducted its business. Haverty was particularly displeased with what he saw as a lack of commitment to expanding cross-border, single-line traffic using the expanded KCSR and KCSM network. While Starling saw the obvious value in longer-haul movements, he was willing to give that process more time. What he found unacceptable was marketing and sales’ continued failure to deliver reasonably accurate sales forecasts. To the process-oriented Starling, this failure was as serious as sin because it reduced his ability to achieve measurable efficiency improvements. How could he run a disciplined operation if he could not be confident of the revenue projections? How could he budget properly? How could he buy equipment, or even determine what equipment types were most needed? How could he hire or layoff? How could he select what infrastructure projects should be given priority? The problem was a combination of personnel and technology. Too many of the department’s personnel, in both the United States and Mexico, were still mostly order-takers. Customers came to them. There was still a reluctance to seek out opportunities and get thorough knowledge and understanding of the markets being served. As one executive put it, the sales force would in effect walk the tracks and throw stones to either side of the tracks. If a rock hit a facility, it was a potential customer. Few looked beyond that for opportunities. Both Haverty and Starling felt marketing and sales needed someone to motivate the sales staff to seize the opportunities that KCS’s expanded landscape provided. Marketing and sales also lacked a disciplined approach to forecasting, which was made worse by not having adequate computer-based analytical tools to help organize customer data and facilitate the process of developing realistic, fact-based forecasts. Too often, forecasts were developed that were primarily intended to bring smiles to the faces of top executives rather than giving a legitimate estimate of what could reasonably be expected in the year ahead. Starling made it clear that neither he nor anyone else in executive management would attack business groups for delivering less-than-spectacular growth forecasts if they were based on solid market analyses. He drilled

K C S T u r n s a P a g e 251

into sales and marketing personnel in the United States and Mexico that it would be better to provide measured, well-thought-out forecasts than to provide management with inflated projections that would inevitably result in inaccurate budgeting, poor allocation of equipment resources, and inefficient train scheduling, which combined would ultimately be a drag on productivity and profitability. A prime example of this could be seen in KCSR’s operating ratios, which were persistently and substantially higher than the average of its Class I peers. The justification given was that the higher operating ratios were the result of the shorter length of hauls (less revenues) and more interchanges (more expense) than the larger railroads. While valid to a point, this did not tell the complete story. The multitude of functions that comprised the railroad were not in sync: network infrastructure limitations, inadequate computer systems, and a lack of employee focus on accuracy and efficiency weighed on performance. Starling, in his calm but forceful way, made it clear that this was going to change. The company had already begun to address the need for change by bringing in Pat Ottensmeyer to overhaul finance. It was time for a similar change in marketing and sales. What was needed was an individual to drive a systematic, in-depth study of the company’s US and Mexican markets and then develop a realistic long-term plan to serve those markets. At the same time, the person would also have to develop a legitimate forecasting methodology that would benefit company planning and resource allocation rather than being a drag on it. It would not be easy to find the right individual—not because of a lack of highly qualified marketing executives in the transportation industry but because it would be difficult to find someone with the personality qualities that were a good fit with KCS’s corporate culture. Past recruitment of established professionals from larger railroads had met with limited success at best. The company had learned from experience that it was difficult for highlevel transportation professionals to step into a situation where they would not have the staff and technology support that they had taken for granted in their prior employment. In most cases, the results had been disappointing, leaving the company and executives frustrated and dissatisfied. In this case, the solution came out of left field—and, in the end, it was perfect.

252 V i s i o n a c c o m p l i s h e d

The Double Switch Generally, in the hierarchies of public corporations, the chief financial officer position is ranked a smidge higher than chief marketing officer simply because everything runs through the finance department in one form or another. The CFO not only has to be in control of his own department but also must be familiar with the inner workings of all departments, particularly marketing, IT, and operations. In addition, the CFO has frequent interaction with Wall Street power brokers and the company’s institutional investors. It is a hugely complex job, especially at a public company of moderate to large size. The point is, seldom does a CFO choose to give up his elevated position to become head of marketing. Putting aside any possible change in status, the two jobs require separate skill sets and different personality traits. Finance and marketing are two very different worlds. Pat Ottensmeyer possessed something ingrained in all of KCS’s most successful executives, beginning with Arthur Stilwell: the ability to think outside the box and embrace the unconventional. In his brief time as CFO, he had already done a great deal to correct many of the finance department’s most serious shortcomings and put it on a path of improvement in terms of both quality of personnel and the introduction of more sophisticated systems. There was still a good deal more to be done, but it was obvious the department had turned a corner. His position was secure; he was a respected member of executive management. Ottensmeyer had embraced the culture of the company with ease, as it so closely mirrored his own character and drive to succeed. He shared Mike Haverty’s enthusiasm for what KCS could and should become, as well as Dave Starling’s intuitive understanding of the organizational changes necessary for the company to get there. Like Haverty and Starling, Ottensmeyer was also ambitious but motivated less by personal financial gain than the satisfaction that came with building something special. Ottensmeyer understood he had a good job and likely could keep it for as long as he wanted. But scarcely two years after joining KCS, he could not rid himself of the feeling that he could play an even larger role in the company’s future. At this point in time, Ottensmeyer felt that marketing was at the epicenter of KCS’s future growth, and he was challenged by the thought of what it would be like to be responsible for the department achieving the kind of

K C S T u r n s a P a g e 253

growth and success that Haverty and a handful of others thought possible. This was one time, he thought, when directing marketing and sales could be a step up the corporate ladder. That would not always be the case, but this was a unique time in the company’s history. For at least the next few years, marketing and sales would be the principal driver of the company’s success. He was not blind to the obvious: he lacked formal marketing experience. On the other hand, he trusted his intelligence, his ability to be a fast learner, and his facility for working cooperatively and productively with others. He also knew that he would have people around him, most notably Haverty and Starling, who both respected him and would have a vested interest in his success. Ottensmeyer felt his people skills, his understanding of the importance of profitability and how it was most efficiently achieved, his ability to put deals together, and his sense of employees’ motivations could more than compensate for his lack of marketing experience. Moreover, his knowledge of the company, along with his experience developing financial forecasts at SF and during his years in corporate banking, would be valuable in designing a practical, comprehensive forecasting methodology for marketing and sales’ personnel. Besides having the respect of the company’s two highest ranking executives, Ottensmeyer thought he just might have another card to play if he decided to pursue the head marketing position. KCS’s record of elevating its own people to executive management positions was hardly stellar. In many cases, the decision to hire from outside the company was simply a reflection of how thinly staffed the company was and the shallowness of its talent pool. Ottensmeyer felt KCS’s abysmal record of promoting from within could, ironically, work to his benefit. He began to formulate a plan that would result with two employees taking on new executive responsibilities, one of whom being himself. In 2007 Ottensmeyer met Mike Upchurch, a former Sprint executive, and quickly realized that he would be an excellent addition to KCS’s finance department. At the time Pat had no position that would persuade Upchurch to join KCS. Mike eventually took another position in the Kansas City area but soon realized that it was not quite what he expected it to be. In early 2008, Ottensmeyer and Upchurch met again and this time their discussion led to an offer for Mike to become senior vice president of financial management and purchasing. The position was still not commensurate with his talent and experience; however, Upchurch had done his research and knew that

254 V i s i o n a c c o m p l i s h e d

KCS was considered one of the hottest ideas in the transportation industry. He accepted the position and joined the railroad in March 2008. Now, only six months later, as Ottensmeyer found himself plotting a longshot attempt to change careers within the company, he thought that just maybe, Mike Upchurch could help him pull it off. He knew that Upchurch possessed the right accounting background and management skills to be chief financial officer at KCS. Pat also thought that it would be a significant corporate statement if two executive positions were filled by insiders. After giving it some final thought and floating the idea to one of his confidants, Ottensmeyer decided to move on his plan. He approached his boss, Dave Starling, with his proposal to have Mike Upchurch become CFO and he to become head of marketing. Starling was not just Pat’s boss, but over the course of a few years the two had become friends. That being said, Starling never let friendship stand in the way of making logical, practical decisions. Friendship alone was not enough to make a decision of this magnitude. Initially, he was more surprised than dismissive of Ottensmeyer’s proposal. He had been caught off guard and could not quite see Pat as head of marketing, which was completely understandable given his CFO’s lack of experience in that area. Starling also did not know Upchurch well, noting the latter was still new to the company and had come from a totally different industry. Finally, because he had joined KCS only three months earlier, Starling knew it would be a bold and risky move for him to support such a proposal so early in his tenure. Nevertheless, if there was anyone who understood the appeal of dramatic changes in career paths, it was Dave Starling. Every move he had made, from railroading to intermodal terminal operations to ocean shipping to running a start-up railroad in Panama, had come with risks and the challenges of learning totally new skill sets. Along the way, people had seen things in Dave that had convinced them he could handle and succeed in positions for which he had little or no prior experience. Starling saw the same quality in Pat Ottensmeyer and so he agreed to at least bring the proposal to Mike Haverty. However, the expression on his face left little room for Ottensmeyer to be optimistic. Haverty rejected the idea, but it was not a “slam the door in your face” kind of rejection. Mike liked Pat and felt he was probably the best public face of KCS to investors. Starling laid out both the merits and the limitations of the moves. While not a hard sell, it was a fair and balanced presentation of

K C S T u r n s a P a g e 255

all sides. It was enough for Mike to say he wanted a little time before giving the “double switch” his final rejection. The final rejection never came. While Ottensmeyer would have a steep learning curve, Haverty and Starling both decided he was up to the challenge. Plus, both of the top executives had enough confidence in themselves to think that they could help him succeed. Also, they knew Pat understood profitability and the capital intensity of the business, as well as the importance of producing strong, sustained returns on investment. Haverty and Starling felt that marketing and sales employees would benefit from having a leader with that perspective. Moreover, he would instill a more disciplined approach to pricing and could lead the development of a more systematic, refined forecasting process. Furthermore, Pat Ottensmeyer embodied KCS’s corporate culture and values and had already proven his commitment to the company’s success. Finally, his selection would be a perfect example of the kind of unconventional thinking and decision-making that had characterized KCS for over a century. So, on October 16, 2008, Pat Ottensmeyer became executive vice president of marketing and sales, and Mike Upchurch was named executive vice president and chief financial officer. If one was to judge the decision by the early returns, one might suggest that perhaps in this instance a more conventional approach might have been the more prudent course. The sales numbers and financial results were definitely moving in the wrong direction. While full-year carloads were down only 2 percent from the year before, on a quarterly basis they were tracking in the wrong direction; down 1 percent in the third quarter and 8.4 percent in the fourth. The trend continued in the first half of 2009, with KCSR carloads declining 17 percent and revenues down by 27 percent. But the numbers did not tell the whole story. No one could have produced decent numbers in the 2008–2009 economy.

Forced to Refinance If anything, the economic conditions posed a greater challenge to Mike Upchurch than they did for Pat Ottensmeyer. KCS had 7.5 percent senior notes coming due in June 2009. Under normal circumstances this would have raised nary an eyebrow on Wall Street. It was still eight months away and the heavily asset-based rail industry rarely had any trouble accessing debt markets. But these were not normal times, and KCS’s heavy debt load had resulted in the company carrying a noninvestment-grade rating from 256 V i s i o n a c c o m p l i s h e d

the three largest rating agencies. By December 2008, the debt markets had all but closed to noninvestment-grade companies. Upchurch and others at KCS, along with its lead investment bank, argued that there was no need for concern; the market would remain open to the company. Their argument was to wait until a time closer to June 2009, feeling market conditions would likely improve by then. But Wall Street was in deep panic mode, and both the company’s debt and equity investors feared the worst. Financial analysts raised the issue of a possible default on the notes, which could possibly lead to bankruptcy and likely would put the railroad in play. In early December, a key investor bluntly told Upchurch not to worry about the absurdly high interest rate that the company would be saddled with by refinancing with the market at its lowest point in many years. “JUST GET IT DONE!” he advised. The investor was right in one respect: getting the refinancing done would allay investor panic, which showed no signs of abating on its own. KCS had to provide tangible proof that the debt market was open to it, no matter what the cost. So, on what turned out to be the worst debt market day during the recession, KCS undertook the refinancing of its 2009 senior notes. It was expensive—very expensive. On December 18, 2008, KCS issued $190 million of 13 percent senior notes at a discount to par giving it a yield to maturity of 16.5 percent. The proceeds were used to repurchase the 7.5 percent senior notes due in March 2009. Upchurch and KCS had been correct in thinking that the debt market would be open to them and also had been right in feeling the market would improve, as it did in a matter of weeks. At the same time, investors had been justified in their concern, as only one other noninvestment-grade company, a utility, was able to access the market during the depths of the financial crisis. If for a second Mike Upchurch felt he could relax and exhale, he was badly mistaken. The company would soon face another potentially catastrophic financing crisis that, if anything, was more serious than the first. With the recession still raging on and taking a harsh toll on its revenues, KCSM was in real danger of defaulting on its $200 million revolver, which was essentially a line of credit used to fund capital spending needs such as payroll. If that was not bad enough, the KCSM revolver had cross defaults that could throw KCS’s entire corporate debt into default, necessitating a complete refinancing. While KCS management had been confident in being able to secure $190 million in December, having to refinance debt in the neighborhood of $2 billion was another matter. With its noninvestment-grade rating, it was K C S T u r n s a P a g e 257

doubtful that the debt market would be readily approachable. In that case, bankruptcy had to be considered as a possibility. Additionally, the prospect of refinancing was made even more daunting in that it concerned the company’s Mexican subsidiary. Nevertheless, Upchurch and his finance team pressed ahead and succeeded in completing the refinancing. But again, it did not come cheap. On March 3, 2009, KCSM issued $200 million of 12.5 percent senior unsecured notes at a discount to par with a yield to maturity of 13.75 percent, using the proceeds to pay off the revolver. From October 2008 through March 2009, KCS stock price fell from $55 per share to $12.62, with the company’s market cap declining from $5 billion to $1.2 billion. Strangely enough, rather than being depressed, the morale in both marketing and finance was better than it had been in many years. The employees in both departments felt that although the numbers were not yet showing it, at long last KCS was on the right track. And it was. In between putting out fires, the two executives had upgraded their departments. Ottensmeyer worked diligently to foster stronger relationships between marketing and sales personnel of KCSR and KCSM, driving home the benefits of promoting a combined network. He took a deep dive into each business unit to evaluate the strengths and limitations of their market opportunities and the people performing the day-to-day activities. Though KCS was not yet where it had to be, Ottensmeyer was getting the point across in the departments that forecasting future carloads and revenues was not a necessary evil of their jobs but a central component of the company’s success going forward. Mike Upchurch continued to bring talent to finance. He was helped by an increased available talent pool in the Kansas City area, the result of recession-related situations at a number of prominent companies. He took full advantage, recruiting people who might not have been available a few years earlier. With his revamped team, Upchurch managed wide-ranging data systems redesigns and the introduction of desperately needed accounting technology upgrades. While he could do precious little to make the numbers look better, he oversaw a remarkable effort to improve financial reporting accuracy and timeliness. Under him, the finance department’s personnel began to communicate more frequently with employees in all other key functional departments and provide them with the useful, up-to-date information they needed.

258 V i s i o n a c c o m p l i s h e d

KCS came out of the Great Recession stronger in many ways than it had been when the economic collapse hit in 2007. However, it would be completely inaccurate and unfair to attribute this success to just a few individuals. It was a company-wide effort that involved every department and employee in the United States and Mexico. Even so, in light of what was accomplished, three people stand out. All three assumed their positions at seemingly the worst of possible times. One of them took over a position in an area where he had no prior experience. Another had an impressive background in his field but absolutely no railroad or transportation industry experience. And yet both Pat Ottensmeyer and Mike Upchurch had succeeded and had set the stage for better days ahead for their departments. And then there was Dave Starling. His stewardship during the bleak days of the nation’s economic crisis was inspiring. He had accomplished the seemingly impossible by simultaneously slashing budgets and boosting employee morale. Through his determined leadership, Starling had gotten the message across that when the economy rebounded, KCS would be ready to achieve more than it ever had before in its history. With the help of Pat Ottensmeyer, Mike Upchurch, and the more than six thousand employees of KCSR and KCSM, the company proved to be more than ready.

K C S T u r n s a P a g e 259

KCS Looks to the Future

21

When the economy finally turned positive, KCS was indeed ready. The recession’s harsh impacts had been underscored by every Class I railroad recording substantially lower carloads, revenues, and operating incomes. KCS had not escaped the carnage, but its turnaround, which began during the second half of 2009, validated what Haverty, Starling, and Ottensmeyer had been saying publicly for some time: that KCS would begin to differentiate itself from the other railroads once the economy improved. KCS’s recovery did come sooner and more robustly than it did for its Class I peers. By the end of 2010, KCS indexed growth in carloads, revenues and operating income had surpassed its immediate prerecession levels. The story was most definitely not the same for the rest of the industry. Average carload and revenue growth for the Class Is, excluding KCS, were not to reach prerecession levels until a full year later. Moreover, the statistical disparity in growth between KCS and the other Class Is in three key growth indicators—carloads, revenues, and operating income—continued annually through 2017. The financial markets responded accordingly. KCS stock price, which had fallen to as low as $12.62 on April 1, 2009, climbed to $47.86 by the end of 2010 and to $68.01 by year-end 2011, sending the company’s market cap above $7 billion. The change in the company’s debt profile proved to be even more dramatic. After surviving two potentially catastrophic debt defaults, KCS executives, with the full endorsement of the board of directors, established the attainment of investment-grade ratings as a primary corporate goal. Some within the financial community did not share the company’s commitment to this objective. They felt that while investment-grade status would be nice, it was not really necessary. Their position was that financial markets 261

were again wide open, rates were coming down, and KCS should concentrate its energies on growth and not mimic the more conservative financial approaches of the railroads who did not share KCS’s robust growth outlook. But KCS executives, who had sat in front-row seats watching the financial community’s panic as the debt markets fell into a deep freeze, thought otherwise. Investment-grade status might not be absolutely necessary immediately following the recession, but management had learned the hard way that economic trends are cyclical and there would come a day when the debt markets would again be less hospitable to noninvestment-grade companies, and KCS should never again find itself in the position it had been in from 2008–2009. Not only was obtaining an investment-grade rating prudent financial management, it was also indicative of a management team and company that was in a position to think and plan for the long term rather than being forced to put out fires whenever the economic winds changed direction. Mike Upchurch led the effort. He became a frequent visitor to the offices of Moody’s and Standard & Poor’s, a fact that that did not go unnoticed at the rating agencies. While his persistence alone was not going to be enough to move the company’s rating, it kept KCS on the radar of the two largest rating agencies. But Upchurch and his financial team did not wait for a major ratings upgrade to begin restructuring the company’s debt profile. He received executive management and board approval to enter the debt market to refinance some of KCS’s higher-cost debt both for reasons of sound financial management and in the belief that lowering KCS’s interest expense would be another arrow in his quiver when trying to convince the rating agencies that it was time for an upgrade. Throughout 2011 and 2012, Upchurch and his team redeemed and refinanced company debt and by the end of the year had since 2009 overseen the reduction of KCS’s debt by $372 million, thereby reducing its annual pretax interest expense by $73 million. The rating agencies had taken full notice. In March 2013, Standard & Poor’s upgraded the debt and corporate credit of KCS, KCSR, and KCSM to investment grade. A month later, Moody’s upgraded KCSM’s debt to investment grade. These 2013 actions—together with Fitch’s previous investmentgrade ratings of KCS, KCSR, and KCSM and Moody’s similar rating of KCS and KCSR in 2012—marked the first time in over a decade that KCS and its subsidiaries earned investment-grade ratings from all three top credit rating agencies. The last time that happened was in 2000, when KCS spun off the 262 V i s i o n a c c o m p l i s h e d

financial services companies. It was an enormously significant development for a company that only five years earlier had been facing extreme financial pressure from all sides. The finance team wasted no time before it turned the emotional high into additional financial gains. KCS leveraged its new credit rating designation with the interest rate environment to complete a series of successful debt offerings. In April and May 2013, KCSM and KCSR raised $1.2 billion in concurrent offerings of seven-, ten-, and thirty-year bonds at a weighted average of 3.35 percent. Proceeds were used to redeem outstanding bonds with higher interest rates and to purchase equipment that had previously been under expensive operating leases. In October, KCSM and KCSR raised $450 million in concurrent offerings, which were used to retire approximately $100 million of higher coupon debt and purchase equipment that had been under operating leases. The proceeds were also employed to purchase replacement equipment when certain operating leases expired. During 2013, KCS also used cash to redeem approximately $100 million of KCSM’s 12.5 percent senior notes that it had taken on in 2009 to protect itself from defaulting on its revolver. The financing activities carried out during 2013 resulted in KCS creating a debt portfolio with the lowest average interest rate among Class I railroads. The financial markets had been waiting for clear evidence that KCS had the wherewithal to solidify its financial status, and now they had it. Finance was not the only department on a roll. With the US economy in full recovery mode, marketing and sales, under Pat Ottensmeyer’s direction, was producing strong results throughout a diverse spectrum of its business units. KCSM’s automotive business had recovered from the deep recession-induced slump, and growth in KCS’s cross-border grain traffic was positioning the agriculture & minerals unit as one of the company’s core business strengths. The movement of grain shuttle trains from Illinois to central Mexico comprised the longest single-line hauls of the railroad and represented exactly what Mike Haverty had projected the combined system could offer. KCS’s chemical & petroleum business unit gained strength as the Texas and Louisiana Gulf Coast had grown into the largest centralized crude refining region area in the world, making KCS strategically well positioned for expansive growth in this business unit in the decades ahead. Frack drilling in Texas and the emergence of oil drilling in Canada also provided new business opportunities. In addition, there was growing momentum in Mexico to open up the energy markets to foreign investment, something that K C S L o o k s t o t h e F u t u r e 263

had been prohibited since the 1930s when the country’s petroleum industry had been nationalized. The Port of Lázaro Cárdenas, solely rail-served by KCSM, was expanding; APM Terminals, a subsidiary of Maersk, was building a facility. Along with a Hutchison facility, Lázaro Cárdenas was growing into an important North American container port, along with its bulk-handling capacity. Revenues in 2010 grew 23 percent. A year later, the trend continued with 2011 revenues increasing 16 percent. Eleven years after the spin-off of the financial services companies and six years after gaining full ownership of the Mexican rail concession, the new KCS had officially arrived. This was also reflected by the improved state of the physical plants for both KCSR and KCSM. Dave Starling had never taken his eyes off the essential need of improving the combined railroad’s infrastructure. Forced to slash capital spending by 51 percent in 2009 from $576.5 million to $292 million, the railroad’s rapid recovery allowed him to allocate $600 million to capital projects in 2013. Major track upgrades were undertaken in the Gulf region to support emerging energy opportunities, and the upgrading of track on the GWWR took place associated with the opening of a new grain facility in Jackson, Illinois. In Mexico, track improvements were made between Monterrey and Nuevo Laredo allowing for train speeds of sixty-eight miles per hour. Starling also green-lit a multiyear project to build a new yard in Sánchez that would replace a small, outdated facility in Nuevo Laredo. He also approved upgrades to facilities in Salinas Victoria and Interpuerto yards to support growing intermodal traffic. To bolster its fleet, KCS purchased 150 Auto-Max and trilevel rail cars to support its expanding automotive business, and 450 jumbo grain hoppers to handle growth in that area as well. With its growing commitment to intermodal growth, KCS, again spearheaded by Dave Starling, committed capital resources to expand and modernize its Wylie, Texas facility, making it a state-of-the-art intermodal center serving the Dallas market. In 2016, the Wylie intermodal facility was renamed the David Starling Yard. While operating ratios are the result of the performance of multiple departments and legions of employees, Starling’s handling of the company’s operating expense reductions, management restructuring, and profitability enhancements resulted in KCS recording stunning improvement in its operating ratio (OR) during the period 2010–2016. In 2009, the final year of the Great Recession, KCS recorded an operating ratio of 82.0 percent, placing it

264 V i s i o n a c c o m p l i s h e d

KCS Adjusted Operating Ratio* David Starling’s Tenure 2008 - 2016

85% 80% 75% 70% 65% 60%

2008

2009

2010

2011

2012

2013

2014

2015

2016

*Non-GAAP financial measure; all reconciliations to GAAP can be found in KCS investors' material

at the low end of Class I rail performance. By the end of 2010, KCS’s OR had improved to 73.2 percent, nearly a nine-point drop. The improvement did not stop there. Improving annually, by the end of 2015, Dave Starling’s final full year as CEO, KCS’s adjusted operating ratio came in at a rail-industry best of 66.4 percent. From 2010 through 2015, the collective efforts of all KCS departments in the United States and Mexico had resulted in an OR improvement of slightly greater than fifteen points.

A Time for Change Dave Starling had been appointed chief executive officer on July 1, 2010. The transfer of leadership, planned for some time, had marked the end of a remarkable run for Mike Haverty. Though he had not become CEO until the railroad had entered its 108th year, no one before or after him better exemplified the spirit, culture, and soul of KCS than Mike Haverty. It was as if everything in his fifty years of life leading up to his arrival in Kansas City was scripted to make him exactly the leader KCSR needed at that moment in its history. It was perfectly fitting that the person with the strength, determination, and skill to complete Arthur Stilwell’s vision of building a railroad

K C S L o o k s t o t h e F u t u r e 265

from Kansas City to Mexico, terminating at a port on the Pacific Ocean, was Haverty. The two men will forever stand side by side in ways that far transcend their business achievements. Arthur Stilwell set the stage for the creation of a one-of-a-kind railroad, and Mike Haverty finished the job of putting it together. Fortunately, Haverty, unlike Stilwell, got to leave on his own terms. While he would stay on for a period as a board member, Mike had been comfortable turning over the reins of the company to Dave Starling, who in every way imaginable had proven himself ready to take on the challenge. On balance, the years 2010–2015 were good ones for KCS. Starling, in his role as CEO, and Pat Ottensmeyer as head of marketing, made a concerted effort to reach out to the other Class I rail executives, expressing a willingness to work with all of them. For the first time in its history, KCS found itself in the position where it could negotiate agreements with the other railroads from a position of equal strength. For decades, the larger railroads had looked down at KCS, thinking of it as a regional railroad with a Class I designation, and most negotiations reflected that bias. The results, more often than not, were that negotiations ended in failure with bitterness felt on all sides. Now, with full control of the Mexican concession and with betterthan-average industry growth in most of its business units, KCS was able to negotiate from a position of parity. The message Starling and Ottensmeyer stressed was that there was plenty of business for everyone to profit and KCS was eager to work collaboratively with others to maximize the potential of US-Mexican rail business. During the years of Starling’s tenure as CEO, employees gained an elevated sense of empowerment, renewed energy, and enthusiasm. The pool of excellent talent in every department of KCSR and KCSM grew deeper than ever before. Employees were given expanded opportunities to not only progress within their departments but also explore opportunities in other areas of the company. The cross-fertilization of talent among departments, which had been exceedingly rare at KCS, promoted greater unity and interdepartmental communication and cooperation. In addition, KCSM employees were brought to Kansas City, with many taking permanent positions at KCS headquarters and others returning to KCSM with meaningful new contacts north of the border and a better understanding of the KCS corporate culture. Similarly, KCSR employees gained greater appreciation of their KCSM counterparts.

266 V i s i o n a c c o m p l i s h e d

Entering 2014, Dave Starling started to think that the time for a change, both for the company and himself, was approaching. He had accomplished much of what he set out to do when he arrived in 2008. He had brought a much-needed, process-oriented methodology to the company’s management from the top down. He also brought greater stability to employees who, for too long, had felt the pressure of the possible loss of their company’s independence. In addition, while the recession had been an unwelcome surprise, Starling was able to use it to promote his personal agenda and strengthen the railroad’s primary departments: operations, finance, marketing and sales, and IT. Of course, there was still much more that needed to be done. Then again, there would always be more that needed doing. Increasingly, Starling came to feel that KCS’s future would be just fine, maybe even better, in others’ hands. Starling decided the time for a change was near at hand. However, always the process-driven manager, he was not about to simply declare his intention to retire and leave it to others to seek his replacement. While he had no desire to dictatorially choose his successor, he wanted to ensure the management methodology he had implanted at KCS would drive the selection and would continue to be central to company decision-making. To that end, Starling had numerous discussions with KCS’s board chair Bob Druten. The two agreed that the next leader would have to embrace technological change and encourage its acceptance into all phases of the company’s operations. A part of railroading would always be steel wheels on steel rails, and that was a good thing. But the twenty-first-century railroad industry would look markedly different in some fundamental ways, and the changes would come soon. Positive train control (PTC) was a perfect example. PTC had been forced down the throats of the Class I railroads in the wake of a tragic rail collision in Los Angeles between a freight train and a commuter train. Reacting to intense public pressure, Congress passed legislation mandating the implementation of technological safeguards to prevent collisions. While railroads were not in a position to overturn the mandate, they made it abundantly clear that almost no one in the industry supported the concept or legislation. The technology needed to implement PTC did not even exist. The railroads argued that PTC was a huge money pit, and rail safety could be better handled by the railroads themselves rather than through legislative mandates from people who understood neither railroad safety nor technology. One

K C S L o o k s t o t h e F u t u r e 267

rail executive after another decried what they saw was a multibillion-dollar waste of money that would net their companies little, if any, benefit and have negligible impact on improving safety. In truth, the PTC mandate had been somewhat ill thought out, and to a degree that was unfairly punitive for Class I railroad companies saddled with paying for the development of the technology, its installation, and its rollout. At the same time, the majority of rail executives failed to grasp the bigger picture. Technology was transforming their industry, as was true for virtually all major industries. Future generations of railroaders would have an entirely different relationship with technology than previous generations could have ever imagined. Maybe it was KCS’s long history of being open to the exploration of unconventional paths, but more than a few people at KCS, most notably Pat Ottensmeyer, understood this. In the spirit of embracing innovation, Starling, Druten, and the board agreed that the next CEO at KCS must promote technology, including PTC. Further, spurred on by Ottensmeyer and fully supported by Starling and the board of directors, a commitment was made that KCS would be an energetic participant in seeking possible applications of PTC technology to other areas of railroad operations. But in order for KCS to assume a leadership role in such an endeavor, it would need a CEO with expansive vision. It was also acknowledged that the next leader should be politically savvy. This realization actually came more than a year before dramatic changes in the US political landscape would occur. At the time, the primary motivation for wanting an individual comfortable working within a complex political environment was the knowledge that in 2018 there would be a presidential election in Mexico, and early indications suggested that there could be a seismic shift in the look of the Mexican government. KCS would be best served by doing everything it could to ensure the continued independence of KCSM if there were to be significant changes in the Mexican government’s political and economic policies. That meant having someone in charge who understood the importance of pursuing political relationships and positioning the company as an ally to whichever party was in power. Of course, engagement with investors, financial analysts, and bankers would not diminish; if anything, it was more likely to become an even greater responsibility of the chief executive going forward. As recently as twenty years earlier, only two transportation analysts had actively followed KCS. By 2014, that number had swelled to the midtwenties, with others 268 V i s i o n a c c o m p l i s h e d

expressing interest in picking up coverage. In addition, KCS never stopped being the subject of possible takeover speculation. Gaining full ownership of the Mexican concession and its abundant growth opportunities had only served to increase rumors. The company needed a person who would engage with the financial community and be able to straddle the line between convincing investors and potential investors that KCS’s value was greater as an independent railroad than if it was consumed by a larger entity, while at the same time stating the company position that management and the board of directors would always do what was in the best interest of investors. Both statements would have to come across as being credible, which meant having someone comfortable working with multiple financial audiences, from hard-driving hedge fund managers to long-only blue bloods. The new CEO would have to carry on the company’s energized pursuit of business partnerships with other railroads and transportation companies that Dave Starling had initiated. At the same time, the person would also need to have a bit of Mike Haverty’s and Dave Starling’s cautious skepticism. KCS was still smaller than the rest of the railroad companies. Even though it had earned the respect of other executives, it still did not have all the resources, financial or otherwise, that others had. The CEO would have to be sophisticated enough to protect the franchise and not give away too much to receive too little. While the new CEO must be open to possibilities, he must be shrewd enough never to jeopardize long-term goals for short-term profit. The board of directors engaged the services of a prestigious executive search firm to seek out candidates. However, the more Starling thought about it, the more he felt that the right person might be sitting in the office next to his own. In a number of ways, Pat Ottensmeyer fit the mold of the contemporary railroad chief executive. In decades past, his lack of on-the-ground operations experience would probably have eliminated him from serious consideration, but the era of operations being the primary requisite for becoming a CEO had run its course. The latest generation of rail CEOs were more comfortable dealing with media, investors, customers, regulators, government officials, and politicians than their predecessors had been. Contemporary rail CEOs had risen through the ranks during a time when a railroad executive was increasingly expected to be a public figure, letting others manage their company’s operation center. Operations performance would always be at the core of good railroading, but the twenty-first-century railroad company needed a CEO who could meld traditional railroad fundamentals with K C S L o o k s t o t h e F u t u r e 269

new technologies that touched every aspect of their organization, from operations to marketing to finance. While the central mission of future railroads would be the same as it had always been—that is, to efficiently deliver freight to end users—much that was connected to the execution of that objective would experience some form of change. The new rail executive would have to both manage the process of innovation and articulate to outside audiences how these changes would benefit customers and investors. After years of working together, Dave Starling felt no one was more suited to take on this responsibility than Pat Ottensmeyer. Confident that he had it right, he went to Bob Druten to rally support, which he received. After an extensive, detailed review, the board came to the same conclusion. On March 1, 2015, Patrick Ottensmeyer was named president of KCS. It bears repeating: Pat’s new title was president, not chief executive officer. For the time being, at least, Starling would retain that role. While the new position gave Pat a leg up, his further elevation was not inevitable. He would have to prove himself able to handle the job. Starling took the responsibility of being his mentor. It was his wish that his colleague and friend rise to the top spot, and he would do what he could to prepare him for the job. At the same time, another reason that Starling wanted to stay on as CEO was if it began to look like Pat might come up short, he wanted to be the person to tell him that it was not going to work out. Sometimes the best friends are the ones who pass along the hard news. Not everyone agreed with the decision that Ottensmeyer was a good choice for president or an appropriate CEO candidate, and some were not hesitant in making their thoughts known. In retrospect, the opposition Ottensmeyer encountered was probably not a bad thing. If there were questions regarding Pat’s toughness, they were answered with his calm, reasonable, and steady response to everything his doubters threw in his way. The process toughened him and taught him the harsh lesson that there would always be adversaries. There would always be those who would like to see someone else in the top position. Such was the life of a CEO. If Ottensmeyer had begun the transition period a bit naive, his eyes had become wide open as the months rolled on. During this period, Starling remained supportive but stayed at a distance. At times he appeared so removed that Ottensmeyer wondered whether he had lost the CEO’s support. He had not, but Starling knew that Pat would have to succeed on his own. Over the course of the next fifteen months, Starling maintained control of the railroad but kept the new president in his 270 V i s i o n a c c o m p l i s h e d

sights and watched to see how he reacted to issues both large and small, both internal and external. Gradually, Starling became convinced the railroad, its customers, and investors would be in good hands in the years ahead. Not wanting to overstay his time at KCS and anxious to begin his next chapter, on July 1, 2016, Dave Starling stepped down from his position and was replaced by Pat Ottensmeyer as president and chief executive officer of KCS. After a short period during which he stayed on as a senior adviser to help with the transition, Starling retired from KCS and moved back to Arkansas where he immediately dove into a number of entrepreneurial ventures. It was no surprise to all who had worked with him that in a short time, Starling Enterprises was going strong. Dave Starling’s legacy is not the same as that of Arthur Stilwell, William Deramus III, or Mike Haverty, but that does not make its importance to KCS any less profound. Employees had needed a feeling of calm stability, in terms of both having job security and knowing that their supervisors were likely to be in place tomorrow and for many years ahead. Starling gave them that and more. He brought a greater sense of continuity than KCS employees had experienced in a long time. He also gave the feeling that he cared for his employees as people. Employees responded to his strong, no-nonsense leadership, matched in equal measure by his humanity. Starling was hardworking and driven, but he was also a fun-loving individual. His actions and demeanor showed that he wanted all his employees to exhibit, to the best of their abilities, the same qualities. It will be for all this that Dave Starling’s legacy will be not confined to his being a successful chief executive, but also as a highly respected man who was well liked by many people both within and outside the company. But there was one other thing that only those who worked closely alongside him from 2008 to 2016 could appreciate. Without Dave Starling, the final chapter of KCS’s extraordinary 135-year odyssey could not have been as well written.

K C S L o o k s t o t h e F u t u r e 271

Service Begets Growth

22

An attribute common to accomplished chief executive officers is an intuitive sense of what actions or strategic initiatives best serve their companies at a given point in time. Not infrequently, their innate sense forces them out of their comfort zones, sometimes even compelling them to embrace options at odds with their professional experience and natural inclinations. This would soon be the case with Pat Ottensmeyer. After taking the helm, it appeared that Ottensmeyer would be in for a relatively easy ride by normal CEO standards. Under Haverty and then Starling, revenues had grown, and operations had improved. Taken together, it resulted in consistently good earnings performance, and the stock price had reacted accordingly. Moreover, the future promised to be even brighter, as it was generally acknowledged by transportation professionals that KCS had only brushed the surface of its market potential. A strong executive team was in place working with a unified purpose. There promised to be adequate cash generated to fund maintenance and system upgrades. After years of struggle, KCS was on the move. Given the situation he inherited, it was understandable that some observers viewed Ottensmeyer as a “caretaker” CEO whose mandate was to concentrate on managing an already well-run machine. Even though that term did not reflect the new CEO’s personality or ambitions, the ship of state did appear stable. It appeared for a time that Pat could concentrate on navigating the fast-changing US and Mexican political landscapes and let others oversee the company’s day-to-day operations. Despite KCS consistently posting solid financial results, it was not long before Ottensmeyer began to have a gnawing sensation that the railroad was gradually losing momentum. Revenue growth had slowed but not 273

drastically. Some of the slowdown could be explained by shifts in the economy and a growing number of trade disputes the United States had with some of its largest trading partners. Even so, Ottensmeyer was concerned that the company’s growth performance was less than it should be. His concern grew more acute when service metrics started to trend in the wrong direction, exposing some network trouble spots in the United States and Mexico. Ottensmeyer respected his executive team, but his intuition told him that something was lacking. It would be up to him to chart a change of direction. The railroad, his management team, employees at all levels, and Ottensmeyer himself needed a spark, a challenge, a different way of looking at their entire operation. During his first three years as chief executive, he watched as one US Class I railroad after another employed elements of E. Hunter Harrison’s operating philosophy, precision scheduled railroading (PSR). To date, KCS had remained a holdout, maintaining that PSR was suited neither to the intricacies of its rail network nor to its corporate culture. Inside the company, it was felt that KCS’s many interchange points with other railroads, short hauls, and lack of an extensive inventory of underutilized facilities and assets made it an unsuitable candidate for PSR implementation. On top of that, PSR appeared to run counter to KCS’s long-held commitment to its customers. As much as possible, KCS had always tried to shape its service around the particular needs of its shippers. PSR seemed to operate from the perspective that shippers must conform to the railroad’s service options, not the other way round. Furthermore, it was entirely possible that there remained within KCS a resentment of Harrison’s operating and managerial philosophies, left over from his central presence in IC’s abortive effort to purchase KCSR in the 1990s. PSR seemingly had a snowball’s chance in hell of finding support within the company, especially given that Pat Ottensmeyer was a passionate proponent of KCS’s corporate culture. But Ottensmeyer also understood that the company’s culture embraced new ideas, change, and innovation. The more he thought about it, the more he wondered whether his team and a sizable segment of KCS’s employees, including himself, were guilty of dismissing PSR without really knowing what it entailed. Would it not be more in keeping with KCS’s history of openness to fresh ideas to at least explore what PSR was and whether it could be effectively employed on the railroad’s network? At the same time, Ottensmeyer was not blind to the fact that PSR was a potentially divisive subject within the company. For PSR to be given a 274 V i s i o n a c c o m p l i s h e d

fair, unbiased review, it needed buy-in: first from his team and then from employees. To that end, when he brought up the subject with his executive team, he made it crystal clear that KCS would go forward with PSR only with their full support. If his team was not unanimously behind the initiative, it would not be pursued. If, on the other hand, the team endorsed the idea, they would move ahead with the understanding that the effort would be an honest investigation of implementing PSR at KCS. Any undermining of that effort, active or passive, would not be tolerated. It was either all in or not at all. Ottensmeyer encouraged a spirited, honest, and open debate, and he got what he asked for. Every aspect of integrating PSR into KCS’s operations, both positive and negative, was discussed. In the end, the executive team agreed that KCS needed an infusion of new ideas, and at minimum, PSR would provide another way at looking at the company’s operations. As there was no one within KCS with a high level of PSR experience, a search was conducted to find someone who could guide the study and help with implementation, if that point was reached. In December 2018, Sameh Fahmy, a rail operations veteran with twenty-three years of experience at CN and a close associate of Hunter Harrison at both CN and CSX, was brought on as a consultant to direct the effort at both KCSR and KCSM. In February 2019, Fahmy became a member of the senior leadership team. After taking a close look at the entire system, by the spring of 2019, Fahmy began working with senior operations personnel in the United States and Mexico to minimize car switching, block more trains at origin, and improve service design, among other things. In addition, two thousand cars were marked for rationalization, certain maintenance contracts were restructured, and crew starts were reduced through train consolidation. Finally, with Ottensmeyer’s declaration that shippers would be given reasonable lead times to prepare for changes in service procedures, KCS wholeheartedly undertook the application of PSR to its system. Really, nothing better defined the strength of the KCS culture better than Sameh Fahmy’s own experience in the process. Fahmy had come to KCS with a reputation of being a hard-driving disciple of Hunter Harrison. As a results-oriented and passionate advocate of PSR, he was prepared to do everything necessary for PSR to be incorporated into KCS’s operations, no matter how disruptive to common practice some of the changes might be. Pat Ottensmeyer wanted KCS to benefit from Fahmy’s extensive PSR experience and his iron will, but he also felt responsible for maintaining his S e r v i c e B e g e t s G r o w t h 275

company’s identity and culture. PSR might provide tangible operational and financial benefits, at least over the short term, but if it undermined the spirit of KCS, it would likely have negative longer-term consequences. Ottensmeyer was determined that KCS would be the same company after PSR implementation, only better, and he continually reminded Fahmy that change must be executed within the context of KCS’s corporate culture. It was during this time that Ottensmeyer coined the phrase “Service begets growth.” In part, the slogan was a means to telegraph to regulators, shippers, employees, and the investment community that KCS had no intention of sacrificing the quality of its service to customers to gain higher profits. Ottensmeyer had come to believe that PSR could lead to improved rail operations in both the United States and Mexico, but he was adamant that it must be implemented without alienating customers. He stressed to Fahmy, the rest of his management team, and—through town hall meetings on both sides of the border—employees that under his leadership, adopting a new approach to rail operations included providing better service to customers and was not solely a means for reducing operating expenses. For Pat Ottensmeyer, “Service begets growth” was the phrase meant to identify to all how he wanted his railroad to operate and prosper. Ultimately, it was probably less Pat’s continual reminders than the strength of the KCS corporate culture that affected Sameh Fahmy. Not for a moment did Fahmy ever question the operational strategies he espoused, but he gained an appreciation for blending them into KCS’ operations rather than aggressively forcing them on employees and shippers without sufficient communication and training. The implementation of PSR proved to be a success. By the end of Sameh Fahmy’s tenure, the operational and financial results had exceeded applications. They included • a 3.6-point improvement to adjusted operating ratio between 2018 and 2020 (64.3 percent and 60.7 percent, respectively); • a fuel efficiency improvement of 9 percent; • measurable improvement to operating performance, including a 37 percent increase in train velocity and an 18 percent reduction in freight car dwell time; • $150 million in annualized savings, with a line of sight to additional savings and operational efficiencies; and • a stronger and more resilient network that better supported KCS customers and positioned the railroad for expanded future growth. 276 V i s i o n a c c o m p l i s h e d

It is noteworthy that KCS’s cautious entry into PSR was orchestrated by Pat Ottensmeyer, whose suitability for the position of chief executive officer some had questioned due to his lack of operations experience. At first glance, it seems counterintuitive that when his legacy is finally written, prominent among his achievements will be that he directed substantial changes to KCS’s operational philosophy and markedly increased the value of the company. Like the best of CEOs, Pat Ottensmeyer possessed the innate sense that his company needed a change, and he had the fortitude to step out of his comfort zone to get it done. But no executive can rely on intuition alone. The most successful ones have an ability to combine their singular personalities, ambition, leadership strengths, and life and work experiences with an intuitive sense of when to adapt to a changing business environment or an altered set of circumstances. KCS had been blessed throughout its history with having the right individual in charge to deal with the railroad’s particular needs at the time. Pat Ottensmeyer, like his immediate predecessors, was dedicated to keeping KCS an independent railroad. However, there was not a single chief executive, from Stilwell to Ottensmeyer, who did not realize that nothing lasts forever. Even Mike Haverty, as staunch a proponent of KCS’s independence as one could imagine, would occasionally admit that for the railroad to realize its full potential, at some point it would have to become part of something larger. There were two questions: When would that moment come, and would KCS be in the hands of the right leader to successfully navigate the transition into something radically new for the fiercely proud KCS? It would not be long before both questions would be answered.

S e r v i c e B e g e t s G r o w t h 277

Game On

23

Private Equity Strikes First

July 31 was the day of the Kansas City Royals’ 2020 home opener. The COVID-19 pandemic had robbed baseball fans of the first four months of the regular season, and the Royals’ faithful, which included a good number of KCS employees, were more than ready to celebrate the occasion. Unlike in years past, there would be no mass exodus from the railroad’s Twelfth Street headquarters to Kauffman Stadium on this afternoon. First, there were barely any employees in the building. Second, no fans would be allowed into the stadium due to concern that a crowd could result in a massive spread of the illness. Still, the pandemic had so disrupted the nation’s rhythms that anything even faintly resembling normalcy, such as opening day, was to be cherished and enjoyed, even if the Royals were hardly favored to compete for a playoff spot. While less than perfect, the idea that it was opening day at the “K’” was a breath of fresh air. But the air was quickly knocked from the chests not only of KCS baseball fans but from employees throughout the entire service territories when news spread of a Wall Street Journal article announcing “Private-Equity Firms Discuss Bid for Kansas City Southern.” The article stated that Blackstone Infrastructure Partners, a division of the prominent investment firm Blackstone Group Inc., and Global Infrastructure Partners were seriously considering extending an offer to acquire KCS. The Wall Street Journal piece was not the only media outlet covering the developing story; the transportation trade press had already speculated on the possibility of an offer being forthcoming, and on the heels of the media reports, sell-side analysts had rushed to get out notes to their clients. Speculation of a possible transaction involving KCS was hardly unusual. Since the 1990s, one could count on a print article or analyst’s report popping

279

up regularly, discussing the generally accepted belief that KCS was a likely acquisition target. So common was such speculation that employees tended to dismiss most of it as idle chatter. Some of the articles made sense: KCS would constitute an attractive growth idea for a number of railroads, and others were nothing more than fanciful speculation that lacked sophisticated knowledge of the rail industry. In the final analysis, it did not really matter whether the articles were well thought out or conjecture without substance; nothing had ever materialized. But this time it just seemed different. To begin with, the economic environment could not have been more favorable for acquisition activity. With surprising exuberance, the stock market had shrugged off the pandemicinduced dark clouds that initially fell over large segments of the economy, and it had soared to stratospheric heights. Investment companies had accumulated unprecedented wealth and seemed almost desperate in their search for fresh ideas into which to deploy their cash. On top of that, borrowing rates had fallen so low that not taking advantage of money so cheap almost constituted bad financial management. It was not only investment firms that were thriving. Since recovering from the harsh recession of 2008–2009, railroads had enjoyed ten years of excellent earnings. Every Class I carrier had bounced back and now had the financial resources to make a move if they so desired. Like its industry peers, KCS financials had taken a severe hit in the quarter when COVID-19 hammered a wide swath of its customer base. Carloads fell 30 percent in the second quarter of 2020. However, KCS’s business had rebounded with startling speed; by the third quarter, carloads had grown 61 percent from their low point. The bottom line was that the Class I railroads were in great shape and flush with money. This only made the railroad with the most impressive array of growth opportunities an even more attractive target than ever for the large rails. What made a move on KCS particularly enticing was not only its bountiful array of growth opportunities but that it was already a mature, successful company. Over the past twenty-year period from 2000 to 2020, KCS had registered the highest compound annual growth rate (CAGR), 19.1 percent, of all Class Is. Its closest peer was CN with a CAGR three percentage points lower. During the same twenty years, KCS stock had grown in value by 3,187 percent, again far outdistancing the median stock growth of its rail peer group.

280 V i s i o n a c c o m p l i s h e d

Table 23.1.  KCS vs. Peer Group: Strongest Industry Growth over 20-Plus Years* Stock Price on 8/7/2020**

CAGR

$187.04 $100.08 $72.93 $182.93 $281.99 $198.99 $3,351.28

19.1% 16.1% 16.0% 15.8% 15.3% 13.5% 4.2%

KCS CNI CSX UNP CP NSC S&P 500

*Measured from completion of Stilwell Financial spin-off (7/13/00) **One week prior to sale rumors Table 23.2.  Stock Growth: KCS vs. Class I Peers 20-YEAR* 10-YEAR 5-YEAR 3-YEAR 1-YEAR

KCS

PEER MEDIAN**

3,187% 444% 104% 88% 59%

2,405% 394% 115% 81% 10%

S&P 500 232% 267% 78% 43% 19%

*Measured from completion of Stillwell Financial spin-off (7/13/00) until one week prior to sale rumors (8/7/20); subsequent metrics measured accordingly by date. **Median TSR of Class I railroads, ex. KCS (CP, NSC, CNR, CSX. and UNP)

According to a 2016 report prepared by the stock research platform Seeking Alpha, KCS attained a 132 percent increase in its net income and 81 percent growth in its cash flow from 2000 to 2015. The report also calculated that over the forty-two years from 1974 to 2016, KCS stock had returned a staggering 1.7 million percent. Translated into monetary terms, every dollar of KCS shares purchased in 1974 would have turned into $16,800. This astronomical return does assume the unlikely 100 percent reinvestment of all dividends, including the Stilwell Financial spin-off “dividend” that was close to $100 per share. Still, using this calculus, KCS ranks as the best performing of the entire universe of stocks over that four-decade period. However, to be fair, while its inspired 1996 investment in the Mexican rail network had supercharged KCS growth and led to a host of excellent arguments for acquiring the railroad, there had also been valid reasons to

G a m e O n 281

hold off. Despite the worthy efforts of Tom Carter in the 1970s and 1980s, and Mike Haverty later, the quality of KCS’s physical plant in some key areas did not match those of its major competitors. But under Dave Starling, the track and facilities infrastructure of both KCSR and KCSM had undergone extensive upgrades. And after Pat Ottensmeyer’s implementation of PSR, rail operations in both the United States and Mexico had improved dramatically. It had reached the point where infrastructure concerns no longer held up as valid reasons for not pursuing an acquisition of KCS.

The Rumor Mill Ramps Up KCS’s executive management had actually gone on high alert months before the Wall Street Journal article appeared; so had the board of directors, through periodic briefings from Pat Ottensmeyer and Mike Upchurch. Alarms had sounded with the July 1, 2019, announcement that affiliates of infrastructure asset management firms Brookfield Infrastructure and GIC had agreed to purchase Genesee & Wyoming (GWR), a Connecticut-headquartered operator of short-line railroads predominantly in the United States, but also with operations in Europe and Australia. The purchase price was approximately $9 billion, including debt and cash. GIC, not to be confused with GIP (Global Infrastructure Partners), managed Singapore’s sovereign wealth fund. The sale was completed five months later on December 1, 2019. The transaction set off an avalanche of calls to Upchurch and Ottensmeyer from representatives of infrastructure funds and investment banks. The infrastructure funds asked about everything from participating with KCS on business projects in Mexico to the possibility of a sale of the railroad. The bankers, of course, would be interested in financing opportunities, or representing KCS in any possible merger activities. The calls alone did not suggest anything was in the works. But what got management’s attention was, of all things, a June 2020 post on a Spanish blog. It noted that Santander Bank was considering working with a group that was contemplating a bid to acquire KCS. Normally, a Spanish blog would have caused at most wry amusement in Kansas City. However, a trusted source alerted KCS to the possibility that the blogger might have gotten the tip from a US investment banker who wanted to get the word out of a possible deal in the works. Though there was no definitive proof supporting the conjecture

282 V i s i o n a c c o m p l i s h e d

that the blog appeared soon after the GWR transaction became public, the source’s comment regarding its possible veracity did capture the attention of some inside KCS headquarters. As the calls kept coming, Ottensmeyer and Upchurch had a hunch that something was developing. Their suspicion grew even more intense after Mike Upchurch took a call from a high-level individual from a bank who had a history of working with KCS. The person asked Mike a question totally out of the ordinary. Essentially, his question was whether there existed any legal reason that his bank would be prohibited from representing another party involved in a transaction involving KCS. He wondered whether the bank’s prior association with KCS precluded them from working on the other side of a transaction involving the railroad. Upchurch replied that to his knowledge, there was no legal reason barring the bank from representing another entity, though of course the bank could not serve both sides of a transaction. Upchurch took a follow-up call from the same individual shortly before the Wall Street Journal article appeared. This time the banker asked whether KCS would be inclined to contract with his bank if an acquisition bid was made for the railroad. This pretty much erased any lingering doubts that something was going to happen soon. The board was put on high alert and plans began to be formulated for taking any and all necessary actions in the event of an announcement. Two days before the Wall Street Journal article appeared, Pat Ottensmeyer and Keith Creel, president and chief executive officer of CP, met for lunch. It was for the most part an informal conversation, covering a variety of topics involving the rail industry. But then Creel asked whether KCS would be amenable to discussing a business combination between the two railroads. Under normal circumstances the question would not have quickened Ottensmeyer’s pulse rate. For the past two decades KCS chief executives had become so used to repeating its mantra: “KCS is not for sale and feels very positive about its future as an independent railroad, but, of course, its management and board of directors have a fiduciary responsibility to review any proposal to determine what would be in the best interests of its shareholders, customers, employees and the community it serves.” They could almost recite it in their sleep. But this time, while responding to Creel in the usual manner, Ottensmeyer thought that word was out that someone was going to make a move on his railroad.

G a m e O n 283

The Transaction Team Already on alert, senior management and the board of directors took preparations to the next level. On Thursday, August 11, the first meeting of what would become the KCS transaction team was held virtually. Due to COVID19 protocols almost all the transaction meetings were to be either telephonic or held virtually. Executive management’s primary representative would be, of course, Pat Ottensmeyer. It was not just his title that justified the distinction but his formidable experience with mergers, first as a corporate banker and then later working alongside his mentor, Dennis Springer, on the merger of SF with BN. Arguably, no rail chief executive had Pat’s breadth of experience with merger activity, at least from a financial perspective, and that experience would soon pay dividends as events unfolded in ways far beyond anyone’s wildest imagination. Ottensmeyer would prove to be well supported by his chief financial officer, Mike Upchurch. Mike, too, had firsthand experience with merger activity from his time at Sprint. Over the past six months he had kept Pat and the board abreast of acquisition chatter involving KCS. In addition, Mike was also the central figure responsible for keeping the railroad’s long-range plan (LRP) up to date. Since the total overhaul of its forecasting methodology under Dave Starling, the LRP had become the centerpiece of KCS’s strategic planning process. Now it would also be central to the board of directors’ and transaction team’s determination of the value of the railroad. With his attention to detail and ability to command the personnel of finance, marketing & sales, and operations, Mike was the ideal individual to keep the LRP current. Throughout the transaction process he repeatedly called on staff to expand the LRP to include multiple variables, both positive and negative. Others forming the first line of the internal KCS team were to be: Adam Godderz, senior vice president—chief legal officer and corporate secretary; Brent Vander Ark, vice president—financial services; Jeff Songer, head of operations, who would later be selected to be executive vice president—strategic merger planning; Mike Naatz, executive vice president—marketing; and Warren Erdman, executive vice president—government affairs. Oscar del Cueto, KCSM president, general manager and executive representative, soon joined the transaction team. As the transaction process heated up, Oscar’s contributions, which involved providing insights as to Mexico’s regulatory processes and associated politics, proved to be invaluable. In 284 V i s i o n a c c o m p l i s h e d

addition, his familiarity with KCSM’s service network and customers served helped in the board’s determination of the value of the entire KCS franchise. Finally, John Orr, a newcomer to KCS and executive vice president— operations, would play an important role not only as an operations professional but also because of his firsthand knowledge of the Canadian rail network. As time went on other KCS executives and staff were brought “under the tent” and contributed extensively, working long hours, giving up weekends and holidays, and sacrificing countless hours with their families. A huge advantage that KCS had from the outset was the long history that its cast of external consultants had working with the railroad. Not only were these individuals successful and highly positioned within their companies and well-regarded in their professions, most of them had also worked side by side with KCS for the better part of three decades. They knew the railroad, they were familiar with management, and they understood KCS’s corporate culture. Like generations of KCS employees, they had crusaded for KCS in battles with larger companies, sometimes winning, sometimes not. Beyond the battles, they had for years advised and consulted with railroad management and board members on a vast array of financial, regulatory, political, legal, shareholder, and public relations matters. Their long association with the railroad and its people resulted in their involvement in this transaction process becoming, to turn around a hackneyed phrase, not just business but personal. Nelson Walsh, vice chair of investment banking at Morgan Stanley, had already become a rising star when he first started cementing a financial relationship with KCS in the mid-1990s. He was a key figure in directing Morgan Stanley’s lead position attaining financing for KCS’s share of the Mexican rail concession, and then ten years later was a principal in the bank’s participation in the buyout of KCS’s Mexican partner, Grupo TMM. Walsh was a committed supporter of KCS through three different KCS leadership teams. He was a member of the family, and like all families there were good times and not so great times, but the bonds only became stronger through the years. Similarly, Stephen Rosenblum, a partner in the law firm Wachtell, Lipton, Rosen & Katz (Wachtell Lipton) had counseled KCS on SEC matters and on issues related to takeover threats and merger activities. No one felt a stronger connection to KCS than Joele Frank, the founder and managing partner of the New York–based strategic financial communications and investor relations firm Joele Frank Wilkinson Brimmer Katcher. Frank and her firm had gained prominence counseling companies during G a m e O n 285

acquisition activities, and she frequently shared with people that her involvement with KCS began in the very first days of her career. The railroad, its people, and its culture held a special place in her heart. Joele Frank was one of the toughest and most passionate advocates for her clients anywhere and never backed away from a fight. She demanded that the railroad’s public and investor relations be well thought out and professionally delivered, and she was expert in preparing the executives for their interactions with the media, investors, analysts, regulators, and politicians. If there was to be an acquisition bid for the railroad, she was determined to do her part in ensuring that KCS achieve the best possible outcome. Bill Mullins, a partner in the Washington, DC, law firm Baker & Miller PLLC, was yet another person whose relationship with KCS dated back to the 1990s. Mullins’s expertise was in regulatory affairs and he was also a veteran of Capital Hill politics. He had provided counsel to KCS during its opposition to the UP-SP merger and while the railroad’s arguments did not derail the merger, the points he helped craft in opposition to the transaction likely played a part in the STB awarding KCS trackage rights over the UP line from Beaumont to Corpus Christi, which had given KCS the connection it needed if it was to attempt to extend its reach into Mexico. Through the years, Mullins counseled the railroad on other regulatory matters and was a contributor to arguments leading to KCS gaining an exemption from having to comply with the revised STB guidelines for Class I mergers enacted in 2001, an important victory for the company and one that was going to become an issue in the drama that was soon to unfold. Another longtime member of the KCS “family” was lawyer and former US congressman from Kansas, Jim Slattery, who was mentioned earlier for his involvement in issues pertaining to crafting the KCS-TMM partnership. Slattery had also, while serving as a KCS lobbyist in Washington, DC, won the railroad considerable support on Capitol Hill in the railroad’s successful effort to be excluded from having a merger involving KCS reviewed under new, more stringent, regulatory review procedures. Transaction team members Warren Erdman and Bill Mullins were instrumental in bringing in William Clyburn, former STB commissioner and vice chair, as a consultant to the team. His insights as to how the STB commissioners and staff look at rail competition and competitive pricing issues were to prove extremely helpful as the process moved forward. Over the past twenty years, KCS had forged a strong banking relationship with Bank of America Securities (BofA). Working with Stephen Baronoff, 286 V i s i o n a c c o m p l i s h e d

Lolli Wu, and Jay Johnson, KCS had accomplished a number of successful financings, none more important than the complete restructuring of its corporate debt. The BofA and Morgan Stanley teams were to become invaluable to KCS in terms of assessing the railroad’s value based on its recent performance and LRP. They provided counsel to KCS’s management and board based on their institutional knowledge and extensive participation in corporate mergers and takeovers. Another time-tested veteran on the teams was Dan Burch, CEO of McKenzie Partners, the firm that had for decades served as proxy advisers for KCS. Burch’s strength was the vast number of relationships he had with Wall Street insiders. Through his many contacts, Burch had the sources to obtain intelligence on behind-the-scenes activities related to merger and takeover activities, and to give management solid advice on how to best respond to any forthcoming offers. The importance of the external parties having long and close institutional knowledge of KCS, as well as having good, cordial relationships with Pat Ottensmeyer and Mike Upchurch and other members of KCS management, cannot be overstated. It meant that there would be no introductory period in which everyone got to know each other. This was especially true during this rarefied time in which the vast majority of meanings would be virtual due to health considerations. The group was ready to hit the ground running. The personalities of each member on the team were known to the others. They knew in what form and manner Ottensmeyer liked to receive information and they knew the same for Upchurch. And at least some of them had worked with Chairman Bob Druten and other members of the board of directors. Not to be overlooked, behind all the names mentioned above were the key internal staff who provided the data and support necessary for decisions to be made and positions to be taken. The fact that there was also a high degree of mutual respect between external and internal staff became increasingly important as prompt decisions had to be made regarding the many twists and turns the acquisition process would take. Everybody was on board and marching together in the same direction.

Speculation Becomes Reality The August 11 call to action initiated by Bob Druten went far beyond following good governance protocol. Throughout senior management, many G a m e O n 287

transportation professionals, and some in the financial community, there was a sense that this time, the talk about someone taking a run at KCS was not merely smoke; this time there was real fire. Someone was zeroing in on KCS. There was a belief shared by more than a few of financial and transportation professionals that if potential purchasers continued to sit on the sidelines and endlessly debate the pros and cons of a move on KCS, the railroad on its own might grow to a size where acquiring it would become so expensive that some of the benefits of its enticing growth opportunities would be diluted. It could very well be better to risk a little and gain a lot by taking the plunge right now. The meeting proved timely as six days later, on August 17, Bob Druten and Pat Ottensmeyer received an unsolicited proposal from a consortium of private-equity infrastructure investors to purchase KCS. The Wall Street Journal had gotten the names of the prominent parties of the consortium correct, but the article had inferred that Blackstone Infrastructure Partners would be the lead participant when, in fact, it was GIP that was to be the lead investor. GIP-Blackstone’s bid to acquire KCS was $195.00 per share cash. The group would finance the acquisition through a combination of equity financing and $6.5 billion in debt financing. The total amount of the bid totaled approximately $20 billion. GIP-Blackstone anticipated that it would succeed in obtaining all regulatory approvals within four to six months of signing the definitive agreement. Hours later, Ottensmeyer and Upchurch participated in what would be the first of many calls with representatives of the private-equity infrastructure group. A special meeting of the KCS board and transaction team took place the next day, August 18. After the participants reviewed the LRP and discussed in some detail the probability of achieving various levels of success in meeting the goals set out in it, the board voted unanimously against accepting the bid as presented. At this point, the board reaffirmed its position that it was in the best interest of KCS shareholders to remain independent and focus on the company’s long-term strategic goals. Ottensmeyer and Upchurch promptly conveyed the board’s decision to the GIP-Blackstone consortium. The decision to reject the bid was not a particularly difficult one for the board to make; the proposal fell far short of what KCS senior management, the board, and its financial advisers considered as the railroad’s long-term value. At the same time, the team felt the bid was an opening salvo to test the waters, and a more aggressive proposal would likely follow.

288 V i s i o n a c c o m p l i s h e d

Some also thought that the bid might have opened the doors to other parties who would now jump into the action, which naturally led to speculation as to which of the major railroads would be most likely to make a move. Its moderate size, coupled with the fact that it interchanged with every Class I, made KCS a possible target for all six majors. And then there was KCSM, which most transportation observers felt had only begun to achieve the early stages of its cross-border traffic growth potential. It made that because the larger rail carriers directly served more prime North American markets than KCS, the Mexican growth opportunity would be even greater for them than it was for KCS. Just think of what this could mean for UP, BNSF, CP, or CN, or even NS or CSX for that matter. All six could more efficiently connect Mexico to all the major North American markets than the medium-sized KCS could.

Two Canadian Rail CEOs Are Heard From The transaction team’s assumption that the initial bid was more than a one-and-done affair was quickly confirmed. On Saturday, August 21, Pat Ottensmeyer received a phone call from his CP counterpart, Keith Creel, who proposed that CP and KCS consider entering into a merger-of-equals transaction in which KCS shareholders would receive consideration solely of new shares of CP stock in an at-market transaction. Creel expressed his opinion that a CP-KCS merger would likely face the least amount of regulatory uncertainty given that they were the two smallest Class I railroads and lacked geographic overlap. The following week, GIP-Blackstone contacted Ottensmeyer and requested a meeting to further discuss the possibility of a transaction. A week after that, the suddenly popular Ottensmeyer received another call, this one from Jean-Jacques Ruest, president and chief executive officer of CN. Ruest, noting the recent activity, suggested that if KCS was open to considering a sale, then CN would be interested in discussing a transaction. The KCS board gave Ottensmeyer the green light to accept the meeting with GIP-Blackstone. But after reviewing possible exchange ratios implied by the historical trading prices of KCS and CP, the KCS team decided not to respond to the preliminary CP proposal Keith Creel outlined during his August 21 conversation with Pat Ottensmeyer. Exchange ratios relate to the relative number of new shares given to existing shareholders of a company

G a m e O n 289

that has been acquired or merged with another. After considering what a merger-of-equals deal might look like, the KCS board, again, did not think pursuing this course would either appeal to or be in the best interests of KCS shareholders. On August 31, GIP-Blackstone came back with a revised offer, this time to acquire KCS for $208.00 per share in cash with the same conditions set forth in their August 17 proposal. The next day, September 1, the KCS board and the transaction team reviewed the new bid, again considering it in light of the company’s LRP. It was determined that the new bid, like the former, fell short of what the KCS team believed to be the value of the railroad. Ottensmeyer communicated the decision to GIP-Blackstone and also contacted Keith Creel to notify him that the latest bid from a private-equity infrastructure group had been turned down. With the exception of a call to Ottensmeyer from an executive of another Class I carrier who reached out to gauge if KCS might have an appetite for a deal to sell a portion of its assets—considering that Ottensmeyer assumed the asset the executive was referring to was the Mexican concession, he dismissed the idea as a nonstarter—the period from early September to November was quiet insofar as no further transaction proposals were received. But quiet did not translate to rest for the transaction team. Mike Upchurch again called on finance, marketing, and operations staff to again review the LRP making sure it reflected as accurately as possible the current state of postpandemic recovery and the positive impact of PSR initiatives on service. The job took a good deal of cooperation among departments and many hours of labor from people who already had full-time jobs keeping the railroad moving and profitable. Others within the transaction team took another deep dive into the railroad’s strategic options, including remaining independent and assessing the possible marketing and operational synergies from combining with each of the Class I railroads. The team also reviewed and discussed the feedback received to date from institutional investors and digested the comments and projections of sell-side analysts’ reports. The goal was to be prepared for the next round—if there was to be a next round. The period of relative quiet ended a couple of days before Thanksgiving on November 23, when GIP-Blackstone alerted Pat Ottensmeyer that a new proposal for $230.00 per share in cash would be submitted later that same day. Ottensmeyer was informed that the GIP representatives had a high degree of confidence that the consortium would be able to obtain firm commitments from its equity partners and lenders once the parameters of a 290 V i s i o n a c c o m p l i s h e d

transaction had been agreed on. Ottensmeyer was confident the group could indeed meet their financial commitments if called on to do so. In retrospect, the new GIP-Blackstone bid marked a major turning point in the process. The earlier offers had set the floor price for the railroad. The KCS rejection of the offers, as well as the less-than-enthusiastic reactions of the “Street” and the railroad’s shareholders, had provided the unmistakable statement that if KCS was to be acquired, the buyer would have to pay a price significantly higher than the offers presented so far. CP’s initial all-stock proposal seemed more intended to gauge KCS’s reaction to the idea of a merger than it was a serious all-in proposal. And similarly, the call from Ruest had mostly been a heads-up that his company would be seriously interested in jumping in if there was a deal to be done. Though the $230.00 all-cash offer was a sizable improvement over GIPBlackstone’s previous $208.00 offer, it did not blow away anyone on the KCS team. But what it did, for the first time, was bring the “time value of money” concept into the discussion. The private-equity infrastructure group had one large advantage over any Class I railroad that would seek to buy KCS: they would not have to go through the arduous STB regulatory process to gain approval of the purchase. Whereas GIP-Blackstone projected a four-tosix-month process from the acceptance of their offer to finalizing the sale, it could be an eighteen-month ordeal to get through the STB. It was anything but certain that the final outcome would be a happy one. There were legitimate reasons to be no more than cautiously optimistic that a Class I railroad bid to acquire KCS would make it through the STB review process successfully. The concern could be traced back to dramatic changes in the regulatory environment overseeing railroads as a result of the public outrage that had arisen in the wake of the 1990s megarail combinations. The large-scale rail mergers of that decade had started with the BN-SF merger, which was soon followed by the UP acquisition of SP. Then came the carve-up of Conrail by CSX and NS. While each of these transactions had its own set of unique characteristics, they all shared one common result—after their combinations had been awarded regulatory approval, all three of them experienced nightmarish difficulties in trying to consolidate the IT, financial, and operating systems, and corporate cultures of two railroads into a new one. For the railroads it was painful, and for their customers it was even worse. There were too many instances of businesses having to shut down temporarily due to the inability of the new railroad combination to deliver raw G a m e O n 291

materials or carry away finished products in anything close to resembling scheduled times. Politicians at federal, state, and local levels who had supported the deals, and the regulators who had approved them, were bombarded by complaints and desperate pleas to do something to correct the mess that they, in the eyes of shippers, had created. The service territories of the newly created giant railroads were so expansive that a good part of the nation felt the pain when their systems crashed. However, in all cases service gradually recovered. The price paid by the railroads and their customers was steep, but slowly service had returned to something resembling normalcy, though the promised streamlined service and improved pricing were sometimes still conspicuously absent. But then out of the blue, just before Christmas 1999, CN and BNSF announced their intention to merge. If approved, it would result in the formation of the largest freight rail in history. The announcement screamed of being the worst possible example of the domino effect triumphing over reason. One large rail combination had led to another, then another, then another, and now there was to be yet another. Who was to benefit? It certainly was not going to be shippers nor the general consumer public. In addition, the timing could not have been worse. Bloodied by the outpouring of anger provoked by the previous three rail transactions, the last thing the STB commissioners needed was to now adjudicate the largest freight rail merger ever. Other than the managements and boards of the two merging railroads, it was hard to find any supporters. It was startling that the CN and BNSF could have been so unaware of the mood of regulators, politicians, and shippers to think this was a good idea at the time. Even investors demonstrated their disapproval as BNSF’s stock price immediately plunged by 12.6 percent. While CN’s declined a more modest 2.8 percent, it still fell and there would be no significant rebound.

Regulatory Risk Grows This time, all the arguments that Mike Haverty had put forth earlier against the BN-SF and UP-SP mergers, and now against the CN-BNSF announcement, took hold—not just with a widespread shipper audience, but with business groups, fellow rail executives, politicians, and a host of regulatory agencies. In light of the outpouring of antimerger outrage, the STB felt it had to act. It did so on March 17, 2000, when rather than proceeding to

292 V i s i o n a c c o m p l i s h e d

review the proposed CN-BNSF merger application, it announced a fifteenmonth moratorium on all rail mergers to give it time to reformulate merger rules that would change the way future large rail merger proposals would be reviewed in terms of their impacts on the economy, smaller railroads, customer service, and labor. Adhering to their fifteen-month moratorium schedule, on June 11, 2001 the STB issued its proposed “Major Rail Consolidation Procedures,” a long list of rules that would govern future Class I rail mergers. In short, the new rules would require rail carriers to show how their proposed transactions would not only preserve but also enhance competition. Further, the merged railroads would be subject to an extensive list of STB oversight requirements for at least five years. The new merger requirements marked a dramatic change from the past rules governing rail mergers that stipulated that rail carriers had only to show that their proposed merger would preserve competition at the level prior to the merger. Notably, one Class I railroad was excluded from having to conform to the new STB guidelines if involved in a merger with another Class I: KCS. Haverty had led the effort to exempt KCS from the new merger guidelines, arguing that KCS should not be harmed by unintended consequences. KCS successfully argued that the railroad’s smaller size, and the fact that it did not have the market dominance to shape customer markets and materially impact service, made it unnecessary and unfair to subject it to the same rules developed to control the larger Class I railroads, which by their very size could substantially alter market dynamics. CN and BNSF immediately challenged the new STB merger review procedures, but their appeal was turned down by the US Court of Appeals. A month later the two called off their proposed merger, citing that the “delay and uncertainty” caused by the moratorium would not be in the best interest of their shareholders. The STB vote to exclude KCS from the new merger guidelines was 2–1, with Commissioner Linda Morgan the lone dissenter. Morgan, who had not been sympathetic to KCS’s opposition to past rail mergers, argued that rather than KCS receiving a blanket exemption, a decision whether a merger involving KCS and another Class I would be reviewed under the old merger guidelines or the new ones should be determined on a case-by-case basis. Her argument was that KCS’s investment in the Mexican rail concession had, in fact, given it greater market presence. Now, twenty years later, all three of

G a m e O n 293

these developments—the adoption of new merger guidelines, the KCS carveout, and the weight of the lone dissenter who felt that KCS should not have a blanket exemption from having a merger review under the revised guidelines—would be factors if a bidding war were to break out to acquire KCS. Why was all this of extreme importance to the developing KCS acquisition process? A few reasons stand out. First, as earlier noted, a private nonrailroad group such as GIP-Blackstone would not be subject to the STB guidelines, old or new. That would give them two advantages. One, the regulatory review process would be significantly less arduous than the STB’s, which suggested that there would be less possibility that the acquisition would be turned down. Two, the process would move much faster, being concluded in approximately four months rather than the likely twelve-toeighteen-month STB process. This meant that a lesser monetary bid by GIPBlackstone than that of a Class I railroad might be preferable, in terms of having both less risk of being denied and the time value of money in which KCS investors would get the cash in their pockets in four months rather than in eighteen. There was a third consideration. In November 2020, a Democrat, Joseph Biden, had been elected president, which meant a new administration would be installed. This one promised to take a tougher view than the previous one toward mergers that could have material impacts on competition. Besides his history of backing consumer interests, Biden was beholden to the progressive wing of his party for supporting his campaign. There is no doubt that curbing the power of big business was a key component of the progressive agenda, and Biden would have to provide them a degree of presidential support. A merger involving two Class I railroads could be just controversial enough to push the politics surrounding the deal to the highest level. The board and transaction team discussed all this in detail. But again, after listening to the perspectives of the Morgan Stanley and Bank of America advisers regarding the present and projected future value of KCS as a stand-alone railroad, the discussion was made to turn down the $230.00 per share all-cash offer. But this time the rejection included a clear sign that KCS was open to a deal with GIP-Blackstone if the bid price approached what the railroad and its consultants considered fair value. The board authorized its management to provide the private-equity infrastructure group with duediligence materials with the expectation that this could provide data that could result in an improved offer.

294 V i s i o n a c c o m p l i s h e d

The Importance of a Voting Trust That was not the only new overture made by the board. Pat Ottensmeyer was directed to contact Keith Creel and notify him directly of KCS’s rejection of the $230.00 per share bid proposal. But more significantly, Ottensmeyer was to deliver the message that in light of the growing likelihood that a higher bid would be forthcoming from the private-equity infrastructure group, and that the numbers were gradually approaching the point requiring serious consideration, KCS would entertain an acquisition proposal from CP. With that being the case, Ottensmeyer would present Creel two conditions of extreme importance to KCS. First, the railroad “contemplated a significant control premium.” Second, it desired “a voting trust to address timing and regulatory issues.” The first of these requests was straightforward. KCS wanted to be extremely well compensated to accept an acquisition proposal, at a number substantially higher than what earlier market prices for KCS would have entailed. In other words, a “merger of equals,” which Creel had suggested to Ottensmeyer back in August, was not going to suffice. While it was best to have it clearly stated, it was inconceivable that CP had not already gotten the message that any future activity on their part would include that understanding. The second request, the voting trust, was more complicated but every bit as important to KCS. A voting trust allows an acquiring company to purchase the shares of the acquired company and place those shares into trust while regulators determine whether the acquisition is in the public interest. While in trust, the power to vote the shares of the company being acquired is held by an independent trustee, and the company being acquired is insulated from being prematurely controlled by the acquiring company. During the time the shares are held in trust, the company being acquired remains in control of its business activities without the influence of the acquiring company. Voting trusts had been frequently used in the railroad industry for over a century. They were commonly employed after the Panic of 1893 during the reorganization process of railroads that had fallen into bankruptcy. In those cases, the trustees protected the railroad being reorganized from being purchased at a low price from a group intent on buying the assets of multiple financially distressed railroads for the purpose of forming rail monopolies in certain geographical areas. The use of trusts had for an extended period

G a m e O n 295

become so routine that in a filing made by CP in 2015, during its ill-fated unsolicited attempt to acquire NS, CP stated that all of the past 144 voting trust applications had been approved by the ICC and its descendant regulatory body, the STB. CP eventually abandoned its bid to purchase with NS, citing “no clear path to a friendly merger” with the “political and economic environment . . . against us.” The acquisition attempt was dropped before the STB had ruled on CP’s voting trust proposal, which would have been the first railroad trust proposed since the revised STB rules governing mergers had gone into effect. It would have been interesting to see what the STB commissioners would have had to say about the trust proposal in light of a statement in its Major Rail Consolidation Procedures, which noted concern about independent voting trusts in future consolidations. If it had been turned down, KCS would have had further reason to desire that if it merged with another Class I railroad, the process be reviewed under the old STB guidelines as getting a voting trust approved under the new procedures might prove to be difficult. There were definite reasons for Pat Ottensmeyer to list establishment of a voting trust as a prerequisite of a CP acquisition overture to KCS. One was to protect KCS and its shareholders during a prolonged regulatory process expected to last as long as eighteen months. Under the voting trust arrangement, when the shareholders of both railroads approved the transaction, KCS shareholders would be paid under the terms of the acquisition. Simply stated, KCS shareholders would be paid days after the customary closing conditions were satisfied and before the merger was given the STB’s final blessing. With the voting trust, the risk would thereby fall on CP. KCS shareholders would be paid under the terms of the deal even if the acquisition was ultimately turned down by the STB. Another advantage of the trust to KCS was that it would partially level the playing field for a CP bid compared to a nonrail bid. If KCS was acquired by GIP-Blackstone, KCS shareholders would immediately be paid upon the deal’s approval. The voting trust would result in a similar outcome for KCS shareholders. On December 4, KCS entered into a confidentiality arrangement with a standstill agreement with GIP-Blackstone. The standstill provision would govern how GIP-Blackstone could purchase, dispose of, or vote KCS stock, thereby effectively stalling or stopping any attempt at a hostile takeover if the two parties failed to negotiate a friendly deal. The standstill restrictions would terminate if KCS were to enter into a transaction agreement with

296 V i s i o n a c c o m p l i s h e d

another party. While the discussions between the private-equity group and KCS at been cordial and productive, the standstill agreement added another layer of protection for the railroad and its shareholders. The due-diligence, confidentiality, and standstill agreements with GIPBlackstone, plus Pat Ottensmeyer’s call to Keith Creel during which he signaled KCS’s willingness to consider a merger with CP, left no doubt that the point had been reached where KCS was prepared to move forward and do a deal that fairly compensated its shareholders. Now it was only a question whether the level of interest of the parties wanting to acquire KCS could match the number that management, the board of directors, and the transaction team had determined as representing the railroad’s true value.

G a m e O n 297

The Canadians Pay a Visit— and Decide to Stay

24

It was one thing for KCS to relay to Keith Creel its willingness to contemplate a merger deal, but it was another to actually mean it. It is only natural that a company whose culture celebrated its employees’ independent spirit would wish to itself remain independent. Formally, when KCS executives had given the statement that the railroad’s board of directors and officers would uphold their fiduciary duties and review legitimate offers to acquire the railroad, they were sincere, and they would do what was right for their shareholders. Nevertheless, it would be a mistake to think that there was no bias to remain independent. Though still a relative newcomer, Pat Ottensmeyer embraced this mindset. He was confident that KCS had a good—maybe even great—future, and he would be proud to remain the chief executive officer guiding its development. The railroad was in the best shape in its history; its infrastructure, internal systems, operations, and market growth potential were all stronger than ever. Why sell now? Plus, did he want to be the guy responsible for selling the railroad that generations of executives had fought to keep independent? During a time away from the office following the flurry of initial bids, these questions dominated his thinking. However, they were not the only thoughts he reflected on. The fact was the KCS network was always going to be geographically challenged. While obtaining the Mexican rail concession had been transformative, its North American network was limited and would always remain so. This meant that KCS’s growth would always be dependent on the other Class I railroads who served the major markets and rail hubs that KCS simply could not reach by itself. Though KCS had

299

proven conclusively that this did not constitute a fatal flaw, it did undeniably put limits on its potential. As expectations for better-than-average industry growth would continue to grow in the years ahead, these limitations could become more of an issue. Ottensmeyer also considered the possibility that KCS’s shareholders might never be in a better position to receive maximum value on their investments as they were right now. While KCS would almost assuredly continue to provide positive shareholder returns, the pace of growth would likely slow simply because as a company grows larger, it becomes mathematically more difficult to consistently post the kind of quarter-over-quarter percentage growth numbers it previously had. And there was one other thought: if being acquired at some point was inevitable, and it probably was, would KCS’s chief executive and board of directors ever be in as good a position to have a major influence on the construct of the deal than they had right now? Probably not. After long reflection, Ottensmeyer concluded that the time had likely arrived. KCS should embrace the idea of doing a deal but only one with which it was 100 percent positive was in the long-term best interests of its employees, shareholders, customers, and the communities served. He related his thoughts to Bob Druten while also beginning to work out a value-versusrisk standard for evaluating merger proposals that might appear. Once the transaction team embraced the idea that a merger could be a meaningful net positive for KCS’s multiple stakeholders, it could concentrate on finding the right balance between obtaining the highest premium and choosing the partner and the deal most likely to make it through regulatory review. The board and transaction team was totally on board with this thinking. Losing one’s independence would hurt, and no one understood this more than Pat Ottensmeyer, who did not relish the thought of introducing anxiety into the lives of his employees. But the bigger picture suggested it would be in their best interests for the railroad to undergo a major change and expand its horizons in a way it could not do on its own. If, however, the transaction team could not find a deal that achieved the optimal value-versus-risk balance, then nothing need be done and life would go on as an independent railroad. A commitment to embrace the idea of a sale did not mean a sale had to be done; to that extent, KCS was in the driver’s seat.

300 V i s i o n a c c o m p l i s h e d

Canadian Pacific Joins the Party On December 9, 2020, CP finally did what the KCS team had expected for months when it submitted an unsolicited written proposal to acquire KCS for 0.469 shares of CP common shares and $77.00 in cash per share of KCS common stock. Based on the price of CP common stock on the date of the proposal, the deal was worth approximately $235.00 per share of KCS stock. The CP bid anticipated the use of a voting trust structure, which its management estimated could be put together within four months of signing a definitive agreement. At that time, KCS shareholders would receive CP shares and the cash per share of KCS stock owned. CP would assume full control of KCS after STB approval of the merger. The total process, CP estimated, would take twelve to sixteen months. The offer led to a call between members of the KCS transaction team, Keith Creel, and other CP executives, resulting in KCS entering into a mutual confidentiality agreement with CP similar to that already in force with GIP-Blackstone. In the eyes of the KCS team, the CP bid was a step forward but it did not differentiate itself enough from the $230.00 per share offer made by GIPBlackstone on November 23. The team unanimously agreed CP failed to provide the level of value that would compensate for the additional risk of having to go through the STB regulatory process. Ottensmeyer communicated this to Creel, but he also relayed to him that KCS was prepared to begin providing CP with due-diligence materials under a mutual confidentiality agreement so that CP could have an opportunity to submit an improved bid. On December 22, the KCS board held a special meeting including senior management, Morgan Stanley and BofA Securities representatives, and KCS’s outside legal counsels. During the meeting, Mike Upchurch presented an update on the LRP, which had recently been revised to reflect management’s more optimistic financial and operational outlook as a result of the faster than originally anticipated recovery from the COVID-19 pandemic and the lower operations costs resulting from its precision scheduled railroading (PSR) initiatives. Morgan Stanley and BofA Securities then laid out their perspectives on the GIP-Blackstone and CP offers as well as their refreshed valuations of KCS in light of the updated LRP.

T h e C a n a d i a n s P a y a V i s i t — a n d D e c i d e t o S t a y 301

The Dam Gives Way For all intents and purposes, December 2020 was when the game got real: speculation and early merger proposals gave way to an all-out bidding contest between GIP-Blackstone and CP. After CP’s initial offer was rejected on December 14, GIP-Blackstone returned with a new proposal on December 28, which was quickly followed three days later on December 31 by a revised submission from CP. The GIP-Blackstone offer was for $235.00 cash per share of KCS common stock. The CP bid came in at 0.489 shares of CP common shares and $78.00 in cash per share of KCS common stock, which combined at the time represented approximately $248.00 per share of KCS common stock. On January 7, 2021, the KCS board and essential members of the transaction team met to discuss the proposals. Pat Ottensmeyer discussed the highlights of each, paying particular attention to CP’s offer. His main thought was that while GIP-Blackstone’s offer posed less risk than CP’s, or with any other bid from a Class I railroad that might be forthcoming, it offered less value due to its lack of the marketing and operational synergies possible with a merger with another railroad. A CP-KCS merger might also provide the best value-versus-risk proposition in that it would be an end-to-end combination with virtually no overlap between the two systems. This meant that not only would there be no loss of rail competition from a merger of the two railroads, the operational complexities posed by the combination would likely be less daunting than those that had arisen in the aftermath of the past rail megamergers. There would still be much work to be done to combine the operating systems of each, though it would not approach the difficulties of those that had arisen in earlier efforts to combine the systems of huge railroads and coordinate the operations of two established and overlapping rail networks. Ottensmeyer, the board, and the remainder of the transaction team took this thinking a step further and speculated that given the combination’s potential synergies and absence of operational bottlenecks, CP was likely in a position to improve on its purchase price bid, thus increasing its value proposition without adding risk. The team felt that the combined stock and cash offer of about $248.00 per share of KCS common stock was a worthy one, but it was convinced that KCS was worth even more. This led to a lengthy discussion of the potential heightened synergies in light of the updated LRP and what it could mean for future offers. 302 V i s i o n a c c o m p l i s h e d

During the meeting, KCS’s chief legal officer, Adam Godderz, discussed the expected regulatory review process and potential timeline if KCS was to pursue a transaction with a Class I railroad. The general feeling was that though the review would be strenuous, KCS’s moderate size and limited direct access to major markets might make the STB process less arduous than if two large rails sought to combine in the current regulatory and political environments. Still, there was question whether the review of a transaction involving KCS with another Class I would fall under the scope of the revised 2001 “Major Rail Consolidation Procedures” or under the previous guidelines. In addition, the entire process would likely take eighteen months, perhaps even longer. The meeting then turned into a debate about whether KCS should reach out to other railroads to assess whether others might have interest in a merger. There were certainly arguments for doing so, the most compelling being the possibility of sparking an all-out bidding war. The underlining point with the argument to reach out to the full Class I community was if KCS was truly serious in pursuing a merger would it not then make sense to do what it could to get the highest price possible for the franchise, thus maximizing the benefit to its shareholders? On one level this argument made perfect sense. But every time the suggestion arose—and henceforth it would arise with each new offer—Pat Ottensmeyer, for one, expressed his reluctance in pursuing this route. He was not against getting a rich premium. His concern was that reaching out to others might start an all-out bidding war among a number of railroads. KCS could inadvertently lose control over the process, which could lead to greater risk. It might open up the possibility of the board of directors being forced by shareholders to accept an offer that did not satisfy its desire to protect multiple KCS constituencies, and it might also come with significantly higher regulatory risk of being rejected. Through its overtures to other railroads, KCS could open itself up to greater STB scrutiny. It was hard to imagine that in the present regulatory climate, a merger with any US Class I railroad would be reviewed under the former STB merger guidelines. KCS had grown to a size that its combination with a large US rail would likely be determined major enough to cause material change in the present market landscape and alter whatever competitive balance still existed in the industry. In addition, the STB’s position regarding the use of voting trust arrangements had not yet been tested under the new merger review rules. T h e C a n a d i a n s P a y a V i s i t — a n d D e c i d e t o S t a y 303

Financial analysts and KCS investors had high praise for how KCS’s executive management, board of directors, and transaction team managed the bidding process. Pictured above are Patrick Ottensmeyer, chief executive officer; Adam Godderz, chief legal officer; and Robert Druten, chairman of the board.

For all the above reasons, Ottensmeyer argued against communicating to all the major railroads KCS’s openness to doing a deal. After lengthy discussions, the board and transaction team agreed with this thinking. Steve Rosenblum of Wachtell Lipton had remained neutral, befitting his position as a legal counsel on SEC-related issues, but he offered a middleground solution by suggesting that KCS protect itself from being trapped in a deal if another, better one came along. He noted the advisability of negotiating a reasonable “friction cost,” in this case a termination fee that would allow KCS to free itself from one deal to enter into one of perceived greater value. KCS should use its preferred negotiating position to settle on as low a termination cost as possible. The number the group agreed on was $700 million, which at first blush appears to be a good deal of money, but when, at the time, the total value of the deals being discussed was in the $25 billion-plus range, $700 million appeared to be a reasonable number. The balance between value and risk, which the board had adopted as its guiding metric for reviewing each bid, helped in bringing into sharper focus the kind of proposal that would be most acceptable to KCS. It also served to 304 V i s i o n a c c o m p l i s h e d

keep the group motivated to maintain as much control as possible over the process. That way, if a merger proposal was eventually accepted, it would not only provided value to KCS’s constituents, but it also had a good chance of making it through the regulatory review process. The January 7 meeting concluded with the board’s decision to turn down both the GIP-Blackstone and CP offers. However, it authorized Ottensmeyer to tell both that they were invited to complete their due diligence by early to mid February with the expectation of providing their best and final offers soon thereafter. Through the remainder of January and into February, Ottensmeyer, members of senior management, and KCS’s legal and financial advisers engaged with GIP-Blackstone and CP representatives to address their due-diligence queries and requests. Druten and Ottensmeyer also had discussions with CP representatives to get readings on how they saw the regulatory process playing out and what concerns, if any, they had about potential political or customer issues. In late January, the board held a meeting with KCS executive management and its legal advisers to be further educated on the process of developing a voting trust arrangement with CP and its odds of being approved by the STB. The board also received an opinion as to the percentage odds of CP getting STB regulatory approval for its merger proposal. Having done as much as possible to prepare for multiple eventualities, the KCS transaction team was relegated to playing a waiting game. They did not have to wait long. On March 3, 2021, both GIP-Blackstone and CP delivered updated proposals. GIP-Blackstone’s proposal contemplated an all-cash purchase price of $245.00 per share. The group informed KCS that it had reengaged with its equity partners and was highly confident that they all would be able to secure final internal approvals to provide official confirmation of the key transaction items over a two-to-three-week period. The $245.00 per share bid was remarkable in that the group had now gone far beyond what KCS’s bankers, as well as independent financial analysts and transportation professionals, felt a private-equity infrastructure consortium would be willing to offer for a railroad the size of KCS. Not only did the bid validate the board’s and its transaction teams’ estimate of the railroads’ value, but it also gave the team plenty to think about. Now more than ever, the time value of money was very much in play. The CP proposal was every bit as impressive as it upped the contemplated purchase price of 0.489 shares of CP common stock, compared to the 0.486 T h e C a n a d i a n s P a y a V i s i t — a n d D e c i d e t o S t a y 305

shares previously offered; and $81.00 in cash per share of KCS common stock, compared to the previous $78.00 per share offer. The combined value of the new bid was approximately $260.00 per KCS share. The proposal anticipated the creation of a voting trust being arranged in four to six months after the agreement to seek a merger was signed. It also contemplated a $400 million reverse termination fee payable to KCS in case the merger agreement was terminated due to the inability to complete a voting trust as a result of STB issues. The CP proposal included other provisions that spoke to the enviable strategic position of KCS that Ottensmeyer had discussed with the board. The bid stated the combined company would be named Canadian Pacific Kansas City (CPKC), with its US headquarters remaining in Kansas City. CP had clearly gotten the message that KCS wanted more than a “take the money and run” deal. As much as practical, the KCS team sought the protection of its Kansas City headquarter employees, preservation of the railroad’s Kansas City heritage, and assurance that its home city would not lose a prominent business. In the days following the new offers, the KCS board drifted closer to agreeing to a deal. A draft merger agreement was circulated to CP representatives. A similar one was provided to GIP-Blackstone a few days later. The drafts included a provision that would permit the KCS board to terminate its agreement with the acquirer to accept an alternative agreement under certain conditions. In its draft to CP, a one-way exchange collar provision was requested in which KCS shareholders would receive a fixed dollar amount of stock consideration if CP’s common stock price fell below a specified threshold. A similar exchange collar was obviously not necessary in the case of GIP-Blackstone as theirs was an all-cash deal. On March 6, the KCS board convened a meeting of the entire transaction team to discuss the details of the two proposals. The discussion took another look at the risk-versus-value balance of each. The board also debated whether the fact that KCS shareholders stood to get full cash payment in approximately four months after signing the GIP-Blackstone agreement was enough of a benefit to choose it over the CP bid, which offered greater value but came with greater risk. Another factor to consider was that KCS shareholders would be receiving CP stock. The stock came with a risk that its value could decline by the time the CP common stock was awarded, in which case the total value of the deal to KCS shareholders might be

306 V i s i o n a c c o m p l i s h e d

substantially diminished. Twenty-five years ago, it happened with the proposed IC-KCS deal and had been one of the reasons the merger agreement had been terminated. The board directed Ottensmeyer, Upchurch, and the company’s financial advisers to talk through the elements of the offers with both parties and ask GIP-Blackstone and CP to submit their final proposals no later than March 15.

Finally, a Deal On March 15, 2021, GIP-Blackstone submitted a revised proposal of an all-cash purchase price of $250.00 per share, which it noted was its “final proposal.” The consortium of private-equity investors had gone far beyond anyone’s expectations, an unmistakable statement as to the value a group of savvy investors placed on the future of KCS. However, at $250.00 per share, GIP-Blackstone had reached their limit. CP raised its bid as well, proposing a transaction that would provide KCS shareholders 0.489 shares (the same as the previous offer) and $86.00 in cash per share of KCS common stock (from its previous $81.00 offer). The new proposal was equal to approximately $268.00 per share of KCS common stock based on the market price of CP common at the time (compared to its previous $260.00 per share deal). The CP proposal also stated that it would agree to the right of the KCS board of directors to terminate the merger agreement to accept a superior proposal in certain circumstances. On March 16, the KCS team met to review the two proposals. GIPBlackstone had gained the full respect and trust of Pat Ottensmeyer, Mike Upchurch, and board chair Bob Druten. The consortium’s intelligent, straightforward, and honest approach went a long way toward gaining credibility with the KCS transaction team, and their proposals were given full attention. But in the final analysis, Ottensmeyer felt, and the KCS team unanimously agreed, CP’s offer would be superior if CP would agree to a few important modifications. The desired modifications were outlined to Keith Creel, along with KCS’s willingness to strike a deal with CP subject to the improvements being added. Ottensmeyer had relayed to Creel the board’s desire for CP to raise the exchange rate from 0.489 to 0.5 of CP common stock, increasing the reverse termination fee from $800 million to $1.3 billion, and accepting the board’s

T h e C a n a d i a n s P a y a V i s i t — a n d D e c i d e t o S t a y 307

right to terminate the merger agreement to accept a superior proposal in certain circumstances. The three proposals reflected Ottensmeyer’s and the board’s commitment to striking a balance between risk and value. Creel replied that he would need to consult with the CP board and would get back to him shortly. He was good to his word: later that day, he responded that CP wished to stay with its 0.489 exchange rate ratio, but it would increase its cash consideration per KCS share from $86.00 to $90.00. The change resulted in a combined value of the offer to $275.00 per share of KCS common stock, up from the earlier $268.00. In addition, CP agreed to increase the reverse termination fee to $1 billion, and also agreed to the right of the KCS board to terminate the merger agreement to accept a superior proposal under certain circumstances. On March 20, the board met with the KCS transaction team to review the CP proposal in detail. Pat Ottensmeyer, supported by Mike Upchurch and the other members of executive management present, expressed their support for the offer. Steve Rosenblum communicated to the board its fiduciary duties under Delaware law, and the representatives of Morgan Stanley’s and BofA Securities presented their financial analyses and rendered their oral opinions of the transaction. Upon digesting all the information, the KCS board issued its unanimous approval and resolved to recommend that KCS shareholders adopt the merger agreement. Following the meeting, parties representing both companies finalized the agreement. In the early morning hours of March 21, 2021, KCS and CP officially executed the CP merger agreement, and the two railroads issued a joint press release announcing the combined transaction. It was a good deal. There was a large collective sigh of relief, hugs, and handshakes all around for a job well done. However, there was no jubilation—certainly none displayed by KCS personnel, and there would be none. The signing of the sales agreement meant the days of KCS remaining independent were numbered, and that hurt. No tears were shed, at least not at this moment, but the mood of the KCS faction vacillated from satisfaction with the deal they helped fashion, to excitement for the growth prospects that the merger presented, to somber reflection that the merger agreement also meant the likely end of the railroad’s proud, unconventional, one-ofa-kind culture. Something great was ending. Still, with this ending there would be a new beginning, and the KCS folks took solace in knowing that that their railroad’s culture had played a part in the design of a very favorable transaction agreement. 308 V i s i o n a c c o m p l i s h e d

Patrick Ottensmeyer is pictured signing the first transaction agreement between KCS and CP, an agreement that lasted all of two months.

On March 22, CP submitted its application to the STB, requesting the approval of a voting trust arrangement. The clock had started ticking. A month later, it stopped. T h e C a n a d i a n s P a y a V i s i t — a n d D e c i d e t o S t a y 309

Another Canadian Railroad Enters Stage Left Even after the merger agreement with CP had been signed, a thought lingered in the back of Pat Ottensmeyer’s mind that the bidding process might not be over. The last seven months had been a time of unremitting stress and mounting physical exhaustion as KCS people had worked their way through eleven acquisition proposals, oversaw multiple refinements to the LRP, coped with a pandemic that had upended normal business practices, and, last but not least, ran a railroad. Nevertheless, Ottensmeyer felt that KCS, and even CP for that matter, had gotten off easier than he had expected due to the absence of acquisition bids from other Class I railroads. He was not disappointed. The deal with CP was a very good one. But why had CN, especially, not been heard from, save for the early phone call he had received from Jean-Jacques Ruest expressing his railroad’s interest in KCS? But after that, there was nothing. Ottensmeyer was aware of CN’s long-standing interest in combining with KCS, which dated back long before Ruest’s August 2020 phone call. It could be traced back to the mid-1990s, soon after KCS had gained minority interest in the Mexican North-East Line rail concession and TFM operations had begun. Paul Tellier, CN’s president and chief executive officer at the time, did not have a railroad background but could boast of a distinguished career in public service, culminating in serving as clerk of the Privy Council and secretary to the Cabinet during Prime Minister Brian Mulroney’s administration. Mulroney had been a major force in the creation of NAFTA; Tellier, like all others associated with its formation, had become energized by NAFTA’s potential for spurring expanded trade among Canada, United States, and Mexico. Tellier left public office in 1992 to run CN. No one who met Paul Tellier could miss the fact that this was a very ambitious man who did not shy away from the spotlight nor back off from challenges. He had a politician’s flair for the dramatic and was determined to elevate CN’s status as a major contributor to Canada’s economic future. He was a driving force in CN acquiring IC and later in his tenure, the Wisconsin Central. Perhaps ambition overwhelmed good judgment when he led CN’s attempt to merge with BNSF, an effort that not only went down in flames but drove the STB in 2001 to adopt new, more stringent, guidelines for reviewing Class I rail merger applications. Part of Tellier’s grand vision for CN was to be recognized as the NAFTA Railroad, which was interesting in that his counterpart at KCS, Mike 310 V i s i o n a c c o m p l i s h e d

Haverty, wanted the same for his railroad. Tellier expressed to Haverty the benefit that would come from a combination between the two railroads. While Haverty also saw its potential value, he understood who the lead actor in this production would be, and it was not KCS. As he had told Landon Rowland and Paul Henson a few years earlier, he liked to build things, not sell them. There would be no CN-KCS merger during his watch. Haverty’s disinterest in doing a deal at that time proved to be the right one for his railroad and its shareholders. To have done so would have meant that many investors would have lost the opportunity to profit from the railroad’s phenomenal financial success down the line. At the same time Haverty wanted to work with CN, just as he wanted to work with CP. In fact, in general he seemed more inclined to work with the Canadians than he did with some of his US brethren. To that end, he proposed to Tellier that the two railroads enter into a trade alliance. Tellier brushed aside whatever residual disappointment he may have had connected to his failed merger idea and was a shrewd enough businessperson to see the benefit of the alliance. The marketing teams of CN and KCS worked out an agreement that gave CN greater access to the southern portion of KCS’s service territory. The fifteen-year trade alliance was signed with great fanfare with prominent US senator from Mississippi, Trent Lott, giving it his considerable public support. This was just the kind of publicity that Paul Tellier thrived on, and the deal allowed him to rightfully advertise CN as a significant NAFTA player. In the minds of some rail observers, and perhaps of some KCS people, the deal also made CN a potential acquirer of KCS somewhere down the line. This made CN’s absence from the scene puzzling. What made it even more surprising to Ottensmeyer was that he was aware that one of CN’s largest and influential institutional shareholders was concerned about a CPKCS merger and had lobbied CN to become involved in the bidding. The investment firm’s position was twofold: first, it understood the value of the KCS franchise and bought into its future growth potential; second, the firm worried that a CP-KCS merger would shift the balance of power in Canada away from CN, which historically had been that nation’s dominant railroad. That shift would not be in the best interest of CN shareholders. So, in light of Ruest’s phone call, his knowledge of CN’s past merger overture to KCS, and the concern of an important CN shareholder, it struck Ottensmeyer as odd that CN had not entered the fray. Odd, but again, not disappointing. T h e C a n a d i a n s P a y a V i s i t — a n d D e c i d e t o S t a y 311

But then, a month after KCS and CP had signed their mutual agreement to merge, that all changed abruptly when on April 20, 2021, CN delivered an unsolicited written proposal to acquire KCS for 1.059 shares of CN common stock and $200.00 in cash per KCS common stock amounting to deal worth approximately $325.00 per share of KCS common stock. The proposal contemplated that CN and KCS would enter into an agreement with terms similar to those of the CP-KCS deal, including a voting trust. Not only had CN stormed onto the scene, but it had also entered with a bid substantially higher in value than CP’s. True, there was reason to speculate that CN’s offer could lead to greater risk, particularly relating to regulatory review, but there could be no dismissing the fact that in terms of its monetary value it dwarfed the CP’s offer. It definitely put the KCS board in a tough situation. How could it justify to its shareholders rejecting an offer that promised so much more value? The KCS board and transaction team convened on April 24 to review the CN proposal and develop a response. After a detailed discussion, the board determined that the CN offer could reasonably be expected to lead to a “Company Superior Proposal” as defined in the CP merger agreement. What this meant was that the new proposal could trigger the right of KCS to void its contract with CP in favor of a superior offer. The board determined that KCS would engage with CN regarding the proposal and directed management to notify CN and CP of its decision to do so. During a subsequent KCS transaction team meeting on May 8, a number of proposed enhancements to the CN offer were developed, including raising the exchange ratio from 1.059 shares, increasing the reverse termination fee payable to KCS if the voting trust was rejected by the STB, and requiring CN to reimburse KCS upon KCS’s payment of the $700 million termination fee due to voiding the merger agreement with CP. The KCS board directed executive management and its legal advisers to submit the requests so that CN could provide a revised proposal allowing the board to determine whether the CN offer did in fact constitute a Company Superior Proposal. On the morning of May 13, 2021, CN responded to the KCS requests stating it would increase the exchange ratio from 1.059 to 1.129 shares of CN common shares to restore the headline value of $325.00 per share. CN also agreed to reimburse KCS for the $700 million termination fee payable to CP, though it would not increase the reverse termination fee. Meeting later in the day, the KCS board determined that the CN offer did constitute a Company Superior Proposal. Under the terms of its existing 312 V i s i o n a c c o m p l i s h e d

agreement, KCS would give CP at least five days to attempt to match the terms of the CN proposal prior to terminating the CP deal and entering into a merger agreement with CN. On May 20, Keith Creel contacted Pat Ottensmeyer to notify him that CP did not intend to pursue revisions to the CP-KCS merger agreement. On May 21, 2021, the board unanimously approved the termination of the CP merger agreement. Shortly after notifying CP of this decision, KCS delivered a signature page to the merger agreement with CN, which had already been executed by CN, and the two railroads issued a joint press release announcing the transaction. The events of the past month culminating in the dissolution of one merger agreement with a Canadian railroad and the signing of a new agreement with another Canadian railroad had left both CP and KCS in states of semishock. Keith Creel and a swath of CP management were left frustrated, and they had every right to be. They had worked diligently and responsibly to craft a good deal, only to have the rug pulled out from under them by CN, who had entered the game late. CN appeared to have waited until KCS had finally accepted an offer and then jumped in with a richer one. However, any resentment that CP management might have felt toward KCS at the time quickly dissipated with the understanding that the KCS board really had little choice but to accept CN’s proposal. KCS shareholders simply would not have supported the CP deal over CN’s offer. The difference between the two offers, though both were excellent, was just too substantial to ignore. But Keith Creel was anything but a quitter. While he was not in a position to be able to match CN’s offer, he had no intention of throwing in the towel. In his heart of hearts, he still felt his railroad was a better match for KCS, and the CP-KCS combination was the only deal with a path to regulatory approval. Creel was determined to do everything he could to convince as many groups as possible that for both those reasons, CP was the better choice. No question his team had lost a major battle, but for Creel, the war was anything but over. Both internally to his employees and publicly, he vowed to press on. KCS also vowed to press on, but in its case that meant working with CN to prepare for the STB review. At the same time, KCS had to adjust very quickly to having forsaken one suitor for another. By no means was there any friction between KCS and CN—quite the opposite. Pat Ottensmeyer and J.-J. Ruest had a very cordial relationship, and some members of KCS’s and CN’s marketing and operations teams were familiar with each other T h e C a n a d i a n s P a y a V i s i t — a n d D e c i d e t o S t a y 313

given the fifteen-year marketing alliance the two railroads had entered into years before. But it had happened so fast. It had only been a few weeks earlier that KCS was celebrating its success in negotiating an agreement with CP. Now, without any bare-knuckle negotiation necessary, it had a new agreement with a new partner. But there it was—and really, it was hardly a bad position in which to be. It would just take a bit of time to adjust, and time was of the essence as the CN and KCS teams had to start planning for the next steps in the process. With the regulatory risks facing the CN-KCS merger application greater than those that CP-KCS would have posed, it was not going to be a hazard-free road to victory. Nonetheless, both CN and KCS were confident. In all the excitement and hullabaloo of the past month, four significant decisions passed down by the STB were all but overlooked by outside observers. First, on April 23, the STB announced its decision granting a waiver that would allow the CP-KCS merger application to be reviewed under the old merger guidelines rather than the new, more stringent ones that had gone into effect in the summer of 2001. On May 6, the STB announced its decision in favor of CP’s application of a voting trust agreement as part of its proposal to merge with KCS. Third, on May 17, the STB rendered a decision stating that CN would not be granted a waiver from having the CN-KCS merger application being reviewed under the new merger guidelines. CN had not actually applied for a waiver as it had earlier given up any chance it could ever had of receiving one with its earlier opposition of the CP-KCS application for a waiver. Many saw this as a tactical error, especially after the STB formally closed the door on the possibility of being granted a waiver even without CN actually applying for one. Fourth and finally, the STB denied CN’s motion to approve its proposed voting trust, though it stated in its decision that it did so without prejudice to CN filing a new motion. It was interesting that at the very same time CN was celebrating its victory in the KCS sweepstakes, CP had taken a four-to-nothing lead in the early voting. But did that really mean anything?

314 V i s i o n a c c o m p l i s h e d

The Curtain Falls on a 136-Year Adventure

25

Just over a week after having its initial motion to form a voting trust as part of its merge proposal denied, CN jointly filed with KCS a revised application to the STB. Though the Major Rail Consolidation Procedures adopted in 2001 did not include specific guidelines governing the review of voting trust applications, comments in the document suggested that the STB would hold future applications to a higher standard during the review process. Included in the statement introducing the revised merger guidelines was the comment that with only a limited number of railroads remaining, it was incumbent on the STB to “take a much more cautious approach to future voting trusts in order to preserve [its] ability to carry out [its] statutory responsibilities” and that under the new approach “[voting trusts] should not be used routinely, but rather should be available only for those rare occasions when their use would be beneficial.” The STB had reacted to a growing chorus of concern that voting trusts, by their very nature, encouraged a reduction of competition between the railroads in the arrangement. For instance, there was concern that if the two railroads operating under a voting trust arrangement had lines that overlapped and served the same markets, the voting trust could serve as a damper on head-to-head competition. Even though the managements of each railroad remained independent, the railroad being acquired may be disinclined to aggressively compete against its acquirer. The renewed motion of CN-KCS for approval of a voting trust attempted to address this concern with CN’s commitment to divest KCS’s seventy-mile line between New Orleans and Baton Rouge following the consummation of the transaction and the STB’s final approval of the merger. It took less than twenty-four hours for CP to offer a scathing response stating that “CN’s 315

commitment does not come close to solving the anti-competitive problems inherent in the proposed CN/KCS transaction.” Not only did CP find CN’s divestiture plan for the line ill conceived, “this token divestment would not begin to address the competitive issues in the rail corridors running north from Louisiana and Mississippi through America’s heartland” and “does not address many shippers and stations that are today served by both KCS and CN in markets like Omaha/Council Bluffs, Jackson, MS, Springfield, IL, and St. Louis.” While CP’s opposition to the voting trust was loud and clear, CN maintained that the competitive issues had been fully addressed. Although the STB did not comment on CP’s objections, on June 8 the agency agreed that the revised CN-KCS motion met the necessary regulatory requirements and established a timeline for its review of the voting trust application. It also stated that all public comments related to the voting trust be filed with the STB by June 28, and CN-KCS replies be submitted by July 6. In a joint statement released following the STB announcement, CN and KCS declared that the “plain vanilla” voting trust was “identical to the CP trust approved for use by the STB.” This was true; in both the CP and CN applications it was spelled out that the voting trusts would insulate the railroad being acquired, KCS, from being prematurely controlled by the acquiring company, either CN or CP, during the regulatory review process. Also, both the acquiring company and the target company would remain financially sound so as not to jeopardize either railroad if the merger transaction was ultimately denied. However, the STB’s ruling on CP’s application had been made within the context of the old merger review guidelines. As former STB vice chair William Clyburn pointed out, before the adoption of the new Major Rail Consolidation Procedures, rarely did the STB or its predecessor, the ICC, devote much energy to reviewing voting trusts. Now that was about to change, as the STB wanted to exert greater control over the voting trust process. Still, for the present at least, one of the four issues listed at the end of chapter 24 had been removed, and the STB would review and rule on the CN-KCS voting trust proposal. What was already coming into focus was that the voting trust question could well become the major factor in determining the fate of the CN-KCS merger.

316 V i s i o n a c c o m p l i s h e d

The Public Comments Though the motion for the voting trust arrangement was a different matter than the CN-KCS application to merge, in the eyes of those who filed their comments with the STB, the two were joined at the hip. The majority of comments filed reflected the parties’ opinions of the merger more than they did the appropriateness of a voting trust. Even those who mentioned the trust frequently reduced it to a brief comment at the end, either for or against, after a more detailed discussion about the merger. As such, the elements that composed the core arguments made by CN and KCS for approving the merger comprised most of the points made in the letters in support of the voting trust application. Similarly, the CP’s primary arguments for rejecting the merger application were used by those who wrote in opposition to the voting trust motion. Some of the key arguments put forth by CN and KCS were as follows: The new single-line routes would eliminate delays associated with interchanges. The combination would reduce cycle and transit times and provide more reliable and timely service for customers. The merger would result in more cost-effective access to southern markets in the United States and Mexico, thus accelerating the economic benefits of the United States-Mexico-Canada Agreement (USMCA). The merger would provide significant benefits by reducing the amount of long-haul truck traffic on the roads in six major shipper market segments. The end-to-end merger would pose no risk to competition and customers would not lose any existing routing options. The potential CN-KCS merger gained wide support, including large segments of the International Brotherhood of Boilermakers and the International Association of Sheet Metal, Air, Rail, and Transportation Workers, Transportation Division (SMART-TD), letters from local leaders of the Brotherhood of Locomotive Engineers and Trainmen, as well as letters of support from three governors, twenty-eight mayors, and eleven members of Congress, and various business associations. In all, 1,700 letters of support for the merger were filed with a little over half, 967, requesting STB approval of the voting trust arrangement.

T h e C u r t a i n F a l l s o n a 1 3 6 - Y e a r A d v e n t u r e 317

CN and KCS had also elicited the support of two consultants, both of whom had formerly held high-ranking positions with the STB. As noted earlier, KCS had brought onto its transition team William Clyburn, who had served as a commissioner and vice chair of the STB from 1998 until the end of 2001. Another consultant, William Huneke, had been director of the Office of Economics and chief economist of the STB. Having served as a commissioner during the development and adoption of the Major Rail Consolidation Procedures, Clyburn believed that when it came to voting trusts, he and his fellow commissioners had focused their attention almost exclusively on ensuring that the revised guidelines took into consideration the protection of the target railroad from unlawful control of the acquiring company during the regulatory review process, and that the financial well-being of both the target and acquiring companies would not be thrown into jeopardy if the merger transaction was rejected after review. He believed that the STB had adopted a standard “designed to focus on the financial fitness of the merging parties,” and that was to be the primary public interest factor considered when reviewing voting trusts. Therefore, Clyburn felt that the CN voting trust application met the STB’s approval standard under the revised merger guidelines. William Huneke argued that two concessions made by CN in the merger applications met the STB’s public interest standard in the revised major merger guidelines in that they demonstrated the commitment of the applicants to maintaining competition at premerger levels. The first concession was CN’s declaration that it would divest the seventy-mile line between New Orleans and Baton Rouge. The second concession, more importantly, was CN’s open gateway offer that would allow shippers, who now had joint line routing with either CN or KCS, to still have those routings available to them in a post CN-KCS merger even if the merged railroads could handle the entire movement via a single-line routing. Huneke’s contention was that nothing in the merger application should pose an obstacle to the granting of the voting trust from a public interest perspective. On the other side of the ledger, CP had raised numerous arguments against approving the trust; those arguments appeared in one form or another in most of the letters filed with the STB. Some of the arguments that most frequently showed up in the filings were as follows: A CN-KCS combination would reduce freight transportation service options for over 340 shippers, and the reduction in competition would have major implications for shippers and the railroad industry. 318 V i s i o n a c c o m p l i s h e d

CN would take on over $19 billion of additional debt if the voting trust was approved, creating risk to its business, employees, and the future of North American rail infrastructure. The 45 percent premium would require CN to find ways to recoup this substantial investment. If CN did not achieve its optimistic forecasts, it may have to under invest in its rail infrastructure or increase shipper rates to service its debt. Allowing CN to use a voting trust to acquire KCS would create immediate pressure for downstream consolidation in the railroad industry. As this would be the first-ever test of the STB’s 2001 merger rules, it would set a blueprint for the use of voting trusts in subsequent rail merger proposals. Approval of a CN voting trust would eliminate the potential for a CPKCS combination that would create a new north–south rail artery that would bring new competition to shippers in America’s heartland, between Canada and the US Gulf Coast. CN and its supporters urge approval of a voting trust to “allow KCS to choose the bid it judges to be best for its shareholders.” Opponents argued that this “shareholder-first” argument would elevate private benefits to shareholders over public interest, and the desire to maximize returns to KCS’s shareholders is not a public benefit. Approving a voting trust on this basis would make voting trusts routine, contrary to the STB’s major merger rules. Hundreds of union officials, consumer advocates, shipper groups, and state and local government officials in the United States and Mexico supported CP’s positions. Notably, while CN had gained the support of a number of SMART-TD locals, CP successfully motivated others within the union to oppose the voting trust, including the SMART-TD General Committee representing KCS employees. In addition, a joint letter in opposition was signed by SMART-TD’s state legislative directors in Kansas, Missouri, Louisiana, Texas, Mississippi, and Illinois. Other letters opposing the trust came from the general chair of the Brotherhood of Locomotive Engineers and Trainmen representing 570 CP (DM&E, Soo) employees, and the president of Unifor Local 101R representing fifteen hundred active CP locomotive and car repair employees in Canada. Amtrak also filed a letter of opposition to CN’s voting trust application. The relationship between freight railroads and passenger rails using tracks owned by freight lines had historically not been without its rough edges. While for appearance’s sake the two tried to make nice in public and often did try to work together constructively, tensions simmered just below the T h e C u r t a i n F a l l s o n a 1 3 6 - Y e a r A d v e n t u r e 319

surface. Amtrak felt like it was a second- or even a third-class citizen operating on the lines of barely hospitable freight railroads, who for their part had concerns about the safety issues and freight service complications posed by passenger service. Mostly, ownership proved to have its privileges. But even though politicians liked to sing of the virtues of passenger rail, when push came to shove, the freight railroads usually maintained political and regulatory advantage over passenger service. However, no US president since Harry Truman was as closely linked to passenger rail as was the current holder of the highest office in the land, Joseph Biden. While serving in the US Senate, the then senator Biden had for years commuted weekly between Washington, DC, and his home in Delaware. He did so for deeply personal reasons that touched the heartstrings of the American public. Biden riding Amtrak was a feel-good story, and even when his rail commuting ended once he became vice president and later president, he remained loyal to Amtrak and passenger rail. That loyalty was recognized within his administration and on Capitol Hill. So, this time when Amtrak filed its opposition to the CN voting trust, it seemed to carry added weight. While its letter was mostly confined to criticizing what it viewed as a flawed CN plan to divest itself of KCS’s seventy-mile Louisiana line, it also spoke to passenger rail’s importance to maintaining and improving public interests. CP was not shy about informing important audiences that it constantly received an “A” rating from Amtrak in its annual host railroad report card recognizing its industry-leading on-time performance record.

The Three CEOs Patrick Ottensmeyer, Jean-Jacques Ruest, and Keith Creel were the public faces of KCS, CN, and CP, respectively. As such, their demeanors in the waning days of the voting trust drama spoke volumes about their moods and the atmosphere within each of their respective railroads. Pat Ottensmeyer had been a major contributor, at times the most important and influential contributor, to the development of KCS’s merger transaction strategy. He had first helped formulate the process the transaction team used to evaluate the bids received from three different prospective acquirers. Then he was integral to the person-to-person negotiations that followed the offers. He kept the dialogue and negotiations fluid, collegial,

320 V i s i o n a c c o m p l i s h e d

professional, and productive. The strategy had proven to be sound, and its execution by the board of directors and transaction team was flawless. Ottensmeyer deserved a good deal of credit. Unless some kind of eleventh-hour surprise occurred, one thing was certain—if KCS was acquired, the multiple paid for it would be the highest ever for a railroad. Pat Ottensmeyer, Bob Druten, the board of directors, and the transaction team had all done their jobs. It was not many weeks before that Ottensmeyer had been Keith Creel’s costar. From late March through late April, the two had made the rounds, championing their proposed merger to the media, investors, financial analysts, employees, shippers, politicians, and government officials. They made a good team, the rapport between them was smooth, and the audiences warmed to their complementary styles. But now it was late June and Pat was costar to another CEO, J.-J. Ruest, with a new script and a new merger proposal. The suddenness with which the change had taken place had to have made the situation a little awkward for Ottensmeyer. He liked both Creel and Ruest and enjoyed solid relationships with each of them. He also knew how much both Ruest and Creel wanted this deal and their railroad to win the day, but Ottensmeyer had a job to do and he did it well. Any discomfort he may have felt was pushed aside so as not to interfere with his unshakable commitment to seeing that his company, KCS, attained the best possible outcome for its employees and shareholders. The CN offer was now superior to that of CP. Throughout the entire process, he never forgot who he represented. His intelligence, wit, thoughtful manner, and ability to present the benefits of the merger in ways that appealed to multiple stakeholders made him an excellent salesperson for what would become a new, exciting railroad company. One could not be a KCS employee and be in the company of Keith Creel for a few minutes before getting the sense that his demeanor, attitude, spirit, confidence, and fortitude was strikingly similar to that of past KCS executives. Even in the face of potential defeat, he pressed on as if his side had the lead and he was going to finish things off. His demeanor displayed not one ounce of defeat, only confidence. A number of observers saw him as a clone of his mentor and CP’s predecessor, Hunter Harrison, and Creel was always quick to pay tribute to his former boss and close friend. He did not shy away from the comparisons, but he was very much his own man, determined to define himself and not be seen as a shadow of Harrison.

T h e C u r t a i n F a l l s o n a 1 3 6 - Y e a r A d v e n t u r e 321

When Creel told people CP was the perfect partner for KCS, and a CPKCS merger was the only Class I railroad merger with a chance of winning regulatory approval in today’s political climate, it was not merely lip service, especially given CP’s tenuous position. In his heart and soul, Creel believed in this combination, and his sincerity and the strength of his convictions came through. In good part because of Creel, CP came across as a dynamic, hungry, and determined railroad that, while smaller than all Class Is except KCS, was not afraid to take on big challenges and had the forward-thinking management team to succeed. Creel’s CP bore many similarities to KCS; would that not be a combination to behold? Creel certainly thought so. Ruest presented himself as an intelligent, rational, honest, and experienced railroad executive, and that is exactly what he was. Before becoming CN’s chief executive officer, he had established himself as one of the premier sales and marketing executives in the rail industry. As such, he fully appreciated the marketing potential of a CN-KCS merger. He believed that over the next ten to twenty years, the CN-KCS combination had a future like none other. It had the potential to grow into a North American rail powerhouse, wildly outdistancing the growth of other Class I carriers. But Ruest and CN had problems. On the one hand, Creel was a worthy opponent and it was clear he was not going to disappear anytime soon even if the voting trust application was approved. True, CN had outbid CP and had strong stakeholder support, but there were still plenty of people who would prefer the merger of the two smallest Class Is, arguing that such a combination would probably have a lesser impact on rail competition, and be less likely to spark further downstream consolidations. These were concerns that Ruest and CN’s consultants felt could be managed. The larger problem for CN at the time and its chief executive officer was that they found themselves fighting wars on two fronts. One was the contest with CP; the other was the attack being orchestrated by an aggressive investment firm with a history of activism in the rail industry. Given it was steadily increasing its ownership of CN stock, the firm was posing a considerable problem at an especially inconvenient time. The Children’s Investment Firm (TCI), a London-based hedge fund founded by Christopher Hohn in 2003, had become, over a two-decade period, one of the most unique investment firms anywhere. It could at times take activist positions; however, more often TCI held long positions

322 V i s i o n a c c o m p l i s h e d

in companies. While they always remained in close contact with managements, they did not usually get involved in day-to-day operations. But now, in June 2021, TCI, which also had the largest position in CP, had become an obstacle in the way of getting the voting trust approved—a major obstacle. While CN had made its play to win the bidding contest to buy KCS, TCI had upped its ownership level of the railroad’s common stock to more than 5 percent, which gave it block holder status meaning it was in a position to influence CN’s direction through exercising its voting rights and that’s exactly what it threatened to do. It sent a letter to CN’s chair, Robert Pace, strongly opposing a CN-KCS merger and also complaining of the railroad’s “weak leadership” that had “resulted in deteriorating financial and operating performance.” TCI called for management changes as well as adding to the board of directors individuals with greater knowledge of the rail industry. TCI had no fight with KCS and went so far as endorsing the idea of a CPKCS combination. The investment firm’s stance against a CN-KCS merger had everything to do with its contention that CN was offering to pay too much to buy KCS at a time when it should be concentrating its attention and its financial and personnel resources to fixing its own house. TCI felt CN’s management and board was putting the railroad in jeopardy by spending vast resources and time pursuing a merger that could very possibly be rejected. Its criticism included the threat of calling for a special shareholder meeting that could result in changes in executive management and board leadership, including the removal of JJ Ruest and Robert Pace. As this weighed on Ruest, two shipper surveys conducted by Wolfe Research and Cowen provided more ammunition for those opposed to the merger. The two surveys provided almost identical shipper positions. Wolfe Research found that 33 percent of shipper respondents opposed the CNKCS merger while only 15 percent supported it. The Cowen survey found only 16 percent of shippers supported the merger while 34 percent would prefer KCS to remain independent rather than combine with CN. The Cowen survey did find 36 percent approval for a CP-KCS merger; similarly, the Wolfe Research survey found 33 percent shipper support and only 15 percent in opposition to a CP-KCS combination. But counterbalancing these negatives were the convictions of respected consultants and outside legal counsels with extensive regulatory experience, who remained confident that the CN-KCS application met all necessary criteria for approval of the voting trust. But one unknown loomed large over

T h e C u r t a i n F a l l s o n a 1 3 6 - Y e a r A d v e n t u r e 323

the proceedings. This would be the first time a voting trust decision would use the new merger guidelines for major rail companies, and no one knew how that would play out. So, even though it should have been Ruest’s finest hour, it was a challenging time for him. He had an unhappy major shareholder loudly complaining and threatening hostile actions; he had broadsides being delivered by a relentless fellow CEO; he had a surface transportation board that would be using, for the first time, merger guidelines that would set a higher bar for the merger of two Class Is; and he had a regulatory environment and an American president whose administration generally opposed large mergers unless they met high public benefit standards. One could forgive Ruest if, despite being head of the company favored to win the prize, he was less than thrilled with the cards he was dealt. Meanwhile, with the deadline having passed for filing letters with the STB regarding the voting trust, KCS was moving ahead with taking care of its regulatory responsibilities associated with the merger. On July 2, KCS had fixed the date of August 19, 2021, for a special shareholder meeting at which a vote on the CN-KCS transaction would occur. Then five days later, on July 7, KCS filed its proxy statement with the SEC with respect to the merger. Sure, the seas were a bit choppy, but KCS and CN were navigating their way through them and the important milestone approval of the voting trust was seemingly in sight. The main objective now was just to keep the line moving.

Pronouncements from on High On July 9, the White House released an executive order entitled “Promoting Competition in the American Economy.” Its issuance was not a total surprise as rumors of President Biden’s desire to make a strong pro-competition statement had circulated through the Capitol for months. The executive order he signed called for regulatory protection from the “anti-competitive extension of market power.” One relatively small section of the order addressed competition in the railroad industry and highlighted a few industry issues on which the Biden administration felt the STB should take positions that promoted competition and advanced public interest. Included in the list was general guidance pertaining to reciprocal switching, competitive access, and passenger rail. Though all touched in some way on issues arising in the CN-KCS merger application, the railroad section of the order was intended 324 V i s i o n a c c o m p l i s h e d

to address the entire railroad issue, not one particular merger. In its entirety, President Biden’s executive order laid out the administration’s guidelines for protecting the “public interest,” but did not place a bull’s-eye specifically on the CN-KCS merger. Only a few hours after the executive order had been made public, STB chair Martin J. Oberman released his own statement: “During my time on the Board, I have been continually concerned with the significant consolidation in the rail industry that happened as a result of a series of mergers decades ago, which dramatically reduced the number of Class I carriers. It is apparent that while consolidation may be beneficial under certain circumstances, it has also created the potential for monopolistic pricing and reductions in service to captive rail customers.” The executive order had provided Chairman Oberman, his fellow commissioners, and the STB staff the necessary air cover to take a hard line on a variety of issues pertaining to railroads’ impact on shippers, ranging from head-to-head competition to competitive pricing, from customer service to the protection of public interests. Oberman’s statement, while paying lip service to the idea that some consolidations “may be beneficial,” made it clear that the STB would be using a higher standard when looking at future major rail merger applications given the “significant consolidation” in the industry. Neither the timing of the executive order nor Chairman Oberman’s immediate response in support of it could have given CN or KCS supporters any comfort. CP lost no time before highlighting what it saw as the executive order’s “clear message: no rail mergers that reduce competition or hurt passenger service, and that the U.S. economy needs more competition among railroads.” CP’s statement continued, “A CP-KCS combination would be a positive step toward more competition—not less—in the freight rail industry with no need for regulatory solutions. In contrast, a proposed CN-KCS combination creates competitive issues and reduces options for rail customers that will require additional regulation to overcome.” On July 19, CP filed a proxy statement asking KCS shareholders to vote against the proposed CN-KCS combination at the special meeting scheduled for August 19. CP stated that it still hoped to complete a friendly deal with KCS, but a “Yes” vote on the CN-KCS merger would lock KCS shareholders up until February 2022 “instead of being free to consider other options.” This argument was not illogical, but at the time still seemed like the somewhat desperate plea of a company watching its chances for success diminish. It T h e C u r t a i n F a l l s o n a 1 3 6 - Y e a r A d v e n t u r e 325

was a foregone conclusion that KCS shareholders would overwhelmingly approve CN’s $325 per share offer. The gap between CN’s $325 offer and CP’s last bid of $275, which it had actually retracted, was just too great.

August 10, 2021: Two Announcements Change Everything Twelve days after filing its proxy statement in opposition to the CN-KCS merger and nine days before the scheduled KCS shareholder meeting, CP, on August 10, announced that it had submitted “a superior proposal to acquire Kansas City Southern (KCS) in a stock and cash transaction representing an enterprise value of approximately USD $31 billion.” CP claimed their bid, which represented a premium of 34 percent, had the benefit of offering KCS shareholders greater regulatory certainty. In its letter to the KCS board of directors that accompanied the offer, CP countered the argument that KCS had made that CP had walked away from negotiations in May and had chosen not to engage in further discussions during the five-business-day period in which it could have reacted to the CN proposal with a revised bid. CP now claimed that reacting immediately to the CN bid would not have been in the best interest of CP shareholders, and that more time had been necessary to evaluate options and develop a financially sound proposal that had the best chance of gaining regulatory approval. Having done so, CP felt it was time to “re-engage with KCS” prior to the KCS shareholder meeting. A negative vote on the CN deal would allow CP and KCS to craft a transaction of “compelling short-term and longterm value,” one that had the added “benefit of STB approval to use a voting trust.” CN’s quick response was to label the new offer as another “inferior proposal to acquire KCS” and went on to say the CN deal “remains superior and the best option for both companies’ shareholders.” If not for the second announcement released later on Tuesday, August 10, it would have been likely that CP’s new offer would have been labeled a last-ditch “Hail Mary Pass,” and it would not have stopped KCS shareholders from voting their approval of the CN-KCS merger application. But later that afternoon, the STB announced that it expected to issue its decision on the CN-KCS voting trust application no later than August 31, 2021. Two days later, the KCS board responded to both August 10 announcements. In its statement, the board declared that after a thorough review, it had determined that the new unsolicited proposal it received from CP did 326 V i s i o n a c c o m p l i s h e d

not constitute a “Company Superior Proposal” and reaffirmed its recommendation to KCS shareholders to vote in favor of the merger with CN. The board also spelled out its confidence that the CN-KCS voting trust application “meets all the standards and the public interest test set forth by the STB and believe it should be approved.” In response to the STB announcement, the board stated that if the STB did not release a decision on the voting trust by August 17 at 6:00 p.m. central time, the special meeting would be adjourned “to give all shareholders and the Board time to receive and consider the STB decision.” There was little expectation that a decision would be rendered by August 17, and sure enough, it was not. So, on August 19, the KCS board set a new date of September 3 for the special shareholder meeting. If not exactly thrilled by the board’s reaffirmation of the CN-KCS deal, CP had to have been pleased with the delay in the KCS shareholder meeting, as it left the door open for a possible change of direction if the STB turned down the voting trust request. CP had delivered another option to KCS, one whose financial value to shareholders had grown closer to CN’s and with perhaps a higher chance of regulatory approval . Never before in rail history had a voting trust held so much importance to so many people.

August 31: The Crushing Blow On Tuesday, August 31, 2021, the STB announced that by unanimous vote, its commissioners had rejected the application for the use of a voting trust arrangement associated with the proposed CN-KCS merger. The STB had determined that the proposed trust was not consistent with the public interest standard under the STB’s merger regulations. Among the reasons for rejecting the voting trust application were the following: The applicants’ failure to demonstrate how their request would result in a public benefit. In fact, the STB expressed concern that the voting trust could potentially pose competition risk. CN would become a beneficial owner of KCS, thus, its financial interest in KCS could alter KCS’s behavior even though the companies’ managements would not have direct interaction. While CN had announced its intention to divest the KCS line between New Orleans and Baton Rouge, the STB believed that service overlap between the two railroads extended from the south northward through the middle of the nation, the impacts of that overlap had not been considered T h e C u r t a i n F a l l s o n a 1 3 6 - Y e a r A d v e n t u r e 327

adequately in the application, and the reduction of competition caused by this overlap would possibly lead to higher pricing and decreased service. There was a greater risk of divestiture under the current major merger regulations due to the heavier burden of proof to show that a rail combination is consistent with the public interest. The STB review of the CN-KCS proposed merger could lead to a decision that would force CN to divest KCS, resulting in a situation that could pose severe financial consequences to both railroads and reduce the current rail competition. The voting trust could speed up consolidation within the rail industry. Other Class I carriers might feel compelled to respond to the CN-KCS combination and be emboldened by the voting trust approval setting a precedent for future mergers. One widely accepted reality of life is that hindsight is always twentytwenty. In retrospect, the CN-KCS voting trust application was probably challenged from the outset not only by seismic changes in major merger regulations but also because of the mounting concern of regulators that large-scale rail mergers were not necessarily always in the best interests of shippers and the general public. The final straw had been the Biden administration’s emphasis on strengthening the role of regulatory bodies in defining and protecting public interest. Remarkably, the only railroad that seemed to recognize this was CP, and for that the company could thank Keith Creel. Six years earlier, CP had seen its hostile run at Norfolk Southern go down in flames before even being reviewed by the STB, in good part because it was seen as a threat to the public good, anticompetitive, and likely to lead to further consolidations. Having joined CP just before the embarrassing fiasco, had Keith Creel learned something from the experience? Did the force of the negative reactions from multiple sources—shippers, consumer groups, government officials, politicians, and regulators—make an indelible impression on him, one that now formed the foundation of the case he was making against the CN-KCS merger? His arguments, which became CP’s arguments, were the main bullet points for those who filed letters with the STB opposing the voting trust and merger. They were, in spirit and often in verse, identical to those the STB cited in their thirty-three-page rejection of the trust. That Creel was not privy to any insider information is beyond question, and there had been no information leaks prior to the STB’s August 31 announcement. Even so, he saw what everyone else had missed. The STB’s mission had undergone 328 V i s i o n a c c o m p l i s h e d

a fundamental shift from looking at consolidations primarily from the railroads’ perspective—did the mergers make good business sense and promise greater efficiencies?—to making their decisions based on the likely impacts the merger would have on the public good. At this particular point in time in the United States, there had grown among liberals, centrists, and conservatives, and between Democrats, Republicans, and Independents, a wariness of big business mergers and the erosion of public interest. Keith Creel deserves credit for being the one rail executive sensing this shift. He may or may not have understood the underlying causes for the change, but the strength of his convictions was bolstered by the sense that the proposed CN-KCS merger would be judged on whether it satisfied the public interest standard. The answer to that question was anything but obvious. As Jason Seidel, a veteran research analyst at Cowen, stated in the aftermath of the STB voting trust decision, “While it’s hard to predict potential next moves from the involved parties, when it comes to regulations, we may just have to ask CP President and CEO Keith Creel, given he has been the only one—ourselves included—who has consistently been correct in how the process will play out.” If the pain of the STB decision was not enough, it only took TCI’s Chris Hohn and Ben Walker a few hours to deliver a letter to CN’s board of directors, attacking the leadership of Chairman Robert Pace and the railroad’s management. The letter called for CN’s immediate withdrawal from its agreement to acquire KCS, bring into management transportation professionals with greater operational experience, and replace Ruest with a CEO capable of creating a culture built around operational excellence. TCI further demanded the board take responsibility for the railroad’s recent underperformance and failure, and it should respond by adding new board members with greater railroad knowledge and experience. The TCI letter went on to state bluntly that the STB “does not want CN to buy KCS” and then stated that CN “can withdraw from the merger agreement, appeal the ruling, or try to proceed without a voting trust. An appeal cannot be won,” and continuing the merger effort would be futile. “Instead, the company should withdrawal and save billions of dollars in break fees. Proceeding without a voting trust would be reckless, irresponsible and massively value-destructive.” While it is common practice for angry shareholders to react venomously toward managements and boards of directors after colossal corporate failures, some of TCI’s attacks were overly harsh and unwarranted, especially T h e C u r t a i n F a l l s o n a 1 3 6 - Y e a r A d v e n t u r e 329

some directed at Ruest, but that is one of the hazards of being a CEO. There could be little doubt that their demand for CN to withdraw from the merger reverberated through the halls of the railroad’s Montreal headquarters.

Where to Go From Here? Later during the day of the STB decision, Creel called Pat Ottensmeyer to reiterate CP’s desire to engage in merger discussions under the terms of CP’s revised proposal, and the two went over the proposal’s details. Creel reminded Ottensmeyer that if, by 11:59 p.m. eastern time on September 12, progress had not reached the point where KCS had shown evidence of having notified CN of its intention to terminate their merger deal and enter into a new agreement with CP, then CP would withdraw the offer. Following the call, Ottensmeyer joined a meeting called by KCS board chair Bob Druten, board members, and the transaction team. There, it was decided that the September 3 shareholder meeting to vote on the CN-KCS merger would be adjourned. A new date of September 24 was set for a special shareholder meeting. Druten convened another meeting of the transition team on September 4 at which Ottensmeyer informed the group that Ruest had indicated CN’s willingness to join KCS in appealing the STB rejection of the voting trust. Ruest also stated that CN would be open to exploring the possibility of pursuing the CN-KCS merger without a voting trust, but that CN would neither increase the financial terms of its merger proposal, nor would it agree to increase the reverse termination fee payable to KCS if regulatory approval of the merger was not obtained. The KCS team was not predisposed to turning its back on CN, but neither was it keen to consider proceeding without incentives, given the uncertainty of moving ahead with the merger application in light of the STB’s voting trust decision. Simply put, if CN remained unwilling to increase the merger premium and the reverse termination fee, KCS would find it difficult to go forward with CN. The team also discussed possible enhancements it might seek to the CP offer. In addition, the KCS board developed a timeline for soliciting final proposals from CN and CP, and ultimately determined that the current CP offer could reasonably be considered to be a “Company Superior Proposal.” Two days later, Creel informed Ottensmeyer that CP was willing to make alterations to its merger proposal, including revising the transaction’s 330 V i s i o n a c c o m p l i s h e d

structure so as it could qualify as a “reorganization,” thus providing KCS certain tax advantages. One day later, on September 9, Ruest repeated CN’s willingness to join KCS in appealing the voting trust decision, or to explore the possibility of moving ahead with the CN-KCS merger application without a voting trust. He also reiterated that CN would not increase the financial terms of its offer to acquire KCS, nor would it entertain the idea of increasing the reverse termination fee it would pay KCS. At this point, the CN deal was as good as dead. The risk-to-value balance had shifted heavily toward risk for both KCS and CN. There was absolutely no way that Bob Druten and the board would consider putting the company in jeopardy by pursuing such an uncertain course—certainly not without further financial protection if the merger was rejected. It was questionable whether the board would have approved going forward with CN even if the financial terms had been improved, but that decision did not have to be made as CN remained steadfast in its position. On the night of September 11, CP’s outside counsel, Sullivan & Cromwell, delivered to KCS’s counsel, Wachtell Lipton, a binding offer letter dated September 12, and final forms of a merger agreement. The deadline for KCS accepting the revised offer was 5:00 p.m. eastern time on September 20, 2021, again conditional on KCS delivering to CN notice of its decision to terminate its merger deal with them and enter into a new agreement with CP. Then on September 12, the KCS board determined that the revised CP offer constituted a “Company Superior Proposal” and proceeded to instruct its counsel to deliver to CN notice of its intention to terminate its merger agreement and enter into a definitive agreement with CP, subject to CN’s right to negotiate amendments to its merger proposals during a five-business-day period. Having no desire to prolong its agony, on September 14 CN communicated to KCS that it was prepared to waive the five-business-day match period, which KCS representatives immediately relayed to CP’s counsel. On September 15, the KCS board announced it had entered into a waiver agreement with CN, and that KCS had officially terminated its merger agreement with CN. Also, KCS had entered into a merger agreement with CP under which, upon closing of CP’s voting trust, each share of KCS common stock would be exchanged for ninety dollars in cash and 2.884 shares of CP common stock. For the termination of the CN agreement, KCS would pay CN a breakup fee of $700 million and return an additional $700 million, which CN previously paid KCS as reimbursement for the fee KCS paid to CP after T h e C u r t a i n F a l l s o n a 1 3 6 - Y e a r A d v e n t u r e 331

terminating their deal in May. Both of these KCS payments would be reimbursed to KCS by CP under the terms of the new agreement. Finally, closing of the CP-KCS merger would be subject to the approval of CP and KCS shareholders, and of course would require regulatory approvals. Following the KCS announcement, CP’s Keith Creel declared, “Our path to this historic agreement only reinforces our conviction in this once-ina-lifetime partnership.” He continued, “This perfect end-to-end combination creates the first U.S.-Mexico-Canada rail network.” Pat Ottensmeyer stated, “The CP-KCS combination will not only benefit customers, labor partners, and shareholders. . . . It will also benefit KCS and our employees by enabling us to become part of a growing and truly North American continental enterprise.” Understandably, the comments from CN had a different tone, concentrating on the US regulatory landscape having grown more challenging for major railroads after its bid for KCS had been launched. CN also referred to the executive order signed by President Biden in July that focused heavily on maintaining and increasing competition in key sectors, including the railroad industry, as being a factor in its voting trust application being rejected.

Shell Shocked For the past seventeen months, KCS had been first the subject of takeover rumors, followed then by fifteen offers to be acquired. Finally, in April 2021, it agreed to merge with CP. That agreement lasted all of a month when that deal was terminated in favor of a new one with CN. This second merger agreement had a slightly longer life span lasting four months before it, too, was terminated for a new one with former partner, CP. All this was happening while the work lives of KCS employees had been turned upside down by the COVID-19 pandemic. One can understand if KCS employees felt like a beach ball being knocked around the stands at a sporting event. If there was a positive associated with the extended period of craziness, it was that any sadness or nostalgia related to the impending loss of their railroad’s independence had been diluted and replaced with a “let’s just get on with it” attitude. KCS people now were eager to be able to look forward, anxious to be part of something new. There was going to be change, and at this point the faster it came, the better. The employees still felt a fierce loyalty to KCS, and that feeling would last, but now they hoped that combining with CP would be their future. They were ready to have that story begin. 332 V i s i o n a c c o m p l i s h e d

Things Move Rapidly Fortunately, things started to progress smoothly after the transaction announcement of September 15. Two weeks later came the good news that the STB approval of CP-KCS’s application for the use of a voting trust arrangement, granted on May 6, 2021, still applied to the new merger agreement between the two railroads. The STB determined that the modified financial terms of CP’s new offer would not impact the status of the voting trust. This was a major hurdle now behind them. On October 29, CP and KCS jointly filed their application to the STB to create Canadian Pacific Kansas City (CPKC). Their application went to considerable lengths to assure the STB staff and commissioners that a CP-KCS combination would not result in a reduction of independent railroad choices for rail customers. They reiterated their commitment to keep all existing freight gateways open on commercially reasonable terms, and that customers would not lose competitive routings because no new regulatory “bottlenecks” would be created. In addition, it laid out how CPKC planned to compete aggressively to attract traffic to its network via new single-line lanes between Canada, the Upper Midwest, and the Gulf Coast, Texas, and Mexico. Upon review, on November 23, 2021, the STB found the CP-KCS merger application complete, containing of all the information required by the board’s regulations. The STB then moved to adopt a procedural schedule that set a deadline of December 13, 2021 for public comment, with the final briefs due by July 1, 2022. Only three days later, on November 26, the KCS and CP were able to announce the good news that they had received the required regulatory pretransaction control approvals from the Mexican Federal Economic Competition Commission and the Mexican Federal Telecommunications Institute (IFT). Another milestone had been reached.

The Merger Wins Overwhelming Support On December 8, 2021, 99.1 percent of CP shareholders voted in favor of the issuance of CP common shares to KCS common shareholders for the proposed CP-KCS combination. Then, on December 10, 2021, 99.6 percent of KCS shareholders voting approved the merger with CP. Four days later, on December 14, 2021, the transaction was “closed into trust,” meaning that KCS common shareholders received 2.884 CP shares T h e C u r t a i n F a l l s o n a 1 3 6 - Y e a r A d v e n t u r e 333

Second time is a charm. On September 12, 2021, KCS and CP signed an agreement to merge the two railroads. Above are CP’s chief executive officer, Keith Creel and KCS’s Patrick Ottensmeyer in Washington, DC, as the two began to communicate to shippers and others the benefits of the proposed new CPKC railroad.

and $90 in cash for each common share held. The transaction was complete though the merger was still pending STB approval.

The “Market” Shouts Its Approval Except for the economic recession from 2007 to 2009, the railroad’s stock price had been on a mostly steady, albeit gradual, ascent since the spin-off of KCSI in July 2000. The positive stock market reaction began when Mike Haverty’s bold initiatives began to take hold. On the day of the spin-off, the railroad’s stock was at $6.25. When he turned over the reins to Dave Starling on August 1, 2010, it was at $36.70, though the value had risen to the midfifties prior to the recession taking everyone’s stock price down. During Starling’s time as CEO, it continued to climb and reached $89.58 on his last day before Pat Ottensmeyer took charge on July 1, 2016. From there the upward trend escalated. Immediately, before rumors started to swirl around a possible bid to acquire KCS, its stock price hit $183.93. From them on as the process played out, the railroad’s stock continued to soar until the last time it was traded. On December 14, 2021, it closed at $293.59. The climb in price from $6.25 to $183.93 should be attributed to the vision and leadership of Haverty, Starling, and Ottensmeyer. Each brought their unique experience and talents to the job, and somehow they melded into something special. In the eyes of all classes of investors—from long-only blue bloods to hedge funds and arbs—the final $100 of growth was due to the masterful way KCS’s executive management and board of directors managed the process. Praise was lavished on both parties for the way they unfailingly served the best interest of the company’s shareholders during a complex and turbulent process. In a sense it was the final manifestation of KCS’s culture guiding the railroad to its final great achievement.

A Quiet Descends on a Great Company Despite the myriad ongoing activities associated with running a Class I railroad company, during the period between December 14, 2021 (when the merger transaction was consummated) and April 14, 2023 (when the STB regulatory approval was finalized and CPKC became official), a quiet had descended on KCS. Early on, much of the quiet in the halls of 427 West Twelfth Street had to be attributed to COVID-19 protocols. But even as employees gradually drifted back to the office, the quiet remained. Of T h e C u r t a i n F a l l s o n a 1 3 6 - Y e a r A d v e n t u r e 335

Table 25.1.  Detailed Timeline of Offers This chart illustrates how the KCS transaction team’s appreciation of the value of their railroad, execution of their negotiating strategy, and patience resulted in a triumph for KCS shareholders. JUL 2020

7/30/20: Kansas City Southern (KSU) closes at $157 per share 7/31/20: Wall Street Journal reports that a private equity investor consortium (PE) is interested in making a bid for KCS

AUG 2020

8/17/20: KCS receives PE offer ($195/share in cash) 8/31/20: PE raises bid ($208/shares in cash)

NOV 2020

11/23/20: PE raises bid ($230/share in cash)

DEC 2020

12/9/20: KCS receives offer from Canadian Pacific (CP) ($77/share in cash & 0.469 CP shares, $235 total consideration) 12/8/20: PE raises bid ($235/share in cash) 12/31/20: CP raises bid ($78/share in cash & 0.489 CP shares, $278 total consideration)

MAR 2021

3/3/21: P  E raises bid ($245/share in cash) CP raises bid ($81/share in cash & 0.489 CP shares, $260 total consideration) 3/25/21: PE raises bid ($250/share in cash, final bid) CP raises bid ($86/share in cash & 0.489 CP shares, $268 total consideration) 3/16/21: CP raises bid ($90/share in cash & 0.489 CP shares, $272 total consideration) 3/21/21: KCS announces transaction with CP ($275 total consideration)

APR 2021

4/20/21: KCS receives offer from Canadian National (CN) ($200/ share in cash & 1.059 CN shares, $325 total consideration)

MAY 2021

5/13/21: CN raises stock portion of bid ($200/share in cash & 1/129 CN shares, $325 total consideration)

AUG 2021

8/10/21: KCS receives offer from CP ($90/share in cash & 2.884 CP shares, $300 total consideration)

SEPT 2021

9/15/21: KCS announces transaction with CP ($300 total consideration)

336 V i s i o n a c c o m p l i s h e d

course, the rail yards through the entire system had remained open and fully staffed. But even there, too, a sense that change was imminent pervaded the atmosphere. No matter whether they were office workers or train service personnel, employees had their jobs to do. Trains had to run; customers had to be served; contracts needed to be written, signed, and adhered to; finances had to be accounted for and reported; IT systems needed to be maintained; and meetings must be held. It was business almost as usual. Almost. The dedication was still there, but the spirit and drive that had energized KCS employees for 135 years had been somewhat muted. Nearly the entire workforce wanted to be part of a CPKC system and culture and play a part in building something new. But from December 2021 to April 2023, there was no CPKC. There was only the disquieting feeling that at this particular moment in time, they, the KCS employees, were no longer driving their destiny—KCS’s destiny. The KCS culture, created by individuals of vision and limitless drive and determination, had inspired generations of employees who in turn had become the backbone of the company and the force propelling KCS to magical heights. But nothing lasts forever. Nothing. That being the case, it is natural, it is human, to feel nostalgia for times past. It is comforting to reflect on past glories. But it is the present and the future that are exciting, not the past. The past is to be cherished and learned from; the future is to be lived. The future for CPKC was wide open. The people of CP, KCS, and KCSM would create—together, over time—a new corporate culture. And that would be great. But the time had not yet arrived, and that made the present unsettling. This narrative has tried to convey, in a small way, that KCS had been a unique enterprise. More than just a railroad, it had been, over a long time, a collection of extraordinary people. But at its core, it was a railroad. By their very nature, railroads are mostly stable entities with pasts, presents, and futures that remain in many ways unchanging even if they take on new names. However, KCS had always been a bit of a different animal. It was conceived by a different sort of man: a man of business, but for whom business was just a means to greater, more humanistic, ends. He was an innovator, dreamer, an individual never hesitant to choose different paths and employ unconventional thinking to reach a desired end. As a result of Arthur Stilwell’s vision, personality, and humanity, he built a company that grew and thrived over time. The company became an organization that welcomed free-thinkers who lacked fear of failure. In some T h e C u r t a i n F a l l s o n a 1 3 6 - Y e a r A d v e n t u r e 337

respects, the “KCSI years” were the greatest manifestation of the creativity that sprang from the energy within the walls of the KCS corporate office. For what other railroad resided comfortably within a corporate structure that owned and operated the following? • A farm that extracted blood from horses to attempt to develop drugs to prevent and cure diseases • A mail delivering airline • Television stations at a time that medium was just starting to grow • A florist • A traveling carnival ride business • An advertising agency • Telecommunication companies before telecom was a “thing” • A coal-burning power plant in Krakow, Poland • Business service companies like DST, Janus Capital, Pioneer Western, or Argus KCS was more than just a railroad; it was an incubator of imaginative ideas, colossal failures, and magnificent successes. Both ludicrous and sublime, all of the listed entities were living manifestations of the KCS culture, spirit, and unique genius. That culture has now largely gone from being a living, breathing entity to taking its rightful place in history. That is where the spirit of KCS’s corporate culture will live on. The most fortunate of families can look with fondness and interest at the lives of their parents, grandparents, and great-grandparents. Some can even trace their family trees back hundreds of years. They may look back with nostalgia. But more importantly, they often see in themselves—in their children and grandchildren—some of the spirit of their ancestors. Someday, someone chronicling a CPKC success story will see a bit of Stilwell, or Deramus, or Haverty, or Ottensmeyer in the achievement. And that will be a wonderful thing.

338 V i s i o n a c c o m p l i s h e d

A NOTE ON SOURCES The first chapters of this book are dominated by a study of the business career, personality and character of Arthur E. Stilwell, the founder of what would eventually become the Kansas City Southern Railway (KCS). It is by no means a definitive work on Stilwell. More worthy of such a distinction is the foremost biography of Stilwell by Keith L. Bryant, Jr., Arthur Stilwell: Promoter with a Hunch, a thoroughly researched, exhaustive study of the man and his resourceful and relentless pursuit of a vision to build a railroad from Kansas City to the Gulf of Mexico. The book was invaluable in my attempt to trace back to Stilwell the core of KCS’s unique corporate culture. Bryant’s book confirmed what I had suspected: Stilwell did not just straddle two very different worlds, but for the most part, he lived comfortably in each. He was at once a champion of the late nineteenth-century Gilded Age ideal of the self-made man, while simultaneously motivated by his innate goodness and generosity, and prized spiritual values above the pursuit of wealth, power, and ostentatious shows of material wealth displayed by many business titans of his era. Also important to my defining the contours to KCS’s culture and values was Stilwell’s memoirs collectively entitled I Had a Hunch, which first appeared in the Saturday Evening Post in 1927–1928, and was later reprinted by the Port Arthur Historical Society in 1972. What his memoirs—written late in life after he had suffered a series of humiliating defeats in his business career—lack in complete historical accuracy, they make up for in providing a personal account of the seeming incongruity of a man driven to succeed in a material world, yet who possessed little interest in wealth, power, or practically anything tied to materialism.

339

A third text, John Leeds Kerr’s Destination Topolobampo: The Kansas City, Mexico & Orient Railway, chronicles Stilwell’s last rail venture, a failed attempt to build a railroad from Kansas City to a Mexican port on the Pacific Ocean. This book, again, illustrates the complexity of a man who sought and, until his professional downfall, largely succeeded in living one life in two worlds and maintained his integrity in both. Chapters eight through fourteen rely to a greater degree on written research. An internal document (available online), the “Saga of Kansas City Southern Lines” whose original author’s name has been lost in time, was useful in that it presents the railroad’s early history and development from the unapologetically biased perspective of an internal source. The flavor of this unassuming history, which was updated by former KCS employee Charles Pitcher, provides a sense of how KCS employees have differentiated their railroad from that of the rest of rail industry. Another internally generated work that was printed by the company is the well-researched A Vision Realized: The Indomitable Spirit of KCS, by Robert K. Dreiling. It is a short, but in parts quite detailed, history of the railroad and the holding company, Kansas City Southern Industries, Inc. (KCSI), and covers the time from Stillwell to Haverty. Dreiling, who was an attorney in KCSI’s legal department, produced an accurate account of the company’s hard-earned growth, while again writing from the perspective of an employee who respected and adhered to KCS’s culture, identity, and vision. Most of the other sources that helped me write the earlier chapters are in the form of essays appearing in journals, newspaper articles, essays appearing in magazines, and academic texts appearing online. With the notable exceptions written by the respected rail and business journalist, Fred Frailey, much of this research is not specific to KCS, but to the railroad industry in general or to the US economy, regulatory and political landscapes at various points in time. Frailey’s articles, however, are important in their depth of coverage of the state of the railroad’s operations and condition of its physical plant from the 1970s through the early 2000s. They provide information not available elsewhere. One other text deserves to be highlighted as important to this book and that is The Civilizing Machine: A Cultural History of Mexican Railroads, 1876–1910, by Michael Matthews. The book is a fascinating account of the birth of Mexico’s rail system, its importance to the nation’s social and economic development, and how it became a prime target for those rebelling against the nation’s social inequalities. Matthews’s book is insightful, well 340 V i s i o n a c c o m p l i s h e d

researched, and opinionated; it does an excellent job of placing Mexico’s railroads into a greater social, economic, and political context. I joined KCS in 1992 during the tenure of George W. Edwards as chief executive officer of the railroad after previously having been Edwards’s speechwriter, as well as assisting in and sometimes directing his public affairs programs, while he served as CEO of a Connecticut electric utility company. Then following Edwards’s departure from KCS in 1995, I had the privilege of working closely with his successors, Michael Haverty, David Starling, and Patrick Ottensmeyer. As my professional duties included directing the company’s investor relations program, I was an employee of the holding company, KCSI, from 1992 to 2000, though most of my day-today responsibilities rested within the railroad. Nevertheless, my job put me in frequent contact with the holding company’s CEO, Landon Rowland. I also had considerable contact with DST’s chief executive officer, Thomas McDonnell, as well as other key individuals in KCSI’s subsidiary companies. After the financial services companies were spun off in 2000, I became an employee of the railroad. In my professional capacities at KCS, I neither take nor deserve credit for the creation of corporate policy or the development of the strategies undertaken to enhance the railroad’s growth. But because of my position within the company, I was frequently present during high-level strategic planning sessions; the assessment of opportunities, threats, and challenges; and the formation of communication strategies targeted to internal and external audiences. Moreover, because of my relationships with the chief executives, I frequently served as a sounding board as they worked through their thought processes on matters of significant importance to the company. I then was responsible for explaining and championing the railroad’s positions to the financial community, including buy-side and sell-side analysts, institutional investors, investment bankers, and financial and rail industry media. I often traveled with the CEOs and members of their executive teams throughout the United States and Europe outlining for potential and existing investors the railroad’s strategies for growth and providing a picture of the railroad’s expanding significance within the North American supply chain. Finally, I was frequently called upon to take on sensitive special assignments for the chief executives that were outside of my normal responsibilities. Given the relationships formed, it would be naive to think that total objectivity is possible. However, insofar as much of what I present in the second half of this narrative has never before been made available to the A N o t e o n S o u r c e s 341

public, I have endeavored to write from the perspective that the decisions, strategies, and actions of Edwards, Haverty, Starling, and Ottensmeyer did not require my embellishments but stood on their own. Their triumphs were theirs, as were their disappointments and frustrations. Therefore, I have striven to recreate as accurately as possible the major events that marked KCS’s final years. To help get a fuller and accurate a picture of the William Deramus III through Ottensmeyer years, I also interviewed key individuals who were intricately involved in major events and developments involving the railroad in the United States and Mexico. The list of individuals is included with notations as to what chapters benefited from the discussions.

Interviews David Brookings, former KCS chief engineer: chapter 9. Vicente Corta, former partner, White & Case, Mexico: chapters 17–19. Robert Druten, former chairman of the board, KCS: chapters 10, 20. Michael Haverty, former CEO, KCS: chapters 14–16, 18, 20. Irvine (Irv) Hockaday, former president & CEO, KCSI: chapters 9–12. James Kniestedt, former chief of security, TFM and KCSM: chapter 19. Thomas McDonnell, former CEO, DST: chapters 9, 10. Patrick Ottensmeyer, former CEO, KCS: chapters 20–25. Landon Rowland, former CEO, KCSI: chapters 12–14. William Skelly, former CEO, Martec: chapters 9, 10. David Starling, former CEO, KCS: chapters 16, 20, 21, 22. James Wochner, former chief legal officer, KCS: chapters 9–12. Jose Zozaya, former president and executive representative, KCSM: chapter 19.

342 V i s i o n a c c o m p l i s h e d

INDEX Page numbers in italics refer to illustrations. Aadnessen, Chris, 216 “Acres of Diamonds” speech, 18 Air Line railroad, 17, 19, 52 Alaska Railroad, 181 Alemán, Bolo, 174, 175, 183 Alton Railroad, 165 American President Lines (APL), 177 American Railway Union, 45 Amsterdam, Missouri, 27 Amtrak, 319–320 Anschutz, Phil, 123–124, 158 Argus Health Systems (Argus), 89–90 Arkansas Power and Light Company (AP&L), 61 Atchison, Topeka, and Santa Fe Railway, 24, 67, 122–123 Atlantic Coast Railroad, 69 AT&T, 88 back-office accounting systems, 91–92 Bailey, Tom, 97 Baker & Miller PLLC, 286 Baltimore and Ohio Railroad, 57 Bammes, Ray, 91, 93 Bank of America Securities (BofA), 286–287, 294, 301, 308 Baronoff, Stephen, 286–287 Batterson, James, 12–14 Baum, L. Frank, 35

Beauregard Parish, 32 Bell telephone system, 88 Benedetti, Dario, 171–172, 175, 176, 181, 183 Berger, William, 98 Berger Funds, 98 Berry, Bob, 224 Bethany Night School, 28, 52 Biden, Joseph, 294, 320, 324–326 Black Mesa line, 125 Black Monday crash/October 19, 1987, 94–95 Blackstone Infrastructure Partners. See Canadian Pacific Kansas City (CPKC) Blair, Rome, 109–110 Blanton, Max, 204–205 Bloomberg, Texas, 27 BN-SF merger/BNSF, 138–143, 156, 158, 163–164, 206–207, 243, 289–294 Boston Financial Data Services, 95 Brave Companions: Portraits in History (McCullough), 170 Brotherhood of Locomotive Engineers, 147 Brown Brothers Harriman, 7 Brown Shipley & Co., 7 Bryan, William Jennings, 18–19, 34–36, 44 Budd Company, 182 Burch, Dan, 287 343

Burlington Northern (BN), 119–120, 138–139, 141. See also BN-SF merger/ BNSF Bush, L. L., 22 Camino Real, El, 185–186 Canadian National (CN), 166, 281, 289–294, 328 Canadian Pacific (CP), 138, 281, 283, 295–296 Canadian Pacific Kansas City (CPKC): all-stock proposal, 289–291; CEOs/ public faces of, 320–324; CN/BNSF, 289–292; CN-KCS merger, 310–330; Company Superior Proposal, 312–313, 322, 326–327, 331; Cowen survey, 323; CP-KCS merger, 301–318, 325–327, 330–335; executive order, 324–326; finalization of, 333; GIP-Blackstone offer, 302, 305–309; initial proposal, 287–289; KCS transaction team, 284–287, 301; Major Rail Consolidation Procedures, 293, 296, 303, 316, 318; New Orleans-Baton Rouge line divestment, 315–318, 327–328; public comments, 317–320; rationale, 279–282, 299–300, 303–306; regulatory approval of, 286, 291–294, 296, 301, 303, 305, 312–316; reorganization plan, 330–335; revised proposals, 290–291; sales agreement signing, 308, 313; standstill restrictions, 296–297; substantiation of rumors, 282–283; termination fee provision, 304, 306–308, 312, 331–332; timeline of offers, 336; voting trust, 295–297, 303, 315–320, 323–330 Cannibals of Finance (Stilwell), 52–53 Cárdenas, Lázaro, 195–196 Carew, Rod, 181 Carter, Jimmy, 115 Carter, Tom, 109–113, 121–122, 282 cellular radio technology, 88

344 i n d e x

Central Transportation Company, 44–45 Chandler, William B. III, 234 Chautauqua circuit, 18–19 Chernobyl disaster, 134 Chicago and North Western (CN&W), 125, 155–156 Chicago and North Western Holdings Corporation, 82 Chicago Great Western Railway (CGW), 77–79 Children’s Investment Firm (TCI), 322–323, 329 Christian Science doctrine, 28 Cleveland, Grover, 45 Clyburn, William, 316, 318 CNBC, 2 coal mining, 105–107 coal slurry projects, 124–127 cocaine, 225 Colorado Railcar, 181 Colorado River Aqueduct, 66 Commerce Trust Company, 67 company towns, 45–46 computer technology, 69–70, 87, 95 container ships/cars, 173–174, 180–181 Corpus Christi, 160 Corpus Christi and Rio Grande Railroad, 160–161 Corta, Vicente, 231, 232, 238–240 Couch, C. P. “Pete,” 63, 65, 68 Couch, Harvey, 60–66, 71 coupon annuity insurance policies, 12–13 COVID-19 pandemic, 279, 280, 301 Creel, Keith, 283, 289, 295, 298, 301, 308, 313, 321–322, 328–332, 334 Crosby, Rufus, 67 Crowell, Russell, 18 de Geoijen, John, 26–27, 182 Delahanty, Les, 120 Delaware and Hudson Railway, 57 Del Cueto Cuevas, Oscar, 284–285 Department of Justice, 164

DeQueen, Arkansas, 27 DeQuincy, Louisiana, 27, 38 Deramus, William N., II, 68–75, 82 Deramus, William N., III: characterization, 77–83, 130–131; cost cutting by, 101–103; death of, 130; KCSI breakup, 223; KCSI business strategy, 82–86; Lee National negotiations, 104–105; loyalty to, 129, 133; mutual funds adoption, 91–93; passenger service cutting by, 103–104; photo of, 80; relationship with Carter, 109, 121; relationship with Hockaday, 129; relationship with McDonnell, 92–93; relationship with Rowland, 133 Deramus, William N., IV, 131, 134 DeRidder, Louisiana, 27, 32 Detroit Car and Manufacturing Company, 44 Díaz, Porfirio, 160–161, 187–193, 199 double-stack trains, 177 Dow Chemical, 164 Dreiling, Robert, 109, 112 Drexel, A. J., 6–7 Druten, Bob, 85, 267, 268, 288, 300, 304, 305, 307, 321, 330 DST Systems (DST), 90–92, 129, 133, 222–223 Dworman, Alvin, 104–105 E. L. Martin & Co., 5 Edson, Job, 58 Edwards, George W., 134–136, 143, 144 Eisenhower, Dwight D., 73–74 electricity, 61, 65, 119–120 El Universal, 226 endowment accident insurance policies, 12–13 Energy Transportation Systems (ETSI), 124–127, 146, 243 Erdman, Warren, 284 Exxon, 119

Fahmy, Sameh, 275–276 Fairmount Park, 17–19, 52 Ferrocarriles Nacionales de México (MNR). See Mexican National Railroad (MNR) Fillmore, Millard F., 139 First Church of Christ, Scientist, 52, 53 Fisk, Jubilee, 58 Flying Crow passenger service, 71, 103 Ford Model T, 74 4R Act of 1976, 113–114 Fox, Vicente, 226, 238 F40PH locomotives, 179–180 Frailey, Fred, 110–111 Frank, Joele, 285–286 French Canal Company, 170 Gates, John W., 48, 49, 53 Gateway Western Railway Company (GWWR), 165–166, 264 Genessee & Wyoming (GWR), 206, 282–283 Gibson, James, 48 GIP-Blackstone acquisition. See Canadian Pacific Kansas City (CPKC) Godderz, Adam, 284, 303, 304 gold mining, 22 gold monetary standard, 34–36 Gould, George, 20 Gould, Jay, 20, 58, 160–161 grain shipping/grain market, 41–42, 59, 67, 136, 155–156, 166, 263 Grand Central terminal, 17 Graysonia, Nashville, and Ashdown Railroad (GN&A), 136 Great Central Coal and Coke Company, 52 Great Depression, 24, 59, 66, 195 Great Recession, 241, 247, 259, 264 Grupo México, 206, 210 Grupo Transportación Marítima Mexicana (TMM): breach of contract by, 234; deceptions by, 217, 219, 228–233;

i n d e x 345

financial crisis, 224–228, 232–233; Haverty Corp partnership, 150–151; KCSI partnership, 156–161, 200–215; MNR stake, 156–161; motivations, 233, 236, 237; North-East concession bidding, 200–212; UP-TMM relationship, 221. See also Transportación Ferroviaria Mexicana (TFM) Guardian Trust Company, 5–6, 14–15, 52 Gulf, Mobile and Ohio Railroad, 165 Hall, Donald, 129 Hallmark Cards, 129 Harriman, E. H., 47–49, 139 Harrison, Hunter, 274, 324 Haverty, Michael R.: business strategy, 155–158, 244–246, 255–256; characterization, 155, 246–247, 265–266, 269, 277; CN-KCS merger, 310–311; GWWR, 165–166; hiring on KCSR board, 145–153; KCSI financial services spinoff, 222–224; marketing agreements, 166–167; Panama Canal Railroad, 169–183; photos, 162; regulatory opposition actions, 158, 161–165, 293; relationship with Serrano, 225–228; TFM operations, 216, 220–222, 225–229; TMM partnership, 156–161, 200–215, 231–237; UP-SP merger, 158, 161–165 Haverty Corp., 150–151, 175 Hawkinson, John, 91, 95 health maintenance organizations (HMOs), 90 Heineman, Ben W., 82 Hell’s Half Acre, 27–28, 52 Henson, Paul, 155, 175, 214, 311 Hills, Carla, 148 Hockaday, Irv, 80, 81, 85, 104–105, 108, 112, 129 Hohn, Chris, 329 home building, 14–15 Home of the Picnics, 18

346 i n d e x

Hoover, Herbert, 66 Hornbeck, Louisiana, 27 Houston, East, and West Texas Railway (HE&WT), 33–34 Howe Coal Company, 105–108 Huneke, William, 318 Hunt, J. B., 148, 150–151, 157 hurricane of 1897, 38, 41 hurricane of 1900, 34, 56 Hutchinson, Cecil Clair, 178–179 Hutchison Port Terminals, 175–176 IDEX Corporation, 97 illegal drug trade, 225 Illinois Central Gulf Railroad, 165 Illinois Central (IC) Railroad, 47, 139–140 Illinois Central Railroad, 2 Indian Territory, 21, 22 In-Terminal Services (ITS), 177 International and Great Northern, 160 International Finance Corporation (IFC), 175, 183 Interstate Commerce Act of 1887, 1, 116 Interstate Commerce Commission (ICC): BN-SF merger, 156, 158, 163; KCSI investigation, 107–108; KCSL&A merger, 65; mergers/consolidations role, 123, 126, 143, 146; railroad rate control by, 74–75; regulatory role generally, 59, 114, 115; Tex-Mex ownership by KCSR, 158–159; UP-SP merger, 158, 161–165 interstate highway network, 73–75, 102 Investors Fiduciary Trust Company, 95 Iowa and Minnesota Rail Link (IMRL), 166 J. B. Hunt Transport Services, 148 Janus Capital Corporation, 96–98, 222 Joele Frank Wilkinson Brimmer Katcher, 285–286 Johnson, Jay, 286–287

Kansas City, Fort Smith, and Southern Railway, 21–22 Kansas City, Mexico, and Orient Railroad (KCM&O), 51–52, 67 Kansas City, Pittsburg, and Gulf Railroad (KCP&G): community building, 27; construction of, 23; corporate culture, 28, 38; equipment shortage, 43–47; expansion of, 29–34, 42; financing of, 24–30, 33, 36, 42–47, 66; promotional schemes, 17, 26–27, 30–33, 31; receivership, 47–49, 67, 210; Splitlog Railroad, 20–23; Stillwell’s vision of, 13–14, 17, 19, 23; Whitaker’s railroad, 20 Kansas City Distilling Company, 5 Kansas City Railway: agricultural traffic, 121–122, 155–156; annual meetings, 81; ballast/chat product, 103, 111; board of directors, 56–63, 68–69, 109–110, 144–145; carload growth, 219–220, 280; coal shipping, 119, 124–127; construction of, 17; corporate culture, 2–3, 13, 57, 68, 246, 248, 274–276; cost cutting, 78–79, 81–83, 101, 112, 248–249; customer service, 117–118; debt offerings, 263; debt reduction, 262; derailments, 109, 110; diversification measures, 82, 107–108; employee stability, 266–267; ETSI lawsuit, 124–127, 146, 243; financial reporting, 241–242, 258; financing of, 2, 3, 6–7, 14–15, 56, 59, 68, 98–100, 104–105, 120, 156, 263–264; GIPBlackstone acquisition, 279–314; heavy trains, 103, 110, 111; incorporation of, 1; infrastructure, 43, 58–59, 69–70, 102–103, 111, 249, 264, 281–282; investment-grade status, 261–263; lobbying against Stagger Act by, 115–118; marketing/sales, 249–256; mergers/ consolidations, 63, 65, 122–124, 134–144, 156–159; MidSouth acquisition, 136–138; negotiating position,

266; operating ratios, 252, 264–265; passenger service, 71–73, 103–104; petroleum coke transport, 108; processoriented management, 247–252, 266; profitability management, 56–63, 81; profitability statistics, 116, 120, 281– 281; promotional campaigns, 71, 72; rate-making by salespeople, 116–117; rebuilding of, 109–113; refinancing, 256–259; relationship development, 3; sale offering, 137–139, 174; selection of Starling’s successor, 265–271; slave units, 110; smaller-volume business, 117; stock profitability, 2, 224, 258, 261, 281, 335; as subsidiary of KCSI, 117; SWEPCO contract, 118–120; technology usage, 69–70 Kansas City Southern de México (KCSM): expansion of, 263–264; financing of, 263, 285; formation of, 238–240; growth of, 281; infrastructure, 264; integration of, 245–246; presidential election 2018, 268; refinancing of, 258 Kansas City Southern Industries (KCSI): board of directors, 85, 92–96, 104–105, 128; breakup of, 99–100; coal mining, 105–108, 113; communications, 87–89; corporate culture, 94, 97; corporate structure, 82–83; financial services, 90–92, 95–98, 222–224; formation of, 82–83; health care services, 89–90; holdings, 86; ICC scrutiny of, 107–108; investment committee, 85–86; Kaskel bid to acquire, 128–130; KCSR sale offerings, 137–141; mission/Deramus’s vision, 86; pharmaceuticals, 89–90; product distribution/creation, 96–99; product technology, 91–92, 129, 133; railroad rebuild financing, 112; TMM partnership, 156–161, 200–215 Kansas City Star, 49 Kansas City Suburban Trust Company, 52

i n d e x 347

Kaskel, Howard, 128–130 Kemper, James M., 67 Kemper, R. Crosby, 67–68 Kemper, William T., 66–68 Kemper Financial, 95 Kemper Grain Company, 67 Kenna, Thomas, 182, 183, 247 Kenna, Tom, 173 Kennedy, John F., 87 Kilpatrick, Willis, 181–182 Kingsley Group, 156–159 Krebs, Rob, 149, 243 Ladenburg, Thalmann and Company, 47 La Jornada, 226 Landry, Margaret, 71 Lanigan, Jack Sr., 178 Lanigan, Mike, 170–171, 174, 176, 177, 181 LDX Group/LDX Network, 88 Lee National Corporation, 104–105 Lee Tire and Rubber Company, 104 Levien, Frank, 104–105 Lewis, Drew, 158 Limantour, José Yves, 192 Lincoln, Abraham, 1 Live and Grow Young (Stilwell), 53 Loree, Leonor Fresnel, 57–59, 61, 62, 70, 111, 126 Lott, Alexander, 190 Lott, Trent, 311 Lott, Uriah, 160–161 Louisiana and Arkansas Railway, 61–63, 62, 70 Louisville and Nashville Railroad, 69 Lucas, Anthony F., 55 lumber industry, 121 Lyman, Bill, 216 Management Training Program (MoPac), 145 Martec Pharmaceutical, 89, 96 Martin, Edward Lowe, 5–7, 15, 36, 47

348 i n d e x

McAlester, J. J., 105 McClain, Michael F., 118–122, 152, 157, 198 McCullough, David, 170 McDonnell, Tom, 85, 92–96, 133– 134, 223 McKenzie Partners, 287 McKinley, William, 35–36, 44 Mena, Arkansas, 27, 30–32, 43 Mexican National Railroad (MNR): construction of, 190–191; foreign ownership of, 188, 191–194; government ownership stake, 212; intention of, 189–191; in intermodal network, 151; Interoceanic Railway, 189; KCSRTMM partnership, 156–161; Loree’s relationship with, 57–58; marketing/ promotion of, 202–203; Mexican Central Railroad, 189–192; nationalization of, 192–194, 200; National Railways of Mexico, 192; North-East concession, 199–212; Pacific-North concession, 199, 204–205, 207; privatization of, 194, 198–199; rail concessions/service areas, 198–199; rail system development, 186–188; South-East Line, 199; Terminal Railroad, 199; trackage rights rates, 204–205; value-added tax (VAT) refund, 212. See also Transportación Ferroviaria Mexicana (TFM) Mexico: anti-American sentiment, 191–193, 215; economic policy, 196–198; Mexican Revolution, 51, 193–195; nationalization of industries, 195–196; presidential election 2018, 268; privatization policy, 197–198; SCT actions, 165, 198–199, 201, 204, 205, 209–210, 214, 237, 238; trade agreements, 197–198; transportation corridor development, 185–186. See also Mexican National Railroad (MNR); Transportación Ferroviaria Mexicana (TFM)

Mid-American Television Company, 87–88 Mid-America Pipeline Company (MAPCO), 81 Midcon Labs, 89, 96 MidSouth Corporation, 136–138, 158 Mi-Jack Products (Mi-Jack), 170–171, 174–178, 183 Missouri-Kansas-Texas Railroad, 2, 57 Missouri Pacific Railroad (MoPac), 2, 42, 138, 145, 178 Mohar, Mario, 214 Monarch Capital Corporation, 95 Monello, Joe, 206, 209–210 Morgan, J. P., 6 Morgan, Linda, 293 Morgan Stanley, 103, 206, 211–212, 228, 285, 287, 294, 301, 308 mortgage product, 14–15 Mullins, Bill, 286 Mulroney, Brian, 310 mutual funds, 91–98, 222

Northern Pacific Railway, 24 North Louisiana Telephone Company, 61, 68 nuclear power plants, 119, 134 Oberman, Martin J., 325 oil market, 55–56, 59, 197, 263–264 Omaha and Saint Louis Railway, 42, 52 Orr, John, 285 Oswald, Lee Harvey, 87 Ottensmeyer, Patrick: characterization, 259, 273–274, 277; GIP-Blackstone acquisition, 279–314; nitial hiring at KCSR, 242–245; marketing/sales strategy, 258; negotiation strategy, 266; photos of, 304, 309, 334; PSR implementation, 274–277, 282, 290, 301; relationship with Starling, 247; selection as CEO, 268–271; switch to marketing/sales, 252–256

Pabtex, 136 Pace, Robert, 323, 329 Naatz, Mike, 284 Palmer, William Jackson, 161, 190 NAFTA, 148, 166, 201–202, 211, 227 Panama Canal Railway Company: concesNAFTA Rail, 226–230, 237, 239 sion agreement, 178–179, 181; conNAFTA RailRoad (CN), 310–311 tainer ships/cars, 173–174, 180–181; National Bank of Commerce, 67 financial success of, 170, 183; freight National Industrial Transportation service, 183; Haverty’s assessment of, League (NITL), 164 170–174; marketing/promotion, 182; National Surety Company, 52 passenger service, 181–183; privatizaNational System of Interstate and Defense tion of, 174–176; rationale to invest, Highways Act of 1956, 74 169–170, 183; rebuilding of, 176–183 Native American displacement, 21 Panic of 1873, 160 natural gas shipping, 118–120 Panic of 1893, 24–25, 295 Nederland, Texas, 27, 32–33 paper industry, 121 Neff, Pat, 60 PCRC. See Panama Canal Railway Neosho Construction Company, 178–179 Company Netherlands, 24–27 Petróleos Mexicanos (Pemex), 196 New Deal, 66 petroleum industry, 55–56, 59, 197, Norfolk Southern (NS), 123, 137–138, 263–264 281, 296, 328 pharmacy network system, 90 Noriega, Manuel, 171 Pilgrim, Bo, 121

i n d e x 349

Pilgrim’s Pride, 121 Pioneer Western Corporation, 96–98 Populist Party, 34 Port Arthur, 36–38, 41 Port Arthur and Mexican Steamship Company, 37 Port Arthur Rice Farm, 32–33, 52 Port Arthur Ship Canal, 52, 56 positive train control (PTC), 267–268 Post Office, 60 poultry industry, 121, 136 precision scheduled railroading (PSR), 274–277, 282, 290, 301 preferred provider organizations (PPOs), 90 presidential election of 1896, 34–36, 44 Procter, William, 7 Procter & Gamble, 7 “Prospectus for Change in the Freight Railroad Industry, A,” 114 Puche, Jaime Serra, 148 Pullman, George M., 36, 43–47, 210 Pullman, Illinois, 45–46 Pullman Sleeper, 44–45 Pullman Standard cars, 182 Pullman strike, 45–46

133–134; monopoly impact on freight rates, 163; national labor strike, 45–46; north-south percentage growth, 148; oil transportation via, 56, 59; overborrowing by, 24; profitability statistics, 116; rate of return, 102; regulation of, 34–35, 74–75, 101, 113–114, 115–118, 133; shipping rates regulation, 74–75, 101, 113–118; tariffs, 120; tax incentives, 73, 75; union agreements, 147 Railway Mail Service, 60 Real Estate Trust Company, 15 Reconstruction Finance Corporation (RFC), 66 Red River bridge, 19–20 Rees, Ab, Jr., 178 Reichsautobahn, 73–74 Reorganization Executive Committee, 49 Republican Party, 34–36 rice farming, 32–33, 52 Rio Grande Industries, 123–126 Roosevelt, Franklin, 66 Roosevelt, Theodore, 18, 56 Rosenblum, Steve, 304, 308 Rowland, Landon H.: business strategy, 133–134; relationship with Edwards, Quincy, Omaha, and Kansas City Rail133–135; relationship with Kaskel, road Company, 42 128; SP bid, 123; TFM role, 214; TMM partnership role, 151–152, 155, 175, Rader, Tom, 181 198, 200, 203, 206, 209–210 Railroad Freight Transportation (Loree), 58 Ruest, Jean-Jacques, 289, 310, 311, 313, Railroad Revitalization and Regulatory 321–324, 330 Reform Act of 1976, 113–114 Ruiz, Carlos, 199, 200 railroad system; bankruptcies, 102; common carrier obligation, 115; Sabine Pass, Texas, 20 decline of, 102; expansion of, 19–20; Sacristán, Emilio, 200 financing of, 24; fixed-rate system, Saint Joseph and Grand Island Rail116–117; infrastructure, 102; intermoroad, 47 dal deals, 147–148; interstate highway Salinas, Carlos, 198, 199 network effects on, 73–75, 102; San Francisco–Oakland Bay Bridge, 66 legislative initiatives, 1–2; maintenance Santa Fe Southern Pacific (SFSP), 123, of, 103; mergers/consolidations, 59, 138–139, 141, 146, 242–243

350 i n d e x

Seabrook Station nuclear power plant, 134 Secretariat of Infrastructure, Communications, and Transportation (SCT), 165, 198–199, 201, 204, 205, 209–210, 214, 237, 238 Segovia, Javier, 227, 229–230 Seidel, Jason, 329 self-made man concept, 18, 25, 44, 60 Serrano, José “Pepe,” 151, 156–159, 203, 206, 216, 222, 225–230, 238 “Service begets growth” slogan, 276 Shell Petroleum, 164 Shipley, Joseph, 7 silver monetary standard, 34–35 Sizemore, Doug, 216 Skelley, William, 85 Slattery, Jim, 204, 286 SMART-TD, 317, 318 Smith, H. C., 6, 7 Songer, Jeff, 284 Southern Belle passenger service, 71–73, 103–104, 181–182 Southern Railway, 69 South Orient Railroad, 151 Southwestern Bell Telephone Company (SBC), 61, 207–208 Southwestern Electric Power Company (SWEPCO), 118–120 Spindletop Hill, 55–56, 59 Splitlog, Matthias/Splitlog’s Railroad, 20–23 Splitlog Land and Mining Company, 22 sports/sporting events, 87 Springer, Dennis, 242–243, 284 Stacktrains, 177 stagflation, 87 Staggers, Harley O., 115 Staggers Rail Act of 1980, 115–118, 133 Starling, David L., 176–178, 181, 182, 245–252, 255, 259, 265–271, 282, 284 State Street Bank, 95 “Steam Road to El Dorado,” 170 steamship freight service, 37, 52

Stilwell, Arthur E.: background, 9–10, 200; career development, 10–13; characterization, 10–14, 25, 39, 44, 53–54, 120; community development, 30–33, 36–37, 52; companies founded by, 52; death/net worth, 54; ethical philosophy, 12–13, 18, 32, 53; philanthropic endeavors, 27–28, 52; photos of, 7; railroading passion, 10–14; receivership, 47–49, 67, 210; relationship with Martin, 5–7, 15; relationship with McKinley, 35–36; religion/spiritualism, 53; trust in, 3; unconventionality of, 2; vision for railroad, 13–14, 17, 19, 23, 179, 211, 265–266; writings, 52–53 Stilwell, Charles, 9, 10 Stilwell, Genevieve “Jennie” (née Wood), 11, 15, 26, 54 Stilwell, Hamblin, 9, 43, 46 Stilwell Financial, 98–99, 224, 281 St. Louis–San Francisco Railway (Frisco), 138 St. Louis Southwestern Railway, 60 Stotesbury, E. T., 7 straight-life insurance policies, 11–12 Streamlined Hospitality campaign, 71, 72 Strong, William Barstow, 146 Sullivan, James, 161, 190 Sullivan & Cromwell, 331 Supervised Investor Services (SIS), 91–92 Surface Transportation Board (STB): CN-BNSF merger, 291–294; CN-KCS voting trust application, 305, 314–316, 324–330; CP-KCS voting trust application, 333; CP-NS merger, 296; KCSTMM buyout, 228, 236; KCS-TMM trackage rights, 205; UP-SP merger, 163–165, 286 Telecom Engineering, 88 telephone service, 60–61, 65, 69, 88 television, 87–88 Television Shares Management, 91

i n d e x 351

Tellier, Paul, 166, 310–311 Texarkana and Fort Smith Railway, 19–20 Texas Mexican Railway (Tex-Mex), 157–161, 164–165, 190, 201, 209, 215, 220–221, 236 Texas Mexican Railway Company, 161 Thalmann, Ernst, 47–48 Three Mile Island disaster, 134 timber business, 32 TMM. See Grupo Transportación Marítima Mexicana (TMM) transcontinental railroad system. See railroad system Transmark, 117 Transportación Ferroviaria Mexicana (TFM): anti-American sentiment, 218–219; binding arbitration provision, 231, 234–235; breach of contract by TMM, 234; business model conflicts, 220–222; carload growth, 219–220; commercial operations launch, 217–219; commercial rail operations control, 215–216; deceptions by TMM, 217, 219, 228–233; formation of, 213–214; headquarters location, 214–215; IT/revenue management platform, 215; KCS motivations, 237; KCSR full ownership acquisition, 227–237; KCSR/TMM relationship, 217, 219–237; labor issues, 216–219; long-haul traffic, 220–221; maritime shipping, 224–225; North-East Line, 217; operations center location, 215; put option provision, 228–229, 235– 236; rail agreement, 216–217; TMM financial crisis, 224–228, 232–233; TMM motivations, 233, 236, 237; VAT/put swap, 238–240; VAT refund provision, 228–229, 232–237. See also Mexican National Railroad (MNR) Travelers Insurance Company, 11–13 Troutman, George, 7

352 i n d e x

trucking industry, 74–75, 102, 147–148 Truman, Harry S., 67 Truman, John, 67 Turk, John, 118–120 Union Pacific Railroad (UP): bankruptcy, 24; BN-SF merger, 141; CN&W acquisition, 155–156; Empresas ICA partnership, 206–210; Harriman relationship to, 47; industry growth vs. peers, 281; MoPac, 138; North-East concession bid, 205–210; Pacific-North concession, 200–201; Splitlog rightof-way, 21; TMM relationship, 221; Transportation Control System, 215; UP-SP merger, 158, 161–165, 207, 209, 286, 291 United Illuminating (UI), 135 United Transportation Union, 147 Universal Peace (Stilwell), 53 Upchurch, Mike, 254–259, 262, 282–284, 288, 290, 301, 307 UP-SP merger. See under Union Pacific Railroad (UP) USMCA, 317 Vander Ark, Brent, 284 Vanderbilt, Cornelius, 9 Vandervoort, Arkansas, 27 Vantage Computer Systems, 95 veterinary products, 89 Vista Chemical, 164 Wabash Railroad, 77 Wachtell Lipton, 304, 331 Walker, Ben, 329 Wall Street Journal, 279, 282, 283, 288 Walsh, Nelson, 203, 285 waterway carriers, 75 waterworks systems, 66 Welsh, John Lowber, 7 Western Union, 88

Whitaker, William L., 19–20 White & Case, 231 Wiley, Rein & Fielding, 204 Williams Telecommunications Group (WTG), 88–89 Wilson, Michael, 148 Wonderful Wizard of Oz, The (Baum), 35 Woodward, George, 216

World Bank Group, 175 Wu, Lolli, 286–287 yellow fever, 42 Zedillo, Ernesto, 199 Zwolle, Louisiana, 27, 32

i n d e x 353

William H. Galligan was employed at KCS from 1992 to 2018, primarily responsible for the company’s investor relations program, as well as being involved in special projects. Retired, he now splits his time between Kansas City, Missouri, and Guilford, Connecticut.

For Indiana University Press Tony Brewer  Artist and Book Designer Dan Crissman  Trade and Regional Acquisitions Editor Samantha Heffner  Trade Acquisitions Assistant Brenna Hosman  Production Coordinator Katie Huggins  Production Manager David Miller  Lead Project Manager/Editor Dan Pyle  Online Publishing Manager Pamela Rude  Senior Artist and Book Designer Stephen Williams  Marketing and Publicity Manager