What will be the DM&E Railroad’s fate when the Canadian Pacific releases a strategic plan promised for December?
Given the importance of rail for the frac sand industry in southwest Wisconsin and southeastern Minnesota, it’s not an idle question. For those concerned about the development of industrial-scale silica mining in Minnesota, ownership and use of the line may prove more important than former DM&E rail boss Kevin Schiefer’s dream of hauling coal from the Powder River Basin through Rochester.
For while the coal mining itself would have been out of sight and out of mind, frac sand mining is in everybody’s backyard in southeastern Minnesota–with calls for a statewide GEIS and a three-year moratorium escalating as residents see what’s happening on the other side of the Mississippi River.
What role will the “good barbarian” hedge fund manager Bill Ackman of Pershing Square Capital Management take in this drama as he engages in the competitive thing he’s got with investor and BNSF rail rival Warren Buffett?
Will a battle over 100+ “unit trains” of frac sand rumbling down through southeastern (and possibly south central) Minnesota prove to be the sequel to the contentious 2006 battle over the DM&E? That shook up southern Minnesota’s political landscape and was a major factor in Tim Walz’s surprise victory in a Republican-leaning district.
Good questions and worth a look at considerations that might factor in as the CP structures its plan.
Proxy skirmish: DM&E bad
During the proxy contest “activist” hedge fund manager Bill Ackman waged to control the Canadian Pacific Railway, former CEO Fred Green’s acquistion of the DM&E line in 2008 was Ackman’s Exhibit A for the railroad man’s supposed bad judgment:
Overpayment for the DM&E – In 2008, under Mr. Green’s leadership and with the Board’s approval, CP purchased the Dakota, Minnesota & Eastern Railroad (DM&E) at a price of approximately 18 times pre-tax operating profit.3 The consensus among the investment community at the time and since has been that CP grossly overpaid for DM&E, by many accounts by over 30%.
Excessive Borrowings to Finance the DM&E Purchase, and Poor Share Buyback Decisions, Resulted in Substantial Shareholder Dilution – Having overpaid for the DM&E, the Board and Mr. Green compounded the problem by financing the DM&E acquisition with excessive debt, contributing to an over-leveraging of the Company’s balance sheet. As a result, during the depths of the financial crisis in February 2009, CP had to raise equity by selling $511 million of stock at fire-sale prices – at $36.75 per share – when they had previously completed repurchasing $517 million of stock at $63.03, only 14 months earlier, materially diluting shareholder value. At the same time, other railroads, whose balance sheets had been protected by boards and management with more effective and prudent oversight, created substantial shareholder value by repurchasing their shares at extremely attractive prices during the financial crisis.
According to Bill Ackman’s Full Presentation on Canadian Pacific, the following slide appeared in a presentation that Ackman made in early February 2012:
Ackman’s Pershing Square Management won that boardroom battle in May, and now the clock is ticking on the new strategic plan the Canadian Pacific Railway promised in recent briefings, such as the Citi Global Industrials Conference, for full strategic review at it December Investor Day in New York .
According a Lexis Fair Dislosure transcript of the CGI Conference, bulk freight like grain, potash, coal and sulfur make up 44 percent of the railway’s shipping, merchandise–including energy–make up 30 percent, while intermodal (container/trailers) rounds off the cargo at 26 percent.
Goals for the new board members and CEO Harrison include longer trains, faster trains, and a lot less terminal and idle time for the rolling stock. Given the condition of the DM&E tracks–and the earlier resistance from the Mayo Clinic for having frequent and long coal trains rumbling through Rochester–this might signal that DM&E might get spun-up by CP’s new executives.
Or maybe not.
Bakken: Is DM&E value breathing again?
Things change, like shifting silica sand in a glass. Could the value of the DM&E track may have changed with the rise of the Bakken Shale oil fields–and the development of the Marcellus gas shale in Ohio and Pennsylvania–and the related decline in coal shipments?
First, fracking has produced a glut of natural gas, and power companies are shuttering older, dirtier coal-fired plants (or converting them to gas). Upgrading tracks and shipping coal east from Wyoming’s Powder River Basin? Probably a waste of money right now.
In the CGI Conference and other investor briefings, CP executives noted that while the railway ships some PRB thermal coal west for export, shipping Canadian metallurgical coal for Teck to export to China dominates CP’s coal hauling.
Instead, “energy” merchandise is a more important driver for CP’s growth, given that the old Soo Line is one of two rail lines into the oil shale lands in Western North Dakota (Warren Buffet’s Hathaway controls BNSF, the other line). The CGI Conference transcipt notes:
Energy-related demand is a point of strength. We continue to see increases in shipments of oil and other energy products, as well as movements of drilling materials such as steel and frac sand. Crude by rail continues to be an exciting area of growth for CP. In fact, we recently announced that we would expect to move 70,000 carloads of crude a year earlier than originally expected. We are investing side by side with key partners who are putting infrastructure in place to move oil by rail over the long term.
On the frac sand front, we have announced agreements to serve three new frac sand facilities in Wisconsin with US Silica, Unimin and Smart Sand*. When all of the announced production capacity comes onstream through 2013, these three plants will collectively have the capability to produce more than 3.5 million tonnes per year.
In total, our energy initiatives will provide up to CAD400 million in annual new revenues over the next three to four years and as Jane announced on our Q2 call, we have direct line of sight to over 80% of these revenues.
CP’s strategic sand partnership: U.S. Silica and Smart Sand
Sources close to the industry–and Bluestem’s general reading–lead us to believe that as more sand mines come online, and the glut of natural gas continues, smaller sand companies will fade from the scene, leaving larger players like U.S. Silica, Unimin and Smart Sand (former governor Tim Pawlenty joined the board this summer).
On June 22, CP announced in Canadian Pacific and U.S. Silica Holdings, Inc. announce multi-year agreement for the transport of frac sand:
Canadian Pacific Railway Limited (TSX: CP) (NYSE: CP) and U.S. Silica Holdings, Inc. (NYSE: SLCA), today announced a multi-year agreement for the movement of frac sand from U.S. Silica’s newest mining and processing facility in Sparta, Wisconsin.
U.S. Silica is the second largest domestic producer of commercial silica, a specialized mineral that is a critical input into oil and gas shale production and various industrial and specialty products. The Company is building a new frac sand facility located on the CP’s rail line in Sparta, Wisconsin that will produce high quality Northern White sand for use in shale basins across the United States and Canada.
Under the agreement, CP will become the exclusive rail service provider at this facility for the movement of U.S. Silica’s frac sand to destination markets. The design of the Sparta facility will allow U.S. Silica to build unit trains of frac sand with a focus on shipments into the Bakken shale in North Dakota to support the area’s growing need for proppant. The facility will produce and ship three different grades of dry sand and is expected to be fully operational in the first quarter of 2013. . .
“Canadian Pacific has proven expertise and has been serving the energy industry in North America for many years. We are pleased to continue to grow this important market through our partnership with U.S. Silica,” said Jane O’Hagan, Canadian Pacific Executive Vice-President and Chief Marketing Officer, who noted CP’s agreement with U.S. Silica is an important component of the railway’s growing energy strategy, which focuses not just on outbound crude oil, but also on the flow of input materials into shale and other energy developments.” . . .
In early September, Prairie Business reported about the Unimin and Smart Sands contracts in Investing for the Long Haul:
Earlier this year, Connecticut-based mineral supplier Unimin Corp. agreed to work exclusively with CP to deliver sand to Bakken producers from a 2-million-ton facility in Tunnel City, Wis. That facility is also expected to be complete early next year. In July, CP took its involvement in frac sand supply operations to the next level, signing a long-term agreement with Smart Sand Inc., a logistics and proppant supplier to the oil and gas industry, to build a frac sand transload facility in the tiny town of Makoti, near Minot, which will serve the Williston Basin beginning in 2013. The project is unique in that CP is a direct partner with Smart Sand for the facility. Typically, railroads provide mainline infrastructure improvements as needed while the customer retains full responsibility for the facilities.
None of these facilities are on the DM&E tracks.
Frac sand in Minnesota and the DM&E
The DM&E was a Class II railroad before it was acquired by the Canadian Pacific under Fred Green, hauling mostly grain and ethanol, but potential developments might cause it to gain some importance as a southern line into the Bakken Shale. Already, the CP includes the line on its map of Bakken Shale rail connections, via independent short lines in the Dakotas.
There’s good reason as Star Tribune staff writer Tony Kennedy writes in St. Charles, Minn., ponders future as sand mining takes off:
Nestled in a trout stream paradise between Rochester and Winona, this picturesque town has long been known as the “Gateway to Whitewater,” a nearby state park known for its stunning ravines.
Before long, it could be the gateway to Minnesota’s new mining frontier.
Local investors have floated a $55 million to $70 million proposal — as large as any in the country — to build an industrial processing plant and rail depot that would convert St. Charles into a regional hub for the nation’s burgeoning frac sand industry and open southeastern Minnesota to what could be a sand mining frenzy.
The proposal could make millionaires out of lucky landowners and transform a quiet corner of the state that yearns for greater economic diversity. With a series of local mining moratoriums set to expire in the coming year, a deluge of other frac sand proposals could follow quickly.
“All eyes are on St. Charles,” said Mayor Bill Spitzer, who is cautiously receptive to the idea. “This could be like the Iron Range of southeastern Minnesota.” . . .
. . .The site hinges on its proximity to an active rail line that sides the property — rare infrastructure in a part of the state that lost most of its railroad network in the 1970s. From St. Charles, unit trains of more than 100 cars each could roll directly to North Dakota’s Bakken oil formation, a high-demand area that many Wisconsin sand plants can’t easily reach.
Foes and supporters say the Minnesota Proppant facility would rival the frac sand processing center in Chippewa Falls, Wis., owned by EOG Resources Inc. of Houston, Texas. Since EOG’s plant opened in 2010, more than 10 other frac sand operations have cropped up in the surrounding county, transforming the hometown of the fictional Annie Hall into a nationally recognized mining center.
And whose tracks? The CP Railway’s tracks. But which direction will those “unit trains,” which are a signature of Ackman’s hand-selected CP CEO Hunter Harrison’s operating style, be headed? East–to join up with the Soo Line tracks–or West, via the CP’s less travelled southern access?
If West, then those long trains will rumble through Rochester and Mankato. Bluestem has read some reports of congested tracks and delays in shipping to and from the Bakken; one of the CP’s goals is to cut shipping time and turn around of rolling stock. Expanding traffic along the DM&E tracks might just do that, especially in relationship to the new terminal being built at the North Dakota ghost town of New Town. And the Soo Line tracks that go through the Twin Cities are nestled in a notorious chokepoint.
Moreover, as the map from the Star Tribune at the top of this section indicates, Southeastern Minnesota isn’t the only place along the DM&E tracks where silica sand is found. Already, sand in being mined by Unimin at Kasota and Ottawa and Preferred Sands is looking to start another mine along the Minnesota River in LeSueur County; all are along the Union Pacific tracks that run down the valley to Mankato, where they veer off toward Worthington and beyond. The UP has already improved its capacity to ship sand from Mankato, the Strib reported in August.
The CP and the UP tracks meet up at Mankato, where the CP/DM&E begins to crawl up the valley to New Ulm. Rumor among the river folks is that a permit is “in the works” for Renville County. It’s likely that the CP would be involved in hauling sand extracted west of Mankato.
Would the CP run the sand west–or take it east through Rochester to meet up with its Soo Line tracks? Alas, Bluestem isn’t close to eithe Mr. Ackman or Mr. Harrison, but perhaps an enterprising business reporter might ask: Where now with the DM&E and the frac sand?
Will “good barbarian” pillage Minnesota for its sand? Or just stick with hauling off Wisconsin?
What’s good for the CP Railway might not be so good for trout in the Whitewater and the Minnesota River Valley’s unique big bluffs along the meandering prairie river, nor the health and safety of people who live there. Most of the attention to fracking’s environmental hazards has surrounded the process of fracking–Environment Minnesota issued a report last month that focused on fracking, rather than mining the sand–but loyal readers of Bluestem should know the price of sand.
Can we hope that a GEIS will allow questions to be asked ahead of profit? Or will demands for a three-year moratorium be answered, so that we can have time to come up with rules that will prevent some of our loveliest southern landscapes from becoming Mordor? How much pressure can be brought not only on the sand companies, but those who ship the sand as well?
Bill Ackman doesn’t like to be called a corporate raider like that Icahn fellow, but deemed an activist in that he takes over companies not to gut them of assets but to quickly turna company around and harvest a profit when its stock rises. Yet, a healthy chunk of the chatter about the CP involves hauling off some of the landscape of Wisconsin and Southern Minnesota. Brutal merchandise, one supposes.
On the other hand, this particular barbarian on the tracks seems to have something resembling a sense of–well, define for yourself. In a profile in the New York Observer, Matt Chaban reported:
Mr. Ackman also sees his investments as improving society, which is how he can spend his nonprofit dollars on the Innocence Project, which helps get people out of prison through DNA evidence, at the same time his fund holds a large stake in private prison company Corrections Corp. of America. “It’s a necessary evil, prisons, unfortunately,” Mr. Ackman said. “We’ve got a huge overcrowding problem in prison, and I think outsourcing is a good solution. And it’s a good business.”
“His goal is to gather up as much assets in the world as possible and redeploy them,” a friend said. “I’ve heard him say that a number of times.”
Perhaps Ackman and his team at CP only see re-deploying sand from these parts to the shale beneath North Dakota, and not the green rolling hills of Minnesota that have to be ripped up to have at that sand.
As for the good business of private prisons: when the dots were connected between CCA’s funding of ALEC and the latter group’s involvement in writing SB1070, a number of organizations of conscience called on all investors to divest their holdings in the private prison industry on May 12, 2011.
Mr. Ackman quietly divested all of his 7 million shares of CCA stock on May 16, 2011. As Mr. Ackman is rarely shy, the silence here might thought to be telling.
A generous political donor who gives mostly to Democrats–including $2000 to Amy Klobuchar in 2006–Ackman promotes the use of social finance instuments to facilitate lasting social change. With his wife Karen, trained as a landscape architect, Ackman has signed the Giving Pledge to give away at least half of his money (certainly a more generous offer than if Bluestem offered her mite).
In his letter for the Giving Pledge, Ackman tells of how the late American philosopher John Rawls’ notion of the original position shaped his own ideas of giving and fairness. Would Rawls’ theories of justice bend toward hauling away the perfect white sand beneath southern Minnesota, if half of Ackman’s share of the profits are donated to the many lovely causes his foundation supports?
Meanwhile, what to do with the DM&E? So that Rochester’s medical industry might know what it’s facing, perhaps a business reporter might get on the next investment call and ask directly just what the plans are.
Photos: CP locomotives (above) the DM&E tracks (middle top); CP Bakken Shale routes (middle bottom); a map of frac sand in Minnesota, via the Star Tribune.