Appendix — Southern Pacific Transportation Co. v. Interstate Commerce Commission
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Supreme Court of the GQnited States
OcY’OBER TERM, 1992
SOUTHERN PACIFIC TRANSPORTATION COMPANY,
and St. LOUIS SOUTHWESTERN RAILWAY COMPANY,
Petitioners,
Ww
INTERSTATE COMMERCE COMMISSION and
UNITED STATES OF AMERICA, et al.,
Respondents.
Petition For A Writ Of Certiorari
To The United States Court Of Appeals
For The District Of Columbia Circuit
APPENDIX TO PETITION FOR WRIT OF CERTIORARI
C. Y. HARVEY PAUL A. CUNNINGHAM*
CAROL A. HARRIS RICHARD B. HERZOG
JOHN MACDONALD SMITH HARKINS CUNNINGHAM
SOUTHERN PACIFIC 1300 19th Street, N.W.
TRANSPORTATION COMPANY Washington, DC 20036
One Market Plaza (202) 973-7600
San Francisco, CA 94105
(415) 541-1756 Attorneys for Southern
Pacific Transportation
Company and St. Louis
Southwestern Railway
Company
April 6, 1993 *Counsel of record
PRESS OF BYRON S. ADAMS, WASHINGTON, D.C. (202) 347-8203
INDEX TO APPENDIX
Order of the U.S. Court of Appeals for the District
of Columbia Circuit and Memorandum denying
petitions for review (Oct. 30, 1992) .....0...0.0....
Order of the U.S. Court of Appeals for the District
of Columbia Circuit denying petition for re-
hearing (Jan. 6, 1993) wooceeccccccccsccsscescsceceeee.
Order of the U.S. Court of Appeals for the District
of Columbia Circuit denying suggestion for re-
hearing en banc (Jan. 6, 1993) ....cccccccccccccceeess
Decisions of the Interstate Commerce Commission
in Finance Docket No. 30,000 (Sub-No. 16), St.
Louis Southwestern Railway Company—Track-
age Rights Over Missouri Pacific Railroad—
Kansas City to St. Louis
ee re Be 2 | aR Tem a Amn
E.C.C.Bd GB (197) .......cccccccscsccascsccsessarovssees
CSET HEHEHE OEE HEHEHE EEE EEE EEE EE EES
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8 1.C.C.2d 80 (1991)
&
CPPS HT OSES TEESE SESE EES ESE SESE SEEEOS
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NOT TO BE PUBLISHED—SEE LOCAL RULE 14
United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
September Term, 1992
No. 88-1186
Union Pacific Corporation, et al.,
Petitioners
v.
Interstate Commerce Commission, et al.,
Respondents
FILED OCT 30 1992
RON GARVIN
CLERK
and Consolidated Case Nos. 89-1443, 89-1483, 91-1529, and
92-1020
ON PETITIONS FOR REVIEW OF ORDERS
OF THE INTERSTATE COMMERCE COMMISSION
Before: MIKVA, Chief Judge, RUTH B. GINSBURG and
SILBERMAN, Circuit Judges.
JUDGMENT
These petitions were considered on the record and on
the briefs and oral arguments of counsel. The arguments
have been accorded full consideration by the Court and
occasion no need for a published opinion. See D.C. Cir.
Rule 14(c). For the reasons stated in the accompanying
memorandum, it is
ORDERED AND ADJUDGED by this Court that the
petitions for review be denied.
2a
The Clerk is directed to withhold issuance of the man-
date herein until sever (7) days after disposition of any
timely petition for rehearing. See D.C. Cir. Rule 15.
Per Curiam
For the Court
/s/ Ron Garvin
Ron Garvin
Clerk
MEMORANDUM
The petitioner railroads seek review of orders of the
Interstate Commerce Commission (“ICC’”’ or ‘“Commis-
sion’’) setting the rate of compensation that Standard [sic]
Pacific (“SP’’) must pay Union Pacific (‘‘UP’’) for the ex-
ercise of its right to use certain UP track. The Commission
approved an ‘earlier railroad consolidation involving UP
subject to certain conditions designed to counteract the
potentially anti-competitive effects of the merger, including
a requirement that the consolidated UP railroad grant
trackage rights to SP and other specified railroads in order
to allow competitive alternatives for travel across the Cen-
tral Corridor of the United States between St. Louis and
the West. Unable to reach a private agreement, the
petitioners entered into proceedings with the Commission
that lasted approximately seven years and produced the
five trackage rights compensation orders that are the sub-
ject of the petitions.
This Court is limited in its scope of review and may
only grant the petitions for review in this case if the ICC
action was arbitrary, capricious, an abuse of discretion, or
unsupported by substantial evidence on the record as a
whole. See Simmons v. Interstate Commerce Commission,
934 F.2d 363, 367 (D.C. Cir. 1991); Cross-Sound Ferry
Services v. Interstate Commerce Commission, 873 F.2d 395,
401 (D.C. Cir. 1989). There is substantial evidence on the
3a
record to support the ICC’s calculation of tracking com-
pensation and interest on delayed payments. Moreover,
throughout the compensation proceedings, the Commission
considered vast amounts of technical evidence, reevaluat-
ing and reformulating its decisions in light of the objec-
tions of the petitioners and the production of new evidence.
Although the Commission did not fully explain why the
petitioners’ suggested approaches were inferior to its own,
the burden upon the petitioners is ‘‘not merely to put forth
an acceptable alternative but rather to demonstrate clearly
and convincingly a fatal flaw in the action taken.” Nader
v. Federal Communications Commission, 520 F.2d 182
(1975), (quoting Goodman v. Public Service Commission,
309 A.2d 97, 101 (D.C. 1973)) (emphasis in original). The
petitioners have failed to meet this burden and their
petitions must therefore be denied.
4a
United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
September Term, 1992
No. 88-1186
Union Pacific Corporation, et al.,
Petitioner
V.
Interstate Commerce Commission and
United States of America,
Respondent
FILED JAN 06 1993
RON GARVIN
CLERK
and Consolidated Cases
BEFORE: Mikva, Chief Judge; Ruth B. Ginsburg and Sil-
berman, Circuit Judges
ORDER
Upon consideration of petitioners’ petition for rehearing,
filed December 14, 1992, it is
ORDERED, by the Court, that the petition is denied.
Per Curiam
FOR THE COURT:
RON GARVIN, CLERK
BY: /s/ Robert A. Bonner
Robert A. Bonner
Deputy Clerk
5a
United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
September Term, 1992
No. 88-1186
Union Pacific Corporation, et al.,
Petitioner
v.
Interstate Commerce Commission, and
United States of America,
Respondent
FILED JAN 06 1993
RON GARVIN
CLERK
and Consolidated Cases
BEFORE: Mikva, Chief Judge; Wald, Edwards, Ruth B.
Ginsburg, Silberman, Buckley, Williams, D. H.
Ginsburg, Sentelle, Henderson, and Randolph,
Circuit Judges
ORDER
Petitioners’ Suggestion Fcr Rehearing En Banc has been
circulated to the full Court. No member of the Court re-
quested the taking of a vote thereon. Upon consideration
of the foregoing it is
ORDERED, by the Court en banc, that the suggestion
is denied.
6a
Per Curiam
FOR THE COURT:
RON GARVIN, CLERK
BY: /s/ Robert A. Bonner
Robert A. Bonner
Deputy Clerk
Circuit Judge Randolph did not participate in this matter.
Ta
INTERSTATE COMMERCE COMMISSION REPORTS
FINANCE DOCKET NO. 30,000 (SUB-NO. 16):
ST. LOUIS SOUTHWESTERN RAILWAY COMPANY--
TRACKAGE RIGHTS OVER MISSOURI PACIFIC
RAILROAD COMPANY—KANSAS CITY TO ST. LOUIS
TRACKAGE RIGHTS COMPENSATION
Decided August 20, 1984
1. In Finance Docket No. 30,000 (Sub-No. 25), the agree-
ments of November 9, 1982, as supplemented January
<1, 1983, governing trackage rights compensation be-
tween Missouri-Kansas-Texas Railroad Company and
Union Pacific Railroad Company and Missouri Pacific
Railroad Company are approved.
2. In Finance Docket No. 30,000 (Sub-No. 18), trackage
rights compensation will be calculated in three parts:
(a) variable costs of operations, (b) a percentage share
of all maintenance and operations expenses and taxes
based upon tenant’s actual usage, and (c) an interest
rental component representing return on investment and
determined by a capitalized earnings approach.
3. In Finance Docket No. 30,000 (Sub-No. 16), the track-
age rights awarded include operations to Missouri Pa-
cific milepost 0.0 in St. Louis, and interchange
operations along the Missouri Pacific lines. The inter-
change rights do not embrace Labadie, MO.
‘This decision also embraces Finance Docket No. 30,000 (Sub-No.
18). Denver and Rio Grande Western Railroad Company—Trackage
Rights—Missouri Pacific Railroad Company—Between Pueblo, CO and
Kansas City, MO, and Finance Docket No. 30,000 (Sub-No. 25), Mis-
souri-Kansas-Texas Railroad Company—Trackage Rights—Missouri Pa-
cific Railroad Company—Between Kansas City, KS and Omaha, NE.
8a
4. In Finance Docket No. 30,000 (Sub-No. 16), trackage
rights compensation will be determined in the same
manner set forth in the Sub-No. 18 proceeding. The
record is kept open for filing of supplemental infor-
mation necessary to complete this calculation.
5. In Finance Docket No. 30,000 (Sub-No. 16), interim
compensation will be paid as agreed by the parties at
the level finally determined in this proceeding and ef-
fective retroactively to January 6, 1983. Interest at the
railroad industry’s current cost of debt will accrue on
the difference in amounts actually paid and the com-
pensation fixed in this proceeding.
6. In Finance Docket No. 30,000 (Sub-Nos. 16 and 18),
landlord retains the right to make improvements to the
property without tenants’ prior consent. Compensation
for improvements will be at their actual cost times lan-
dlord’s then current cost of capital times tenants’ usage
share for each improvement. Tenants will have the op-
tion to reimburse the landlord for a portion of the con-
struction expense at the time of construction rather
than increasing the improvements valuation base.
J. Peter Byrne, Paul A. Conley, Jr., Mark M. Hennelly,
Gregg H. Levy, William J. McDonald, Charles A. Miller,
Arvid E. Roach II, C. Barry Schafer, M. Lauck Walton,
and Nina K. Wuestling for Union Pacific Corporation, Pa-
cific Rail System, Inc., Union Pacific Railroad Company,
Missouri Pacific Corporation and Missouri Pacific Railroad
Company.
John H. Caldwell, Samuel R. Freeman, Denise M.
O’Brien, and Kendall T. Sanford for Denver and Rio
Grande Western Railroad Company.
William R. Denton, Eva Polin, Michael A. Smith, Doug-
las E. Stephenson, and Herbert A. Waterman for Southern
Pacific Transportation Company and St. Louis Southwest-
ern Railway Company.
9a
Donald E. Engle, Nicholas P. Moros, and Donal L. Tur-
kal for Burlington Northern Railroad Company.
John O’B. Clarke, Jr. and John J. Sullivan for the
United Transportation Union.
Harold A. Ross for the Brotherhood of Locomotive En-
gineers.
Decision
By the Commission:
Background
By decision served October 20, 1982, the Commission
approved the consolidation of Union Pacific Railroad Com-
pany (UPRR or UP), Missouri Pacific Corporation (MPC),
Missouri Pacific Railroad Company (MP or MPRR), and
the Western Pacific Railroad Company (WPRR or WP)
under the common control of Union Pacific Corporation
(UPC) and Pacific Rail System, Inc. (Pacific) (all referred
to as the UP system). Union Pacific-Control-Missouri Pa-
cific: Western Pacific, 366 I1.C.C. 459 (1982) (referred to
as UP-MP or the Consolidation decision). Several railroads,
including Southern Pacific Transportation Company (SP)
and its subsidiary St. Louis Southwestern Railway Comany
(SSW), Denver and Rio Grande Western Railroad Company
(DRGW), and the Missouri-Kansas-Texas Railroad Com-
pany (MKT), opposed the transaction and filed responsive
applications for the imposition of trackage rights condi-
tions.
In Southern Pacific Transportation Company v. I.C.C.,
82-2253 (D.C. Cir. May 22, 1984), the Court of Appeals
affirmed the consolidation decision in all respects material
to these proceedings but remanded for further consider-
ation of an unrelated issue.
In approving the consolidation the Commission identified
several anticompetitive effects of the transaction which
_—————————————eaxXxeow’S Fo.
10a
could be remedied by grants of trackage rights to com-
peting carriers. The greatest competitive impact was iden-
tified in the central transcontinental corridor. Based on
1979 market shares, the UPRR share would increase with
the consolidation from 75.7 percent to 85.1 percent (west-
bound) and from 78.0 percent to 85.5 percent (eastbound)
in the corridor east of Denver, UP-MP at pp. 510-11. These
potential increases presume that all preconsolidation MP
traffic would shift to the UP system. In order to preserve
competition in the central corridor east of Denver, the
Commission conditioned approval of the consolidation on
a grant of trackage rights to DRGW between Pueblo, CO,
and Kansas City, MO. Almost all of MP’s preconsolidation
transcontinental traffic was delivered to or received from
DRGW, UP-MP at 571. DRGW’s trackage rights to Kansas ,
City precluded DRGW’s foreclosure from this market, al-
lowed it to reach major eastern carriers. at Kansas City,
and-ensured a continued competitive presence in the cen-
tral corridor. Solely on the basis of these trackage rights
DRGW should be able to hold its present market share,
for it is assured the ability to continue to handle the traffic
it handled prior to the consolidation.? The Commission con-
cluded that with the Pueblo-Kansas City trackage rights
DRGW would remain a successful competitor to UP in the
central corridor, UP-MP at p. 577. DRGW’s competitive
" presence assures that any post-consolidation traffic shifts
to the UP system will occur because UP offers superior
service, and not through the exercise of undue market
power.
The direct, parallel competition in the central corridor
east of Denver was the only market where traditional mar-
? The only exception would be exclusive MP originated or terminated
traffic which will probably shift to UP single-system service. However,
the shift of this traffic does not reflect a iessening of competition. See
UP-MP at p. 543. Rather, it reflects the benefits of the consolidation.
UP-MP at p. 488, and the efficient UP system service.
lla
ket shares, in terms of a percentage of a specific market,
were available as a tool for analysis of the consolidation.
Because of the prevalence of interchanges, the balance of
the central corridor analysis necessarily relied on a meas-
ure of “participation shares.”’ Participation shares were
defined as the sum of all traffic in the corridor in which
either UPRR, MPRR or WPRR participated.
Participation shares cannot be treated in the same man-
ner as traditional market shares in analyzing competitive
impacts, although both are expressed in terms of a per-
centage of an overall market. Market shares represent the
business that a firm individually controls, while partici-
pation shares, an artificial measure used to reflect inter-
change, represent the business that a firm participates in
with the cooperation of other firms. In the case of inter-
changed traffic, neither firm exclusively controls the busi-
ness; thus, one participant in an existing movement
generally cannot unilaterally shift that traffic into new
patterns as a result of consolidation.
Analysis of participation shares demonstrated the po-
tential impact of the WP acquisition. If showed the worst-
case effect if all traffic moving anywhere on the compo-
nents of the UP system stayed exclusively on the UP
system after consolidation. UP-MP at p. 513, table 5, and
p. 514, table 6. The greater portion of the traffic shown
in each table was interchanged with SP at Ogden: 49.1
percent eastbound and 50.3 percent westbound. After con-
solidation SP has a distinct disincentive to interchange its
traffic with UP at Ogden. Granting of trackage rights to
DRGW provides SP an alternative outlet to the east and
ensures that most of the SP traffic will not move on the
UP system. The SP-DRGW route is a strong competitive
alternative in the central corridor, UP-MP at p. 516 and
579. The worst-case participation shares shown in tables
5 and 6-will be correspondingly reduced.
12a
To further strengthen the central corridor alternative
to UP, the Commission granted SP/SSW trackage rights
between Kansas City and St. Louis. This allows an SP-
DRGW-SP route which should provide excellent service in
the corridor. UP-MP at pp. 587-88. The SP/SSW trackage
rights will also result in a 400-mile shortening of SP’s
southern corridor transcontinental route, further sharp-
ening competition between SP’s southern corridor route
and UP’s route in the central corridor.
In order to address the loss of a horizontal competitor
in the market between Kansas City and Omaha/Council
Bluffs, UP-MP at p. 526, and to prevent foreclosure of
MKT from a significant share of midwestern grain traffic
moving to the Gulf, UP-MP at p. 530, the Commission
conditioned approval on a grant of trackage rights to MKT
in that corridor. These rights will preserve the opportunity
for MKT to be an effective competitor for traffic, primarily
grain, originating at Omaha/Council Bluffs, Lincoln, At-
chison, and Topeka.
Each grant of these trackage rights was designed to
remedy a specific anti-competitive effect of the consoli-
dation. However, we recognize that the key to the success
of the conditions lies in the terms of compensation for use
of the trackage rights. The Commission declined to set
specific terms for the trackage rights in the consolidation
decision, UP-MP at pp. 589-90. Cf. Louisville & N. R. Co.-
Merger—Monon Railroad, 338 I.C.C. 134, 186 (1970). In-
stead the Commission required the parties to attempt to
reach agreement as to the terms of each grant of trackage
rights. If the parties failed to agree, the Commission re-
tained jurisdiction to set terms, UP-MP at p. 589.
Consummation of the consolidation was allowed without
final resolution of the terms of the trackage rights. How-
ever, the trackage rights tenants were assured of an in-
terim right to operate pending final settlement of the
compensation, UP-MP at p. 590.
13a
We now have before us a final agreement on trackage
rights terms and compensation covering the MKT opera-
tions, and petitions to set the terms and compensation
applicable to SP/SSW and DRGW operations. We will ad-
dress each matter separately.
Summary
DRGW and SP/SSW were unable to reach agreement
with UP on terms of compensation for trackage rights
over the Pueblo-Kansas City line (DRGW) and the Kansas
City-St. Louis line (SP/SSW). They have requested us to
set these terms. We have adopted a methodology for com-
puting compensation designed to reimburse UP for (1) var-
iable costs incurred as a result of tenants’ operations, (2)
tenants’ share, on a car-mile percentage use basis, of main-
tenance and operation (M&O) expense, and (3) tenants’
share on a usage basis of an interest rental component
representing return on investment. The interest rental
component is computed by applying MPC’s 1979 pretax
rate of return to the value of the subject lines. As we
believe that the latter figure should reflect the earnings
potential of the lines, we have rejected valuation methods
based upon replacement cost and book value urged by var-
ious parties in favor of a capitalized earnings approach.
An “earnings multiple,” representing the ratio of MPC
value (outstanding liabilities plus stock purchase price) to
1979 MPC earnings (adjusted for time parity), was applied
to 1979 earnings for the respective lines. For the Pueblo-
Kansas City line, we have computed an interest rental
component of $2,048,565 based on projected usage factors
for each segment of the line. As no net revenue figures
were available for the Kansas City-St. Louis line, we will
direct the parties to submit, within 60 days, calculations
based upon the methodology adopted in this decision.
We have also disposed of a number of issues regarding
the Kansas City-St. Louis line. We have determined (a)
that the terminus of the line in St. Louis is milepost 0.0
l4a
near Gratiot Tower, rather than milepost 2.3 near Grand
Avenue, as contended by UP, (b) that the trackage rights
granted to SSW contemplate interchange at five Missouri
points, including Pleasant Hill, but not Labadie, and (c)
that there is no basis for requiring SSW to compensate
the Burlington Northern Railroad Company for the use of
the Grand Avenue Interlocking. Also, we have provided
for the payment by SSW of interest on retroactive ad-
justments to compensation due under an interim operating
agreement, and for the separate valuation and compen-
sation of new improvements made to the line.
Finally, we have approved the agreement between UP
and MKT for trackage rights between Kansas City and
Omaha/Council Bluffs.
Preliminary Matter
The United Transportation Union (UTU) and the Broth-
erhood of Locomotive Engineers (BLE) have filed petitions
in the Sub-No. 16 and Sub-No. 18* preceedings requesting
that terms of trackage rights applicable to SP/SSW and
DRGW operations respectively not be set by the Commis-
sion prior to negotiation or arbitration of an implementing
agreement between both the landlord and tenant in each
case and labor representatives concerning the selection of
employees for the operation of the trackage rights. UTU
and BLE argue that 49 U.S.C. 11347 requires us to protect
the interests of all employees involved in a consolidation
proceeding and that this provision mandates a negotiated
settlement between employee representatives and both the
landlord and tenant carriers as to which employees, lan-
dlords’ or tenants’, are to actually perform tenants’ op-
erations. UTU and BLE contend that we cannot set the
trackage rights terms absent such an agreement for two
*The UTU petition was late-filed and accompanied by a Motion for
Leave to File. We will accept the petition because it does not unduly
broaden the issues before us.
15a
reasons. First, they contend the 4R Act‘ narrowed our
authority under 49 U.S.C. 11341 to exempt the approved
transaction from the operations of other laws such as the
Railway Labor Act (RLA).® Second, the labor interests
argue that this exemption was not necessary for the rail-
roads to carry out the approved transactions and that any
exemption from the RLA falls outside of our authority
under 49 U.S.C. 11341.
We have specifically addressed UTU and BLE’s argu-
ments concerning the scope of our jurisdiction, our ability
to exempt the instant transaction from the RLA, and the
extent of the exemption actually granted in these pro-
ceedings. See Finance Docket No. 30,000 (Sub-No. 18),
Denver and Rio Grande Western Railroad Company—
Trackage Rights—Missouri Pacific Railroad Company—Be-
tween Pueblo, CO and Kansas City, MO (not printed),
served October 25, 1983. We specifically rely on our dis-
cussion in that decision, which was issued in response to
a petition for clarification of the DRGW and MKT trackage
rights filed by the same parties now before us. In that
decision we concluded that, contrary to the UTU and BLE
assertion, use of tenants’ crews to perform tenants’ work
does not constitute a unilateral change in the working
conditions of the landlord’s employees that would fall within
the purview of the RLA. Further, our jurisdiction over
railroad consolidations under 49 U.S.C. 11343 is plenary
and exclusive. Our approval exempts such a transaction
from the requirements of all laws, including the RLA, as
necessary to permit the transaction to be carried out. See
Brotherhood of Loc. Eng. v. Chicago & North Western Ry.
Co., 314 F. 2d 424, 432 (8th Cir. 1963), cert. denied 375
U.S. 819 (1963). The 4R Act did not limit our authority
to preempt other laws in authorizing a transaction; it sim-
‘The Railroad Revitalization and Regulatory Reform Act of 1976.
Public Law 94-210.
*45 U.S.C. 157 et seq.
16a
ply specified standards for the minimum level of employee
protection to be imposed in cases such as this. The Con-
solidation decision imposed the appropriate level of em-
ployee protection under 49 U.S.C. 11347, and _ that
protection is the full extent of labor relations involvement
in these proceedings. If an MP employee is displaced by
DRGW operations, for example, he or she will receive
benefits under the conditions set for in Norfolk and West-
ern Ry. Co.—Trackage Rights—BN, 354 I1.C.C. 605 (1978)
as modified by Mendocino Coast Ry. Inc.—Lease and Op-
erate, 360 I.C.C. 653, 664 (1980), which were imposed in
these proceedings, MP-UP at pp. 621-22. That employee
has no right absent a negotiated settlement to take part
in the DRGW operations.
The second argument advanced by the labor interests—
that the exemption of selection of forces was not necessary
for implementation of the transaction and therefore could
not be approved—was disposed of in the Consolidation pro-
ceeding. If the exemption was not necessary to implement
the transaction as proposed, it can not now be argued that
the RLA prevents implementation of the trackage rights.
See MP-UP at p. 556, note 99.
We conclude that there is no limitation on rights of the
various tenants to use their own crews in these trackage
rights operations, or on our ability to finally set the terms
in these proceedings.
Trackage Rights
I. Between Pueblo and Kansas City
A. General.—As part of the decision approving the UP-
MP consolidation, the Commission imposed trackage rights
in favor of DRGW over 619 miles of MP line between
Pueblo, CO and Kansas City, KS. Finance Docket 30,000
(Sub-No. 18). The greater portion of this line is without
substantial grades and has an authorized speed of 55 miles
17a
per hour. There are 47 sidings on the line, of which 32
are over a mile long. The longest siding is 12,160 feet.
Following the decision approving the consolidation,
DRGW and UP negotiated for interim and permanent
terms governing DRGW’s operations over the MP line re-
quired by the Consolidation decision. On November 5, 1982
an agreement was reached setting interim rental which
allowed DRGW to begin operations and cleared the way
for consummation of the approved consolidation. DRGW
has operated over trackage rights between Pueblo and
Kansas City pursuant to this interim agreement since the
consummation of the consolidation on December 22, 1982.
However, DRGW and UP have been unable to agree on
the permanent terms for trackage rights operation and
have requested us to set the compensation.
B. DRGW.—DRGW proposes to compensate UP for its
usage of MP trackage in three parts: (1) the variable costs,
including standard additives, of train operations, switching,
and mechanical services incurred by MP as a result of
DRGW operation; (2) DRGW’s allocated share, on a car-
mile percentage use basis, of maintenance and operation
(M&O) costs, taxes, and standard additives; and (3) interest
rental of $1.58 million a year calculated by capitalizing
MP’s expected earnings on the Pueblo line as specifically
described below. The three elements of DRGW’s formula
reimburse UP for, respectively, (1) its variable cost in-
curred as a result of DRGW operations, (2) a share of its
maintenance costs including part of UP’s fixed costs, and
3) a return on its investment.
* [Interim operations of the required trackage rights was made a con-
dition precedent to consummation of the consolidation. UP-MP at 590.
The terms of the interim agreement called for DRGW to pay $1.5
million a year in rental plus the costs of operation to UP. The terms
of the interim agreement were approved by decision served November
24, 1982.
18a
The methodology employed by DRGW to calculate the
variable costs of operations is the standard method em-
ployed in the industry for trackage rights agreements. UP
does not contest the calculation of this item.
The treatment of M&O expenses is subject to some con-
troversy. DRGW ultimately took the position that it would
reimburse UP for its ratable share of these expenses as
actually incurred by MP and based upon DRGW’s actual
use.” This results in a variable annual payment for M&O
expenses. In its initial petition DRGW cited an example
of M&O expense reimbursement yielding a contribution to
UP fixed costs of $4.8 million. UP construed this calcu-
lation to be an additional “set payment’? by DRGW in
addition to its interest rental described below; it inter-
preted the DRGW position to be that the ‘overhead com-
ponent” of M&O expense was offered by DRGW as an
additional contribution to UP not necessary to offset any
additional overhead costs to be actually incurred. In its
response DRGW clarified that it did not contemplate bi-
furcation of the fixed component of MP and M&O ex-
penses, and considered the reimbursement of a percentage
of these costs actually incurred to be the full extent of
compensation for these expenses. In a subsequent Motion
for Leave to File Reply and a Reply, which we will allow,
filed August 2, 1983, UP argued that DRGW was oppor-
tunistically changing its position and our decision should
be limited to the initial proposals of the parties. DRGW
replied on August 25, 1983.
UP’s argument goes only to procedural considerations,
for we are charged with determining the most appropriate
result in this proceeding notwithstanding the positions of
the parties. See Lamoille Valley R. Co. v. ICC, 711 F.2d
295 (D.C. Cir. 1983). However, our decision is bounded by
7 DRGW used Rail Form A estimates of these expenses in its petition
in this proceeding, but acknowledges line-specific actual costs should
be the basis for this calculation.
19a
considerations of procedural fairness and the opportunity
of an opposing party to address a proposal before us. In
this proceeding we specifically allowed UP to file a reply
to DRGW’s response, a pleading normally barred by our
rules, 49 CFR 1104.13(c). There is no unfairness in our
consideration of all positions advanced in this proceeding,
and we will do so.
Finally, DRGW proposed calculating the third element
in its compensation formula, the interest rental portion,
using a capitalized earnings approach. DRGW argues that
a proper rental for the Pueblo line is the value of the line
to UP measured by net earnings, multiplied by MP’s actual
rate of return and adjusted by DRGW’s percentage of use.
DRGW’s proposal calls for payment of $1,586,216 in in-
terest rental to UP calculated as follows:
1. Divide MPC’s pretax operating profit for
1979 ($262,966,000) into the market value of eq-
uity at time of merger ($998,910,000). This equals
3.8. Thus, the value of the equity was 3.8 times
the pretax operating profit for 1979.
2. Develop MP’s 1979 net revenues for the
Pueblo-Osawatomie line of $3,473,037; for the Os-
awatomie to Kansas City line of $2,404,409; and
for the total of the two lines of $5,877,446.
3. Multiply the figures in (2) by 3.8 to give
valuation to the lines equal to $13,197,540
(Pueblo-Osawatomie); $9,136,754 (Osawatomie-
Kansas City); and $22,334,294 (total).
4. Develop a rate of return by taking a 9.33
percent after-tax return for MP for 1979 and
calculate a pretax rate of return of 11.38 percent
using the MP’s 1979 effective tax rate (18 per-
cent).
5. Multiply the results in (3) by the 11.38 per-
cent rate of return to produce interest (for 100
percent use) of $1,501,880 for Pueblo-Osawatomie
and $1,039,763 for Osowatomie-Kansas City.
20a
6. Apply DRGW usage factors to these num-
bers to produce interest rental of $1,201,504 for
Pueblo to Osawatomie (80 percent usage);
$384,712 for Osawatomie to Kansas City (37 per-
cent usage); and $1,586,216 total.
The DRGW procedure is more specifically described in
appendix A.
UP did not dispute the basic concept underlying DRGW’s
calculations but did argue for the inclusion of assumed
liabilities of MPC ($1,361,814,000) as part of the purchase
price, for a total of $2,360,724,000.° Inclusion of MPC
liabilities as part of the purchase price results in a change
in the earnings multiple of 3.8 used by DRGW to a mul-
tiple of 9.0 proposed by UP. UP also argues for the use
of the statutory, not the effective, tax rate in the com-
putation of the rate of return element. Applying these
changes to the DRGW’s figures produces the following:
1. Valuation of Pueblo-Osawatomie equals
$31,257,657; Osawatomie to Kansas City equals
$21,639,681; total equals $52,897,338.
2. Pretax rate of return at the statutory tax
rate (48 percent, including 2 percent for State
tax) equals 17.94 percent.
3. Multiplying the results in (1) by the 17.94
percent rate produces interest rental (for 100 per-
cent usage) equal to $5,607,624 for Pueblo to
Osawatomie and $3,882,159 for Osawatomie to
Kansas City.
4. Utilizing the DRGW’s usage factors pro-
duces interest rental of $4,486,099 for Pueblo to
* DRGW argues that if liabilities are included in the purchase price
for this calculation, then the value of MP’s equipment should be ex-
cluded.
Z2la
Osawatomie; $1,436,399 for Osawatomie to Kan-
sas City; and $5,922,498 total.?
Finally, UP attacks the estimate of traffic on the line
which DRGW used to determine the line specific earnings.
DRGW assumed that 3 years after consummation of the
consolidation, rerouting of traffic would divert all MP
traffic except that originating or terminating on the line
and a minimal amount of traffic interchanged at Pueblo
between DRGW and MP which neither carrier could divert
from the other. UP offers four specific categories of traffic
allegedly increasing MP’s traffic and revenue over the
Pueblo line:
(1) Unit coal train movements originated on
DRGW and interchanged at Pueblo contribute
significant revenues. UP lists movements to Dan-
iel, MS, Federal, IL, and Metropolis, IL as ex-
amples. However, in reply DRGW notes that
shippers in each of these accounts have changed
the junction in favor of DRGW—to Kansas City
on the Federal and Metropolis movements and
to Osawatomie on the Daniels movement—leaving
only a 55-mile haul in the MP account.
(2) Movements between exclusive DRGW
points and points in MP served States such as
Arkansas and Louisiana constitute the second
category. A 16-percent decline was registered for
this traffic between the first 7 months of 1982
and the first 7 months of 1983.
(3) On traffic from DRGW points through St.
Louis, the third category, the year to year 7-
month decline was 25 percent.
*The $5,922,498 figure was calculated from the data given. UP’s
calculation was slightly lower ($5,909,291). This difference was due to
the way in which UP compared the effective and statutory tax rate
adjustments.
22a
(4) A final significant category is traffic be-
tween western points on SP and MP points. How-
ever, the Pueblo line year to year 7-month decline
for this traffic totalled 74.8 percent.
C. UP.—In its separate submission, UP also proposes
to fix the compensation due from DRGW in three parts:
(1) variable costs of operations, (2) allocated share of M&O
expenses, but including half of the taxes attributable to
the line, and (3) an interest rental of 50 percent of the
ownership costs of the line. Ownership costs for this pur-
pose are defined as the value of the line, calculated as the
reproduction cost new less depreciation (RCNLD), multi-
plied by an appropriate rate of return.
UP conducted a study of the Pueblo line and concluded
that (1) the appraised value of real estate on the line is
$14,555,790,° (2) the value of existing facilities is
$219,685,299," and (3) the total value of the Pueblo line
is $234,241,089. The value for grading along the line, in-
cluded within the figure for existing facilities, is
$65,879,530 without depreciation adjustment. If grading
were depreciated 75 percent, the total value of the line
would be $184,831,422. UP considers the range of value
of the line to be $184,831,422 to $234,241,089.
UP does not offer a specific rate of return to be applied
to its calculated value. Rather, it suggests that a number
of guidelines might be appropriate including the railroad
cost of capital (1981 determination—16.5 percent) and MP’s
pretax return on net investment (1981—15.3 percent using
the statutory tax rate).
Ultimately, UP selects $10 million as an appropriate
interest rental payment for the Pueblo line and works
This figure does not reflect any assemblage premium. Including
such a premium would result in a real estate value of $30,064,934.
" This figure represents a total reproduction cost for existing facilities
of $372,883,699 less depreciation of $153,198,400.
———EEeEVeVE
23a
backwards through its RCNLD approach to show that the
rental is justified. Using the lower end of the valuation
range ($184,831,442), the $10 million annual rental reflects
a rate of return of 10.8 percent. UP notes that this rate
of return is less than MP’s pretax return on net invest-
ment and below the rate of return used by DRGW in its
calculations. UP suggests that such a result is justified for
the Pueblo line because, while a high quality line of con-
siderable length, it does not have the strategic importance
to UP that characterizes the Kansas City to St. Louis lines.
UP also notes that the Pueblo line trackage nights involve
a significant market extension for DRGW with correspond-
ing risks justifying a lower valuation and rate of return.
DRGW argues that UP conceded the correctness of its
earnings multiple approach and that we should not con-
sider the RCNLD methodology. Additionally, DRGW ar-
gues that fixing interest rental at the level of $10 million
a year would render its service noncompetitive and defeat
the purpose of the trackage rights. DRGW offers the fol-
lowing annualized pro forma income statement to illustrate
the asserted anticompetitive result of the proposed $10
million rental. It reflects actual revenues and line specific
expenses experienced in operating the Pueblo line trackage
rights during late 1982 and part of 1983 and gives effect
to UP’s proposed $10 million annual interest rental and
UP’s $5 million estimate of 1982 M&O expenses.
Pro forma income statement based on 1982-88 traffic levels, revenues
and expenses (Millions of Dollars)
IE IIE, cserccsnstanansadsrerecoregntinntinsnensennnnabinnedinn $43.9
BE CE CIEE eccnccerecasncessnetnnnnsncsanncesenninntinnmninins $32.7
I: GEE GRIND, in csensisscrsccerennneninscntninninenciendindaints 5.0
IIIS OIE. sseccccisscenstcinnscensncciinnaniievsanmnnnatisineaneniennehalinneniinn _10.0
I: UTES GOED citrceinictarnectsiiierasiaticinmnnns ($3.8)
24a
D. Discussion.—We adopt the earnings multiple ap-
proach as the most appropriate technique of valuing the
railroad assets at issue in this proceeding. This technique
has been utilized in a number of contexts to value rail
assets. See New Haven Inclusion Cases, 390 U.S. 392, 436-
482 (1970) and Ecker v. Western Pac. R.R. Corporation,
318 U.S. 448 (1943). A similar approach to valuation was
also employed in the primary consolidation proceeding to
determine the fairness of the financial terms of UP’s ac-
quisition of WP stock. UP-MP at pp. 635-36. The decision
noted at p. 635 that this method is predicated on the
carrier continuing as a going-concern. This characteristic
is perhaps the methodology’s greatest advantage in valuing
assets using in trackage rnghts operation. In this context,
the tenant railroad will enter the property of the ongoing,
owning railroad to provide competitive service where we
have found that competition to be required by the public
interest. The purpose of this proceeding is to set compen-
sation for the trackage rights which will put the tenant
in the same position as the owning carrier. The owning
road is now using and will continue to use the asset in
the conduct of its ongoing operations as a railroad. We
are favoring the methodology which values the asset for
this use. The RCNLD approach does not value the asset
as a going-concern business, but rather solely as individual
parcels of land and specific existing structures. This is not
to say that RCNLD valuation is inappropriate in other
contexts, or that the methodology used here is appropriate
outside the immediate setting where trackage rights have
been imposed to remedy anticompetitive effects of a con-
solidation. Where we are attempting to place the tenant
in precisely the position of the owning road, however, the
earnings multiple approach is more appropriate.
Fortunately we have before us a specific sale to use to
construct the earnings multiple analysis—the primary con-
solidation transaction itself. This transaction effectively es-
tablished the fair market value of MPC to UP. We
——— ;
eE_
25a
recognize that applying the earnings approach to infer the
value of a specific asset involves assumptions that (1) the
rate of return on investment for the corporation as a whole
applies to each of its component parts in an identical man-
ner, and (2) all assets are financed using the same mix of
equity and debt as that for the corporation as a whole.
Absent an exhaustive study of proprietary data, no other
procedure can be utilized. Notwithstanding the minimal
disadvantages of these assumptions, the earnings multiple
approach results in the best estimate of the fair market
value of the Pueblo line in its ongoing use as a railroad.
The use of this method predicated upon the actual pur-
chase price paid by UP is especially appropriate here, for
we must be particularly sensitive to this proceeding to
avoid overstating the value of the subject lines. These
trackage rights have been imposed to remedy anticom-
petitive effects of the consolidation, and the tenant must
be able to operate competitively.
While we have accepted the earnings multiple method-
ology, we have not accepted all of the calculations relied
upon in the DRGW proposal. The specific terms of the
formula are discussed below.
1. Interest Rental.
a. Earnings multiple.—The capitalized earnings ap-
proach requires the generation of a number, the earnings
multiple, which relates corporate earnings to corporate
value. The major issue presented in this area is whether
the value of MPC used to generate the multiple should be
the value of the MPC stock at the time of the consolidation
($998,910,000) or also should include the liabilities of MPC
at the time of the consolidation (an additional
$1,361,814,000). .
We conclude that the value used to compute the earn-
ings multiple must include the liabilities of MPC. We are
attempting to estimate the value of an asset of MP. A
return on investment approach using capitalized earnings
el
26a
measures a return on assets acquired and financed by both
debt and equity capital. While there is disagreement among
the parties as to whether the liabilities of MPC were “‘as-
sumed” by UP as part of the purchase, we consider that
distinction irrelevant in estimating the value of MPC’s as-
sets. UP actually paid $998,910,000 for MPC’s stock. The
purchase price for the company’s assets, on the other hand,
would be the stock purchase price (equity) plus all out-
standing MPC debt on the date the company’s stock was
purchased, a total of $2,360,724,000.
We note that this total value figure represents the price
paid for MPC assets at the time of the consummation of
the consolidation—1982. It is not significant that the value
is stated in 1982 dollars and that other operational factors
used in the formula (i.e. line specific earnings) are ex-
pressed in 1979 figures. These items are not directly com-
parable, for the 1982 value is used only to create a single
abstract number, the multiple, which relates earnings to
value. However, it is critical that the figures used to gen-
erate the multiple be comparable. The use of values of
equity and debt expressed in 1982 dollars in comparison
with MPC earnings expressed in 1979 dollars, as proposed
by UP, is inappropriate. We will instead use MPC’s 1979
earnings. This is the base year for the primary consoli-
dation proceeding, the last year prior to the announcement
of the consolidation, and the year’s results which formed
the basis of the investment decision. Updating the nominal
1979 earnings to compare with the expression of value in
1982 dollars also avoids the distortions of the recent reces-
sion. Thus, we have converted the 1979 earnings dollars
to 1982 dollars using the Gross National Product Deflator
issued by the Department of Commerce Bureau of Labor
Statistics."2 This results in the nominal 1979 dollars of
earnings being increased by 26.805 percent.
2 Other indices, such as the Consumer Price Index (CPI) or the
Railroad Freight Price Index could have been used. However, we con-
27a
Another significant change was made in the earnings
calculations. The parties utilized only operating earnings
for the MPC. The equity and liabilities assumed, however,
financed all of the assets owned by the MPC. Many of
these assets produced earnings classified as nonoperating
income. In order to establish an earnings multiple for the
entire corporation, we included both the operating income
and the nonoperating income in our calculations.'* The ex-
clusion of this nonoperating income would result in a mul-
tiple that overstates the value of these lines.
Finally, we are interested in valuing the rail assets of
the rail company. To the extent that the value of other
assets of the corporation along with their attributable earn-
ings can be excluded from the calculation, the multiple
generated will more accurately reflect the relation of rail-
road earnings and value. One item lends itself to such
exclusion. On August 10, 1983, UP announced that it had
sold Mississippi River Transmission Company (MRTC), an
MPC subsidiary, for $256.3 million. MRTC had 1982 earn-
ings of $29.1 million. We will exclude MRTC’s liabilities
just as we included MPC liabilities. We take official notice
of the liabilities of MRTC reflected in its consolidated bal-
ance sheet as of December 31, 1982 published in Moody’s
Public Utility Manual, 1983, Volume 2 page 5,466. The
total liabilities of MRTC, less common stock, capital sur-
plus, and retained earnings, amount of $185,443,000. The
total value of MRTC assets was $441,743,000. To more
accurately reflect the relation of railroad earnings and
value, we will exclude both the value and the earnings of
MRTC from our calculation.
sider the GNP deflator, which measures the effect of inflation through-
out the economy, more appropriate for updating the value of a diverse
collection of assets than these more specialized indices.
‘* Based on nominal 1979 dollars, nonoperating income for the MP
Corporation was $36,541,000. Operating income was $262,966,000. To-
tal income in 1979 dollars is $299,507,000. In 1982 dollars, income is
$379, 790,900.
28a
DRGW has argued that we should treat equipment as
an extraneous asset in the same way that we have de-
termined to treat MRTC. We cannot treat equipment val-
ues in this way, for we have no definitive earnings
attributable to equipment. It is inappropriate to reduce the
value component of the rates without also reducing earn-
ings.
Total 1979 earnings before interest and taxes, expressed
in 1982 dollars, less 1982 earnings of MRTC when divided
into the total of the equity purchased and liabilities of
MPC, less the value of MRTC, produces a multiple of 5.47.
See appendix B. This is the earnings multiple we will use
in our compensation calculation.
b. Earnings of the Pueblo Line.—While there is a dispute
among the rarties as to the appropriate level of traffic to
be ascribed to MP on the Pueblo line, we conclude that
DRGW has adequately demonstrated that the only MP
traffic remaining on this line 3 years after consolidation
will be originating and terminating traffic and a nominal
amount of traffic interchanged with DRGW at Pueblo. UP
has an alternative transcontinental line through Cheyenne
and a line between Denver and Kansas City. These lines
clearly make the Pueblo line largely surplus in the UP
system. UP has acknowledged that the consolidation ef-
fectively has converted the Pueblo line, formally a tran-
scontinental link for MP, to a branch line for the UP
system. We accept the DRGW traffic estimates.
DRGW developed net revenues for the lien in twe sec-
tions: Pueblo to Osawatomie, KS, and Osawatomie to Kan-
sas City. These two segments were employed because the
DRGW usage factors, as set forth below, are different on
each segment. The development of costs for this traffic
as set forth in appendix A. The 1979 net revenue was
$3,473,037 for the Pueblo-Osawatomie line and $2,404,409
for the Osawatomie-Kansas City segment. The net reve-
nues for the Osawatomie-Kansas City segment also include
29a
net revenue from north-south traffic moving only between
Kansas City and Osawatomie and not affected by the post-
consolidation volume reductions.
We are using 1979 revenue figures because (1) they are
compatible with other figures to be used in this calculation
such as 1979 rate of return, (2) the 1979 figures formed
the basis for the investment decision, and (3) 1979 was
the base year adopted in the consolidation proceeding.’
Use of 179 figures for the balance of our calculations is
consistent with the practice throughout the consolidation
proceeding. It also is not inconsistent with our use of 1982
figures in the calculation of the earnings multiple. As ex-
plained above the multiple is a separate and independent
calculation creating a unitless number (i.e., not 1979 dol-
lars of 1982 dollars). In calculating the multiple we con-
verted 1979 corporate earnings to 1982 dollars to directly
compare with the purchase price paid and the corporate
liabilities as they existed in 1982. That calculation is in-
ternally consistent and yields a multiple that can be used
independently (as a simple, unitless ratio) in an equation
which is expressed wholly in terms of 1979 results—line
specific earnings, tax rate, and rate of return. We de-
parted from the use of 1979 base year figures only to
incorporate liabilities into the calculation of the earnings
multiple.
c. Investment base.—Multiplying the line specific earn-
ings by the 5.47 earnings multiple results in valuation of
the Pueblo-Osawatomie segment at $18,997,512 and of the
Osawatomie-Kansas City segment at $13,152,117.
d. Pretax return on investment.—Both parties advocate
the use of a pretax rate of return on investment for MPRR
“The 1979 figures are used to determine the profitability of the
traffic which MP handles on the line, not the volume of traffic. The
traffic levels with which we are concerned are realized after the con-
solidation.
30a
for the year 1979 in developing the rate of return for
these lines under the capitalized earnings methodology.
DRGW advocates the use of the actual or effective tax
rate to compute this return factor. UP, on the other hand,
advocates the use of the statutory tax rate. The Consol-
idation decision proceeding supports the use of the effec-
tive tax rate: ‘“‘*** the landlord’s actual rate of return on
the value of its rail property should be given considera-
tion***,”” UP-MP at p. 590. We use effective tax rates in
other contexts to determine valuation of rail properties
and rates of return, see 49 CFR 1152.34(b) and 1154.35(a),
and we will use the effective rate in this proceeding. MP’s
effective tax rate in 1979 was 18 percent.
Using MP’s annual report to the Commission (form R-
1) and our return on investment methodology in effect
since 1978, MP’s after-tax return on investment was 8.37
percent. Backing out taxes at MP’s effective rate yields
a pretax return of 10.21 percent. This is the rate of return
we utilized in our calculations.
e. Total return on Pueblo Line.—Multiplying the value
of each line segment by the calculated 10.21 percent rate
of return produces interest rental (for 100 percent usage)
of $1,939,646 for the Pueblo-Osawatomie segment and
$1,342,831 for the Osawatomie-Kansas City segment.
f. DRGW usage factor.—DRGW developed usage factors
based on its percentage of total traffic on each segment.
DRGW’s percentage of post consolidation traffic on the
Pueblo-Osawatomie segment is estimated to be 80 percent.
Because additional UP traffic will move over the Osawa-
tomie-Kansas City segment, the DRGW usage of this seg-
ment is estimated at 37 percent.
UP argues that the tenant share for purposes of cal-
culating the interest rental portion of compensation should
be considered to be 50 percent. UP considers the interest
rental component of trackage rights compensation to be
similar to a rental payment for the unlimited right to use
6
3la
of the landlord’s property; the rent itself is not variable
with usage. UP argues that DRGW will acquire a right
of usage which is comparable to MP’s right in the property
and that fairness requires a 50 percent share of the in-
terest rental value be borne by the tenant. We disagree.
The trackage rights imposed in favor of DRGW were
imposed to redress a specific competitive problem which
we identified in the consolidation proposal. It is not a
forced sale, or a lease, of an individual one-half interest
in the line as suggested by UP. Rather, the rights we have
imposed are analogous to a license in the law of property,
and compensation (rental) for licenses is often described
in terms of usage. We will require rental from DRGW to
be computed on the basis of its expected usage in each
segment of the line. For DRGW, this will result in a higher
rental for the Pueblo-Osawatomie segment and a lower
rental for the Osawatomie-Kansas City segment.
g. DRGW interest rental. Applying the estimated seg-
ment usage factors to the total return by segment cal-
culated above yields $1,551,716 for the Pueblo-Osawatomie
segment and $496,848 for the Osawatomie-Kansas City
segment. The total interest rental portion of compensation
for the Pueblo-Kansas City line for the estimated DRGW
usage is $2,048,564.
2. Portion of Maintenance and Operation Expenses.
No real dispute remains as to the treatment of M&O
expenses. Both DRGW and UP agree that the most ap-
propriate means of sharing M&O expense is to allocate a
portion of the actual expense incurred by MP to DRGW
on a percentage use basis. This comports with standard
practice in the industry for joint facility compensation.
UP initially interpreted part of DRGW’s M&O pro, osal
to be a fixed annual contribution to the interest rental
portion of the compensation. We have discussed interest
rental fully and we will not impose any element of M&O
Se
32a
expense as a set annual payment. DRGW’s obligation for
M&O expenses will vary with use. This ensures that DRGW
will not be obligated for greater than its proportionate
share of expenses if its traffic volume does not reach ex-
pected levels. It also ensures that UP does not cross-sub-
sidized DRGW traffic if DRGW usage exceeds expectations.
Put another way, UP presently has the total obligation
for the line of railroad from Pueblo to Kansas City. We
will require DRGW to relieve UP of its obligation to main-
tain that line only to the extent of DRGW’s usage of that
line. This limit ensures that DRGW’s traffic will be subject
to the same cost structure on the Pueblo line as MP’s
traffic.
For the same reasons, we will also allocate State and
local taxes'® on the line to DRGW on a percentage use
basis. UP argues that because it is required to hold the
line open for DRGW use, the latter should be considered
a half-owner for purposes of property taxes associated with
the line. We disagree. UP remains the sole owner of these
properties and liable for all expenses attributable to them.
Our imposition of trackage rights, in this setting, does not
constitute a forced sale of a share in these lines. UP re-
mains obligated as their owner, and our calculation of in-
terest rental reimburses it for the use of its property. All
expenses are allocated strictly on a usage basis.
3. Variable Costs of Operation.
No dispute exists as to these costs. DRGW will reim-
burse UP for all variable costs, including standard addi-
tives, of train operations, switching, and mechanicai
services incurred by MP as a result of DRGW operations.
We approve this portion of the formula.
‘8 Taxes encompass all property and ad valorem taxes, assessments,
fees and similar charges attributable to the lines.
33a
4. Conclusion.
DRGW will be required to compensate UP for the use
of its Pueblo-Kansas City line to the extent of (1) all var-
iable costs, including standard additives, of train opera-
tions, switching, and mechanical services incurred by MP
as a result of DRGW operations; (2) a share of MP’s main-
tenance and operation expenses, including taxes, attrib-
utable to DRGW’s percentage use of the line; and (3)
interest rental, as calculated above.
We note that DRGW’s proposal contemplates a fixed
annual rental payment calculated with the projected usage
shares. This approach varies from the MKT agreement,
discussed later, which contemplates updating the interest
rental payment to reflect actual usage share on a monthly
basis. We have set all the other terms of the rental pay-
ment which fix UP’s right to receive a certain rate of
return on a certain value. It is fairer to all parties not to
fix the interest rental based on projections but to allow
it to vary, along with the other compensation terms, with
the tenant’s actual usage. This approach also comports
with our characterization of the transaction as a license
in DRGW rather than a lease of an individual interest in
the property. For this reason, the figures giver. for
DRGW’s interest rental are examples of the payment at
a given usage. The actual payment will vary with DRGW’s
actual usage.
II. Between Kansas City and St. Louis
A. General.—As part of the decision approving the UP-
MP consolidation, trackage rights were imposed in favor
of SSW over approximately 4380 miles of MP track between
Kansas City and St. Louis. The route includes 124 miles
of centralized traffic control (CTC) territory between St.
Louis and Jefferson City, MO, and two separate lines from
Jefferson City to Kansas City. The River Subdivision line
is a 157-mile single track line controlled by automatic block
signals. There are 11 principal sidings on this line, the
34a
shortest of which is 5,810 feet. The continued Sedalia Sub-
division line from Jefferson CIty to Kansas City is a 149-
mile single track line. Automatic block signals control 116
miles of this line and CTC controls 34 miles. The sidings
on the Sedalia Subdivision are generally shorter than those
on the River Subdivision, and it has a 1.4 percent con-
trolling grade. The River Subdivision does not have sub-
stantial grades.
These trackage rights, in conjunction with DRGW’s
trackage rights between Pueblo and Kansas City, were
designed to preserve efficient competitive alternatives for
transcontinental traffic moving through the central corri-
dor. Additionally, these rights improve the position of SP’s
southern corridor transcontinental route as a competitive
alternative to the consolidated UP. UP-MP, 366 I.C.C. at
pp. 586-87,
No agreement has been reached between UP and SP
as to the terms and conditions to govern the trackage
rights. The parties established certain interim terms al-
lowing trackage rights operations to begin January 6, 1983,
but those terms are subject to retroactive adjustment based
on this decision. The effect of interim operations remains
in dispute because SP has objected to the assignment of
interest to the difference between the amount finally de-
cided to be appropriate and the amounts it has paid as
interim compensation. UP has proposed assessing interest
at 15 percent annually on the difference beginning January
6, 1983. The interim agreement merely provides that the
compensation terms which we shaii determine ‘‘shal]l be
retroactive to the date hereof.”’
SP chose not to enter a specific interim operating agree-
ment and submit that agreement for our approval. Instead
it will rely on a single determination of the appropriate
level of compensation in this proceeding and give our de-
termination retroactive effect. Under the terms of such an
agreement, we will treat the payments ultimately deter-
35a
mined to be due as if they were due periodically through-
out SP/SSW’s interim operation. The make UP/MP whole
in this circumstance, interest will be allowed from the due
date of each payment at a rate equal to the railroad in-
dustry’s then current cost of debt.
B. Threshold issuwes.—Two threshold issues must be re-
solved before we address the compensation to be paid for
SSW’s trackage rights operations. First, a question has
arisen regarding the exact scope of the rights within the
St. Louis terminal. Second, a dispute exists over the extent
to which, or whether, our decision granting SSW trackage
rights contemplated any interchange rights on the MP
lines.
1. Scope of Trackage Rights.
The dispute over scope concerns whether the trackage
rights within the St. Louis terminal extend to MP milepost
(.0 near the Gratiot Tower, as contended by SSW, or only
to MP milepost 2.3 near Grand Avenue, as contended by
UP. If the rights end at Grand Avenue, SSW’s operations
through St. Louis would necessary have to be conducted
through the Grand Avenue interlocking plant and over
tracks of the Burlington Northern Railroad Company (BN)
and the Terminal Railroad Association of St. Louis (TRRA).
SSW estimates that this operation would add at least $2
million per year to its cost of operating the trackage rights.
If the rights extend to Gratiot Tower, SSW will have the
right to operate trains through both MP’s 12th Street and
23d Street yards.
UP argues that SSW did not request service to Gratiot
Tower and that, accordingly, we should not approve such
service as part of the trackage mghts. However, UP ac
knowledges our authority to require SSW operations over
this terminal trackage under 49 U.S.C. 11103. Should these
rights be prescribed under 49 U.S.C. 11103, UP advocates
the use of condemnation principles to set compensation for
their use in addition to the compensation which we will
ee
36a
set for the trackage rights granted in response to the
consolidation. Since the consolidation UP has undertaken
improvements at the MP yards, chiefly the addition of a
second running track around the yards, intended to im-
prove the handling of interchange traffic. According to UP,
these improvements would also enable SP/SSW to move
trains through the yards without unduly congesting op-
erations in the immediate future.
SSW acknowledges that it did not specifically include
the 2.3 miles of MP line in its trackage rights operating
plan,'® and that its application did not contain specifié mi-
lepost designations. However, SSW argues that it re-
quested the right to operate over MP’s Sedalia Subdivision
which includes the disputed 2.3 miles of track. SSW al-
legedly sought to use, to the extent possible, the same
lines between Kansas City and its connections in East St.
Louis that MP uses.
BN filed a reply to UP’s petition for clarification in this
matter, arguing that UP’s objection to SP operation over
MP lines to Gratiot Tower is predicated on hypertechnical
arguments. BN opposes the shift of SP/SSW operations
from the MP lines to BN lines. BN objects to what it sees
as an attempt to burden BN with the costs and obligations
of conditions which should rightfully be borne by the con-
solidation applicants.
Trackage rights were granted SSW to enable it to pro-
vide service competitive to the consolidated UP/MP in the
transcontinental central corridor. In approving the SP/SSW
request the Commission anticipated that the trackage
‘* SSW argues that it did not specifically include this trackage because
at the time of its application the proposed improvements were unknown
to it. SP/SSW had requested, in discovery, a list of all improvements
proposed for the UP/MP system. SP Interrogatory 59, dated October
2, 1980. These improvements allegedly were not included in the UP/
MP response. SP/SSW did not include the then single-track line through
two yards.
emmaansea acai
37a
rights would be operated in the most efficient manner
possible. One of the most efficient routes through St. Louis
is over the MP line to milepost 0.0 at Gratiot Tower. This
trackage is included in the MP Sedalia Subdivision over
which SP/SSW specifically sought to operate. Had the
Commission been presented with the need for SSW to
operate over trackage other than MP’s, such as BN’s track
near the Grand Avenue interlocking plant, it would have
been specifically addressed in the same manner that SSW
operations over a portion of ATSF trackage near Kansas
City were approved. UP-MP at pp. 586-88. We will there-
fore treat the SSW trackage rights as commencing at MP
milepost 0.0 near Gratiot Tower and include the disputed
2.3 miles of track in the calculation of compensation ad-
dressed by this proceeding.
Finally, BN has requested that SSW be required to com-
pensate BN for the use of the Grand Avenue interlocking
plant even if SSW operates over MP lines to Gratiot
Tower. The Grand Avenue interlocking plant was con-
structed pursuant to an 1895 agreement between MP and
BN’s predecessor. The purpose of the plant is to allow BN
to cross MP tracks in St. Louis. The 1895 agreement
contemplates MP maintaining and operating the plant for
the benefit of BN and BN reimbursing MP for all costs
of maintenance and operation. BN alleges that SSW op-
eration over the plant is of substantial value to SSW and
that BN’s right to reimbursement should be recognized.
We disagree.
SSW will operate straight through the facility on MP
tracks and will not be benefited by the interlocker. The
interlocker benefits only BN by enabling it to cross MP
lines. SSW will operate solely on MP trackage, will stand
in the shoes of MP regarding the interlocker, and should
not incur an obligation to support a facility operated for
the benefit of BN.
38a
2. Interchange Rights.
The second threshold issue regarding the SSW trackage
rights is whether the grant to SSW included the right to
interchange traffic along MP’s line. UP argues that SP/
SSW sought only bridge rights over MP’s lines and listed
only Sedalia, MO as a possible interchange in its Sub-No.
16 application.!’? Thereafter an SP witness allegedly aban- |
doned the interchange request.'* We disagree.
SSW defined bridge trackage rights in its initial appli-
cation as contemplating ‘“‘only the night to bridge traffic
across [MP] tracks, plus the right to interchange at in-
termediate points with other carriers.”"® SSW’s witness
did riot abandon this request in admitting that no signif-
icant interchange was identified in the SP traffic study.
SSW has identified six points in Missouri at which it
wishes to interchange traffic: Sedalia (MKT), Pacific (BN),
Valley Park (BN), Marshall (ICG), Pleasant Hill (SSW), and
Labadie (SSW). The application, approved in the consoli-
dation decision, clearly encompassed interchange at the
first four of these points. However, the dispute revolves |
around Labadie and Pleasant Hill. UP argues that neither
of these points can be interchanges, for an interchange is
defined as the transfer of cars from the account of one
carrier to the account of another.-See United States v.
Terminal Railroad Association of St. Louis, 397 F. 2d 467,
471 (7th Cir. 1968) and Southern Railway Co. v. Louisville
and Nashville Railroad Co., 185 F. Supp. 645, 651 (W.D.
KY 1960), affirmed 289 F. 2d 934 (6th Cir. 1961). This
definition does not bar approval of operations at Labadie
‘7 Finance Docket No. 30,000 (Sub-No. 16), Application, Volume 1, p.
19 (January 13, 1981).
18 Witness Owen Tr. 14066-14068.
'* Finance Docket No. 30,000 (Sub-No. 16), Application, Volume 1, p.
4 (January 13, 1981). This language introduced the bridge rights sought
in both the Sub-No. 15 and Sub-No. 16 applications.
)
39a
and Pleasant Hill as “interchanges” simply because the
operation after the consolidation would be between SSW
over trackage rights and the same carrier on its own track.
We would consider the point as an interchange point for
purposes of the trackage rights if MP-SSW interchanges
could have occurred at that point prior to the consolida-
tion. Pleasant Hill appears to qualify as an interchange
point. Labadie does not. The MP and SSW tracks do not
meet at Labadie because they cross at different grades,
and MP has never conducted interchange operations at
Labadie.
_ SSW argues that it should be able to serve a utility plant
at Labadie from the MP line over the-utility’s tracks. SSW’s
line from St. Louis connects with the utility’s trackage and
SSW is currently able to serve the plant from the east. It
anticipates moving DRGW originated coal traffic to the util-
ity from the west using the trackage rights we have ap-
proved. “The Commission and rail carriers in general have
recognized a distinction between trackage rights for bridge
purposes and trackage rights for local service on lease track-
age.’ Atchison, T. & S. F. Ry. Co.—Operating Agreement,
331 1.C.C. 367, 371 (1967). Bridge rights may include in-
terchange but are “granted upon the condition that the
applicant shall not move over the joint line any traffic orig-
inating at or destined to any point thereon.” Panhandle &
S. F. Ry. Co.—Construction, 166 I.C.C. 681, 682 (1930). The
operation contemplated by SSW at Labadie is local service
to the utility and is outside the scope of its bridge trackage
rights.
SP also argues that we may authorize its service to the
plant at Labadie under 49 U.S.C. 10902. Without deciding
the scope of our authority under that section we will not
entertain such a request as part of this proceeding to set
compensation for the use of the trackage rights granted
as a condition to the UP/MP consolidation. Service to the
Labadie plant was never in issue in that proceeding. We
have decided the issue of the scope of SSW’s trackage
rights, and we will not adjudicate other issues here.
40a
C. Compensation
i. a
In approaching the issue of compensation for SSW’s
trackage rights, UP first examines the value of the specific
lines to the UP system and of the trackage rights to the
SP system. Kansas City and St. Louis are both key Mid-
western gateways, and MP’s lines between them are of
great strategic importance. UP states that the Kansas City-
St. Louis lines were among the most valuable of the MP
assets acquired by UP in the consolidation, and that they
play a key role in realizing the benefits of the consoli-
dation.
Further, UP argues that these lines are of extraordinary
value to SP, both operationally and strategically. SP has
long sought direct access between Kansas City and St.
Louis in order to reduce by some 400 miles the length of
its present transcontinental route between the West Coast
and St. Louis (over Corsicana, TX).?° UP alleges the op-
erational savings accruing to SP as a result of SSW’s
trackage rights will exceed $60 million a year. UP alleges
further benefit in the form of nonrecurring savings of
$71.8 million from avoidance of track structure expenses
and other expenditures on the Corsicana route.
Notwithstanding the significant operational benefits, UP
argues that the greatest benefit of the trackage rights to
SP is strategic: the enhancement of SP’s position as a
transcontinental carrier. SP, with these trackage rights,
has a greater ability to attract traffic to its lines, either
for single-line SP movement between the St. Louis gate-
way and the West Coast or in conjunction with DRGW in
the central corridor.
* See St. Louis S.W. Ry.—Pur.—Rock Island (Tucumcari), 363 1.C.C.
223 (1980); and Norfolk Southern Corp.—Control—Norfolk & W. Ry.
Co., 366 1.C.C. 171 (1982).
4ia
UP advocates consideration of the great value of these
lines in determining appropriate compensation for their
use. UP’s compensation proposal is similar to its proposal -
regarding the DRGW rights. It has three basic parts. First,
SSW should assume all variable costs of its operation.
Second, it is argued that SP should pay a share of the
M&O expenses attributable to the trackage rights lines,
with that share being equal to SP’s proportion of total
car-miles on the lines. SP should also pay half of the taxes
attributable to the lines.
Third, it is claimed that SP should make annual interest
rental payments for use of the existing facilities on the
lines in an amount equal to $19 million, which represents
a 50-percent joint-user share of a total, fair annual return
on the subject lines of $38 million.2) UP believes that this
interest rental rate best reflects the value to the lines of
SP as a source of substantial, low-risk financial benefits,
as well as all other pertinent factors bearing on the value
of the lines and the rate of return that UP/MP should
receive on that value.
Additionally, for any future new improvements” in the
lines, UP proposes a separate annual interest rental be
* UP proposes that this figure be fixed, with no indexing for inflation
in subsequent years, and, correspondingly, no adjustments downward
when existing facilities are removed and improvements installed. Sim-
ilarly, in line with the usual practice in joint facility agreements, the
rental would not be reduced to reflect year-to-year depreciation of the
existing facilities, but SP would also not be charged with annual de-
preciation expense as an element of M&O.
* These are what were traditionally referred to as additions and
betterments. However, for purposes of interest rental calculation, the
full value of capital expenditures would be used and depreciation would
be disregarded. Consequently the term “improvements” was employed
to avoid the application of Alternative Methods of Accounting for Raul-
road Track Structures, 367 I.C.C. 157 (1983), in which the Commission
adopted depreciation accounting to replace the traditional “better-
ments” approach in accounting for railroad track structures.
42a
paid (until the new facility is itself replaced) in an amount
equal to one-half of the cost of the improvement times a
rate of return equal to the cost of capital for the im-
provement.
With respect to new improvements, UP’s proposed
trackage rights agreement would, among other things: (1)
allow SP to require the installation of any new facility
that would not have a material adverse effect on opera-
tions on the lines (subject to MP approval, which could
not be unreasonably withheld), (2) entitle MP to undertake
new improvements without first securing SP consent, and
(3) require, as already noted, that SP pay a 50-percent
share of interest rental on improvements (unless solely
used by MP).
UP’s proposal with regard to M&O expenses and taxes
is identical to its proposal concerning the DRGW trackage
rights. SP argues that all M&O expenses and taxes should
be allocated on an actual use basis rather than a fixed 50
percent for the tenant, and that UP has not shown that
another method is more equitable as required by the Con-
solidation decision at p. 589.
The area of greatest dispute, as with DRGW, is the
determination of the interest rental component of com-
pensation. UP computed the interest rental, defined as
compensation to the landlord for the partial loss of the
use of its assets, as the product of three terms: tenant
share, asset value and rate of return.
UP again argues that the tenant obtains an unlimited
right to use the landlord’s property and a 50-percent share
should be ascribed to SSW. SSW responds that its ex-
pected proportionate usage of the line is about 30 percent
and that it has bridge rights with a right of interchange
which are not equal to MP’s retained right of ownership
and service to all local points on the line. For these rea-
sons, SSW seeks an allocation of interest rental on the
basis of its percentage usage share.
43a
UP conducted a study of the Kansas City-St. Louis lines
and concluded that (1) the appraised value of the real
estate on the line is $16,523,220,23 (2) the value of existing
facilities is $368,826,711,%4 and (3) the total value of the
Kansas City-St. Louis line is $385,349,931.
SP argues that this valuation is grossly inflated.” It ar-
gues that the actual purchase price paid for MP by UP
provides the best evidence of value and indicates that the
actual value of the MP lines is substantially below book
value. SP offers its own valuation which will be addressed
below.
Again UP does not offer a specific rate of return which
should be applied. It suggests a number of benchmark
rates, as discussed previously with regard to DRGW’s
trackage rights. UP concludes that no single, scientific
principle can govern the selection of a rate of return, and
that we should be guided by the revenue adequacy objec-
tives of the Staggers Rail Act of 1980, the realities of
today’s capital market and the high value and low risk of
the trackage rights to SP.
UP ultimately concludes that an appropriate overall an-
nual return figure for these lines is $38 million. A 50-
percent allocation to SP/SSW results in a $19 million an-
nual interest rental. UP argues that $19 million is a con-
servative rental when compared to amounts generated by
* This figure does not include any assembladge premium. Including
such a premium would result in a real estate value of $35,876,206.
™ The value of improvements was calculated as RCNLD. The resulting
figure represents a total reproduction cost for existing facilities of
$452,589,124 less depreciation of $83,762,413. No discount for depre-
ciation of grading was included in these figures. UP argues that no
depreciation is normally charged to grading. See Teras Midland Rail-
road, 75 I.C.C. 1, 184 (1918), and that depreciation factors employed
in the DRGW and MKT proceedings are justified by the special cir-
cumstances of those proceedings.
** SP argues first that the value must be reduced by the 75 percent
grading depreciation factor, yielding a value under the UP formula of
$281 million...
44a
various possible rates of return, even when these rates
_ are applied to a valuation reflecting a depreciation of grad-
ing by 75 percent, as shown in the following table:
SP rentals assuming 50-50 allocation, $281 million property valuation,
and various return rates
Annual
Return rate rental
million
18.2 percent Current cost of capital
Se Ne I ic coco mamcenademnanicceanceunveaviaceiaiuniens $25.6
16.5 percent Current cost of capital
COTE erhs CUII TION osc ssevensconssscvecssecnecserersecenssnccononcces 23.2
15.3 percent MPRR pretax return on net investment
CR GPIT IIT sansscheslclausiseclaseaeetitcemannlebuh dicate cbscamacpadibecioceatdaiaacauteaisanissaeiatin 21.5
14.2 percent Cost of debt (1982-AAR testimony).................. 20.0
13.7 percent Cost of debt (1981-ICC determination)............. 19.3
‘The first two figures would be higher if the equity component of
the cost of capital were stated on a pretax basis.
* MP pretax rate of return was calculated using the statutory tax
rate, not MP’s effective tax rate.
SP cites the Consolidation at pp. 589-90 for the prop-
osition that rates of return in this proceeding based on
current cost of capital may not be reasonable. The highest
rate of return in any existing trackage rights agreement
between SP, UP, MP or WP is 8 percent. This rate ap-
pears in the October 1981 agreement governing SP’s use
of WP trackage between Lathrop and Niles Junction, CA.
SP states that it does not participate in any trackage
rights agreement with a rate of return greater than 8
percent. The effective rate of approximately 13.7 percent
employed by UP is alleged to be manifestly unreasonable
in light of the existing SP trackage rights return structure
and the Commission’s stated intent to preserve competition
and permit SP to compete on equal terms with UP.
UP also proposes to treat new improvements in the
following manner, First, MRPP may install new facilities
45a
in its discretion. Unless such new facilities are exclusively
for the use of MPRR, their cost would be placed in an
Improvements Valuation Base and SP would pay a sepa-
rate interest rental of them.” For each new facility, in-
terest rental is calculated as one-half of the actual cost of
the particular improvement, times the cost of capital at
the time the improvement is made. When such a new
facility is itself removed from service, interest rental pay-
ments on that facility cease, and interest rental is paid on
any replacement facility.?’
Second, SP may request a particular new facility, and
it will then be installed by MPRR so long as it would not
materially interfere with or hinder operations on the lines
and MP approves the installation (which approval may not
be unreasonably withheld). The cost of construction and
maintenance of the facilities would he borne by SP, and
no interest rental would be charged.
SP objects to the suggested Improvements Valuation
Base on several grounds. First, the concept of a separate
rental calculation at a differing interest rate for improve-
ments is unprecedented in any trackage rights agreément
to which SP is a party. In every SP trackage rights ar-
rangement that employs an interest rental calculation, new
improvements are added to the total valuation base at their
current cost, and rental is payable thereon pursuant to
** UP advocates the inclusion of its improvements in the St. Louis
yards as the first entry in these accounts should we determine that
SSW may operate to milepost 0.0 near Gratiot Tower. We have dev-
ermined that SP’s trackage rights extend to Gratiot Tower. The im-
provements to the running track wili benefit SP’s operation and they
should be included in the improvements valuation base as calculated,
infra.
“ Depreciation would be disregarded both in the Improvements Val-
uation Base and in the calculation of M&O expenses. Here, as with
the calculation of interest rental for existing facilities. SP would neither
be charged with annual depreciation as an operating expense nor cred-
ited with annual depreciation in the calculation of interest rental.
46a
the same formula as for the existing facilities. Second, the
creation of a separate improvements rental base would be
virtually unworkable from an accounting standpoint. In the
ensuing years, as new improvements are gradually made
to the lines, the parties will be required to make separate
rental calculations on each individual new improvement,
creating the prospect of numerous separate rental caicu-
lations. SP argues that any reimbursement for improve-
ments should be based on the percentage usage share and
that, at least, it should retain the option to reimburse UP
in advance for its share of the cost of new improvements
rather than automatically including the cost in a separate
valuation base.
SP also objects to UP/MP’s proposed trackage rights
terms that would not require SP’s consent in the event
of significant or major improvements (defined as those in
excess of $100,000). Such consents are commonly required
in major trackage rights resolved through the arbitration
mechanism provided in the proposed agreement.
2. SP/SSW.
SP/SSW proposes to reimburse UP for (1) the variable
costs of operation; (2) its percentage usage share of taxes,
assessments and M&O expenses; and (3) rental based upon
SSW’s percentage usage share, on a car-mileage basis, of
4 percent per year of the ledger value of the line plus
subsequent additoins and betterments.
SP/SSW’s offer is based on existing agreements beeween
SSW and MP covering SSW’s use of MP trackage between
Valley Junction, IL and North Junction, IL; and MP’s use
of SSW trackage between Illmo, MO and Paragould, AR
(collectively the Illmo agreements). The Illmo agreements
cover the lines south of East St. Louis, IL, for a distance
of approximately 230 miles. These lines form a significant
part of SP/SSW’s Corsicana route.
|
47a
Using a ledger value of $68.2 million for the Kansas
City-St. Louis lines and an SP/SSW usage share of 30
percent, the interest rental portion of SP/SSW’s compen-
sation formula would amount to $820,000 annually.
SP/SSW argues that a substantial portion of the traffic
moving over the trackage rights will be traffic shifted from
its Corsicana route, and that, therefore, it is appropriate
to employ the terms of the Illmo agreements in setting
terms for the new trackage rights.
UP argues that the terms of the Illmo agreements pro-
vide no basis for calculating the terms appropriate for the
instant trackage rights because those agreements are re-
ciprocal agreements. Originally negotiated in 1904 and re-
newed in 1954, they involve SSW use miles of MP track
and MP use of 110 miles of SSW track. The primary
consideration passing between the parties—the exchange
of reciprocal operating rights allowing each party to avoid
building additional tracks—is reflected in the interest rental
terms.
UP argues that the Illmo agreements actually support
its proposal to use an RCNLD methodology ad current
cost of capital. The terms of the agreements were derived
from the cost of constructing the Valley Junction-North
Junction line, completed November 1, 1903 for $35,000 a
mile, and the actual 4 percent ccupon rate on the bonds
used to raise capital for its construction. UP concludes
that the Illmo agreements provide no support for the terms
proposed by SP/SSW in this proceeding. -
UP also objects specifically to two items in the SP com-
pensation proposal. First, UP argues that the 4 percent
rate of return adopted 80 years ago in different circum-
stances is inappropriate.
Second, UP objects to the use of book value of its lines,
or book value weights in reducing the price paid for MPC
48a
to line-specific value,“ as the valuation used in this pro-
ceeding because book values of rail assets bear no fixed
relationship to their real economic values. First, because
of betterment accounting, book value weights significantly
overstate the relative share of MP’s total assets attrib-
utable to equipment. Second, because book value is a func-
tion of physical improvements in place and the dates of
their installation, it gives no weight to the relative stra-
tegic and economic importance of specific lines. UP notes
that these lines are responsible for over one-third of the
projected revenue gains reflected in the applicants’ rail
traffic diversion study and more than one-half of the new
revenue estimated in the nonrail traffic study.
Finally, the SP/SSW proposal would require SSW’s con-
currence prior to any major improvement of the line. SP/
SSW acknowledges that it would not refuse to concur in
necessary improvements to the line. UP responds that such
a veto power in SP/SSW is unnecessary in light of its
undeniable motive to avoid unnecessary expenditures.
3. Discussion.
The decision authorizing the consolidation statec that
‘“{vjaluation of the property should be the current fair
market value, rather than book value or replacement
value.” UP-MP at p. 589. Neither SP not UP has con-
vincingly shown that we should accept their valuation
methods based respectively on book value and replacement
* As support for its use of MP’s ledger value for the Kansas City-
St. Louis line, SP calculaetd interest rental compensation using five
different formulae all reaching valuations less than ledger value. Each
of these methodologies was, in one way or another, based on book
value. One of them purported to allocate the actual purchase price paid
for MPC on the basis of the relative book values of specific MP assets.
Using this method, SP concludes that the value of these lines is $54.6
million. The result of this calculation is argued to justify SP’s use of
ledger value notwithstanding the admonition that “[vjaluation *** should
be the current fair market value, rather than book value ***’’ UP-MP
at p. 589.
49a
value. We have already discussed the drawbacks of UP’s
RCNLD approach with regard to the DRGW trackage
rights. The RCNLD approach does not value the asset as
going-concern business, but solely as individual parcels of
land and specific existing structures. Thus it ignores a
characteristic vital to this proceeding: an asset’s income
producing potential.
The book value approach, either by direct use of ledger
values as proposed by SP/SSW or through use of book
value weighting of the purchase price, suffers from all of
the same infirmities as the RCNLD approach with one
addition: time. The ledger value simply reflects the cost
of a given asset like the RNCLD approach, but the cost
at a past time. Those historical costs arose at different
times, in different markets, and should not be relied upon
as an accurate indication of present value or as an accurate
method of apportioning present value.
We find the SP’s reliance on the Illmo agreements for
rate of return particularly misplaced. An 80-year-old rate
of return negotiated in a context of reciprocal trackage
rights is wholly inappropriate here. The relatoin of these
agreements to SP/SSW’s Corsicana route is irrelevant. The
cost structure of the SP-system outside of these particular
trackage rights is as irrelevant to our consideration here
as is the value of these rights to the SP. =
UP/MP has argued that we should consider the value
of the trackage rights to SP in determining the valuation
of the property. Such consideration are appropriate in de-
termining the reasonableness of trackage rights terms in
privately negotiated agreements. However, value to the
tenant should not be determinative in calculating rental
when trackage rights have been imposed by this agency
to ameliorate the anticompetitive effects of a consolidation.
We will not allow the consolidated UP/MP system to defeat
that competition by extracting rents for these lines that
reflect the value of SP/SSW operations. We have already
~
50a
specifically rejected this theory during the discovery phase
of this proceeding*® and we reaffirm that rejection here.
We have determined that the most appropriate method
of determining the value of the Pueblo line is the capi-
talized earnings approach applied by DRGW. We will apply
the same methodology to the valuation of the Kansas City-
St. Louis lines. All factors in the capitalized earnings cal-
culation described above will remain the same except the
usage share and the net revenues on the line. SP has
suggested that their usage share for the line will be 30
percent. However, no figure for the net revenues of these
lines are now before us. We will, therefore, require that
both SP and UP prepare and submit calculations developed
from the earnings multiple methodology and based on line-
specific net revenues. Information necessary for making
these calculations may not presently be available to SP.
We except UP to cooperate in its expeditious discovery.*
We are aware that using the earnings multiple approach
on these lines reflects the strategic value of the facilities
to UP through the higher net revenues attributable to
these lines as a result of consolidated operations." This
will result in a higher post-consolidation valuation. How-
ever, the increase in UP traffic will also result in a lower
SP usage share and these effects will, to some degree,
offset. Nonetheless, we remain concerned that SP be able
to operat with a cost structure competitive to that of the
* Finance Docket No. 30,000 (Sub-No. 16) St. Louis Southwestern
Railway Company—Trackage Rights Over Missoun Pacific Railway
COmpany—Kansas City to St. Louis (not printed), decision served April
25, 1983, at sheet 2.
* To the extent that proprietary information may be involved, ag-
gregate figures, averages or any other appropriate techniques may be
used to make these calculations.
* As noted above, the Kansas City-St. Louis lines are alleged to be
responsible for over one-third of the projected revenue gains reflected
in applicants’ rail traffic diversion study and over one-half of the new
revenue estimated in the nonrail traffic study.
5la
UP on these lines*® As a point of reference for our review
of these costs, we will also require each carrier to submit
calculations using the net revenue generated on these lines
during 1979, MP’s last year of operation before announce-
ment of the consolidation. This is the base period for the
consolidation proceeding and the information should be
readily available.
Actual net revenues should be developed where possible,
or fully allocated costs may be developed using Rail Form
A. For overhead traffic, revenues should be allocated to
the line on a mileage prorate basis.
The required calculations should be submitted as soon
as possible, but not later than 60 days after service of
this decision.
With regard to improvements on the lines, we will not
require UP to obtain SP consent prior to making improve-
ments. In light of UP’s incentive not to undertake un-
necessary improvements, we see little possibility of abuse.
However, we retain continuing jurisdiction in this matter.
and, should difficulties arise, SP may seek relief from the
Commission. Accounting for the interet rental on improve-
ments should be undertaken using a separate Improve-
ments Valuation Base. This account should be generated
using the actual cost of the new imprevement multiplied
by the actual UP cost of capital at the time the improve-
ment is made and by SP’s usage share. SP also must have
the option to reimburse UP in advance for its share of
the cost of new improvements rather than including the
cost in a separate valuation base.
Finally, the parties are directed to compute interest on
the difference between payments under the interim op-
“The premise of using the earnings multiple approach is that it
reflects what UP actually paid for particular assets of the MP system
based upon the earnings potential of those assets. Historic MP cost on
these lines is less relevant.
52a
erating agreement and compensation due as a result of
our action here in the manner described above.
III. Between Kansas City and Omaha/Council Bluffs
As a condition to the consolidation, the Commission also
granted trackage rights to MKT over Mp’s lines between
Kansas City and Omaha, NE; between Union and Lincoln,
NE; and over UP’s lines between Omaha and Council
Bluffs, [A and between Kansas City and Topeka, KS, with
use of related terminal facilities.
On November 9, 1982, MKT entered agreements with
both UP and MP, then separate corporations, setting the
terms of operation and the compensation for these track-
age rights. These agreements were modified by a supple-
mental agreement entered January 21, 1983. The
agreements as modified are submitted for our approval.
As noted in the Consolidation decision, at p,. 589, we will
approve any reasonable terms agreed to by the parties.
The agreement contemplates MKT assuming the variable
cost of its operations.* Additionally, MKT will pay a per-
centage, based upon its uage share on each portion of the
joint track, of M&O expenses plus standard additives and
of taxes and assessments. Finally, interest rental will be
determined by multiplying MKT’s usage share on each
portion of the joint facility by the following amounts:
Gillmore Jct.- Topeka-
Co. Bluffs Kansas City
First 6 months
(December 22, 1982 to July 1, 1988)..... $775,000 $930.000
Second 7 months
(July 1, 1983 to February 1, 1984)...... 2,305,000 3,014,000
Second year
* The agreement requires UP/MP to conduct studies of the actual
cost of switching services on the joint track and to bill MKT accord-
ingly.
a e
53a
(February 1, 1984 to
PE Be MR sthictavesercerccdetevecssccsens 4,610,000 6,028,000
Third and succeeding yearsS................. 6,500,000 8,500,000
Calculation of the interest rental for the third and suc-
ceeding years is based on the reproduction cost new less
depreciation of the track, track structure, grading,*
roadbed, signal and communications facilities, and other
appurtenant facilities on each portion of the joint track.
The RCNLD value is then multiplied by the 1981 pretax
rate of return of Pacific Rail Systems, Inc. (Pacific), the
holding company controlling the railroads, of 14.23 per-
cent.
Usage share is calculated as the ratio of tenants’ gross-
ton-miles to total gross-ton-miles of all users. All payments
are to be made monthly in advance.
UP has reserved the right to make improvements to the
trackage without the prior approval of MKT. The cost of
any improvements will be added to a separate Improve-
ments Valuation Base. Interest rental for each improve-
ment will be calculated using actual cost, Pacific’s pretax
cost of capital at the time the improvement is completed,
and MKT’s usage share based on the gross-ton-miles ratio.
The terms agreed to by UP/MP and MKT are reasonable
and will be approved.
Findings
The calculation of compensation and the terms of track-
age rights agreed to by UP/MP and MKT are reasonable
and will be approved.
Compensation for the DRGW and SP/SSW trackage
rights should be determined in three parts: (1) the variable
“ Grading was depreciated 75 percent to reflect a variety of nego-
tiating factors.
)
54a
cost of operation including standard additives, (2) a pro-
portionate share of maintenance and operations expenses
and of taxes and assessments based on the tenant’s usage
of the facility, and (3) an interest rental calculated using
an earnings multiple approach as set forth in the decision.
Neither DRGW nor SP/SSW shall have,the right of prior
approval of improvements on the lines of UP or MP. Com-
pensation for improvements will be determined using a
separate improvements valuation base account. Compen-
sation for improvements should be based on the actual
cost of the improvement times the landlord’s then-current
cost of capital times the tenant’s usage share for each
improvement. However, each tenant will have the option
to reimburse the landlord for a portion of the construction
expense based upon its usage share of the facility at the
time of construction rather than increasing the improve-
ments valuation base.
SP/SSW’s application contemplated trackage rights ex-
tending to MP milepost 0.0 in St. Louis, and compensation
for the St. Louis terminal trackage will be included in the
overall compensation formula. SP/SSW was granted the
right to interchange traffic with other carriers at points
on the MP line. However, Labadie, MO, is not an inter-
change point and SP/SSW does not have the right to serve
local industry at Labadie from the MP line even though
it may serve those industries from its own line.
This decision will not significantly affect either the qual-
ity of the human environment or energy conservation.
It is ordered.
1. In Finance Docket No. 30,000 (Sub-No. 25), the
agreements dated November 9, 1982 as supplemented Jan-
uary 21, 1983 between Missouri-Kansas-Texas Railroad
Company and Union Pacific Railroad Company and Mis-
souri Pacific Railroad Company are approved.
55a
2. In Finance Docket No. 30,000 (Sub-No. 18), trackage
rights compensation will be determined in three parts: (a)
variable cost of operations, (b) a percentage share of main-
tenance and operations expenses and of taxes and assess-
ments based on tenant’s actual usage, and (c) an interest
rental determined by the capitalized earning® approach set
forth in the decision. ’
3. The trackage rights granted in F.D. No. 30,000 (Sub-
No. 16) include operations to Missouri Pacific Railroad
Company milepost 0.0 in St. Louis and the right to in-
terchange traffic at points on the line.
4. In F.D. No. 30,000 (Sub-No. 16), compensation will
be calculated in the same manner as described for the
rights in F.D. No. 30,000 (Sub-No. 18). The record will be
kept open for 60 days from the date of service of this
* decision for the parties to file appropriate information for
the calculation of the interest rental component as de-
scribed in the decision.
5. The difference between the compensation amounts
finally determined in F.D. No. 30,000 (Sub-No. 16) and
those actually paid for interim operations will bear interest
at a rate equal to the railroad industry’s then-current cost
of debt.
6. This decision is effective on August 30, 1984.
By the Commission, Chairman Taylor, Vice Chairman
Andre, Commissioners Sterrett and Gradison. Chairman
Taylor was absent and did not participate.
APPENDIX A
DRGW Interest Rental Calculation
After the consolidation has been in place for 3 years, re-
routing of traffic will substantially reduce UP/MP’s volume
on the Pueblo-Kansas City line. DRGW assumed all that
will remain will be traffie originating or terminating on
the line and a minimal amount of traffic interchanged be-
|
56a
tween MP and DRGW at Pueblo, which neither carrier
could divert from the other. This will reduce the gross
tonnage between Pueblo and Osawatomie, KS, from 15.4
million gross tons per mile in 1979 to approximately 3.4
million gross tons. A breakdown of this traffic is as fol-
lows:
\
Traffic segment Cars Net tons Gross tons
DRGW-MP coal trains................... 5,138 498,728 827,786
DRGW-MP noncoal....................0... 7,515 379,838 861,217
Originating/terminating traffic....... 11,497 952,523 1,688,773
eecsccitdcmacantacitheheniuassavamacantaees 24,150 1,831,089 3,377,776
The DRGW projections were based on an analysis of
1979 traffic interchanged with MP by DRGW and Mp
traffic originating and terminating on the line, including
revenue and cost information, from data provided to
DRGW by MP. This volume will require only one train in
each direction per day, as opposed to three trains in each
direction per day before consolidation.
Costs associated with the traffic were develcped using
1979 MP Rail Form A unit costs. Since Rail Form A costs
were used, all calculations are based on betterment ac-
counting for track structure. These costs were determined
by costing the average characteristics per car for the three
traffic segments as they would have been handled in 1979
at the reduced volume.
Certain modifications to Rail Form A were made to
measure the costs more accurately. These modifications
were designed to reflect those costs appropriate for inclu-
sion in a pro forma income statement. The costs do not
include the cost of capital components—return on road
property and return on equipment.
<<
57a
Car costs were based on the average car-hire rate paid
by DRGW on foreign railroad owned cars.! These rates
were developed for each of the Ex Parte No. 334 car type
classifications. Empty return ratios were assumed to be
100 percent. A tare weight of 32 tons per car was used.
Interchange switching costs and inter- and intra-train
switching costs were computed on an estimated occurence
basis.
Loss and damage expenses were computed on a net ton-
mile basis. Costs were developed by 5 digit STCC number
from actual 1979 DRGW claim payments.
Individual per car costing was initially done at the var-
iable cost level. However, to estimate more accurately the
costs associated with the traffic. MP fully allocated costs
were also calculated using the ton/ton-mile method of es-
timating constant costs. Per car costs were multipled by
the number of cars in each segment to develop total fully
allocated costs. Since the MP Form A unit costs excluded
depreciation, the fully allocated costs were adjusted ac-
cordingly. The methodology is similar to that employed in
Finance Docket No. 30,000.
The following table sets form the development of the
costs relied upon by DRGW and the Rail Form A core
locations:
I. Development of car ownership costs per day or mile
A. Railroad-Owned Cars
1. Mileage Rate x (1 + B2268) x B1175
2. Time Rate x (1 + B2268) x 24 x B1197
3. Ownership/Day = [(line 1 x B1181) + (line 2 x
B1206)] (divided by) B290
4. Ownership/Mile = [(line 1 x B1180) + (line 2 x
B1205)] (divided by) B74
‘ DRGW suggests this standard is appropriate to reflect MP car cost,
since the car—hire rates are uniform.
58a
B. Rail Form A Core Locations
Core
Value Source Description
i REPRO Sch. B. Col. 40, line 8.... Rev. car miles, excl.
pvt. cars
NO cesinseitaens Sch. A, Sheet 4.11, 9/ Car days switching,
BND Sh ciscccevementenicanmtumencones leading, unloading
55) Sch. B. Col. 34, line 8.... Rev. car miles excel.
pvt. cars
3) | Sch. A. Sheet 4.10 8/ Percent car mile run-
TONE DP icscsnrnncnneiahinnebapinhtiininiae ning
B1181.......... Sch. A. Sheet 4.10 8/ Percent car mile
SE TNO ssnhacnenvicaibicmnatenente switching
1) er Sch. B. Col. 35, line 8.... Total car days
RGD svricesnsc Sch. A. Shett 4.11 9/ Percent car day run-
BG DW viniccinbuiatacisiacincanemsiiin ning
BROS wnsscseess Sch. A. Sheet 4.11 9/ line Percent car day switch-
DP i sssctisicnitinlcsishinbdaeaablanneaaaent ing
EEE wccsaccoes Summ. 1. Col. 24, line 4, General overhead
II. Development of variable cost of movement
A. Carload Costs:
Miles x GTM x lading
Milex x empty return x GTM x tare
Miles x empty return x B3186
Miles x empty return x ownership/mile
(number of O&D) x [(4 x ownership/day + B3265
+ B3273 + B3187 + (lading x B3276) + (2 x
B3290)]
6. Empty return x .5 x number of I/I and (X) switches
x ownership/day
7. Empty return x [(B3715 x number of (X) switches)
+ B3716 x number I/I switches)]
8. Lading x miles x loss and damage cost per net ton
mile
rr rrr
59a
NOTE: (1) I/I = Intertrain and Intratrain; (X) = In-
terchange; empty return = (1.0 + empty return ratio)
(2) GTM = sume of B3261, B3262, B3263, and B3173
adjusted for number of locomotive units and training
weights of trains handling each traffic segment. Way train
(B3325) assumed on 20 percent of haul on traffic origi-
nating or terminating.
B. Rail Form A Sources
Core
Value Source Description
ys See Sch. B. Col. 9, line 12...... Train Mile—Crew
BOLGG cocssesse Sch. B, Col. 24, line 12.... TS&E—Running
EE Sch. B, Col. 25, line 12.... TS&E—O&D
| Sch. B, Col. 7, line 12...... Gross ton mile
oo. : ae Sch. B, Col. 8, line 12...... Locomotive unit mile
B3268 .......... Sch. B, Col. 10, line 12.... Train mile other
ae Sch. B, Col. 14, line 12.... Station Clerical—CL
BS278 .....0000- Sch. B, Col. 22, line 12.... Spec. Sves.—CL
>, Sch. B, Col. 28, line 12..... Claims Clerical—CL
ee Sch. B, Col. 51, line 12.... Switching—O&D—CL
ROBES cccsesonss Sch. B, Col. 7, line 19, GTM Cost—way train
«eS ERRORS R eRe
B3715 ......... Summ. 1, Col. 3, line 3, Switching—
OOF pithuibaiesnaspdedanuhenensanamanencids Interchange
Be i cccbiacins Summ. 1, Col. 4, line 3, Switching—I/I
PRETEEN RRM ENeonD Ro TT
III. Development of fully allocated costs
A. Constant cost related to distance (per ton mile)
(B3393) and unrelated to distance (per ton) (B3395) cal-
culated on a per car basis for each traffic segment.
B. Constant costs per par added to variable cost per
car to develop fully allocated cost per car. Fully allocated
cost per car multiplied by total cars in each segment to
arrive at total fully allocated cost.
60a
IV. Adjustment of fully allocated costs to include de-
preciation
A. MP 1979 depreciation from R-1 = $62,144,000.
B. Total operating expense, excluding depreciation from
MP 1979 Form A (B2364) = $1,162,519,000.
C. Ratio to increase fully allocated cost to include de-
preciation = 1.053 [(A divided B) + 1)).
D. Multiply ratio in C by fully allocated cost to develop
total operating expenses associted with traffic.
By deducting the fully allocated costs from the revenues
on each of the three traffic segments described above,
DRGW developed the estimated net revenues attributed
to the reduced traffic between Pueblo and Kansas City.
The net revenues were pro-rated between the Pueblo-Os-
awatomie and Osawatomie-Kansas City segments on a
mileage basis.
Net revenues on north-south traffic moving only be-
tween Osawatomie and Kansas City and not affected by
the volume reductions were added to that line segment to
develop total net revenues for each of the two line seg-
ments.
DRGW then developed the fair market value of each
line segment as follows:
Pueblo- Osawatomie- Total
Osawatomie Kansas City
1. Operating revenue........ $15,824,894 $1,565,100 $17,389,994
2. Operating expenses....... 12,351,857 1,221,612 13,573,470
3. Net revenues................ $3,473,037 $ 343,487 $ 3,816,524
4. Additional traffic (1).... _ $2,060,922 _
5. Total net revenues....... $ 3,473,037 $2,404,409 $ 5,877,446
6. Fair market value (2).. $13,197,540 $9,136,754 $22,334,294
(1) In 1979 north-south traffic moving only between Osawatomie and
Kansas City amounted to 10.8 million net tons, based on MP density
6la
chart. This is 6 times projected 1.8 million net tons moving between
Pueblo and Kansas City. Line 3 ($343,487) x 6 = $2,060,922, estimated
net revenues on north-south traffic.
(2) Line 5 values x 3.8 which represents earnings multiple
($998,910,000 market value divided by $262,966,000 MPC 1979 pretax
operating profit).
DRGW developed its rate of return using MPRR’s 1979
after-tax return of 9.33 percent on its net investment in
railroad property. ICC Bureau of Accts. Class I Line-Haul
Railroads’ Selected Earnings Data for 12-Months ending
December 31, 1980 and 1979. This is an after-tax rate of
return which, when converted to a pretax rate of return
by dividing 9.33 percent by .82 (1 — 0.18, MP’s effective
1979 tax rate) yields a pretax rate of return of 11.38
percent.
The following table sets forth DRGW’s ultimate calcu-
lation of the interest rental portions of compensation ap-
propriate for the Pueblo-Kansas City line:
Pueblo- Osawatomie-
Osawatomie (Kansas City
1. Fair market value based on $13,197,540 $9,136,754
earnings multiple.......
i I Sc aricnisnseestonaessens .1138 .1138
3. Interest rental for 100 per- 1,501,880 1,039,763
cent use (L.1 x L.2)
4. Rio Grande’s portion of total 0.8 0.37
Si scsianniisennsvidesenieicics
5. Rental per segment (L.3 x 1,201,504 384,712
ei icchidibhiakecnenissininsdeasnns
The proposed combined rental of the two segments is $1,586,216.
62a
APPENDIX B
I.C.C. earnings multiple calculation of initial interest rental
for MP line between Pueblo, CO, and Kansas City, MO
I. DEVELOPMENT OF EARNINGS MULTIPLE
MPC Value
1982 MPC stock price......... $998 ,910,000
1982 MPC liabilities ............ $1,361,814,000
Total 1982 MPC value..... $2,360,724,000
1983 MRTC stock price...... 256,300,000
1982 MRTC liabilities.......... 185,443,000
Total 1982 MRTC value... — 441,743,000
Total 1982 value .............. $1,918,981,000
MPC Earnings
1979 MPC operating $262,966,000
ER ee
1979 MPC nonoperating 36,541,000
Se eiennstanennmnahtnskennies
Total 1979 income before $299,507,000
interest and taxes.........
Times GNP Deflator ........... x 1.26805
MPC earnings expressed in 379,790,000
TS MI piece eanceasaracnsas
1982 MRTC earnings.......... -29,100,000
Total earnings expressed 350,690,000
in 1982 dollars ..............
OE BI SUID selncsccviacadcencsnsteesatanateentensnnn $1,918,981,000
Total earnings expressed in 1982 dollars .......... + 351,197,000
63a
Il. RATE OF RETURN
CU BOL using MP 1979: Rel ....ccccccsecessccescoseeeses 8.37 percent
1-0.18 (MP’s 1979 effective tax rate) ............... + 0.82
10.21 percent
III. INTEREST RENTAL
Pueblo to Osawatomie
Osawatomieto Kansas City
BT CE i vicntrindacectcccsnvicesecsenas $3,473,087 $2,404,409
Earnings multiple ...........c00cccc000ee X 5.47 x 5.47
Valuation of investment base...... 18,997,512 13,152,117
i et oe 0.1021 0.1021
TE aici cetincstasancudindatenis 1,939,646 1,342,831
DRGW usage share..................00. 0.80 0.37
Interest rental (segment)............. 1,551,716 496,848
Total interest rental.................... $2,048,564
64a
INTERSTATE COMMERCE COMMISSION REPORTS
Finance Docket No. 30,000 (Sub-No.16)'
ST. LOUIS SOUTHWESTERN RAILWAY COMPANY—
TRACKAGE RIGHTS OVER MISSOURI PACIFIC
RAILROAD COMPANY—KANSAS CITY TO ST. LOUIS
TRACKAGE RIGHTS COMPENSATION
Decided December 18, 1987
The Commission is modifying the formula for setting trackage
rights compensation for trackage rights in the merger de-
cision Union Pacific—Control—Missouri Pacific, Western
Pacific, 366 1.C.C. 459 (1982).
BACKGROUND
BY THE COMMISSION:
General. By decision in Finance Docket No. 30,000, the
Commission approved the consolidation of the Union Pa-
cific Railroad Company (UP), Missouri Pacific Railroad
Corporation, Missouri Pacific Railroad Company (MP), and
the Western Pacific Railroad Company (WP) under the
common control of Union Pacific Corporation and Pacific
Rail System, Inc. Union Pacific—Control—Missouri Pa-
‘This decision also embraces Finance Docket No. 30,000 (Sub-No.
18), Denver and Rio Grande Western Railroad Company—Trackage
Rights—Missourn Pacific Railroad Company—Between Pueblo, CO and
Kansas City, MO. The previous decision in these proceedings, St. Louis
Southwestern Ry. Co.—Trackage Rights Compensation, 1. 1.C.C.2d 776
(1984), also included Finance Docket No. 30,000 (Sub-No. 25) Missouri-
Kansas-Texas Railroad Company—Trackage Rights—Missouri Pacific
Railroad Company—Between Kansas City, KS and Omaha, NE. In that
decision, we approved the trackage rights a in Finance Docket
No. 30,000 (Sub-No. 25.)
ee
65a
cific; Western Pacific (UP—Cont.—MP; WP), 366 I.C.C.
459 (1982) (consolidation or merger decision) aff'd in part
sub nom. Southern Pacific Transp. Co. v. I.C.C., 736 F.2d
708 (D.C. Cir. 1984) (Southern Pacific). In approving the
consolidation, the Commission identified several anticom-
petitive effects of the transaction which could be remedied
by grants of trackage rights to competing carriers.
The greatest competitive impact was noted in the cen-
tral transcontinental corridor. To preserve competition in
that corridor east of Denver, the Commission conditioned
approval of the merger on grants of trackage rights. One
grant of such rights was to the Denver Rio Grande West-
ern Railroad Company (DRGW) between Pueblo, CO and
Kansas City, MO. In another, the Commission granted the
Southern Pacific Transportation Company and the St.
Louis Southwestern Railway Company (collectively re-
ferred to as the SP) trackage rights between Kansas City
and St. Louis. The Missouri-Kansas-Texas Railroad Com-
pany (MKT) received the third grant of trackage rights
over MP’s lines between Kansas City and Omaha, NE:
between Union and Lincoln, NE; and over UP’s lines be-
tween Omaha and Council Bluffs, IA and between Kansas
City and Topeka, KS with use of related terminal facilities.
We did not set the terms of compensation for the track-
age rights. We preferred that the parties agree to the
terms themselves. If they did not, we stated we would set
those terms. UP—Cont.—MP; WP, supra, at 589-590. We
delineated ‘general principles” for just and reasonable
compensation for trackage rights imposed in merger pro-
ceedings. Those principle applied to both voluntary and
Commission-imposed agreements. An owning carrier was
found entitled to recovery of costs and rent. Rent is based
on an allocated share of return on the value of property.
Valuation of the property should be based on current fair
market value. Concerning rate of return we stated:
66a
Current cost of capital or opportunity cost may
not be reasonable. In order to provide a realistic
opportunity to compete, the trackage rights ten-
ant should operate over the involved lines under
economic conditions similar to the landlord’s.
Therefore, the landlord’s actual rate of return on
its properties should be given consideration in
determining just and reasonable rate of return.
Id. at 589-90.
Finally, we noted that, since the purpose of the trackage
rights was to maintain a competitive balance where com-
petition would otherwise be significantly lessened by the
merger, ‘‘any terms so onerous to the tenant as to defeat
the purpose of the trackage rights cannot be considered
just and reasonable.” (Citation omitted). Jd. at 590.
In Southern Pacific, supra, the Court of Appeals af-
firmed the merger decision and remanded the case for
reconsideration of the DRGW’s request for independent
ratemaking authority, an issue unrelated to these pro-
ceedings. Concerning the issue of trackage rights, the court
stated that ‘(t]he Commission has extraordinarily broad
discretion to impose protective conditions, 49 U.S.C. §
11244(c), and the courts have appropriately given the Com-
mission's selection of such cond.tions great deference.”’
(Citations omitted.) Jd. at 721. Concerning trackage rights
compensation terms, the court noted that we have in-
structed the railroads to negotiate acceptable terms based
on the general criteria we outlined, supra, and that we
had reserved the authority to set terms in the absence of
an agreement. The court also stated:
This procedure was entirely rational, in that the
ICC specifically provided that the terms, whether
agreed to or imposed, must be such as to make
the new transcontinental corridor (SP/DRGW)
competitive with the merged system. (Citation
omitted.) * * * [W]e trust the Commission to en-
67a
sure that the compensation terms will not defeat
the purpose of the trackage rights. The ICC has
in fact guaranteed that it will see to the proper
functioning of the trackage rights. (Citation omit-
ted.) Id.
The MKT entered into trackage rights agreements with
the UP and MP which were submitted for our approval.
In our decision in this proceeding concerning trackage
rights, 1 I.C.C.2d 776 (1984) (the 1984 decision or the
trackage rights decision) we found that the terms agreed
to by the UP/MP and MKT were reasonable and were
approved.? Jd. at 802-04.
The DRGW and SP were unable to reach agreement
with UP on the terms of compensation for the DRGW’s
Pueblo-Kansas City trackage rights and the SP’s Kansas
City-St. Louis trackage rights. They requested that we set
terms. Jd. at 779.
In the trackage rights decision, we found that the com-
pensation should be determined in three parts: (1) the var-
iable cost of operation including standard additives; (2) a
proportionate share of maintenance and operation ex-
* The trackage rights compensation agreements are set out in detail
in the 1984 decision. Generally, the MKT assumed the variable costs
of its operations. Additionally, MKT was to pay a percentage, based
on its usage share on each portion of the joint track, of maintenance
and operation expenses plus standard additives and of taxes and as-
sessments. Finally, interest rental was to be determined by multiplying
MKT’s usage share of each portion of the joint facility by specified
amounts during the first two years. For the third and succeeding years,
calculation of the interest rental is based on the reproduction cost now
less depreciation. (RCNLD) of the track, track structure, grading,
roadbed, signal and communications facilities, and other appurtenant
facilities on each portion of the joint track. The RCNLD value is then
multiplied by the 1981 pre-tax rate of return of Pacific Rail Systems,
Inc., the holding company controlling the railroads, tat 14.23%. St.
Louis Southwestern Ry. Co.—Trackage Rights Compensation, 1 I.C.C.2d
776, 802-804 (1984).
68a
penses based on the tenant’s usage of the facility, and (3)
interest rental. Jd. at 779-80.
There was no dispute among the parties concerning var-
iable costs and maintenance and operation expenses. /d.
at 790-791 and 799. The parties disagreed about the in-
terest rental factor. We found that interest rental should
be based on the tenant’s usage and the MPC’s 1979 pre-
tax rate of return to the value of the lines. In determining
value, we rejected valuation methods based on replacement
costs and book value and adopted a capitalized earnings
approach. Jd. at 780.
Under this method, developed principally from a pro-
posal by the DRGW, the earnings of the line segments
were ‘‘capitalized’’ using an earnings multiplier derived by
dividing the consideration the Union Pacific Corporation
paid to acquire the MP Corporation by MP’s earnings. It
was assumed that all MP properties, standing alone, would
yield the same return as the percentage relationship be-
tween MP’s system earnings and the purchase price of the
MP. Actual earnings of the particular line segment are
then multiplied by the earnings multiple to arrive at an
approximate value for the line segment. This figure was
multiplied by the MP’s pre-tax rate of return on invest-
ment to produce a total pre-tax return on investment. This
amount was then multiplied by the percentage of usage
of the tenant railroad (i.e., the DRGW or the SP) to de-
termine the total interest rental payment.’ Jd. at 786-90.
* The formula adopted in our decision can be outlined in the following
manner:
MP Value
+ MP earnings
= Earnings multiplier
x MP Earnings over line segment
= Valuation of line segment
x Rate of return
69a
Thus, the $1,918,881,000 value of the Missouri Pacific
Corporation was divided by earnings of $350,690,000 to
produce an earnings multiple of 5.47. The rate of return
was 10.21%. For the Pueblo-Kansas City line, we computed
an interest rate component of $2,045,565 based on proj-
ected usage factors for each segment of the line. Jd. at
790. See Appendix A. No net revenue figures were avail-
able for the Kansas City-St. Louis line; we directed the
parties to submit calculations based upon the methodology
we adopted to enable us to compute the interest rental
component. Jd. at 801-802.
SP/SSW and UP/MP field supplemental evidence and
replies concerning the calculation of the interest rental
component for the Kansas City-St. Louis line. Petitions to
reopen were filed by the SP and UP. Replies to the
petitions to reopen were filed by the SP, MP, and DRGW.
Petitions to Reopen. The SP contends that the procedure
developed in the 1984 decision impedes its ability to com-
pete with the UP. The SP asserts that the trackage rights
rental formula must consider the relative elasticities of
demand for the traffic carried by both railroads. The pro-
posed methodology would force the more demand elastic
traffic carried by the SP to make the same relative con-
tribution as the less demand elastic traffic carried by the
UP/MP. This would divert traffic from the SP to the UP/
MP (because the more demand elastic traffic would not be
priced competitively) and thus lessen competition.
The SP also alleges that the capitalized earnings meth-
odology considerably overstates the value of the track be-
tween St. Louis and Kansas City. It argues that the book
value of the line is substantially lower than the value of
developed using the earnings multiplier approach. Fur-
= Necessary earnings.
x Tenant share
= Rent
70a
thermore, the interest rate used (10.21%) is much higher
than the rate found in other trackage nghts agreements,
which allegedly never exceeds 8%. The SP claims that
other trackage rights agreements do not use the price
earnings multiplier approach, which allegedly would pro-
duce rents so high as to make the prospective tenant un-
able to afford the use of the trackage rights.
The SP states that the record in this proceeding estab-
lishes a more precise estimate of the value of the trackage
involved. Specifically, it contends that the price agreed to
by a willing buyer and willing seller in a recent purchase
(i.e., the UP purchasing the MP) should be used as the
fair market value for the property.
Finally, the SP argues that, if the price earnings mul-
tiplier approach is used, certain adjustments need to be
made to the components that are used in that methodol-
ogy. It contends that the methodology should use or con-
sider: (1) a multi-year average of both capitalized earnings
and rates of return, as opposed to a single year’s figures;
(2) material changes, over time, in traffic patterns over
the involved lines; (3) the earnings and rates of return
both the landlord and tenant railroads; and (4) the type
of trackage rights (bridge versus total).
The UP/MP’s arguments are essentially concerned with
the date used by the Commission in the rental formula,
as opposed to the use of the formula itself. They contend
that the Commission should have used an earnings multiple
based on 1979 data rather than 1982 data. Moreover, they
argue that the Commission’s restatement of 1979 figures
‘UP/MP state that they reserve the right to seek judicial review of
all parts of our decision. The purpose of their petition to reopen, they
say, is to demonstrate errors in our application of the capitalized earn-
ings approach. UP/MP Petition, at 3 and 13. The DRGW also states
that it reserves the right to seek judicial review if we should decide
to reopen and change our 1984 decision. Reply to Petitions to Reopen,
at 15, fn. 10.
Tla
to 1982 levels had certain flaws. The Mississippi River
Transportation Corporation (MRTC) earnings figure used
by the Commission is alleged to be erroneous. The UP/
MP concludes that earnings multiples of 83.6 or 9.73 should
be used for 1979 and 1982 bases, respectively, instead of
5.47, and that the 1979 figures are preferable to 1982
figures. Finally, they contend that a 13.71% pre-tax ROI
should have been used.
The DRGW in its reply to the petitions to reopen argues
that the methodology the Commission prescribed must be
affirmed because it strikes a reasonable balance between
the desire of the landlord for interest rental and the ability
of the tenant to provide competitive service. Concerning
the UP/MP arguments, the DRGW states that the Com-
mission was correct in taking into account the actual 1979
price as well as reconstructed 1982 earnings. It also con-
tends that the Commission’s treatment of the Mississippi
River Transportation Corporation and our rate of return
analysis was proper.
The DRGW argues that the SP has not submitted fig-
ures to prove its ability to compete will be undermined.
It disputes the SP’s argument that the capitalized earnings
methodology is an incorrect means of valuing assets. Fi-
nally, the DRGW states the SP was afforded an oppor-
tunity to submit calculations developed from the earnings
multiple methodology that are based on line specific net
revenues.
PROCEDURAL MATTERS
The DRGW requests that we reject a letter from the
UP/MP which seeks “‘to correct certain mistakes” in the
DRGW’s reply to the petitions to reopen. The DRGW ar-
gues that the UP/MP filing is an impermissible reply to
a reply prohibited by our rules of practice. See 49 C.F.R.
§1104.13(c). The DRGW also included a reply to the UP/
MP’s arguments in the event we accepted the UP/MP’s
72a
filing. The DRGW is correct in characterizing the UP/MP
filing as a reply to a reply. Both the UP/MP pleading and
the DRGW’s reply to it will be stricken.
The DRGW also moves to strike verified statements of
Gregory H. Dickinson and Gregory M. Broderick in the
UP/MP petition to reopen. It argues that the UP/MP did
not explain why these statements were not previously ad-
duced as required under 49 C.F.R. §1115.3(c). Moreover,
it argues that the material runs afoul of the prohibition
at 49 C.F.R. §1104.8 against ‘‘any redundant, irrelevant,
immaterial, impertinent, or scandalous matter. * * * .”’ Mr.
Broderick’s statement, the DRGW claims, “is not even
cited in support of any arguments in the UP/MP Petition
to Reopen.”
We shall deny the motions to strike. Mr. Dickinson’s
verified statement does ‘‘not appear to be cumulative’”’ (49
C.F.R. §1114.3) since it addresses the rate of return and
earnings multiple discussion in the 1984 decision. Mr. Brod-
erick’s statement shall also be accepted. In addresses our
findings on the issue of the Pueblo-Osawatonie and Osa-
watenie-Kansas City line-specific earnings. It is used in
the petition to reopen to support the argument that the
line-specific earnings figure submitted by the DRGW and
adopted by us ‘contain various technical errors.”” (UP/MP
Petition to Reopen, at 17, fn. 9).
DISCUSSION
Based on the pleadings and upon our own reconsider-
ation of the issue of trackage rights compensation, we
affirm our finding that the capitalized earnings approach
is the proper method of determining the interest rental
component. However, we find that each part of the for-
73a
mula should be modified,‘ including: (1) use of railroad
earnings and market value investment instead of total MP
corporation earnings; (2) use of 1979 data, not adjusted
to 1982 levels; (3) use of a multiplier based only on the
market value of roadway property and not based also on
equipment; and (4) use of pre-tax current cost of capital
instead of the railroad’s actual rate of return on invest-
ment. Usage would be based on a three-year moving av-
erage. For the Kansas City to St. Louis line segment,
earnings are based on bridge, not total, traffic. The net
line earnings of the Pueblo to Kansas City line also needs
to be reexamined.
We believe the capitalized earnings for multiplier ap-
proach is the most appropriate technique for valuing rail-
road assets in these proceedings. The consolidation decision
stated valuation should be based on fair market value,
rather than book or replacement value. UP—Cont.—MP;
WP, supra, at 589. The capitalized earnings approach es-
timates the value of the lines on the basis of a contem-
poraneous arms-length transaction, thereby reasonably
approximating the fair market value. The going concern
value of a corporation has been found to be an appropriate
method of valuation. See Consolidated Rock Products v.
DuBois, 312 U.S. 510, 526 (1941); see also trackage rights
decision at 786. In evaluating “going concern value,’’ the
“commercial value of property consists in the expectation
of income from it.” Galveston, H.&S. A. Ry. v. Texas, 210
U.S. 217, 226 (1908).
Before discussing the issues concerning the individual
parts of the formula, we will address arguments about the
overall capitalized earnings approach.
*MP/UP argue that we should deny the SP’s petition because ma-
terial error has not been shown. DRGW contends that MP/UP and SP
petitions should be denied for lack of “clear error.” Our decision is
being modified and it must be reopened to receive evidence on roadway
investment and Pueblo-Kansas City net earnings.
74a
We do not agree with the argument that the capitalized
earnings grossly overstates the value of the Kansas City
to St. Louis line segment. The SP contends that the book
value of this line is substantially lower than the value
obtained using that approach. This argument, however,
ignores the fact that the purchase price or market value
of a piece of investment property usually is based on the
earnings potential of that property, not on the historical
cost value shown on the earnings potential of that prop-
erty, not on the historical cost value shown on the balance
sheet. The line segments in question in these proceedings
are high density main lines of the MP and thus have a
higher income producing potential resulting in higher cap-
italized value than many of the lower density line seg-
ments.
The SP argues that the actual market value of the Kan-
sas City-St. Louis trackage can be calculated from the total
sale price. This value was determined to be $54.6 million
by allocating the purchase price over book values, which
results in a ratio of 80%. The ledger value of the line is
multiplied by 80% to reach the net value of the Kansas
City-St. Louis line. Alternatively, the SP argues that val-
uation could be calculated by allocating the purchase price
over mainline route miles, gross-ton miles, total route
miles, or projected post-merger traffic volumes. The value
of the lines under these alternative methods would not
exceed $54.6 million.
We must reject the book value approach of valuation.
As we noted in the trackage rights decision, such a method
“‘does not value the asset as a going-concern business, but
solely as individual parcels of land and specific existing
structures. Thus it ignores a characteristic vital to this
proceeding: an asset’s income-producing potential.’’ St.
Louis Southwestern Ry. Co.—Trackage Rights Compensa-
tion, 1 I.C.C.2d 776, 801 (1984) at 801. Moreover, this
method reflects a ‘‘cost at a past time. Those historical
costs arose at different times, in different markets. and
75a
should not be relied upon as an accurate indicator of pres-
ent value or as an accurate method of apportioning present
value.” Jd. We prefer the capitalized earnings approach,
which develops line value by taking the net earnings of
the St. Louis-Kansas City line ($18,287,939 without an
adjustment for incentive per diem (IPD)), see infra and
multiplies this by an earnings multiplier based on the mar-
ket value of railway property divided by net revenue from
railway operations. This multiplier will be reduced when
the market value of road property is determined.’ The SP
dies not explain sufficiently or adequately justify its other
alternative methods of valuation.
The SP also contends that the procedure developed in
the 1984 decision impedes its ability to compete with the
UP. It argues that the UP’s “corrections” to the 1984
decision would more than double the SP’s rental, forcing
it either’ to rehabilitate the former Rock Island line or use
the circuitous Corsicana route. Use of that route would
allegedly have an adverse impact on the environment.
In its reply statement, the SP includes a table which
compares costs and net earning for the SP and MP op-
erating over the same line. This table is reproduced below:
*The market valuation for road property we are developing should
be relatively close to the $54.6 million valuation advocated by the SP.
As shall be discussed infra, the 7.74 earnings multiplier, based on the
market value of both road and equipment property, will be reduced to
reflect the market value of only road property. If, for example, the
market value, as a percent of total road and equipment property is
43.5% (the percentage relationship on a book value basis), the resulting
multiplier would be 3.37 (43.5% times 7.74) which when multiplied with
the net line earnings of $18,287,939 gives a valuation of $61,630,354.
76a
a J MP
Carloads 300 700
Revenues/Carload $1,500.00 $1,500.00
Operating Costs/Carload 1,000.00 1,000.00
Revenues Minus Operating Costs 500.00 500.00
Rental/Carload
(700 x $500 x 1.15 x .3/300) 402.50 0
Net Earnings/Carload $ 97.50 $ 500.00
The 1.15 multiplier under ‘‘Rental/Carload”’ is derived by
multiplying the UP’s proposed capitalized earnings multi-
plier of 8.36 by the proposed UP return on investment of
13.71%. The usage factor is .3.
This table shows the SP realizing substantially less earn-
ings than the MP. Since the operating costs are shown to
be the same for both carriers, it appears that the cost of
road property (including the cost of capital) has not been
included. Such costs must be considered to accurately de-
termine net earnings per carload. Some of these costs are
reflected in the $402.50 rental per carload for the SP, but
none of these costs are included in the MP’s figures, re-
sulting in an overstatement of MP’s net earnings per car-
load. If the MP’s costs per carload are increased to include
the cost of road property (including the cost of capital)
we believe that the differential between the SP and MP
earnings would be substantially reduced, if not entirely
eliminated.
The SP also argues that the capitalized earnings formula
is flawed because a lower usage share does not necessarily
result in a lower rental, as demonstrated in the following
Sp examples:
Capita- SP share of
SP MP MP Multi- lized Capitalized
Cars Cars Earnings plier Value Value
Case 1 250 500 $ 50,000 5.5 $275,000 $ 91,667
Case 2 250 1,000 $100,000 5.5 $550,000 $110,000
77a
This example, SP contends, shows a greater rental bill
when MP's traffic increases.
The SP misconstrues the formula. The net earnings of
the line, as well as the earnings multiple, is a fixed figure.
An increase in line earnings will not increase the rental.
Based on our modifications to the formula, the usage share
will be based on a three-year rolling average and the pre-
tax cost of capital will be changed annually. Thus, unless
offset by a sufficient increase in the cost of capital figure,
the rental would decrease when the renter’s usage is low-
ered.
As noted, the capitalized earnings method of valuation
consists of four elements: earnings multiplier, return on
investment, line earnings, and usage. Although we are
affirming the basic capitalized earnings methodology of the
trackage rights decision, we conclude that the decision’s
findings concerning each element of the formula should be
changed. Our discussion follows.
A. Earnings Multiplier
The earnings multiple is used because in theory it is
assumed that all MP properties, standing alone, will yield
the same return as the percentage relationship between
MP’s system earnings and the purchase price of the MP.
Specifically, in the 1984 decision, the MPC value was de-
rived by subtracting the Mississippi River Transportation
Corporation (MRTC) stock price and liabilities from the
MPC stock price and liabilities. This amount was divided
by a figure derived by adding MPC operating earnings
and non-operating income, multiplying that amount by the
Gross National Product Deflator issued by the Department
of Commerce Bureau of Labor Statistics and subtracting
MRTC earnings.
78a
The trackage rights decision found a multiplier of 5.47.”
We find two errors in our 1984 analysis: using a mixture
of 1979 and “‘escalated’’ 1982 figures for the MPC value;
and using after-tax earnings instead of pre-tax earnings
for the MRTC. In addition, we are changing the 1984
decision’s treatment of the earnings multiplier by using
1979 railroad-only value and earnings and requesting data
to determine a multiplier based only on road property.
Use of 1979 Data. Our trackage rights decision used 1979
data except in the development of the earnings multiple.
See St. Louis Southwestern Ry. Co.—Trackage Rights Com-
pensation, supra, at 787. For the multiplier, we stated
that the $2,360,784,000 figure ‘represents the price paid
for MPC assets at the time of the consummation of the
consolidation—1982.”’ Jd. We did not have 1982 MP cor-
* Development of earnings multiple:
MPC Value
1982 MPC stock price $998,910,000
1982 MPC liabilities $1,361,814,000
Total 1982 MPC value $2,360,724,000
1983 MRTC stock price $ 256,300,000
1982 MRTC liabilities 185,443,000
Total 1982 MRTC value - — $441,743,000
Total 1982 value $1,918,981,000
MPC Earnings
1979 MPC operating earnings $262,966 ,000
1979 MPC non-operating income 36,541,000
Total 1979 income before interest and taxes $299,507,000
Times GNP Deflator x _ 1.26805
MPC earnings expressed in 1982 dollars 379,790,000
1982 MRTC earnings . — 29,100,000
Total earnings expressed in 1982 dollars $ 350,690,000
Earnings Multiple
Total 1982 value $1,918,981,000
Total earnings expressed in 1982 dollars + 351,197,000
Earnings multiple 5.47
a ne |
79a
poration earnings data available at the time of our 1984
decision. Therefore, we extrapolated 1979 MP earnings
forward to 1982, using the Gross National Product Defla-
tor. We now find that 1979 data should be used for the
entire earnings multiplier analysis as well as for net earn-
ings. As discussed, infra, we shall use the current cost of
capital and a moving average for usage.
We erred in stating that the $2,360,784,000 was a 1982
figure. The agreement that placed the $2.36 billion value
on the MPC’s assets cccurred on January 4, 1980. This
amount was based on 1979 information concerning both
the value of the consideration given and the earnings
stream acquired. Thus, our 1984 decision held this 1979
(but assumed to be 1982) valuation constant but increased
earnings with the GNP deflator of 26.805% to
$379,790,000. In fact, MPC’s actual earnings in 1982 were
only 4% above 1979 earnings—$313,.131,000 compared with
$299,507,000. Moreover, the $2.36 billion was not the cor-
rect 1982 valuation. UPC had agreed on January 4, 1980,
that upon consolidation it would issue a set number of
shares of UPC stock and assume all liabilities of MPC.
When the acquisition was finally consummated on Decem-
ber 22, 1982, both the value of the UPC stock and the
value of MPC’s liabilities were significantly greater, a total
of $2,888,015,000* or 22% greater than the amount used
in the decision.
* CONSIDERATION GIVEN BY UPC FOR MPC.
Value On Value On
January 4, 1980 December 22, 1982
8,667,327 shares of
UPC common stock» $ 624,048,000 $ 780,059,000
4,333,664 shares of
UPC preferred stock. 374,862,000 424,699,000
MPC liabilities « 1,361,814,000 1,683,257,000
TOTAL $2,360,724,000 $2,888,015,000
RO0a
The DRGW supports the use of 1979 data for valuation
but argues that actual 1979 earnings should be escalated
to the 1982 level to avoid distortions attributable either
to a recession or abnormally favorable results in actual
1982 earnings. Thus, the earnings multiple would take into
account the price paid for MPC’s future earnings stream.
We believe that a mixture of ‘‘actual’’ and “‘escalated’’
figures, as well as use of different years figures, is im-
proper. If the carrier was acquiring the future earnings
stream, it was also acquiring the future valuation of the
other carrier. One figure cannot be held constant and the
other increased. Since we now have the data for both 1979
and 1982, a multiplier could be employed with the data
from either year. Since there was no way to predict in
1979 the actual 1982 figures (as is evident from escalated
1982 valuation and earnings data), we believe that 1979
figures are more theoretically sound since all the terms of
the merger were based on earnings and investment data
as of 1979.
.Figures are rounded to the nearest thousand.
» NYSE Composite prices on January 4, 1980, ($72 per share) and 2-
for-1 split). See UP/MP/WP, 366 I.C.C. 459, 628 n.140.
«Stated value on January 4, 1980, ($86.50 per share) (see id.) and NYSE
Composite price on December 23, 1982, the first day of trading ($98
per share).
«Market value of the liabilities on December 31, 1979, and December
31, 1982, as calculated by UPC’s accountants in 1980 in connection
with proxy statement to UPC shareholders and in 1983-1984 in con-
nection with post-merger accounting consolidation of UPC and MPC.
Dickson V.S., at 1.
* According to the UP/MP, using actual 1982 data would yield a
higher multiplier than using 1979 data. The UP/MP contend that for
1979 the multiplier would be 8.36; for 1982 it would be 9.73. The
multiplier is derived by subtracting MRTC stock price and liabilities
from MPC stock price and liabilities and dividing that by a MPC before
tax earnings (derived by subtracting MRTC before tax earning from
MPC operating and non-operating earnings). The UP/MP’s figures were
derived by making adjustments to the MRTC’s data. (See tex infra.)
8la
As noted, the earnings multiplier approach employed
adjusted MP Corporation earnings. An affiliate of the MP
Corporation, MRTC was sold on August 10, 1983, for
$256.3 million. The 1984 decision added to this amount
$185.4 million in liabilities to determine the value of the
MRTC. The MRTC earnings for 1982 were subtracted from
MPC earnings (see footnote 7). The parties all commented
on these adjustments. The DRGW concluded that the ad-
justments were essentially correct. The SP argued that
the liabilities of the MRTC should also have been consid-
ered. The UP contended that these adjustments erro-
neously used after-tax earning for the MRTC and book
value for the 1982 liability figure. Moreover, the UP claims
of the MRTC stock sold in 1983 would have to be con-
verted to a 1979 equivalent using a price/earnings ratio.
After examining the evidence, we conclude that the
MRTC earnings figure used in the original decision was
erroneous. This error was due to the use of after-tax earn-
ings for 1982 instead of 1982 pre-tax earnings."® Moreover,
since we are using 1979 data, a proper method of deter-
mining the 1979 value, liabilities, and earnings of the
MRTC would have to be developed. The MRTC issue, how-
ever, has been mooted since we are relying (see discussion
below) solely on data for the the MP Railroad in developing
an earnings multiplier. The use of railroad-only data pre-
cludes the need for any consideration of adjustments for
the sale of the MRTC, and also excludes consideration of
any other non-railroad assets or earnings of the MP at
the time of the merger.
Use of MP Railroad Data. Although trackage rights are
railroad-specific in nature, relating only to the use of track
‘© This adjustment erroneously used after-tax earnings for the MRTC
of $29,100,000. MRTC before-tax earnings for the MRTC of $56,610,000
should have been employed. With other multiplier components un-
changed this correction results in the earnings multiple being increased
from 5.47 to 5.94 based on MP’s 1982 valuation of $1,918,000 divided
by corrected 1982 MP earnings of $323,178,000.
82a
and other related road property, the formula used in the
1984 decision relied on an earnings multiplier model based
on the earnings and market value of the entire MP Cor-
poration. This was done because the only evidence avail-
able in the original pleadings was on a corporate basis.
We found that the total value of the MP Corporation was
$2,360,724,000. We subtracted from this figure the total
value of the MRTC, $441,743,000. This left a net value of
$1,918,981.
In its petition to reopen, the UP/MP included a market
valuation of the MP Railroad as of the end of 1979, de-
termined by their witness Gregory H. Dickinson to be
$1,422,328,000. Mr. Dickinson calculated this figure in con-
nection with the return on investment issue by comparing
the book value of the MP Corporation in 1979 to the
market value for the MP Corporation and restating the
railroad’s investment base to account for the fact that the
market value of the MP Corporation was less than its book
value. This figure was not disputed by the SP.
The DRGW criticized the method of arriving at the
$1.422 billion figure as “‘simplistic’’ and based on ‘“‘ques-
tionable assumptions.’’'! We shall accept the $1.422 billion
figure as the best evidence of record for the market value
of the railroad. Parties may present further evidence of
record for the market value of the railroad. Parties may
present further evidence on this issue in support of a more
accurate market valuation. The MP’s market valuation is
not needed to determine return on investment since we
are using pre-tax cost of capital data. However, the market
value will be used as the numerator in determining the
earnings multiplier. This figure will be further adjusted by
“Tt should be noted that this criticism was made in the rate of
return context where the lower the valuation, the higher the return
on investment and, consequently, the rental. In this instance, the lower
the valuation, the lower the multiplier number and rental.
aE
83a
an allocation for the market value of road property (see
following discussion).
Development of the Multiplier. The multiplier is calcu-
lated by dividing the market value of the railroad property
(from Witness Dickinson) by the net revenue from railway
operations (as shown in the MP’s 1979 Annual Report
Form R-1). This procedure produces a multiplier of 7.74.
The parties have not made an issue of the multiplier
being based on a valuation derived from both road and
equipment property. Since the tenant railroads would be
using their own equipment, the use of a multiplier based
on both road and equipment overstates the value of the
railroad property to be used. For example, as reported in
the 1979 Annual Report Form R-1 of the MP, road prop-
erty was 43.5% of railroad property, equipment was 55.2%,
and other 1.3%. Thus, a more precise multiplier would be
one based only on the market value of the road property
when the merger was undertaken. Since we do not have
this figure, the multiplier would be one based only on the
market value of the road property when the merger was
undertaken. Since we do not have this figure, the multi-
plier cannot be developed at this time. Consequently, com-
ments are requested concerning the value of this road
property. Specifically, we are interested in the market
value of that portion of the UP’s consideration paid for
the MP that is allocated to road property. This, in turn,
will serve as the basis for developing a revised “road prop-
erty only” multiplier to apply to the line segment earnings.
We have outlined below the development of the multi-
plier without the adjustment made for use of road property
only.
Development of 1979 Multiplier
RW Op Rev 1,418,727
RW OP Exp 1,234,979
Net Rev RW Ops 183,748
84a
Market VA] RW Prop 1,422,328
Multiplier 7.74
B. Determine Rate of Return: Use
of the Current Cost of Capital
In the 1984 decision, we approved the use of the actual
rate of return in 1979 for the MP on a pre-tax basis
(10.21%) to develop the return element for the line seg-
ment.’ The SP supported use of the five-year pre-tax rate
of return of both the landlord and tenant railroads
weighted by percentage use. The SP argues that the so-
called “Niles Canyon Agreement’’ between the SP and
Western Pacific is a “‘state-of-the-art joint facility con-
tract.’’ It has an interest rate of 8%, while the prime rate
at the time the agreement was executed was 19%. More-
over, the SP states that none of the hundreds of existing
voluntary trackage agreements imposes an interest rate
exceeding 8%. The UP/MP argue that freezing the MP’s
pre-tax rate of return for use in determining annual in-
terest rental prevents the UP/MP from ever earning ad-
equate revenues on the trackage rights lines. Instead, they
argue that DRGW and SP will be cross-subsidized in their
efforts to attain adequate revenues at the expense of UP/
MP. Nevertheless, ‘‘accepting the Commission’s basic ap-
proach for purposes of this petition,” the UP/MP argue
that our return on investment methodology should use in
the denominator of the fraction an average net investment
in railroad property based on fair market, not book, value.
We now believe that return on investment should not
be applied to determine the necessary rate of return.”
‘2 We have defined rate of return on investment as net operating
| income divided by the net investment base. See Standards for Rail
| Revenue Adequacy, 364 I.C.C. 803, 821 (1981).
'* We must also reject the SP’s arguments concerning the “Niles
Canyon Agreement’’ between SP and Western Pacific. Those trackage
EEE OO
85a
Instead, the pre-tax equivalent of the current cost of cap-
ital rate for the railroad industry should be used.'* A goal
of the national rail transportation policy is to “‘promote a
safe and efficient rail transportation system by allowing
rail carriers to earn adequate revenues, as determined by
the Interstate Commerce Commission * * *” 49 U.S.C.
§10101a(3). Congress has directed us to aid rail carriers
in attaining revenues that are ‘‘adequate, under honest,
economical, and efficient management to cover total op-
erating expenses, including depreciation and obsolescence,
plus a reasonable economic profit or return (or both) on
capital employed in the business.” 49 U.S.C. §10704(a\2).
Perpetuating, without valid reason, a return that is in-
sufficient in the long run to allow for adequate reinvest-
ment is not justified.
Besides the Congressional mandate, we believe there are
sound practical and policy reasons for using the current
cost of capital. the cost of capital rate represents the av-
erage cost to any of the railroads for obtaining capital.
Its use favors no carrier over another and places both the
rights agreements have been freely entered into by two parties who
are in agreement. The Niles Canyon Agreement was an “‘arms-length
contract”’ derived from hard bargaining on both sides.’”’ (SP Petition
to Reopen, at 7, quoting V.S. of Thor H. Sjostrand). Furthermore,
trackage rights agreements are usually reciprocal in nature, with each
railroad granting the other trackage rights over their lines. In the
instant proceeding, we are faced with adversary parties who are en-
tering into trackage rights agreements not because of a mutual agree-
ment, but as the result of the Commission’s order in a consolidation
proceeding. We are being asked to set trackage rights compensation
due to the inability of the parties to achieve a meeting of the minds.
‘The cost of capital includes cost of borrowed funds (interest ex-
pense) and equity capital. The current cost of capital for the Class I
railroads is determined annually by the Commission. The most recent
determination setting 11.7$ as the updated cost of capital was in Rail-
road Cost of Capital—1986, 3 I.C.C.2d 948 (1987). Prior years’ findings
are all higher. The 1986 cost of capital calculated on a pre-tax basis
is 19.13%. (See discussion in text, infra, and Appendix B).
86a
incumbent and tenant railroads on an identical footing re-
garding a required rate of return. It prevents “railroad
shopping” where a carrier with a low return on investment
is an attractive trackage target. It ensures that the renting
carrier is not subsidized by the owning road. Moreover,
the pre-tax equivalent of the industry cost of capital is
used in abandonment proceedings and rate prescription
proceedings in the absence of justification for some other
figure. Such justification is not present on the record. See
Abandonment Regulation—Costing, 3 1.C.C.2d 340 (1987);
Abandonment of Rail Lines—Use of Opportunity Costs, 3
I.C.C.2d 810 (1987); Omaha Public Power District v. BN
R. Co., 3 1.C.C.2d 123 (1986), affd, 3 1.C.C.2d 853 (1987).
This principle was recognized in a pleading dated Oc-
tober 21, 1985, by the Santa Fe Southern Pacific Cor-
poration (SFSP)** in Finance Docket No. 30400 et al., Santa
Fe Southern Pacific—Control—Southern Pacific Transpor-
tation Company. Citing testimony of Dr. William Baumol,
the SFSP argues that the compensation formula in our
trackage rights decision is fundamentally flawed. It cirti-
cizes different elements of the formula. In particular it
supports use of the current cost of capital. To tie trackage
rights compensation to the rate of return of the railroad
(and an internal earnings multiple) ‘‘virtually forecloses the
landlord with inadequate revenues from ever earning ad-
equate revenues on the assets in question* * *.”’ SFSP
Initial Brief, part two, at 422. When all the landlord costs
are not covered by compensation terms, ‘‘trackage rights
constitute a cross subsidy from the landlord or its cus-
tomers.”’ Jd. at 416.'*
'’ The SFSP is the holding company that controls the Santa Fe and
owns the SP but holds it separately by virtue of a voting trust approved
by the Commission. Decision in F.D. 30400 (not printed), served De-
cember 23, 1983.
6 The SFSP also adds that trackage rights compensation should not
be placed so high as to preclude the renter from providing efficient
87a
Finally, we must determine which method should be em-
ployed for calculating the cost of capital: pre-tax or after-
tax; nominal or ‘‘real]’’,17 Statutory or effective rate. The
pre-tax value should be used because all other costs as-
sociated with the trackage rights are also on a pre-tax
basis and, as noted, it is employed in other proceedings.
We have used the nominal instead of the real cost of
capital to develop the pre-tax value since we are not chang-
ing the investment base by indexing it for inflation. If we
had indexed the investment base, use of the nominal cost
of capital would have resulted in a double count. For the
nominal cost of capital, we are using the statutory tax
rate (46% through 1986) since it places both the tenant
and landlord railroads on an equal footing. The effective
tax rates would differ for each of these railroads on an
equal footing. The effective tax rates would differ for each
of these railroads, and a determination of which one’s
effective tax rate should be used would have to be made.
There would arise a problem similar to using a particular
rate of return: the “shopping” for the best railroad as a
tenant or landlord would be encouraged. '®
Service through the exercise of the trackage rights. It states that “if
trackage rights cannot be priced so that they are both fully compen-
Satory to the landlord and low enough to enable the tenant to provide
efficient service, then trackage rights should not be imposed, for it is
clear that affected markets cannot support both rail competitors.” [bid.
‘The nominal cost of capital is tiie real cost of capital including
inflation. The real cost of capital is the cost of obtaining financing (debt
and equity), including a risk premium, absent inflation.
‘* There is no evidence to determine what the effective tax rate would
be for the line segments. The difference between the Statutory and
effective tax rates is due to investment tax credits (ITC) and/or timing
differences between accelerated and straight line depreciation. Absent
a large amount of line specific data, we cannot determine how much
f either of these two elements exist. It is also likely that there is
ittle in the way of deferred taxes associated with the ling segments
tue to their age and the likelihood that most of the deferred taxes for
that line segment may already have been recovered. Deferred taxes
and ITC's are largely related to new purchases, mainly equipment.
88a
Appendix B to this analysis depicts our calculations for
the development of the cost of capital for 1982 through
1986 on a pre-tax basis. These pre-tax rates have been
developed in the same manner used in various abandon-
ment and rate prescription cases. The cost of equity has
been converted to pre-tax equivalents using the 46% sta-
tutory tax rate in effect for those years. The cost of debt
is the same on both an after-tax and pre-tax basis.
C. Line-Specific Earnings
SP Earnings. Evidence concerning line specific earnings
for the Kansas City to St. Louis
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