Short-Line Railroads Prove To Be Appealing Investments

Private equity funds and other investors are scouring 35,000 miles of North American short-line rail track for deals even as the industry sees one of the biggest volume drops since 2008. 

The hunt for acquisitions among the roughly 500 companies in the space comes as investors see first-mile access to shippers as the next smart way to deploy large pools of capital and the demand for railcar storage increases. 

Brookfield Infrastructure Partners and GIC's $8.4 billion acquisition of Genesee & Wyoming, the largest short-line operator with some 120 short-lines operating on 16,000 miles of track globally, stands out. Below that mega-deal, there are a host of smaller ones. 

Since June 2018, there have been 19 acquisitions of short-line railroads or other closely held rail assets, such as transloading facilities, according to S&P Global Market Intelligence. A bit over half of those deals occurred this year. In October, U.K.-based 3i acquired the Florida operations of Pinsly Railroad, which owns 208 miles of track spread across three short-line operators serving Orlando and Tampa. 

Pinsly is being folded into 3i's Regional Rail acquisition made in April. Regional Rail is the parent company of three short-line railroads spanning Pennsylvania and New Jersey, covering 155 miles of track. 

Australia's First State Investments bought Patriot Rail and Ports, an operator of 12 short-lines over 585 miles of track across 14 southeastern states, from SteelRiver Infrastructure Partners in August.   

In May 2019, a group including Related Companies, Brookhaven Capital Partners and investment bank Stephens, acquired Pioneer Railcorp, the owner of 15 short-lines covering 12 states. The group said that Pioneer will become a "platform investment" with additional capital to be committed to growing Pioneer's trackage and customer base.

Platform investments are also a strategy of RailUSA, an operating company that received a $200 million injection in 2018 from Equity Group Investments, a fund controlled by billionaire Sam Zell, and International Rail Partners. 

RailUSA acquired 430 miles of track in the Florida panhandle from CSX Corporation CSX earlier this year, its second acquisition after buying Grenada Railroad, a 212-mile line between Memphis and Canton, Mississippi. 

RailUSA Chief Executive Gary Marino cited the potential to get closer to customers and the ability to offer railcar storage as keys to the acquisition. 

"We see a substantial opportunity to enhance the suite of services we offer [customers], as well as to attract new customers with concentrated local services," Marino said at the time. 

Denver-based infrastructure fund Broe Group was also active this year through its operating company, OmniTRAX, the second-largest U.S. short-line railroad operator.  OmniTRAX did three acquisitions, the biggest being the $105 million deal for the Winchester & Western Railroad, which serves the Virginias, Maryland, and New Jersey.

"The Broe Group and OmniTRAX are very bullish," said OmniTRAX Chief Executive Officer Kevin Shuba. "We continue to think rail is an efficient mode of freight. And it can continue to gain market share from trucks."

Part of the reason for the deal binge is that infrastructure funds are flush right now. The promise of steady free cash flows from the long-term customer contracts that short-lines typically have to make them a good candidate for those funds, Shuba said.  

"There's an unprecedented amount of capital that needs to be deployed," Shuba said. "The characteristics of short-line are very attractive, even in an industrial recession, since they have a very good free cash flow yield-to-equity."  

With buyouts of public infrastructure assets such as roads and airports facing heavy regulatory review, "it can be much simpler and quicker to buy a short-line since it is a private-to-private transaction, said Chuck Baker, President of the American Short-Line and Regional Railroad Association (ASLRRA). 

In some cases, short-lines are the result of trackage that the Class 1 railroads deemed as low profit or requiring too much service. But short-lines are making a business case for high-touch customer service, which is seen as lacking among the Class 1 railroads in the age of precision scheduled railroading, Shuba said.

Short-line railroads are "looking for commodities that are shipping in a 300- to 750-mile radius that could be transferred over from truck to rail," Shuba said.

While railcar storage is not a big earner for short-lines, Baker said it does offer another revenue stream for the companies. "These are light density lines," Baker said. "If their customers need railcar storage, they can typically find some room."

Along with buyouts, private equity is providing a source of growth capital for short-lines or for specific projects. Oaktree Capital injected $450 million of equity into Watco, which operates 41 short-lines. Investment fund Drexel Hamilton and Rio Grande Pacific also pledged $1.5 billion to build a crude-by-rail service for Utah, dependent upon shipper demand. 

Private equity owners also benefit from an array of federal and state grants aimed at increasing rail access. The Grenada rail line is tapping a $7.5 million U.S. Department of Transportation grant along with Mississippi state funding.

Georgia plans to sell $35 million in bonds to upgrade state-owned tracks with service operated by Genesee & Wyoming. Baker said New York, Oregon, Pennsylvania, and Virginia have also been standouts for state support of short-lines. Short-lines can also tap the U.S. Consolidated Rail Infrastructure and Safety Improvements (CRISI) program, which handed out $326 million in grants to freight and passenger railroads in June.  Baker's group is also pushing to reinstate a federal tax credit for 50% of the cost of ongoing track work and capital projects on short-lines. 

Short-lines are "a policy favorite since they provide access to rural and underserved areas," Baker said. 

In November 2019, Canadian Pacific purchased a portion of track from Central Maine and Quebec Railway, a portfolio company of Fortress Investment Group. The purchase will give Maine's shippers direct access to Canadian Pacific line-haul for the first time since the 1980s.

RailUSA is reported to be spending up to $14 million to rehabilitate the Grenada line so that it can offer service for the first time since 2011. Baker said those investments benefit the entire rail industry in the long-run.    

"I am most interested in the public reputation and that short-lines are doing good," Baker said. "From what I have seen, the private equity investments haven't changed how the rails operate or look."

In the face of a likely coronavirus-fueled recession, short-line railroads offer investors a certain sense of security. 

Photo courtesy of FreightWaves.