By Bill Alpert

When Union Pacific and Norfolk Southern announced their merger deal Tuesday to form "America's first transcontinental railroad," it puzzled some who recalled the golden spike driven in 1869 at Utah's Promontory Summit. That last spike only connected two railroads from Omaha, Neb., to Sacramento, Calif.

The proposed Union Pacific Transcontinental Railroad will link every corner of the country. And it may spur a second transcontinental network if Union Pacific's western rival, BNSF -- a unit of Warren Buffett's Berkshire Hathaway -- feels forced to bid for Norfolk's eastern counterpart, CSX.

The resulting freight traffic could get rail stocks unstuck. That would be quite an achievement.

A combination of Union Pacific's western reach with Norfolk's East Coast network would cross 43 states and more than 50,000 miles. It would connect the ports of Seattle, Oakland, Calif., and Long Beach, Calif., with those in Houston, New Orleans, Norfolk, Va., and New York.

Union Pacific says a single train could take freight coast to coast without spending two days in Chicago shuffling cars between railroads. The time saved could let the railroad win freight business away from truckers -- ending years of flat rail volumes and flat rail stock prices.

"We're going to cut a day or two off every transit time," Union Pacific CEO Jim Vena told listeners on a call to discuss the deal. He will run the combined company.

Though the deal will take two years to go through the approval process, there's a strong case that it could lift Union Pacific stock nearly 50% in the next five years.

Union Pacific stock has slipped 3.2%, to $222, since Tuesday's announcement. Norfolk has slid 2.9% to $278, which is $42 shy of the $320 announced value of the deal -- a share of Norfolk swapped for a share of Union Pacific, plus $88.82 cash. That $42 spread implies that traders put a 60% probability of the deal going through.

The discount makes sense for now. The companies say it could take until early 2027 for the merger to win approval from shareholders and the Surface Transportation Board, or STB, that oversees the rail industry. Investors in short-term Treasuries could earn a guaranteed 5% in that time frame, while the deal could hit delays along the way.

The STB adopted rules in 2001 that raised high hurdles to large-scale rail mergers. Objections may come from shippers and from rivals such as CSX and BNSF. Unions have already criticized Union Pacific's labor and safety record.

But Vena is betting that Washington has gotten more comfortable with mergers. The STB's new chair, Patrick Fuchs, has scheduled meetings that may reassess the 2001 merger rules. And President Donald Trump can appoint a fifth board member to the STB, tilting the body that's now evenly split between Republicans and Democrats.

On the Tuesday call, Union Pacific and Norfolk executives contended that their combination would help U.S. port cities by winning away some of the "intermodal" container shipments now carried by Canadian National Railway and Canadian Pacific Kansas City.

Vena said the merger will improve service and expand options for shippers. The two companies currently hand off a million cars a year in Midwest rail yards. By eliminating that friction, rail freight will become faster, cheaper, and more competitive with the $400 billion trucking market.

"One intermodal train removes more than 550 trucks from the highway and is 75% more fuel efficient than trucks," Vena said.

The resulting company will also offer significant upside to today's shareholders, said Norfolk CEO Mark George. "[It] will be a must-own large-cap stock and should trade at a robust multiple."

He may be right. Rather than worrying about the spread between the two stocks, long-term investors should be weighing how Union Pacific's transcontinental railroad -- and its rivals -- will fare.

The terms of Union Pacific's deal value Norfolk at a generous 22-times estimates for Norfolk's 2026 earnings, handing over more Union Pacific stock in order to leave the combo with less debt. J.P. Morgan analysts figure the deal will add about $24 billion in debt to the $46 billion that the two railroads will have when the deal closes.

The combined 2024 revenue of the two railroads was $36.4 billion, with $18 billion in combined earnings before interest, taxes, depreciation, and amortization, or Ebitda. In a Wednesday note, J.P. Morgan analyst Brian Ossenbeck forecast that 2030 Ebitda could be $27 billion, with net profit of $16 billion, or $20 a share. Free cash flow would be $13.6 billion.

If an investor put a 13-times multiple on that 2030 Ebtida -- comparable to what Union Pacific rates today -- the enterprise value of the transcontinental railroad would be around $350 billion in 2030, compared with $245 billion for the two companies today. The 2030 market capitalization would be $280 billion, or some 47% above today's combined market caps.

Ossenbeck has Hold ratings on both Union Pacific and Norfolk, citing their long haul to a closed deal. But he thinks the transcontinental combo could generate substantial free cash.

"[Union Pacific] looks like it will be the most interesting way to play the first transcon railroad theme when the dust settles," Ossenbeck concludes.

Buffett's Berkshire may be having thoughts about CSX, so that its $100 billion investment in BNSF isn't left at a competitive disadvantage. Bloomberg reported Thursday that CSX had hired Goldman Sachs for advice on its future. In combination, those two railroads would rival the reach, revenue, and profit of a Union Pacific/Norfolk combo.

The J.P. Morgan analyst figures that could lead Berkshire to an offer of at least $43 a share for CSX, which currently trades for $35.50.

Write to Bill Alpert at william.alpert@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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August 01, 2025 00:01 ET (04:01 GMT)

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