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Is This Any Way to Run a Railroad?

You think you've got problems? Amtrak's got an overpaid workforce. Its trains and tracks are falling apart. Worse, the carrier's balance sheet is a flat-out mess.
John Goff, CFO Magazine
November 1, 2005

As Marx Brothers movies go, Go West isn't much. The aging comedy team was running out of ideas, and it shows: the plot is predictable and the gags are stale. Yet there is one memorable scene in the 1940 film. In it, the boys — desperate to keep a steam-powered locomotive chugging along — feed the entire train to itself, car by car, piece by piece, caboose to tender.

Management at the National Railroad Passenger Corp., better known as Amtrak, performed a similar sacrifice in 2001. Four years into an effort to wean itself from federal operating subsidies, the rail carrier was running on empty. Executives had already started diverting funds earmarked for capital projects to help plug operating holes. But even that wasn't enough, and soon, Amtrak's management began cannibalizing the railroad. Recalls Cliff Black, Amtrak's director of media relations: "We mortgaged everything."

Things got so bad that the railroad took out a loan on New York's Pennsylvania Station to cover three months of expenses. It was a move the U.S. Office of Management and Budget called "a financial absurdity equivalent to a family taking out a second mortgage on its home to pay its grocery bills." Eventually, Amtrak conceded it couldn't break even, and Congress continued pumping funds back into the rail operator.

The damage to the balance sheet had been done, however. During the five-year plan, the carrier's debt load nearly tripled, from $1.7 billion to $4.8 billion. Once dubbed the "Glide Path to Profitability," Amtrak's intended march to self-sufficiency is termed something else by current CFO David Smith. "I call it the slippery slope to hell," he says.

Since taking the reins last November, Smith has personally spent considerable time in purgatory — stuck awaiting vital federal funding for the carrier while politicians dither over the future of passenger rail service. "Amtrak's never had full support from any Administration. And it has no ongoing real capital budget," notes James Coston, chairman of Corridor Capital LLC, which specializes in finance and development for intercity and commuter rail systems. "So each year, they go up to Capitol Hill with a tin cup."

And that cup remains far from full. Last February, for example, the White House announced it intended to cut off Amtrak's billion-dollar-plus annual subsidy — which covers about half the railroad's total budget — unless the carrier agreed to a radical restructuring. Both the House and the Senate defied the Administration, calling for subsidies ranging from $1.17 billion to $1.45 billion for 2006 (the carrier generated $1.9 billion in revenues last year against $2.9 billion in costs). But the details have yet to be ironed out, and it's still unclear just how much money Amtrak will get.

Amid the revenue uncertainty, Smith must somehow pay down Amtrak's borrowings, upgrade its information technology and financial skills, and wring concessions from entrenched unions. He is also charged with mapping out long-term capital investments on the railroad's antiquated infrastructure — a tall order when you don't actually know what funds will be available to finance the repairs. And he must do all this under the scrutiny of an Administration whose purported goal, says Amtrak president and CEO David Gunn, is "to destroy Amtrak."

It is, in sum, a nearly impossible to-do list. But judging from his efforts so far, Smith has what it takes to defy long odds: steadiness, belief, and a certain imperviousness to the Coliseum crowd. Some observers say his first year on the job could be used as a case study for grace under fire. Says Coston: "I can't imagine a tougher job than being CFO at Amtrak."

Mr. Smith Goes to Washington
David Smith is used to tough jobs. In 1986, the Northwestern University–trained MBA took over as vice president of finance at troubled steelmaker LTV Corp. Over the next nine years, the home-spun, low-key finance manager helped guide the company through a highly publicized bankruptcy and restructuring, ultimately setting the company on a solid financial footing.

In 1995, Smith left LTV and accepted the post of finance chief at the Tennessee Valley Authority. During his tenure at the TVA, he refinanced nearly all the power producer's $24 billion debt portfolio, paring about 25 percent from debt-servicing costs. Once, Smith even convinced then–Tennessee senator Fred Thompson to broker an 11th-hour deal that enabled the TVA to retire a $3.3 billion Federal Financing Bank loan facility ahead of schedule. Officials at the FFB were so thrilled by the unexpected loss of revenue that they acknowledged the repayment by sending Smith a terse, handwritten note on a piece of crumpled notepad paper. The letter, now framed, hangs on Smith's office wall in Union Station in Washington, D.C.

The White House, no doubt, would be pleased if Smith applied a similar brand of financial discipline to Amtrak, a quasi-government corporation that has steadily lost money ever since its creation in 1971. The Administration's vision of the carrier is based loosely on Japan's passenger rail system, which was privatized in 1987 (see "A Model Train?" at the end of this article).


Under the plan, the railroad would be split into three distinct companies. One would operate the Northeast Corridor (NEC) network, which accounts for half of Amtrak's passenger revenues. Another company, under the Amtrak DBA, would compete against private and public-authority carriers for intercity routes. The third company would maintain rail infrastructure on the Northeast Corridor at the behest of the states. "The President has threatened to veto significant appropriations for Amtrak without reforms such as this," insists Mark Yachmetz, associate administrator for railroad development at the Federal Railroad Administration (FRA).

Smith understands that Amtrak isn't exactly in a position to argue. "We're not financially self-sufficient," he says, "and, realistically, we probably never will be." But in the past, the railroad's management has doggedly resisted changes to its business model. Smith and Gunn, however, seem more receptive to restructuring the carrier's operations. In 2004, Amtrak exited the mail and express cargo business. This year, the company commenced a plan to create a wholly-owned subsidiary out of the NEC infrastructure.

The plan did, however, mimic President Bush's proposal to set up a matching federal/state grant system for the upkeep of trains and tracks — a system that would relieve Amtrak of a mighty load. In the carrier's $1.8 billion subsidy request for fiscal-year 2006, about 40 percent of the money is earmarked for capital-asset investments.

With the White House's plan, however, that tab would be picked up. The trade-off: states would be free to choose carriers other than Amtrak to run routes. But unlike former Amtrak executives, Smith doesn't seem overly spooked by the specter of competition. "If the states have this money to spend, I think they'll still come to us," he predicts.

Nice Work If You Can Get It
In fact, the carrier's new CFO appears quite willing to apply a dose of reality to the monopoly mind-set rampant at Amtrak. "Both David Gunn and I are going to tell it like it is," vows Smith.

Amtrak, for instance, has announced plans to benchmark the financial performance of its 13 long-distance lines, with the aim of improving or shedding underperformers. "What we're trying to do," explains Smith, "is to create, in the most objective way possible, a ranking system, and then hold it up for all to see."

And if that system tells a particularly ugly tale? "If Congress decides 'here's the ratty-ass little route, it's not meeting the criteria, and there's nothing we can do to make it better,'" answers Smith, "we'll shut it down."

Some of Amtrak's long-distance lines need to be shut down. While none turns a profit, a few are prohibitively expensive to run. Last year, per-passenger loss on the Orlando-to-Los Angeles Sunset Limited, for example, worked out to $466 — not including depreciation. Says Joseph Vranich, former Amtrak Reform Council member and author of End of the Line: "It would be cheaper just to buy those passengers airplane tickets."

The operating cost of the Sunset Limited highlights a reality of rail service: shorter routes do better than cross-country ones. In Amtrak's case, 3 percent of the carrier's 22,000-mile rail network (primarily the Northeast Corridor) accounts for 66 percent of ridership. Insists Vranich: "There's not a company in the world that wouldn't reconfigure that system."

Probably not. But even if Amtrak can reconfigure its system — no easy task, given congressional self-interest — Smith faces an even bigger hurdle. Despite a decades-long reduction in staffing, the wages, salaries, and benefits for Amtrak's 20,000 employees ate up all of the carrier's fare-box revenues last year — and made up about half of its total costs. By comparison, worker-related expenses account for 37 percent of costs in the U.S. airline sector. Says the FRA's Yachmetz: "You can't do anything significant at Amtrak unless you address labor costs."

Worker representatives dispute the assertion. Frank Wilner, a spokesman for the United Transportation Union, says that a decade ago its members agreed to concessions that have resulted in a 40 percent increase in worker efficiency. "Conductors used to get paid by the mile," he notes. "Now they're paid by the hour."

Whatever the scale, Amtrak employees appear to be doing just fine. Based on the carrier's most recent figures, the average worker at the railroad receives $70,000 in annual compensation. Moreover, certain work rules — some call them featherbedding — pump up the number of employees required to perform specific tasks. The rules do take a toll. According to Ronald Utt, the Herbert and Joyce Morgan Senior Research Fellow at The Heritage Foundation, Amtrak moves 105 passengers per employee; Canada's VIA railroad moves about 130 per worker.

Cutting worker-related costs won't be easy, though. Smith must deal with 14 different unions and 26 bargaining units. "There's a lot of low-hanging fruit," he says. "[But with the unions], you have considerable limitations on what you can do."

Like executives at other highly unionized companies — particularly airlines — Amtrak managers have zeroed in on trimming generous benefit packages. One example: Amtrak management recently floated a plan to reduce the carrier's $200 million annual pension obligation by switching new employees to Social Security rather than the current plan administered by the Railroad Retirement Board.


The concept has not been received warmly by union officials. Transportation Communications International Union president Robert Scardelletti labeled Amtrak's proposal "an outright assault" on employees' pensions. And as Ross Capon, executive director of the National Association of Railroad Passengers, points out, the pension plan is pretty much a "third-rail issue" for the 200,000 unionized railroad workers in the United States. Says Capon: "I think the [various railroad] unions would rather see Amtrak shut down than set a damaging precedent."

Planes, Trains, and Government Grants
The list of those wanting to see Amtrak shut down — or at least radically altered — is getting longer each year. To critics, Amtrak represents all that's wrong with big government: waste, institutionalized indifference, lack of accountability. Moreover, bashers argue that rail travel is a technology past its prime. "Trains are not practical," argues Utt. "In the time that one airplane goes back and forth 10 times [from Chicago to Seattle], trains have their capital tied up for 19 hours."

The on-time performance on many of Amtrak's overland lines hasn't helped matters. Overall, Amtrak's 13 long-distance lines (excluding the Northeast Corridor) recorded a 43.5 percent on-time rate for the first nine months of the railroad's 2005 fiscal year. Trains on six of those routes arrived on schedule less than one in three times — a dismal performance that only adds fuel to the "liquidate Amtrak" sentiment.

Then again, Amtrak's poor performance (both in meeting schedules and budgets) is not entirely of its own making, says Smith. Of the 22,000 miles of rails the carrier traverses, he notes, only 730 are owned by Amtrak. In many cases, its trains travel on single-track freight routes. Even on the Northeast Corridor, Amtrak must accommodate cargo carriers and commuter lines. Says Utt: "There's not a shred of give in the system."

And while critics howl about the $30 billion or so Amtrak has received in federal subsidies since 1971, that largesse pales in comparison with what airlines received during the same period. Observers estimate that, from 1971 to 2004, federal and state grants for the construction of airports, improvements to the national grid system, and other items topped $2 trillion. The sector received nearly $15 billion in federal assistance after 9/11 — and still, airline after airline files for Chapter 11 protection.

In fact, it's not entirely clear if any form of inter-city transportation makes money, once you subtract federal and state subsidies. Smith notes that the federal government spends billions on research and development for military aircraft. Developed at great cost to taxpayers, the innovations in those planes eventually make their way into commercial aircraft. Adds Smith: "Nobody's helping us design trains."

Installment Plan
That fact is apparent in the recent brake problems that scuttled Acela service for five months. That disruption to the popular high-speed train service underscores a huge challenge facing Smith: repairing and replacing the railroad's deteriorating assets. Some of Amtrak's assets, things like overhead power lines and switches, went into service at the turn of the 20th century. In one report, the Department of Transportation's inspector general noted that "continued deferral [on capital spending] brings Amtrak closer to a major point of failure on the system."

Amtrak has earmarked $787 million for capital spending in its 2006 appropriations request. But most of the railroad's current projects will take several years to complete. "It does make it difficult to make long-term decisions when you have a year-by-year-by-year appropriation process," concedes Smith.

Smith's task will become more difficult if Amtrak's credit rating slips any further. In May, Standard & Poor's placed the railroad's BBB- rating on CreditWatch, with negative implications. "Without the [government] subsidy, the numbers wouldn't support the current credit rating," notes S&P analyst Lisa Jenkins.

A drop of just two notches would reduce Amtrak's debt rating to non-investment-grade, driving up the cost on future borrowings. That's worrisome, considering the railroad paid $203 million last year just to cover the interest expense on the mountain of debt taken on during the previous administration. "It's a lot [of debt] for a company of this size," Smith grants. "Heck, it's a lot for a company that operates at a loss and depends on federal funding."

Still, it's unclear what changes — if any — would push Amtrak into the black. Even critics within the DoT concede that passenger rail in the United States, as in other countries, will always require some government backstopping. But bringing more financial rigor and transparency to Amtrak would at least place Smith in stark contrast to earlier managers at the railroad, say observers.

So far, the CFO has moved to strengthen Amtrak's 250-member finance department, hiring more analysts. He has also launched plans to improve the railroad's outdated data-gathering systems. And he has brought a dose of reality to the profitability issue. "We can do a reasonable rate of return, but it's not going to be a rate of return that most people understand," he insists. "A large component of the return is going to be the social good we do."


In a sign that some lawmakers may understand that social good, the Senate recently began considering a bipartisan bill that would provide Amtrak with nearly $5 billion over the next six years for capital improvements. As of press time, the proposed legislation, which also empowers the DoT to assume some of Amtrak's debt, was still in committee. It won't likely come up for a vote until next year.

Until then, Smith will be busy trying to land a line of credit for Amtrak, most likely with his old friends at the FFB. Staring up at the framed letter from the agency on his office wall, he notes: "We don't have a line of credit. We're a $2 billion operation, and we don't have a line of credit."

Smith shakes his head. "I tell you, it's a hell of a way to run a railroad."

John Goff is technology editor at CFO.



A Model Train?

In announcing the Administration's free-market vision of Amtrak, Secretary of Transportation Norman Mineta attempted to debunk the notion that passenger rail service cannot be a moneymaker. "I just returned from a trip to Asia, where I saw firsthand how the Japanese have transformed failed passenger rail into a model of efficiency."

Indeed, critics of Amtrak often cite Japan's system — which features six private operators — as an example of train service done right. But while Japan's sleek bullet trains are impressive (and mostly on time), admirers ignore some salient details.

First, when Japan's government privatized the country's national rail service in 1987, it assumed nearly $300 billion in legacy debt — or roughly 4 percent of the country's gross domestic product. In addition, the government offers tax breaks to rail commuters and encourages train travel by imposing sizable taxes on gasoline. Further, freight carriers in Japan are not allowed to use the busiest part of the network during business hours. By contrast, Amtrak's trains compete with cargo carriers on the vast majority of rails the carrier traverses. Also important: passenger trains in Nippon travel relatively short distances between densely populated urban centers — a far cry from the 13 long-distance lines Amtrak operates.

So, are Japan's intercity passenger trains truly profitable? Depends on your definition. The government still invests in the rail network, relieving operating companies of a large expense. Moreover, the double-digit earnings reported by some of Japan's passenger services are above the rails — meaning they don't include such things as amortization of fixed costs. In 2004, depreciation and debt servicing totaled $852 million at Amtrak. The railroad's total loss? Just north of $1 billion. — J.G.




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