Kansas City Southern Industries, Inc. Business Information, Profile, and History

History of Kansas City Southern Industries, Inc.

Kansas City Southern Industries, Inc. (KCSI) controls a number of operations in its transportation and financial services divisions. Kansas City Southern Railway (KCSR) is KCSI's primary subsidiary, operating direct transportation service over approximately 4,000 miles of track primarily in the central and southern United States. As of the late 1990s, KCSI derived a substantial portion of its revenues from its fund management subsidiaries Janus Capital Corporation and Berger Associates, Inc., which together had assets of approximately $70 billion. KCSI also held 41 percent of DST Systems Inc., which supplied the financial services industry with record-keeping and computer services.

Entrepreneurial Beginnings

KCSI was founded on January 8, 1887, by Arthur Edward Stilwell, a native New Yorker and grandson of one of the builders of the Erie Canal. Stilwell's original goal was to provide passenger service and transport for local meat-packing houses and granaries. An astute entrepreneur--he was able to secure initial funding for the railway in a matter of hours--he recognized that considerable opportunity existed in the transport of coal, lead, and zinc from southern mines. In just over six months, he raised $2.5 million and in 1891 extended the line southward to Fort Smith, Arkansas. Two years later, despite a severe nationwide depression in the railroad industry, Stilwell secured $3 million in backing from a commodities broker in Amsterdam, the Netherlands, to extend the line directly south to the Gulf of Mexico, where goods could then be shipped to eastern markets by sea.

Stilwell's original intent was to extend the railroad to Shreveport, Louisiana, and use the tracks of other lines to continue the journey to the Gulf. Noting that coastal towns were periodically subject to violent hurricanes, Stilwell changed his mind and decided to route his lines to Lake Sabine, a well-protected body of water seven miles inland from the Gulf. He then built a port on the lake and dug a canal to connect it to the Gulf. Port Arthur, named after Stilwell, became the second largest grain port in the United States after New York City.

Stilwell left Kansas City Southern Railway Company in 1900, a year before oil was discovered in Beaumont, Texas. He was replaced by Leonore F. Loree, who made concerted but unsuccessful efforts in the late 1920s to merge the Missouri-Kansas-Texas Railroad, the St. Louis Southwestern Railroad, or Cotton Belt, and KCSR. Loree established KCSR's reputation as a well-run, professional business. His sound financial and operating philosophy helped the company weather the Great Depression of the 1930s, and in 1939 KCSR company purchased the Louisiana and Arkansas Railway, extending its territory through Baton Rouge to New Orleans, Louisiana, and westward to Dallas, Texas. KCSR's strength during the Depression led General Motors in 1939 to choose the railroad to test the first diesel-electric locomotive for passenger service in the United States.

Post-World War II Prosperity

A bitter battle ensued in 1944, when local businessmen wrested control of KCSR from East Coast investors, demanding the resignation of then Chairman Charles P. Couch. The nomination of William N. Deramus as president ushered in a new era for the company, during which it focused on developing business in existing territories that were experiencing a post-World War II industrial boom. By the early 1950s KCSR was one of the most profitable railroads in the country.

Building on a solid base of well-maintained railways, Deramus was instrumental in incorporating innovative technology to keep ahead of competition. He acquired surplus World War II radio equipment, helping KCSR become a pioneer in the use of microwave signals to control portions of the rail system from a centralized location. During the 1950s KCSI also became an innovator in developing computerized data processing systems to control the flow of paper work through the system, an expertise it later applied to providing computerized accounting systems for the railroad industry.

A profitable partnership between Deramus and his son William N. Deramus III began in 1955, when the young Deramus was president of the Chicago Great Western and Katy Railway. The father-and-son team began a joint study of a proposed propane line along the right-of-way of their respective railways. This led to a key role for both entrepreneurs in building the Mid-America Pipeline (MAPCO), which grew to become a major U.S. energy company. KCSR's small interest in MAPCO ended, however, when shares in MAPCO were distributed as dividends to KCSI stockholders in 1973 and later in 1982.

Diversification in the 1960s

In 1961 William N. Deramus III left his post at Chicago Great Western and joined his father in senior management of Kansas City Southern. Their partnership instituted a series of far-reaching transformations within the company, centering on the incorporation of Kansas City Southern Industries as a holding company, which in turn purchased Kansas City Southern Railway through a two-for-one stock swap with its investors. "The prospects for significant growth in the railroad industry are lacking," the younger Deramus told the International Commerce Commission (ICC) in 1962, "and the interest of shareholders can be better shared by diversification." At the time, this transaction was the largest in a trend among railroads to diversify in an attempt to remain viable in the face of growing competition from the trucking and airline industries.

The new Kansas City Southern Industries began a series of acquisitions starting in 1963 with the purchase of a 40 percent interest in Television Shares Management Corp., a Chicago-based mutual funds manager that attracted KCSI in part for its holdings in the electronics and aerospace industries. John Hawkinson was appointed president, and the name of the acquisition was changed to Supervised Investors Services Inc. (SIS).

As the volume of mutual fund transactions grew at SIS, Raymond P. Bammes and others at KCSI capitalized on KCSR's experience in computerized data processing to develop data management systems for mutual funds. A new company, DST Systems Inc., was incorporated in 1968 to market these systems to the financial services industry. In 1983 DST Systems Inc. went public, filing an initial public offering of 1.38 million shares. All shares were sold, and KCSI retained approximately an 86 percent interest. DST Systems grew to become one of the cornerstones of KCSI's financial services division.

In 1966 KCSI ventured into the broadcast media industry, purchasing six television and radio stations in Illinois and Missouri. The company acquired KRCG-TV and KWOS-radio in Jefferson City, Missouri; KMOS-TV in Sedalia, Missouri, for a purchase price of $3 million; and WEK-TV and WEEQ-TV in Peoria, Illinois, for $3 million.

In 1969 a new member of KCSI's legal department, Irvine O. Hockaday, discovered that Lee National Corporation had purchased 20 percent of KCSI stock and was secretly trying to gain control of the company. KCSI sued Lee National for $40 million to prevent the takeover on grounds that Lee National was an investment firm and was therefore barred from purchasing securities without prior Securities and Exchange Commission (SEC) approval. Lee countersued with two civil suits asking $110 million in damages; the company charged that KCSI management was engaged in a conspiracy to thwart Lee's legal attempts to participate in control of the company.

Ultimately, due to Hockaday's efforts, Lee National agreed in November 1970 to transfer its 21.5 percent interest back to KCSI in exchange for $23 million in cash, real estate, and other securities. Largely as a result of his handling of the Lee National affair, Hockaday was named president and chief operating officer of KCSI in 1971, replacing William N. Deramus III, who continued as chairman and chief executive officer.

The late 1960s were difficult years for KCSR. In 1967 the railway terminated its passenger service after three consecutive years of losses totaling over $7.2 million. KCSI had been expending the bulk of its energies in diversification ventures and ignoring the needs of the railway. Furthermore, during an industrywide probe of the effects of railroad diversification in 1971, the ICC's Bureau of Enforcement proposed an investigation into KCSI's activities.

Among other things, the ICC alleged, "If there has not been a deliberate policy to deprive the railroad of its non-operating assets and to drain off its operating revenues, management, in pursuit of its independent enterprises, has been so indifferent to the financial well-being of the railroad company as to accomplish the same result." The ICC went on to accuse KCSI of wasting $9 million in the spinning off of its north Baton Rouge development project and the transfer of most of the carrier's $44 million nonoperating assets to the holding company. Another issue was the use of $9 million of the railroad's cash in the purchase of Howe Coal Co. in the late 1960s, an investment that led to a $15.4 million write-off when the coal company became unprofitable. Despite these setbacks, KCSI reported a net income of $12.8 million in 1971, up from $5.9 million a year earlier.

Another lawsuit was brought forward in 1971, challenging the merger of Supervised Investors Services and Kemperco Inc. and asking payment of profits made through the stock swap. The consolidation between SIS and Kemperco resulted in Kemper Financial Services. One of the largest mutual fund managers in the United States, it handled more than $30 billion in dividends.

Rejuvenating the Railway in the 1970s and 1980s

By 1973 KCSR was in worse shape than it had been in 1962. Neglect of the railway division by KCSI was addressed when a civil engineer, Thomas S. Carter, was appointed president of KCSR. Carter asked the KCSI board for $75 million to improve rail beds, which he promptly received. The impetus for this massive rehabilitation program was a 20-year contract to transport coal to power plants in Louisiana and Texas. Continuing his renovation program using only money generated by KCSI operations, Carter invested more than $200 million by 1978 to make the 1,500-mile track one of the safest and most efficient in the nation. As a result of the improved rail lines&mdash well as a new coal delivery contract--coal tonnage grew from just above one percent of KCSR's cargo in 1973 to approximately 20 percent in 1982 and 33.1 percent in 1991.

KCSR's profits grew in the early 1980s, thanks to an increase in coal transport and a favorable mix of other freight traffic yielding high revenues. Likewise, DST and Pioneer Western Corp.--which marketed insurance and investment services through its subsidiary, Western Reserve Life Insurance Co.--grew rapidly from 1975 to 1981, in part because of the expanding mutual funds industry. In 1983 the company bought a majority interest in Janus Capital Corp. and Janus Management Corp., a Denver-based mutual funds company that managed nearly $120 million in assets for private accounts. Also in 1983 KCSI joined Telecom Engineering to form LDX Group Inc., a telecommunications holding company formed as an umbrella company for KCSI's erratically profitable broadcasting subsidiary, LDX Network Inc.

In 1986 William N. Deramus IV became president of KCSR, and by the company's centennial in 1987, the Deramus family boasted a 75-year history with the railroad. That same year KCSI unsuccessfully bid $2.6 billion for Southern Pacific Corp., a railway ten times the size of KCSR that was considering a merger with Santa Fe Railway.

KCSI reported a net loss of $33 million in 1988, after paying $50 million to settle lawsuits filed by Energy Transport Systems Inc., which was involved in a project to build a coal slurry pipeline from Wyoming to Texas. The transport company alleged that KCSR had conspired with other railroads to block construction of the pipeline, which would have competed with KCSR's coal transport business. In a separate but related suit, the court ordered KCSI to pay $844 million in damages to the state of South Dakota. The U.S. Circuit Court of Appeals later overturned the judgment and the matter was settled by mid-1989.

Export coal volume grew tremendously in 1989, and KCSR was poised to handle overflow from eastern ports into ports on the Gulf of Mexico, notably Port Arthur. The railroad acquired total ownership of the facilities in Port Arthur in 1991. In April of that year, a nationwide labor dispute threatened the railroad; a one-day strike ensued that was immediately halted by congressional intervention. A National Mediations Board was installed to settle differences and decreed that railroads could operate two-man crews, regardless of the number of cars and length of trains. As a result of this determination, KCSR was able to pare down the number of its train operators by one-third from 600 employees to 400.

KCSI's strong showing in its financial services division in the late 1980s reflected the booming growth of the mutual funds industry. When KCSI entered the financial services market in 1962, managed assets were about $50 billion nationwide. By the end of 1991 managed assets had grown to nearly $1.4 trillion. Janus Capital Corp. sold about 10 percent of all growth funds in 1991, prompting U.S. News & World Report to name it the top fund family in the United States.

KCSR's railroad tracks ran through a generally prosperous area of the Sun Belt and benefited considerably from local traffic. In the early 1990s the company had streamlined its railway operating procedures and, with total control of the facilities, was poised to handle an increased volume of coal transport, its primary moneymaker. KCSI had also tightened its financial services division, paring off unprofitable ventures. The company had learned from its nonproductive endeavors and planned to concentrate its energies in the areas in which it excelled: transportation and financial services.

Prosperity in the 1990s

Janus Capital and Berger Associates enjoyed tremendous growth in the early 1990s, as investment in mutual funds continued to rise throughout the United States. In 1992 revenues at Janus rose 134 percent, contributing a third of KCSI's operating income. The following year the company's fund businesses outstripped the railroad business for the first time in providing income for KCSI. The fund management provided $112 million out of KCSI's total of $175 million in pretax income.

Although DST Systems suffered some setbacks in the early 1990s, it held a strong position in its area of expertise and was expanding its services. DST's operating income dropped 33 percent in 1992 after losing Vanguard as a customer. The mutual fund leader had accounted for 10 percent of DST's business, and the company had to scramble for new accounts to make up the loss. DST was the leader in providing third-party services to the mutual fund industry in 1993, holding 40 percent of the market. The company was moving into new service areas in an attempt to supply all of the back-office needs of the mutual fund industry. To offer portfolio accounting and stock transfer services, DST entered into joint ventures with Kemper Financial and State Street Boston. It also moved into new industries by adding a subsidiary called Vantage Computer Systems to provide record keeping and custom software to the life and property insurance industry. Its 50 percent-owned Argus Health Systems used DST computers to process medical claims.

The success of its financial asset management segment allowed KCSI to invest in improvements to its railroad segment. Between 1987 and 1993 the company spent $500 million to modernize track and facilities and to purchase modern diesel locomotives. In 1992 KCSI purchased MidSouth Corp. for $220 million. The acquisition added approximately 1,200 miles of track in Mississippi and Alabama, almost doubling the size of the railroad. More importantly, it extended KCSR's line from Dallas to Birmingham, Alabama, complementing its traditional north-south line between New Orleans and Kansas City. The extension strengthened KCSR's position in the lucrative chemical hauling and intermodal segments.

Throughout the early and mid-1990s, KCSI debated splitting up the company to concentrate on either the railroad or the financial asset management segments. The trend toward diversification in the 1960s had led KCSI into the unusual combination of industries, and an equally strong trend in the 1990s toward divestiture and single-industry companies encouraged KCSI to sell one off. Plans to sell the railroad accelerated in 1993, and the company reached an agreement to sell with Illinois Central in July 1994. Three months later, however, the deal fell through and debate about the company's structure continued.

In 1995 KCSI sold 51 percent of DST to the public. The money gained in the initial public offering helped reduce the company's debt ratio.

In 1997 KCSI teamed with Transportacion Maritima Mexicana S.A. de C.V. (TMM) to bid on Mexico's northeast railroad concession. At $1.4 billion, the KCSI/TMM bid won the 50-year concession to operate the northeast line of Ferrocarriles Nacionales de Mexico. With the addition of this line, KCSR linked lines stretching from Chicago to Mexico City, forming what was being called "The Nafta Railroad."

In 1998 both the railroad and the financial asset management segments of KCSI were healthy. Plans to divide the two segments continued, although KCSI was then working on spinning off the financial asset management segment rather than the railroad.

Principal Subsidiaries: Kansas City Southern Railway Company; Carland, Inc.; Berger Associates, Inc. (87%); Janus Capital Corporation (83%); DST Systems Inc. (41%).