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RailWorks to reorganize; drop in earnings expected


Citing higher interest rates and a slowdown in transportation spending, RailWorks Corp. announced yesterday that it will streamline operations and implement a restructuring plan that will result in a $35 million to $45 million third-quarter charge against earnings.

A plan to sell the Baltimore-based railroad construction and services company to a "leading financial sponsor" and certain members of the management team also has been called off, the company said. The company expects a gradual recovery and has downgraded second-half 2000 earnings to zero to 10 cents per share.

The news surprised analysts, who had predicted earnings of 60 cents per share and continued growth for the company. It also sheds light on RailWorks' decision Tuesday to cancel plans to purchase the transportation division of AAI Corp., a Hunt Valley defense contractor.

Neither AAI nor RailWorks disclosed why the deal fell through. A spokeswoman for AAI's parent company, United Industrial Corp., said Wednesday that the company is pursuing other buyers for the division, which builds rail car components and does overhaul work for transit systems.

Officials at RailWorks' Baltimore headquarters declined to comment yesterday. The company, which employs about 30 people in Baltimore and more than 3,500 nationwide, began selling its stock in 1998 at an initial price of $12 per share. Yesterday, it's shares fell 54 percent, or $4.50, to end the day at $3.88 per share. Trading volume was 72 times the three-month daily average.

"Obviously, they're under pressure from shareholders to do something," said Arthur W. Hatfield, an equity analyst with Morgan Keegan & Company Inc. "The question is, do they find somebody out there willing to pay for the company considering what the fundamentals are?"

RailWorks' troubles can be traced in part to the bureaucratic and cyclical nature of the public transportation business and partly to its unique organizational structure, which makes it vulnerable to rising interest rates. In a fast-paced age of Internet investing, its stock has languished as a result of its poor liquidity. Despite RailWorks' rapid growth and sizable backlog of contracts, institutional investors are reluctant to buy stock that they might not be able to sell quickly when the market turns sour.

"You have big shareholders out there today who are losing millions of dollars because they can't sell their stock," Hatfield said.

Though it was formed only about two years ago, RailWorks is actually a collection of 35 mostly older companies that serve various niches in the rail and mass transit industry. Member companies do everything from constructing new transit systems to disposing of old railroad ties.

In financial circles, it's known as a "roll-up." A roll-up results when a pool of small- to mid-sized companies that operate within the same industry are consolidated into a larger company in hopes of achieving new economies of scale and brand recognition. RailWorks was founded when 14 companies merged, each taking equity in the new entity. L. K. Comstock, an electrical contractor based in White Plains, N.Y., was the primary founder, accounting for 40 percent of 1998 revenues.

Roll-ups were popular with investors in the mid-1990s. But RailWorks is among several roll-ups that have stumbled since their inception, leaving the organizational concept with a tarnished image on Wall Street.

To succeed, roll-ups must rapidly acquire new companies, increase revenue exponentially and drive up their stock price to finance more purchases.

RailWorks was no exception. In 1999, the company grew revenue to $468.1 million, a 120 percent increase over the prior year. And it has grown from 14 founding companies to 35.

The Transportation Equity Act for the 21st Century, or TEA-21, was expected to help fuel RailWorks' growth. Signed into law in June 1998, the act meant billions in federal dollars would be spent to encourage cities to grow their mass transit systems. Transit authorities, railroads and industrial companies are RailWorks' primary clients. The New York Transit Authority accounted for 17.7 percent of the company's 1999 revenue, according to Morgan Keegan.

But federal transportation spending has come more slowly than expected, contributing to reduced revenues, RailWorks said in its news release. The New York Transit Authority also has slowed spending on rail transit projects as a result of a temporary delay in state funding. As a result of tabled mergers, even Class I railroads have scaled back expected spending on maintenance and capital programs. All this comes at a time when the company says its borrowing costs have increased.

Morgan Keegan's Hatfield, who once gave RailWorks his highest rating, says he expects the company's recovery to take well into next year.

"It's a long end game," he said.

Most likely, he said, the company will try to find a buyer, or its management team could attempt a buyout and take it private. However, he said the latter scenario is unlikely given the current state of the company's balance sheet.

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