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Caterpillar expected to make Electro-Motive more competitive

(Dow Jones Newswires circulated the following story by Bob Tita on June 4, 2010.)

WASHINGTON, D.C. — Caterpillar Inc.'s (CAT) purchase of Electro-Motive Diesel Inc. will enable to the locomotive builder to pursue the market share it's lost in recent years to General Electric Co. (GE), said Electro-Motive Chief Executive John Hamilton.

Caterpillar, the world's largest manufacturer of construction machinery, revealed Tuesday it intends to purchase Electro-Motive from a pair of private-equity firms for $820 million. The deal is expected to close before the end of the year. The LaGrange, Ill., company is a distant second to GE in a North American locomotive market comprised of just the two companies.

Hamilton said Electro-Motive has about 30% of the North American market, down from about 40% a few years ago. The company's inability to match GE's investment in new product development left Electro-Motive at a disadvantage in the domestic market. Moreover, Hamilton acknowledged that some railroad customers have been concerned about Electro-Motive's viability as a stand-alone company.

"That anxiety completely vanishes," Hamilton said in an interview with Dow Jones Newswires. "Customers are reacting positively to this deal. They've got a strong supplier to buy locomotives from. I do think there'll be [market] share change."

Electro-Motive, or EMD, is expected to leverage Caterpillar's engineering talent as well as the engines it uses for off-road construction equipment and power generators. The deal, which is expected to close by the end of the year, is regarded as complementary to Caterpillar's Progress Rail unit, a rail car service and track maintenance business that the Peoria, Ill., company bought in 2006.

But industry analysts say chipping away at GE's market lead will be difficult and costly for Caterpillar, which is accustomed to leading the pack in its construction equipment markets. Freight railroads have limited experience with locomotives powered by Caterpillar engines. Meanwhile, developing a new variant of Electro-Motive's high-horespower engine will be expensive and time-consuming.

"The EMD engine is still a popular engine, but they haven't made the level of investment that the rail industry would like to see," said Edward Burkhardt, chief executive of Chicago-based Rail World Inc., a management company that owns regional railroads in the U.S., Canada and Europe. General Electric has "steady improved their engine, that's why they've gained share."

A spokesman for General Electric's transportation unit declined to comment on Electro-Motive's equipment, but added the diversified industrial company considers the purchase of EMD as a positive development for the rail sector.

"We view Caterpillar's acquisition of EMD as a vote of confidence in the long-term profitability of the rail industry," said Stephan Koller, a spokesman for GE.

But Caterpillar's transformation of Electro-Motive is likely to face additional headwinds from a depressed market for locomotives. North American production is running at half the rate of a couple of years ago, as railroads scaled back their purchases of locomotives in the wake of car-load traffic falling nearly 20% last year from 2008.

"The railroad industry still isn't hauling the freight that it was two years ago," said Toby Kolstad, president of Rail Theory Forecasts LLC, an Oregon-based consulting firm. "The railroads have locomotives in storage, so they don't need new equipment."

Kolstad predicts locomotive production in North America will total no more than about 400 units this year and will remain below 500 units for the next three to five years. From 2003 to 2008 production averaged 800 to 1,000 units a year.

The longer the market slumps, however, the longer Caterpillar would have to wait to recoup investments in Electro-Motive, which had sales last year of $1.8 billion.

Hamilton declined to reveal specifics about Electro-Motive's performance while the sale of the company is still pending, but he added the business was profitable last year. He said Electro-Motive has income-generating options beyond head-to-head competition with GE for sales of new equipment.

In recent years, Hamilton has redoubled the company's efforts to sell parts and service for EMD locomotives already in service. Electro-Motive's 50-year dominance over the locomotive market until the 1980s created a base of EMD locomotives that's twice the size of General Electric's existing fleet.

Train locomotives typically remain in service for decades, consuming replacement parts and undergoing multiple engine overhauls. Earlier this year, Electro-Motive opened an engine remanufacturing plant in Mexico.

"EMD didn't do any of its own remanufacturing before," Hamilton said. "It's a market we should be doing much better in."

Hamilton managed EMD since 2005 when Berkshire Partners LLC and Greenbriar Equity Group LLC bought the business from General Motors Corp. for $201 million.

Electro-Motive also has been emphasizing sales to overseas railroads, particularly in developing countries where investment in railroad infrastructure is surging. With the domestic market slumping, three of every four locomotives the company builds are now shipped to overseas, compared with one out of four locomotives five years ago, Hamilton said.

Caterpillar's stock ended Friday down 5.4%, or $3.35, at $57.76.

Monday, June 7, 2010

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