I'm not sure about that. I have heard of folks having problems with that, but I NEVER allow TSM to compress my .S files directly, because I like to correct some of the errors TSM conversion leaves/created (in a Unicode editor) before compressing, so I'm not sure. Doesn't TSM look to the MSTS directory for doing some of it's conversions (like if you have it make the .ACE files from the textures, it looks at "MakeACE" in the "../Train Simulator/UTILS" directory - another thing I don't leave up to TSM), so I suppose it's possible that the .S file compression makes use of something like that too, and if it's not finding the correct routine, it may fail.
There are plenty of options for compressing .S files (that I'm sure are better than allowing TSM to do it anyway). Why not just skip the step and use one of those other compression routines? There's Shape File Manager, Compiler/De-Compiler, Route Riter (which is probably overkill for just compressing .S files), and a few other utilities I'm sure you can find in the File Library.
Steve