Kansas City Southern said it’s backing out of a merger agreement with Canadian National Railway Co. and plans to accept a competing offer from Canadian Pacific Railway Ltd., the latest step in the fight over which railroad would become the first to operate in Canada, the U.S. and Mexico.
Canadian Pacific’s proposal was declared superior even though at about $27 billion it’s lower than Canadian National’s $30 billion offer, which began to unravel last month amid questions over whether it would win regulatory approval. Canadian National has about five business days to negotiate terms that could change the U.S. railroad’s decision, Kansas City Southern said in a statement Sunday.
The months-long saga has now come full circle, after Canadian Pacific and Kansas City Southern initially agreed to a deal in March, only for Canadian National to swoop in with a higher offer. The Canadian companies are battling for the rare opportunity to acquire a U.S. railroad and build a network spanning much of North America.
Canadian Pacific’s offer values the U.S. railroad about about $300 a share. Kansas City Southern ended last week at about $280 in New York trading, up from about $224 before the CP’s overture became public on March 21. Canadian National shares fell 5.2% to C$150.74 in Toronto last week, while Canadian Pacific declined 4.1% to C$86.91.
Regulatory Roadblock
Sunday’s decision by Kansas City Southern looked increasingly likely after the U.S. rail regulator rejected Canadian National’s proposal for a voting trust, which would have allowed Kansas City Southern shareholders to be paid even before the combination received regulatory approval. The Surface Transportation Board’s forceful ruling on Aug. 31 against the trust proposal suggested it was unlikely the regulator would give final approval to the deal.
Canadian National’s offer was further undercut after the regulator raised issues with a possible decline in competition that went beyond 70 miles of overlapping track in Louisiana that was to be addressed with an asset sale. What’s more, the STB cited concern that the Canadian National-Kansas City Southern tie-up could kick off more acquisition activity because the deal would isolate Canadian Pacific mostly to Canada.
The ruling was a “stinging rebuke” of Canadian National’s proposal, Cowen analyst Jason Seidl said in a Sept. 7 note. It also gave Canadian Pacific the upper hand because the STB already had approved its voting-trust proposal and said its merger would be judged under less-stringent rules than Canadian National’s.
Canadian Pacific and Kansas City Southern had initially agreed earlier this year to a $25 billion merger, which was derailed by a surprise $30 billion counteroffer from Canadian National that the U.S. railroad accepted in May.
No Bidding War
Although Canadian Pacific Chief Executive Officer Keith Creel vowed not to get in a bidding war and predicted that the regulator would swat down the Canadian National proposal, he increased his bid to $27 billion only days before Kansas City Southern shareholders were scheduled to vote on Canadian National’s trust. The U.S. railroad postponed the vote until after the STB’s ruling.
On Sept. 4, Kansas City Southern said it would take a second look at Canadian Pacific’s offer and re-engage in talks.
“We are pleased to reach this important milestone and again pursue this once-in-a-lifetime partnership,” Creel said in a statement Sunday, calling the potential union a “perfect match.” “This merger proposal provides KCS stockholders greater regulatory and value certainty.”
Three Nations
The potential Kansas City Southern deal puts Canadian Pacific on track to be the first railroad to operate in Canada, the U.S. and Mexico, where Kansas City Southern gets about half of its revenue. The combined companies would have 20,000-mile network spanning from Vancouver to Veracruz, Mexico’s largest port on the Gulf of Mexico.
The deal would also allow Creel to compete more effectively with Canadian National, which already has a T-shaped network that reaches coast-to-coast in Canada and down to the U.S. Gulf Coast at New Orleans. The STB consistently praised the Canadian Pacific-Kansas City Southern deal as an “end-to-end” arrangement. The two networks don’t have overlapping track and meet only in Kansas City.
While Canadian National could attempt to sway Kansas City Southern with more money, the railroad already is feeling heat from shareholders to drop the deal. TCI Fund Management, which owns 5% of the railroad, is leading that charge with plans to call a special shareholders meeting to nominate five director to the board and task them with replacing Chief Executive Officer Jean-Jacques Ruest.
If Canadian National walks away, it won’t be empty-handed. Under the terms of the prior deal, Kansas City Southern is subject to a breakup fee of $700 million, which Canadian Pacific has pledged to reimburse.
