Canadian Pacific ups offer for Kansas City Southern in bid to break up CN deal

Canadian Pacific Railway said Aug. 10 it is making a counteroffer for Kansas City Southern of more than $27 billion in a bid to break up rival Canadian National's pending acquisition of KCS that has moved forward amid an environment of great regulatory uncertainty.

While Canadian Pacific's new cash-and-stock offer of about $27.3 billion falls short of CN's nearly $30 billion deal, the proposal is still well up from CP's original merger agreement with KCS of about $25 billion that KCS ultimately spurned back in May.

CP had refused to enter into a bidding war at the time but is now raising its offer with the thought that the CN deal may not pass regulatory muster with the US Surface Transportation Board.

Either CN or CP buying Kansas City Southern would create the only Canada-to-Mexico rail network in North America that could move Canadian crude exports to the US Gulf Coast and refined products to Mexico. That combination is expected to prove more beneficial thanks to the revised United States-Mexico-Canada Agreement trade deal. With only CN having rail routes stretching from Alberta to the US Gulf Coast now, adding KCS would allow CN to further dominate the crude-by-rail market.

KCS shareholders are scheduled to vote on the CN deal Aug. 19 while still awaiting a decision from the STB on whether it will approve a voting trust that is considered critical for the deal to win necessary support. Because CP is notably smaller than CN, and because CP has no logistical overlap with KCS, there could be less regulatory risk in a potential CP deal.

"We believe that now is the right time for us to re-engage with KCS, as the regulatory uncertainty of the proposed CN merger has placed KCS stockholders in the unfortunate position of having to vote on the proposed CN merger and, as a consequence of approving such proposal, eliminate KCS's ability to consider superior offers, all the while not having any level of certainty with respect to whether the STB will approve CN's use of a voting trust," CP CEO Keith Creel said in a letter to CN shareholders.

"We are excited to provide KCS stockholders a significantly more attractive alternative to this situation: this opportunity to turn down the CN merger proposal and once again pursue a combination of CP and KCS — a more certain transaction which offers compelling short-term and long-term value that is actually achievable, already has the benefit of STB approval to use a voting trust and is, in our view, the only viable Class 1 merger," Creel added.

CN responded that its deal "remains superior and the best option for both companies' stakeholders to deliver on a combination that will enhance competition and provide new servicing options for customers." CN also reiterated it is confident it will receive regulatory support from the STB.

Kansas City Southern said its board of directors will evaluate the new counteroffer and respond in due course.

With only seven major freight railroad companies left in North America, CP's argument is that only the two smallest — CP and KCS — should be allowed to merge because their networks do not overlap and meet neatly in Kansas City, Missouri. Approving the CN-KCS deal or any others would set a dangerous precedent inevitably leading to more mergers in an already consolidated industry, CP said.

The White House recently expressed concerns about any more major railroad consolidation in a July executive order, and that order came after the US Justice Department already stated its opposition to the CN deal and after the STB indicated the deal would face a high degree of regulatory scrutiny.

The CN-KCS merger potentially depends on the approval of a voting trust from the STB. Part of CN's argument is KCS shareholders have nothing to lose because they would be paid from the voting trust even if the deal fails to receive regulatory approval.

CN and KCS said the plan is to close the deal within the voting trust during the third quarter, but not combine until 2022 upon full STB approval. If the merger falls through, CN would owe KCS a $1 billion breakup fee.

While Creel said the CN deal eliminates choice and competition, CN instead has contended its acquisition would result in cheaper customer rates, more selection, new rail construction, and that it would steal market share from the trucking industry. CN also said it would sell a duplicative section of rail in Louisiana between New Orleans and Baton Rouge to alleviate regulatory concerns.

CN has a lot of north-to-south parallel routes with KCS, but the only direct overlap is in Louisiana. CN's existing rail network moves crude to the refining hub of St. James, Louisiana, but KCS additionally offers more direct access to hubs along the Texas Gulf Coast and into Mexico.

Regulatory questions

The STB already approved a voting trust for CP, but rejected it for CN, arguing that CN did not yet have an acquisition agreement in place with KCS, so the second application was jointly filed May 26. If the trust is rejected, then the merger could still fall apart, CN executives have acknowledged.

Also in question are STB's updated merger regulations from 2001 that require major deals to show they are in the public interest. Since then, no major rail mergers have come to fruition, not counting Berkshire Hathaway's 2010 acquisition of US leader BNSF.

The STB already waived the 2001 regulations to the now-defunct CP deal with KCS because KCS is the smallest major US railroad and is more regionally focused with less overlap with competitors. But the waiver was rejected for the CN-KCS deal, meaning the more stringent regulatory process applies.

CN noted it would only have the fifth-largest rail network in the US if it acquires KCS. Within all of North America, however, CN would grow large enough to rival the two biggest railroads, BNSF and Union Pacific.