US STB rejects voting trust for Canadian National acquisition of Kansas City Southern, possibly killing deal

US regulators Aug. 31 rejected a critical voting trust for Canadian National's pending $30 billion acquisition of Kansas City Southern, potentially killing a massive rail deal that would have created the only end-to-end rail network from the Canadian oil sands into Mexico.

The US Surface Transportation Board decided the CN-KCS deal carries too many anti-competition risks and could set a precedent that would quickly trigger more consolidation within the rail industry. Therefore, the STB said approving the voting trust "would not be consistent with the public interest."

While the STB ruling does not prevent the CN-KCS deal, the acquisition was built upon approval of a blind trust because much of CN's argument was KCS shareholders would have nothing to lose. The investors would have been paid from the voting trust this year even if the deal failed to receive full regulatory approval in 2022.

The STB ruling now opens the door for the smaller rival Canadian Pacific to revive its talks with KCS. CP has a standing offer of more than $27 billion to acquire KCS. While less money is involved, the STB already approved a voting trust for CP because CP and KCS do not have any overlap; their rail networks meet neatly in Kansas City, Missouri.

Initially, KCS agreed to be acquired by CP this year before spurning CP in favor of CN's larger, but riskier, offer. If the merger falls through, CN would owe KCS a $1 billion breakup fee.

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.

In the Aug. 31 ruling, STB said, "Applicants have failed to establish that their use of a voting trust would have public benefits, and the board finds that using a voting trust, in the context of the impending control application, would give rise to potential public interest harms relating to both competition and divestiture."

STB placed the blame on CN for relying so heavily on a voting trust. "CN voluntarily assumed the risk that the voting trust might be rejected when it chose to make a voting trust an essential element of its offer, knowing that a CN-KCS proposed transaction presents geographic network overlap and that voting trusts must meet a heightened public interest standard for approval in major control proceedings under the current regulations."

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. CN said it would sell a duplicative section of rail in Louisiana between New Orleans and Baton Rouge to alleviate regulatory concerns.

STB emphasized, however, that the CN-KCS "competitive overlap" extends well beyond Louisiana. "Applicants operate parallel lines through the central portion of the United States and compete for north-south traffic on these lines, particularly where KCS's network parallels the section of CN's network that CN acquired from Illinois Central in 1999. If the voting trust were approved, there would be a heightened risk of reduced incentive to compete for this business as well."

Regulatory questions

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-KCS deal and after the STB indicated the deal would face a high degree of regulatory scrutiny.

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 has repeatedly said.

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.