Kansas City Southern will 'evaluate' options after regulators reject trust for CN merger

Kansas City Southern said Sept. 1 it will "evaluate the options available to us" after US regulators rejected a critical voting trust for Canadian National's pending $30 billion acquisition of KCS, potentially killing a massive rail deal that would have created the only end-to-end rail network from the Canadian oil sands into Mexico.

KCS said it will adjourn a previously scheduled Sept. 3 shareholders vote on the CN deal while continuing to discuss its options with CN. But KCS also will consider a roughly $27.3 billion acquisition offer from the smaller rival, Canadian Pacific, which carries less regulatory risk and already has a voting trust approved by the US Surface Transportation Board.

After having rejected the revised CP offer earlier in August, the KCS board said it "will evaluate CP's proposal in accordance with the terms of KCS' merger agreement with CN and respond in due course."

KCS said its acquisition offer is valid through Sept. 12

The day prior, the STB 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."

CN expressed its disappointment in the STB ruling, but added its deal still represents the best offer. However, in the past, CN has acknowledged the deal could fall apart without the voting trust. 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 that 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.

"We remain confident that our pro-competitive, end-to-end combination is in the public interest and that it would offer unparalleled opportunities and benefits for customers, employees, the environment and the North American economy," CN said in a prepared statement.

However, Canadian Pacific emphasized that its smaller, but less risky offer still stands, and that its offer is the only one that can realistically be completed.

"The STB decision clearly shows that the CN-KCS merger proposal is illusory and not achievable," said CP CEO Keith Creel in a statement.

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 will 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 USGC now, adding KCS would allow CN to further dominate the crude-by-rail market.

In its 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."

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."

Regulatory questions

The White House recently expressed concerns about any more major railroad consolidation in a July executive order. That order came after the 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 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.