Canadian Pacific 'ready to re-engage with KCS' if regulators reject Canadian National voting trust

Canadian Pacific Railway stands ready to re-engage with Kansas City Southern to acquire the US railroad if its deal falls through with its larger rival Canadian National, CP CEO Keith Creel said July 28 during an earnings call.

The pending, nearly $30 billion CN-KCS deal is potentially hinging on an upcoming decision in August from US regulators on whether to approve a voting trust that is considered critical for the deal to win shareholder approval. If the US Surface Transportation Board rejects the voting trust because of anti-competition concerns, CP could jump back into negotiations again.

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.

"We stand ready to re-engage with KCS should the STB rule in opposition to Canadian National's trust," Creel said during CP's earnings call, arguing that CP offers the only deal likely to pass regulatory muster. "It's all winners; there's no overlap. We have a path to approval."

CP previously planned to acquire KCS for about $25 billion back in March, but KCS spurned the deal in May -- paying CP a nearly $700 million breakup fee -- after CN stepped up with a nearly $30 billion offer.

But the White House 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.

"Our combination is pro-competitive and it will lead to significant customer benefits," CN CEO JJ Ruest said last week. "We are within a few weeks of a decision from the STB."

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.

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.

The public comment period for the voting trust expired on June 28 and CN and KCS jointly submitted their response July 6, leaving the matter up to the STB in the coming days and weeks ahead.

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.