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CN Rail Chief Pounces While Kansas City Southern Is in Play

Thomas Black and Derek Decloet
·6-min read
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(Bloomberg) -- Canadian National Railway Co. offered $30 billion to snatch Kansas City Southern from a rival, spurring a possible bidding war in one of the industry’s biggest potential deals in decades.

The bid of $325 a share consists of $200 in cash and 1.059 Canadian National shares for each share of Kansas City Southern, Montreal-based CN said in a statement. Canadian National gave its offer an enterprise value of $33.7 billion.

Tuesday’s offer tops a $25 billion deal Kansas City Southern reached with Canadian Pacific Railway Ltd. last month.

Canada’s two biggest railroads are vying for a rail network that links their country with the U.S. and Mexico as a reworked trade alliance gets underway and the economic recovery from the Covid-19 pandemic gathers steam. Kansas City Southern’s sprawling system connects farms in the U.S. Midwest to ports along the Gulf of Mexico. It also reaches deep into Mexico, which made up almost half of the Kansas City, Missouri-based company’s revenue last year.

“Railroads don’t come for sale very often,” Canadian National Chief Executive Officer Jean-Jacques Ruest said in an interview with Bloomberg TV. “Our vision has been for a long time to create a very solid north-south network.”

Canadian Pacific attacked the bid in a written statement Tuesday afternoon.

“Canadian National’s proposal is illusory and inferior because it creates adverse competitive impacts and raises other serious public interest concerns,” the Calgary-based railway said. “CN’s proposal increases regulatory and antitrust risk for KCS shareholders and decreases benefits for customers, employees and other stakeholders.”

Truck to Rail

Canadian National estimated that there’s a pool of about $8 billion of annual truck freight that it could convert to rail and projected that a deal would add to earnings in its first full year. Profit could increase more than 10% when efficiency gains kick in, the company said.

The combination would create a “railroad that can really rival with truck,” Ruest said on a call with analysts. “A lot of the freight today that moves north-south is only getting a partial ride by rail or is actually moving all truck, and these are huge distances.”

Stephens analyst Justin Long expressed surprise at Tuesday’s offer, given the healthy price that Canadian Pacific had agreed to pay.

“But we think Canadian National understood the competitive challenges this deal could present, given the much broader geographic reach of the pro forma CP network,” he wrote. “The Canadian rails face-off has begun.”

Whoever doesn’t win Kansas City Southern would face a competitive disadvantage, making a bidding war likely, said Citigroup analyst Christian Wetherbee.

​“We believe it’s likely that CP remains engaged and may try to come back with a higher bid,” he said in a note to clients. “This clearly would stretch valuation but could be justified by the long-term growth potential of the combined entity.”

Kansas City Southern said it would evaluate the new offer and respond in “due course.” Canadian Pacific didn’t return a request for comment.

Kansas City Southern rose 15.3% to close at $295.50 in New York. Canadian National slumped 6.3% to C$138.85 in Toronto, its biggest drop in 13 months, while Canadian Pacific fell 2.2% to C$447.71.

Canadian National already has large U.S. operations, adding its Chicago-New Orleans line with the purchase of Illinois Central Railroad in 1998. The Canadian railroad overlaps with Kansas City Southern along roughly 70 miles (about 110 kilometers) in Louisiana of its 7,000-mile network and affects only five major customers, the company said. The two networks also run parallel about 40 miles apart during stretches in the southern U.S.

Canadian Pacific’s U.S. tracks don’t extend south beyond Kansas City, so it’s planned merger would give the railroad its first access to busy U.S. ports on the Gulf of Mexico.

The Canadian railroads are longtime rivals with interlacing histories. Canadian National was privatized from government ownership in the 1990s and outperformed its smaller competitor for much of the early 2000s, cutting costs and expanding its network south through acquisition.

In 2012, Canadian Pacific shareholders rebelled, backing hedge fund manager Bill Ackman in a proxy fight to replace the board and install Hunter Harrison, its rival’s former leader, to be chief executive officer. Harrison then poached Keith Creel from Canadian National. Creel is now Canadian Pacific’s CEO. Harrison died in 2017.

In 2016, Canadian Pacific paid C$25 million ($20 million) to its rival to settle a lawsuit claiming that Canadian Pacific had pilfered customer lists using employees that had moved between the railroads.

Regardless of which offer ultimately wins, it is likely to get close scrutiny as U.S. regulators study whether to approve the biggest rail merger in two decades. Canadian Pacific has already crossed swords with the U.S. Justice Department over a voting trust the company plans to use to close its deal.

What Bloomberg Intelligence Says:

“A deal would create North America’s third-largest railroad, meaning the regulatory hurdles for clearance are going to be higher than the $25 billion deal KCS accepted from Canadian Pacific. The latter combination would still be the smallest Class I railroad, interchanging in only one spot. KCS interchanges with Canadian National in Springfield, Illinois and East St. Louis, Missouri.”-- Lee Klaskow, BI transportation analyst

Click here to read the research.

Canadian National also plans to use a voting trust, which would hold shares of the new entity and allow control to change hands before gaining regulatory approval. In both proposals, the U.S. and Canadian railroads would operate independently while awaiting government sign-off.

Either deal would also face a question over whether a purchase of Kansas City Southern, the smallest of the major U.S. railroads, should be subject to a tougher U.S. standard adopted in 2001 for railroad mergers. The Surface Transportation Board, which has final authority, had exempted Kansas City Southern from the new rules, which require a transaction to benefit the public and improve service. The Justice Department, in an advisory role, had urged using the higher standard.

Both Canadian National and Canadian Pacific expressed confidence that their proposals would be approved regardless which standard is used.

JPMorgan Chase & Co. is advising Canadian National, while Bank of America Corp. and Morgan Stanley are advising Kansas City Southern. BMO Capital Markets and Goldman Sachs Group Inc. are Canadian Pacific’s financial advisers.

(Updates with statement from Canadian Pacific and closing share price. An earlier version of this story corrected Canadian Pacific’s stock movement in premarket trading.)

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