‘Canadian rails face-off has begun’
CN, CP may be headed for a bidding war over Kansas City Southern
Canada’s two iconic railways may be headed for a bidding war after Canadian National Railway Co. offered US$33.7 billion for Kansas City Southern on Tuesday, topping an earlier bid from rival Canadian Pacific Railway Co.
The offer from Montreal-based CN comes one month after CP launched a friendly agreement to buy the U.S rail operator — whose routes extend to the Pacific Gulf and into Mexico — for US$25.2 billion.
“We think that the combination of CN and KCS will create the premier railway for the 21st century, connecting ports in the United States, Mexico and Canada to facilitate trade and economic prosperity across North America,” CN spokesperson Mathieu Gaudreault said in an email. “Overall, we are the better bid, better partner, the better railway and the best solution for KCS and the North American economy.”
CN’S cash-and-stock offer of US$325 per share includes US$200 in cash and 1.059 shares of CN stock per KCS share. The deal represents a 27 per cent premium to Kansas City Southern’s closing price of US$256 on Monday and a 45 per cent premium to the price prior to CP’S offer, according to CN. CP’S bid stands at US$275 per share, including US$90 in cash.
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.”
But shareholders will have more to think about than just the sticker price. While CN’S offer is higher, it provides shareholders with less of an equity stake in the combined company than the CP deal, according to Deutsche Bank analyst Amit Mehrotra.
“What’s important for KCS is a deal that allows existing shareholders to earn a nice premium today and also be able to participate in the upside of the combined entity,” Mehrotra said in a phone interview. “CN may say that cash in your hand today is worth more than some hypothetical value in the future, whereas CP may say that we’ll be real partners in this and you can participate in a much bigger degree in the upside of the combined entities.”
CN also offered to include four of KCS’ directors on its board and said that Kansas City would become the combined company’s U.S. headquarters. The company launched a website touting the advantages of its offer for customers and shareholders, and chief executive J.J. Ruest conducted interviews on U.S. broadcast networks to promote the deal to American audiences.
“We’re reaching out to Kansas City, their shareholders, their board members and their employees to create a solid continental railroad,” Ruest said on CNBC.
KCS closed up 15 per cent Tuesday at US$295 in New York. CN closed down seven per cent and CP slumped two per cent in Toronto.
Both proposed mergers would create true North American rail networks that touch the U.S., Mexico and Canada.
CP’S rail system currently runs from coast-to-coast in Canada, but only as far south as Kansas City in the U.S. The deal would provide it access to high-traffic ports in the Gulf of Mexico. CN, meanwhile, already reaches as far south as New Orleans.
Whichever railway loses will miss out on key trade routes and could face a significant competitive disadvantage.
“We believe it’s likely that CP remains engaged and may try to come back with a higher bid,” said Citigroup analyst Christian Wetherbee. “This clearly would stretch valuation but could be justified by the long-term growth potential of the combined entity.”
CN said that the merger could yield US$1 billion annually in new revenue opportunities and savings by reducing truck costs.
CP declined request for comment. KCS said in a press release the offer from CN was unsolicited but that its board would consider the bid.
KCS’S board earlier recommended CP’S offer, but the deal needs the approval of shareholders and regulators.
While KCS is the smallest of the large railroads in the U.S., a takeover from either Canadian firm would need the endorsement of the Surface Transportation Board, a U.S. regulator that requires that mergers enhance competition and avoid reducing choices for customers.
CP and KCS released a joint statement on Tuesday afternoon saying KCS’ largest customer, Kansas City-based flour miller and feed manufacturer Bartlett Grain, had added its name to a list of 405 stakeholders that have submitted letters of support to the STB.
CN’S offer, meanwhile, could face scrutiny from the STB because about 65 miles of its existing track — less than one per cent of its 7,500-mile network — overlaps with the KCS network near New Orleans.
On an investor call Tuesday morning, CN said that it would explore alternatives to garner the regulatory board’s approval, efforts that could include selling track, according to Mehrotra.
“It will be harder for Canadian National to get this through the regulatory process than CP, because of their relative size and the fact that there is overlap,” he said.
In a press release, CP alleged CN’S proposal was anti-competitive.
“Canadian National’s proposal is illusory and inferior because it creates adverse competitive impacts and raises other serious public interest concerns,” the company said in the release. “CN’S proposal increases regulatory and anti-trust risk for KCS shareholders and decreases benefits for customers, employees and other stakeholders.”