STB call alters KCS plans
Decision likely kills $33.6 billion deal while reviving Canadian Pacific’s merger effort
THE KANSAS CITY SOUTHERN
merger saga took a dramatic twist on Aug. 31 when federal regulators denied Canadian National’s request to put KCS into a voting trust. The decision almost certainly dealt a fatal blow to the $33.6 billion CN-KCS combination, and prompted KCS to revive talks with its previous merger partner, Canadian Pacific.
The Surface Transportation Board said CN and KCS adequately explained how the voting trust would insulate KCS from unlawful control by CN while the merger is under regulatory review. “But the Board finds that the proposed use of a voting trust, in the context of their impending control application, would not be consistent with the public interest,” the STB said in a unanimous, 33-page decision.
Placing KCS into a voting trust — a key first step in the merger process— would potentially harm the public interest in two ways, the board said. The first would be its potential impact on competition between CN and KCS while the merger is under review. The second was if CN were forced to sell KCS if the merger were ultimately rejected.
The STB said the Class I merger rules adopted in 2001 changed the board’s votingtrust standard. But the board said a voting trust was not essential and that CN and KCS could still proceed using different deal terms. Analysts considered that highly unlikely, particularly in light of renewed CP-KCS merger talks.
CP and KCS announced their $29 billion merger deal in March, only to have KCS accept CN’s higher offer in May. CP in August sweetened its deal to $300 per share, or $25 below CN’s offer, to give KCS shareholders an alternative to CN.
A CP-KCS merger has a much easier regulatory path: The STB has already approved CP’s proposal to put KCS into a voting trust and would review a CP-KCS merger under the lessstringent, pre-2001 merger review rules.
CN had argued its KCS trust proposal was identical to CP’s plan and therefore should receive the board’s blessing as well. The STB disagreed, noting the CN-KCS merger would be judged under the tougher new merger rules. The STB also said the mergers are fundamentally different because CP-KCS would be a true end-to-end merger, while CN-KCS involves some route overlap.
The STB also said that approval of a CN-KCS voting trust arrangement could lead to further consolidation among Class I railroads, particularly
“A CP-KCS COMBINATION IS SUBSTANTIALLY DIFFERENT. ... IT IS AN END-TO-END MERGER, WHEREAS THE CN SYSTEM OVERLAPS KCS.” — CANADIAN PACIFIC CEO KEITH CREEL
since an expanded CN would put CP at a competitive disadvantage.
Railroads commonly use voting trusts to allow the railroad being acquired to remain independent while the merger is under regulatory review. Absent a voting trust, it’s possible another suitor for KCS could emerge and top CN’s bid, analysts and railroads have said.
The decision was a major victory for CP, which has maintained all along that the only viable Class I railroad merger was between CP and KCS. “The ruling … confirms what we’ve always believed to be true. And I’ll use their words: A CP-KCS combination is substantially different, substantially different. Those are key words. It is an end-to-end merger, whereas the CN system overlaps that of the KCS,” CP CEO Keith Creel said on Sept. 1.
If the KCS board accepts the $30 billion CP bid by a Sept. 12 deadline and its shareholders back the deal, the railways expected to file a merger application within weeks. If approved, it would be the first merger of Class I railroads in two decades.
The board’s ruling was a worst-case scenario for CN. Not only did its deal to create the first railway to link Canada, the U.S., and Mexico fall apart, it looks likely that smaller rival CP will acquire KCS and become a stronger competitor with a network that nearly mirrors CN’s.
Worse still: An activist investor immediately demanded the ouster of CN CEO JJ Ruest and Chairman Robert Pace, citing the KCS merger outcome and what it sees as CN’s financial underperformance over the past five years. London-based TCI Fund, which waged a successful proxy fight at CSX Transportation in 2008, in May had urged CN to drop the KCS merger bid, citing the regulatory risk involved.
“CN has lost its way and the business needs to be fixed as a matter of urgency,” TCI Managing Director Chris Hohn and Partner Ben Walker wrote in a scathing Aug. 31 letter to CN’s board. With a 5.2% stake in the company, TCI is CN’s secondlargest investor — as well as CP’s single largest shareholder. TCI said it had the support of at least 20% of CN’s investors, which was enough to call a special shareholder meeting where a management shake-up would be considered.
TCI recommended replacing Ruest with CN veteran Jim Vena and adding Gil Lamphere, a former board member at Illinois Central, CN, and CSX, to CN’s board along with four other people it did not name. Vena is fresh off an operational makeover at Union Pacific, where he was chief operating officer, a position he held at CN from 20132016. As IC chairman, Lamphere was an early proponent of E. Hunter Harrison’s Precision Scheduled Railroading operating model.