Blockbuster Rail Deal Faces Regulatory Slog as M&A Era Ends
(Bloomberg) -- Canadian Pacific Railway Ltd.’s agreement to buy Kansas City Southern faces a long journey to win regulatory approval from a powerful federal agency that approved two blockbuster mergers since it was created in 1996 and then tapped the brakes on industry consolidation.
While the Justice Department or Federal Trade Commission review mergers in other industries, railroad combinations must clear the five-person U.S. Surface Transportation Board.
“They have total authority over making the decision over whether this goes forward,” said Deb Miller, who served as a member of the board until in 2018. “I think this will get a very long and hard look from the board.”
Kansas City Southern closed down more 2% to $246.82 in New York, after surging 11% at the close Monday, the biggest gain in about a year. Canadian Pacific was down less than 1% at C$445.81 in Toronto after falling 5.4% Monday.
Canadian Pacific said in a statement that it expected board approval for the $25 billion deal sometime in 2022. The company said the merger would “create the first rail network connecting the U.S., Mexico, and Canada.”
But the process to win approval for a merger between two of the seven largest railroad companies in North America can take years instead of months, said Miller, who currently serves as director of the University of Kansas’ Public Management Center.
A potential merger the board considered between Norfolk Southern Corp. and Canadian Pacific was withdrawn in 2016 amid concern from other railroads and shippers, Miller said.
Miller predicted this deal would have better luck. Kansas City Southern is one of the smallest Class I railroads, which is defined by the board as rail lines with a 2019 revenue of at least $504 million, in the U.S. and it operates from north to south, diminishing concerns about displacing competitors’ east-to-west service, Miller said.
“Unlike some other potential mergers where you think ‘that is never going to happen,’ I think this one will be given very serious consideration,” Miller said.
Martin Oberman, chairman of the Surface Transportation Board, confirmed Tuesday the panel received a “notice of intent” regarding the proposed merger. It is the first major transaction to seek board approval in more than two decades, he said in a statement.
“The agency intends to scrutinize the transactions carefully and diligently,” Oberman said. “The agency is committed to moving forward expeditiously, while ensuring meaningful opportunities for public participation and stakeholder comment.”
Michael Booth, a spokesman for the board, said there is no set time for completion of the review.
“Each case has its own complexities,” Booth said. “It runs a lot like a court case. The railroads have to put in a filing for the purchase and we’ll have to review that. People will probably have a ton to say, and we’ll have to review that. There will be several public comment periods.”
The board is the successor to the Interstate Commerce Commission, which was disbanded by Congress in 1995. It is empowered to protect service reliability and settle disputes between shippers and railroads. Board members are Senate-confirmed and serve five-year terms. The panel is currently made up of three Republicans and two Democrats.
“It’s not going to be quick,” said Larry Mann, a rail safety expert with the law firm Alper & Mann.
Canadian Pacific announced the deal to buy Kansas City Southern on Sunday, creating the first railroad to traverse Canada, the U.S. and Mexico. The combined company would be called Canadian Pacific Kansas City, or CPKC, will have revenue of about $8.7 billion and almost 20,000 employees.
The transaction, if approved, would give the Canadian carrier access to the Missouri-based Kansas City Southern’s sprawling Midwestern rail network connecting farms in Kansas to ports along the Gulf of Mexico. It would also give it reach to Mexico, which made up almost half of Kansas City Southern’s revenue last year, and create the only network that cuts through all three North American countries.
“This transaction will be transformative for North America,” CP President and Chief Executive Officer Keith Creel said.
Previous CP efforts to merge with American rail companies CSX Corp. and Norfolk Southern never made it to regulators. Those deals faced opposition from shippers who raised concerns about competitive balance issues and were scuttled before the surface transportation panel weighed in.
Tony Hatch, a rail industry consultant, said CP and Kansas City Southern are the sixth and seventh biggest of the seven Class I railroad companies. The proposed combination would be a “stabilizing merger” that “takes two of the smallest Class I’s, puts them together and gives them a little bit of a bigger seat at the table.”
Hatch expects the merger to ultimately be approved by regulators.
Jennifer Hedrick, executive director of the National Industrial Transportation League, an association of shippers, said while the organization is “optimistic” about the new deal, “any merger in this industry and on this scale will be viewed with healthy skepticism based on prior history and experience of rail mergers.”
In 2000, the Surface Transportation Board imposed a 15 month moratorium on rail mergers to prevent over-consolidation. It then the imposed stringent rules designed to maintain competition.
The agency’s rules “require applicants to demonstrate that, among other things, a proposed transaction would enhance competition where necessary to offset negative effects of the transaction, such as competitive harm, and to address fully the impact of the transaction on service, including plans for service reliability,” according to a June 2001 press release.
CP has explored mergers with American rail companies before, but those mergers faced opposition from shippers who raised concerns about competitive balance issue. The Kansas City Southern tie-up could make Canadian Pacific more competitive with Canada National Railway Co.
The merger is expected to be one of the largest major attempts by freight rail companies to consolidate because the existing big U.S. rails are currently split into groups of two eastern and two western companies. It’s unlikely that a merger would win approval to create one one eastern or western giant, or a new transcontinental railroad.
Teamsters Rail Conference and Brotherhood of Locomotive Engineers and Trainmen National President Dennis Pierce said the Surface Transportation Board’s review will “likely take 12 months or longer, and will require the involved Rail Carriers to negotiate implementing agreements with the affected Rail Unions.”
The teamsters intend to participate in those proceedings, and “stand ready to protect the work rights, pay rules and benefits of all BLET members who may be impacted by this proposed merger,” Pierce said in a statement.
Wall Street has a largely positive outlook on the deal.
Lee Klaskow, a Bloomberg Intelligence analyst, said the proposed merger has “most of the hallmarks for regulatory approval.”
He said the combined company “will remain the smallest Class I railroad and the lack of overlap and the extension of the combined networks will not impede competition.”
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