CN Rail’s Kansas City Southern Deal Imperiled by U.S. Rebuff

(Bloomberg) -- Canadian National Railway Co. was dealt a potentially fatal blow in its $30 billion effort to acquire Kansas City Southern as U.S. regulators rejected a plan to use a voting trust to make the purchase.

“Applicants have failed to establish that their use of a voting trust would have public benefits,” the U.S. Surface Transportation Board ruled Tuesday. Using a voting trust “would give rise to potential public interest harms relating to both competition and divestiture.”

Kansas City Southern had demanded the trust -- a means to pay shareholders even before the deal gets a final antitrust nod -- for any merger deal. The STB ruling could prod Kansas City Southern to rethink Canadian National’s offer and send the U.S carrier back into the arms of Canadian Pacific Railway Ltd.

That company had reached a $25 billion deal for Kansas City Southern only to have it snatched away by Canadian National in May. A last-ditch $27 billion bid by Canadian Pacific in August was rejected. The U.S. railroad will now have to decide how the STB ruling changes the equation.

The outcome will determine which Canadian company will become the first railroad to operate tracks through Canada, the U.S. and Mexico. Kansas City Southern gets about half its revenue from Mexico, which is poised for an investment surge as companies seek to shorten supply lines that stretch to Asia.

Canadian National’s shares jumped 7.4% to C$148.40 in Toronto, the biggest one-day gain since March 2020. Kansas City Southern dropped 4.4% to $280.67 in New York. Canadian Pacific slid 4.5% to C$86.69.

The STB has already approved Canadian Pacific’s voting trust, which could give it a strong hand. The board’s ruling against Canadian National vindicates Canadian Pacific Chief Executive Officer Keith Creel’s decision not to match his rival’s bid in that hope that regulators would reject Canadian National’s trust.

Creel, who said Canadian Pacific didn’t have the financial firepower to win a bidding war, was emboldened after the STB said Canadian National would have to prove that its deal would be in the public interest, a heavy burden adopted in 2001 to quash industry consolidation.

Canadian Pacific, the second smallest of the seven major North American railroads, after Kansas City Southern, only had to establish that its tie-up wouldn’t hurt competition -- a lesser standard than faced by the larger Canadian National. The STB in April noted Canadian Pacific’s lack of overlapping routes with Kansas City Southern.

What Bloomberg Intelligence says:

Kansas City Southern shareholders might see Canadian Pacific’s $300 per share takeover offer (vs. Canadian National’s $325) as superior, we believe, since it may have a higher likelihood of regulatory approval following the Surface Transportation Board’s rejection of use of a voting trust in CN’s offer. KCS shareholders are slated to vote on the CN deal Sept. 3.

Lee A. Klaskow and Adam Roszkowski, BI transportation analysts

Click here to read the research

Canadian National had sought to blunt some concern by committing to sell a 70-mile stretch of track that overlapped with Kansas City Southern’s network in Louisiana.

But the regulator was unswayed, saying Tuesday that the overlap could extend beyond that region. Nor was the STB moved by Canadian National’s argument that its trust and Canadian Pacific’s were essentially the same, calling the two transactions “substantially different.” Canadian Pacific’s proposed merger is end-to-end and its rival’s system overlaps with Kansas City Southern’s.

The board also expressed concern that a Canadian National takeover “would trigger downstream effects and, potentially, further consolidation initiatives.” If that deal went through, the STB said, Canadian Pacific “might need to look for potential strategic alliances, which might, in turn, trigger yet more strategic responses by other rail carriers.”

Tuesday’s ruling is a defeat for Canadian National CEO Jean-Jacques Ruest in his effort to leave his smaller national competitor even further behind. The two railroads have waged a century-old rivalry that has included litigation over poaching employees and clients. Ruest and Creel worked together at Canadian National when Creel was its chief operating officer.

TCI Fund Management, the second-largest shareholder in Canadian National, sent a letter to the railroad urging it to abandon the merger. The investor said that the company didn’t and was forced to pay another breakup fee, both Ruest and Chairman Robert Pace should resign.

Canadian Pacific has been hoping that purchasing Kansas City Southern would narrow a size gap with Canadian National and match its T-shaped network, which spans Canada and drops down through the U.S. to the Gulf of Mexico. Without the acquisition, Canadian Pacific would be isolated in Canada.

Under the terms of its merger agreement with Canadian National, Kansas City Southern can walk away if the regulator rejects the voting trust. In that circumstance, Canadian National would have to pay Kansas City Southern a $1 billion breakup fee. Canadian National may decide to appeal the STB ruling.

A Kansas City Southern merger with Canadian National would create the third largest railroad in North America, leapfrogging Norfolk Southern Corp. and CSX Corp., according to a Bloomberg data analysis of five-year sales trends.

©2021 Bloomberg L.P.