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Canadian Pacific-Kansas City Southern Deal Back on Track

Canadian National dropped out of the bidding war Wednesday.

In this May 23, 2012 photo, surveyors work next to Canadian Pacific Rail trains which are parked on the train tracks in Toronto.
In this May 23, 2012 photo, surveyors work next to Canadian Pacific Rail trains which are parked on the train tracks in Toronto.
Nathan Denette/The Canadian Press via AP, File

OMAHA, Neb. (AP) — After initially getting derailed this spring, Canadian Pacific's $31 billion acquisition of Kansas City Southern railroad is back on track to move forward after Canadian National dropped out of the bidding war Wednesday.

The deal could still face tough scrutiny from regulators at the federal Surface Transportation Board, which hasn't approved any major railroad mergers since the 1990s, bus KCS shareholders will be set to get paid once shareholders of both companies and Mexican regulators approve it regardless of what the STB ultimately decides.

The $31 billion deal includes 2.884 CP shares and $90 in cash for each shareholder and the assumption of roughly $3.8 billion in debt.

“We’re elated. We’re tickled to death,” CP President and Chief Executive Keith Creel said. “It has been a long journey. No dull moments obviously, but it came to a conclusion where we intended it to in the beginning and believed it ultimately would end up. And we think it’s in a very good place for Canadian Pacific as well as KCS and all the stakeholders that we serve. We're exited about that and ready to get to work.”

Canadian Pacific triumphed in the bidding war even though it offered less than Canadian National's $33.6 billion bid because federal regulators wouldn't let CN set up a voting trust to acquire and hold Kansas City Southern during their prolonged review. Canadian National will receive $1.4 billion in breakup fees for its trouble in the deal that has gone back and forth since CP and KCS first announced their merger agreement in March. CP will reimburse KCS for those breakup fees under the terms of their deal.

Canadian National CEO JJ Ruest said his railroad will focus on “profitable growth and opportunities for excellence” in its operations. CN had faced pressure in recent weeks from a major investor to abandon the deal and focus on its own performance.

The London-based TCI fund, which owns about 5% of CN’s stock, has already announced plans to call a special meeting to nominate four new directors who would help choose a new CEO for the railroad. A TCI spokesman said Wednesday that the fund didn't have any immediate comment on CN's decision.

Shares of all three railroads were up after Wednesday's announcements with CN posting the biggest gains with its stock trading nearly 4% higher midday. The other two rails posted more modest gains of around 1%.

For more than two decades the railroad industry has been stable, with two railroads in the Western United States — BNSF and Union Pacific — two in the Eastern United States — CSX and Norfolk Southern — Kansas City Southern in the Midwest and the two Canadian railroads that serve part of the United States. Regulators have said that any merger involving two of the largest railroads generally needs to enhance competition and serve the public interest to get approved.

The only deal involving one of those major railroads to be completed since the 1990s was when Warren Buffett's Berkshire Hathaway bought BNSF in 2010, but that deal faced less scrutiny because it wasn't a merger of two of the big railroads.

Creel said he expects the STB will work to protect competition and the public interest when it reviews CP's acquisition of Kansas City Southern but he he believes the deal will meet those standards easily because there is little overlap between the two railroads and plenty of potential benefits. The two railroads expect to generate at least $1 billion in synergies mostly by growing revenue while still keeping open all their existing connections with other railroads.

“I do not expect regulatory problems getting this deal approved,” Creel said.

Kansas City Southern made an attractive acquisition target because it was the smallest of the major railroads and the only one with direct lines into Mexico, so the new combined railroad will benefit from expanding trade across North America under the new trade agreement Canada, Mexico and the United States all signed. KCS President and Chief Executive Officer Patrick J. Ottensmeyer said the deal will “benefit KCS and our employees by enabling us to become part of a growing and truly North American continental enterprise.”

The new railroad will also be well positioned to benefit from companies deciding to move some of their manufacturing closer to their end markets in North America instead of relying so heavily on global suppliers

“Railroads are such a critical part of the backbone of supply chains. and this is going to be a very unique franchise to drive some of those investment decisions,” Ottensmeyer said.

The heads of both railroads don't expect this deal to lead to more consolidation in the industry partly because the combined Canadian Pacific-Kansas City railroad will still be the smallest of the major railroads even though it will include roughly 20,000 miles of track and employ about 20,000 people.

“We are going to uniquely create a historic network through all three countries that won’t be replicated,” Creel said. “I think it stabilizes the network. It creates competition west of the Mississippi, east of the Mississippi and in Canada. It puts us at a level playing field.”

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