Canadian Pacific to buy Kansas City Southern in bet on trade

Biggest North American rail deal ever valued at US$25 billion

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Reuters — Canadian Pacific Railway (CP) agreed on Sunday to acquire Kansas City Southern in a US$25 billion cash-and-stock deal to create the first railway spanning the United States, Mexico and Canada, standing to benefit from a pickup in trade.

It would be the largest ever combination of North American railways by transaction value. It comes amid a recovery in supply chains that were disrupted by the COVID-19 pandemic, and follows the ratification of the U.S.-Mexico-Canada Agreement (USMCA) last year that removed the threat of trade tensions that had escalated under former U.S. President Donald Trump.

“Think about what we’ve gone through, think about the importance in North America of near-shoring that is occurring. This network uniquely provides a supply chain that allows our customers and our partners to actually benefit from that and leverage that opportunity,” CP CEO Keith Creel told Reuters in an interview.

The combination needs the approval of the U.S. Surface Transportation Board (STB). The companies expressed confidence this would happen by the middle of 2022, given that the deal would unite the smallest of the seven so-called Class I railways in the United States, which meet in Kansas City and have no overlap in their routes. The combined railway would still be smaller than the remaining five Class I railways.

The STB updated its merger regulations in 2001 to introduce a requirement that Class I railways have to show a deal is in the public interest. Yet it provided an exemption to Kansas City Southern given its small size, potentially limiting the scrutiny to which its acquisition will be subjected.

“I don’t see it as the kind of consolidation that should raise concerns because it’s what you call an end-to-end or vertical merger. Their networks fit nicely with each other and help fill out North America with real service,” said economist Clifford Winston, a senior fellow at the Brookings Institution who specializes in the transportation sector.

An STB spokesman said the regulator had not yet received a filing from the companies, which would start its formal review process. He declined to comment further.

Still, CP agreed in its negotiations with Kansas City Southern to bear most of the risk of the deal not going through. It will buy Kansas City Southern shares and place them in an independent voting trust, insulating the acquisition target from its control until the STB clears the deal.

Were the STB to reject the combination, CP would have to sell the shares of Kansas City Southern, and one source close to the agreement suggested they could be divested to private equity firms or be relisted in the stock market. Kansas City Southern shareholders would keep their proceeds.

There is a $1 billion reverse breakup fee that CP would have to pay Kansas City Southern if it cannot complete the formation of the trust, the source added (all figures US$).

Shareholders of Kansas City Southern will receive 0.489 of a Canadian Pacific share and $90 in cash for each Kansas City Southern common share held, valuing Kansas City Southern at $275 per share, a 23 per cent premium to Friday’s closing price, the companies said in a joint statement. Including debt, the deal is valued at $29 billion.

Kansas City Southern shareholders are expected to own 25 per cent of Canadian Pacific’s outstanding common shares, the companies said. Canadian Pacific said it will issue 44.5 million shares and raise about $8.6 billion in debt to fund the transaction.

It is the top M+A deal announced thus far in 2021. While it is the biggest ever involving two rail companies, it ranks behind Berkshire Hathaway’s purchase of BNSF in 2010 for $26.4 billion.

Creel will continue to serve as CEO of the combined company, which will be headquartered in Calgary under the name Canadian Pacific Kansas City (CPKC), the companies said in a statement.

Kansas City would be designated as the combined company’s U.S. headquarters, while its Mexico headquarters would remain in Mexico City and Monterrey. CP’s current U.S. headquarters, in Minneapolis, would still remain “an important base of operations,” CP said.

The companies also highlighted the environmental benefits of the deal, saying the new single-line routes that would be created by the combination will help shift trucks off crowded U.S. highways and cut emissions.

Rail is four times more fuel efficient than trucking, and one train can keep more than 300 trucks off public roads and produce 75 per cent less greenhouse gas emissions, the companies said in the statement.

For Chicago alone, CP said, the combination would allow some traffic between KCS-served points and the upper U.S. Midwest and Western Canada to bypass that rail hub city by way of the CP route through Iowa, potentially reducing rail congestion and fuel burn.

Failed bids

Calgary-based CP is Canada’s No. 2 railroad operator, behind Canadian National Railway (CN), with a market value of $50.6 billion.

It owns and operates a transcontinental freight railway in Canada and the U.S. Grain haulage is the company’s biggest revenue driver, accounting for about 58 per cent of bulk revenue and about 24 per cent of total freight revenue in 2020.

Kansas City Southern has domestic and international rail operations in North America, focused on the north-south freight corridor connecting commercial and industrial markets in the central U.S. with industrial cities in Mexico.

CP’s latest attempt to expand its U.S. business comes after it abandoned a hostile $28.4 billion bid for Norfolk Southern in April 2016. CP’s merger negotiations with CSX Corp., which owns a large network across the eastern U.S., failed in 2014.

CP last year did buy the Central Maine and Quebec Railway (CMQ), which gave it additional track through Quebec and a line to the U.S. east coast through Maine, including the assets of the ill-fated Montreal Maine and Atlantic Railway.

A bid by CN to buy BNSF was blocked by U.S. antitrust authorities more than two decades ago.

A private equity consortium led by Blackstone Group and Global Infrastructure Partners (GIP) made an unsuccessful offer to acquire Kansas City Southern last year. The sources said that bid helped revive CP’s interest in Kansas City.

— Reporting for Reuters by Nandakumar D and Ann Maria Shibu in Bangalore and Rebecca Spalding and Greg Roumeliotis in New York; writing by Denny Thomas. Includes files from Glacier FarmMedia Network staff.

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