CN wins battle for Kansas City Southern, setting stage for first big U.S. rail merger in decades

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Canadian National Railway Co. emerged the victor in the takeover fight for Kansas City Southern on Friday, beating rival Canadian Pacific Railway Ltd. and setting the stage for the first major U.S. railway merger in more than 20 years.

But after paying a premium price to outbid its domestic rival for a shot at creating the first North American railway, CN faces two new battles at the U.S. regulator. First, CN must convince the Surface Transportation Board to approve the voting trust that will independently operate KCS while awaiting the outcome of the second battle – for STB approval of the takeover itself.

The outcome of either ruling is not assured, analysts say.

Cameron Doerksen, an analyst at National Bank, said a recent STB ruling on the CN-KCS file shows the board will take a cautious approach in deciding whether the trust is in the public interest. The STB raised concerns about the level of debt CN would take on to pay for the deal, and questioned the share price premium CN has offered.

“CN has characterized trust approval as relatively routine, but in our view approval is far from assured,” Mr. Doerksen said.

Takeover battle will force railways to scrap their old route maps

The Missouri-based railway said on Friday it has accepted CN’s US$29.8-billion offer and terminated a US$25.2-billion agreement it reached with CP in March. CN’s offer is worth US$325, or US$200 in cash and 1.126 shares of CN stock. This tops CP’s offer of US$275, or US$90 in cash and 2.445 CP shares.

CN also agreed to reimburse KCS for the US$700-million break fee KCS will pay CP to terminate the earlier deal. CN has also agreed to pay KCS US$1-billion if the voting trust proposal is rejected by the STB.

A decision on the trust is expected by July, while a ruling on the takeover could take until late 2022 or early 2023, CN said. The deal also requires approval by the Mexican regulator and a majority of KCS shareholders.

The takeover would form the first railway that links the three North American countries and give CN access to key ocean and river ports in the southern U.S., Gulf of Mexico and Atlantic and Pacific coasts of Mexico. KCS’s network, which runs south from the U.S. Midwest, reaches deep into the Mexican petroleum and automotive industrial regions.

KCS employs 6,500 people who run an 11,400-kilometre network. CN is Canada’s largest railway, with 24,500 employees and 32,000 kilometres of track in Canada and the United States. CN’s network spans Canada and extends south to the U.S. Gulf Coast.

JJ Ruest, CN’s chief executive officer, said in a statement he is “thrilled” by KCS’s acceptance of CN’s offer. “I am confident that with KCS’s experienced and talented team we will meaningfully connect the continent – enhancing competition, offering more choice for customers, and driving environmental stewardship and rewarding shareholders,” Mr. Ruest said.

Patrick Ottensmeyer, KCS’s CEO, said the combined routes will bring revenue growth and new opportunities for customers.

Keith Creel, CP’s chief executive officer, refused to raise CP’s bid, calling CN’s offer “fantasy money” that carried a heavy debt burden. He has repeatedly cast doubt on CN’s ability to win approval from the U.S. regulator for the trust and the takeover.

Voting trusts are intended to preserve the independence and operation of a railway during a takeover’s regulatory process. CN and CP both named former KCS CEO David Starling to run their respective trusts.

If the takeover is rejected by the STB, CN would sell KCS out of the trust.

In a letter to the STB on Friday morning, CP lawyer David Meyer said the railway is ready to make a new offer for KCS should the CN-KCS voting trust fail to receive approval. CP’s plan for a voting trust has already received STB approval.

“CP anticipates being available to engage with KCS to enter into another agreement to acquire KCS. CP expects that such an agreement would be in substantially the form of the merger agreement previously entered into by CP and KCS,” Mr. Meyer said.

Christian Wetherbee, a stock analyst at Citigroup, said KCS’s move on Friday “signals the next chapter in this deal, but potentially not the last.”

“The next hurdle will be whether the STB approves CN’s trust,” Mr. Wetherbee said, adding CN has until January to appeal the trust’s rejection without triggering the US$1-billion fee.

“CP’s bid will remain in place as a backstop,” Mr. Wetherbee said.

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