CP-CSX deal could spark new era of M&A in rail

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The news that Canadian Pacific Railway Ltd and CSX Corporation could be getting together – with a combined market capitalization of approx. $66-billion (U.S.) – is sending shockwaves through the rail industry. In a telephone interview Fadi Chamoun, analyst with BMO Nesbitt Burns Inc. said CP's overture towards CSX, and how to respond "is a discussion going on in the board room of every railroad right now."

There is much uncertainty over whether CP and CSX will ultimately do a deal. Firstly, CSX has reportedly rebuffed CP's approaches, which, as in dating, isn't a great start, but neither is it necessarily the end of the road. Secondly, regulatory approval from the Surface Transportation Board (STB) in the U.S. is far from certain. Mr. Chamoun says this hurdle is "pretty big," and would drag on for at least two years.

But if CP-CSX gets the regulatory nod, that could spur a new wave of deal making among the railway companies. Benoit Poirier, an analyst with Desjardins, wrote in a note that "we believe the acceptance of this transaction by authorities would likely create further M&As in the sector, as other railroads would then face a competitive disadvantage."

CP's competitors likely won't sit idly by if it attempts to gobble up CSX. Mr. Chamoun believes other bidders would emerge for CSX.

"A Union Pacific–CSX combination makes even more sense than a CP-CSX combination," he says. Union Pacific Corporation is a beast of a company, with a market cap just shy of $90-billion (U.S.). Mr. Chamoun argues that a union between Union Pacific and CSX would result in bigger cost savings than CP-CSX. "The freight density is much greater inside the U.S. than it is between Canada and the U.S."

And what about the prospect of a bidding war breaking out between CP and Union Pacific for CSX? It's "possible" says Chamoun. Don't count Burlington Northern Santa Fe Railway out of a possible takeover battle for CSX, either. While Burlington Northern "has its hands full trying to fix its own operations," Mr. Chamoun says, "if there are deals they would have to be thinking about getting involved. It would be very difficult for Burlington Northern to sit that out, as it will affect their business for the next 100 years."

Finally, Mr. Chamoun says Norfolk Southern Corporation, with a market cap of $32-billion (U.S.), could find itself being acquired by the likes of a CN or Union Pacific.

The Class 1 category is already a small club. There are seven Class 1 railroads in the U.S. The Association of American Railroads defines a Class 1 as a railroad with 2013 operating revenue of $467-million (U.S) or more. Two Canadian companies, CP and Canadian National Railway Corporation., fit this criteria. If the CP-CSX deal happens, the number of Class 1 railways in the U.S. could fall to six.

The message from the analyst community is, deals in an oligopolistic sector rarely happen in a vacuum. One major move from a Class 1 railroad could force the hand of a competitor. And if that happens, all bets are off.