He can't afford to show it, but Hunter Harrison has to be frustrated. For someone whose success stems from being so hard-nosed, courting Norfolk Southern by cooing, not crowing, must be wrenching.
Canadian Pacific Railway's saviour has no other choice. To fulfill his dream of creating a railway that touches three coasts, he must do more than win over shareholders – he also has to convince a powerful U.S. regulator that his $28-billion (U.S.) offer for Norfolk Southern is about more than building an empire.
Calm, lawyerly types are not his kettle of fish. Asked last year about his willingness to pick fights, Mr. Harrison summed up his strategy this way: "When you go to a new location, in a railroad or whatever, you've got to find the meanest son of a [expletive] and whip his ass – you get a lot of attention."
Unlike investors, who would be silly not to consider Mr. Harrison's stellar operational record, the Surface Transportation Board (STB) isn't so fussed with shareholder value. The major U.S. regulator has to review the deal's effect on all stakeholders, and that means weighing what will happen to rail competition if Mr. Harrison gets his way.
In the middle of a consolidation boom – global mergers and acquisitions have now topped $4-trillion in 2015 for only the second time since 1980, according to Thomson Reuters – the joining of railways can seem inevitable. CP certainly wants to paint that picture. Earlier this month, chief operating officer Keith Creel argued that on this topic, "it's not if, it's when."
That's probably true for industries in which mergers are arguably the only way to stay competitive. Pharmaceutical companies are watching their best drug patents expire, so they must buy new ones to replenish the pipeline. Cable companies are under threat from startups such as Netflix, which have changed the way people consume televised content, and that's prompting major U.S. rivals to court one another.
Railways are a different beast. After a merger frenzy in the 1990s, there are only six so-called "Class 1" companies in North America. Imagine if the Big Six Canadian banks were allowed to merge. And because railroading is built on expensive physical assets, it is one of the industries that is arguably the farthest from being disrupted. "Uber-for-trains" would be a pipe dream.
Because these six companies hold such sway over the movement of physical goods – from commodities to cars – regulators are extremely careful when reviewing merger proposals. After CN tried to merge with Burlington Northern Santa Fe in 1999, the STB spent nearly two years reviewing the deal, shot it down, and then released new merger guidelines that put the onus on railways to prove their combination would be good for competition. Under these strict guidelines, the easiest way to make a merger look good is to approach it in a friendly matter. The minute CP goes hostile, the STB, as well as Canadian and Mexican regulators, are more likely to get rattled. A war of words with Norfolk Southern will put the entire industry on edge – from rival railways to shippers – and that would make it very easy for CP to lose control of the message, which is a key component of any contentious deal.
Mr. Harrison's already partly lost the plot. Having pursued CSX Corp., Norfolk Southern's major rival in the eastern United States, a year ago, the ease with which he has jumped to another deal makes him look a little desperate. If he gets feisty, his intentions – and his competitive assurances – will be questioned.
Surely there would be synergies if the two railways came together. Maybe they wouldn't amount to the $1.8-billion CP has estimated, but they exist, because there are problems at the gateways where railways hand off traffic to one another. Mr. Harrison is also a railway whiz, and has proven he'll do whatever it takes to scrap yards and to reduce locomotive fleets in order to boost margins.
CP's latest quarterly results prove that. The company's operating ratio – the gospel for any railway – fell by 70 basis points year over year, despite weaker volumes, because costs are continually getting stripped out of the business. That's got to be appetizing to Norfolk Southern's shareholders, who are watching their revenue drop because of a weak coal business, and have seen their margins lag at the bottom of the industry.
But synergies aren't the only thing that matter to regulators. CP's rivals know that, which is why they've been talking down mergers for a year now. Ever since Mr. Harrison approached CSX, every Class 1 railway has been asked about the potential of consolidation. The regulatory burden always shuts down the conversation – because one deal is likely to spur many.
Knowing regulators are terrified of this knock-on effect, CP ought to play this smartly. All any of the railways need to do is float a trial balloon and say they are willing to merge with each other if this deal goes through.
Doing so would only frustrate Mr. Harrison even more. Give him a railway to run, and he'll deliver. He's proven that three times over. But bog him down in regulation, and his greatest strength can be his worst enemy.