Canadian National Steals Deal from Canadian Pacific to Merge with Kansas City Southern Railway
On March 21, 2021, the Canadian Pacific Railway and the Kansas City Southern Railway Company (“KCS”) announced a cash and stock deal valued at $29 billion to link the United States, Mexico, and Canada by rail for the first time (Lauren Hirsch, The New York Times). The two corporations would have merged their rail networks into a combined 20,000 miles of tracks stretching from British Columbia through the central U.S. and into Mexico. Id. The combined company, called Canadian Pacific-Kansas City, would have been the smallest of all the major railroads operating in North America, but it would have provided significant economic benefits based on the United States-Mexico-Canada Agreement, a multilateral free trade agreement that was enacted as a successor to NAFTA in July 2020. Id. The merger would have resulted in the common stock shareholders in KCS receiving 0.489 of a Canadian Pacific share and $90 in cash per share for each share held of KCS common stock. (March 2021 Investor Presentation).
Surprisingly, almost exactly two months later, KCS announced that it was instead merging with the Canadian National Railway, the direct competitor of Canadian Pacific, after receiving a superior proposal from the Canadian National. (Kansas City Southern, CN to Combine with Kansas City Southern). Under this deal, KCS shareholders will receive 1.129 shares of Canadian National common stock and $200 per share for each share of their KCS common stock. Id. The total value of the deal exceeds $33 billion, including Canadian National’s assumption of approximately $3.8 billion of KCS’s debt. Id. The companies will be combined through the same mechanism proposed for the Canadian Pacific merger: a voting trust where Canadian National will hold all of KCS shares until the deal is finalized. Id.
The deal is expected to be completed in the second half of 2022, but it will first need to be approved by three regulatory agencies, including two in Mexico. Id. The biggest legal hurdle facing the deal is securing approval from the Surface Transportation Board (“STB”), a U.S. independent regulatory agency. The STB primarily regulates the economic aspects of national railroads, including mergers and other related transactions. (About STB). In 2001, the STB adopted new regulations that “substantially increase the burden” on railroads to prove that a merger with another railroad would be in the public interest. (STB, Major Rail Consolidation Procedures). However, the STB explicitly waived KCS from the new regulations unless the agency was persuaded by KCS’s competitors that a waiver should not be granted for a particular transaction. Id. It is likely that the other major railroads will argue to the STB that KCS should not be given a waiver for this deal, just as Canadian National did for KCS’s proposed merger with Canadian Pacific.
KCS will have to persuade the STB that the merger is in the public interest if a waiver of the merger rules is declined by the agency for the Canadian National deal. Specifically, the company will need to show that the merger’s benefits, such as improved service for freight customers and greater economic efficiency, outweigh its costs, such as reduced competition and potential temporary service problems. (49 CFR §1180.1). KCS will also have to explain how the transaction will enhance competition between other major railroads, as well as develop safety and service assurance plans. Id.
If the deal is approved by the STB and other regulators with or without a waiver for KCS, it would be a welcome sign of a strong rail industry despite losses incurred due to the COVID-19 pandemic. The companies believe that the deal will significantly reduce air pollution and truck congestion along the rail corridor, which will extend south from Minneapolis to Mexico. (Kansas City Southern, CN to Combine with Kansas City Southern). Canadian National has also promised to make significant infrastructure investments across the network, which will lead to more economic and job opportunities. Id. However, as expected, Canadian Pacific has not taken the breakdown of the initial deal well and will likely strongly oppose KCS merging with its national competitor, setting up a battle before the STB.
Considering the low number of major railroads in North America and the overall significance of the merger, healthy skepticism from the STB and the other major freight rail providers appears likely in addition to a presumed Canadian Pacific protest. Nonetheless, barring any major disclosure or finding that jeopardizes the deal, it appears probable that the deal will close next year, resulting in the most significant transformation of North America’s freight rail industry in decades.