Canadian Pacific gains advantage in fight to merge with U.S. freight railway Kansas City Southern

Freight carrier Canadian Pacific Railway (CP) last night took the inside track in its battle with rival Canadian National (CN) to acquire the U.S. rail line Kansas City Southern (KCS), thanks to a decision by U.S. regulators that a CN-KCS merger would be anti-competitive.

At stake is a merger deal valued at $31 billion from CP or $33.6 billion from CN, both of which would be designed to create a continuous rail network spanning the North American continent and connecting Canada, the United States, and Mexico. Despite that argument for the deal, federal regulators may have been disinclined to approve such a path, given a Biden Administration executive order issued in July that pushed back against recent trends toward monopolistic mergers and consolidations.

Specifically, the non-partisan U.S. Surface Transportation Board (STB) yesterday denied a joint application by CN and KCS to create a “voting trust,” a legal arrangement that would have granted control of the combined companies’ ownership shares to a third-party trustee. In theory, that arrangement would have ensured that KCS stayed independently managed pending completion of the STB’s review of the proposed transaction. If full approval were granted, the two companies would then terminate the trust and CN would assume full control of KCS.

In fact, the STB had approved such an arrangement in May for the potential merger of CP and KCS. However, the board found yesterday that the same approach would not work for a CN-KCS combination.

“Applicants have adequately explained how the voting trust agreement would insulate them from an unlawful control violation, but the Board finds that the proposed use of a voting trust, in the context of their impending control application, would not be consistent with the public interest,” the STB said in its decision. “Applicants have failed to establish that their use of a voting trust would have public benefits, and the Board finds that using a voting trust, in the context of the impending control application, would give rise to potential public interest harms relating to both competition and divestiture. Accordingly, Applicants’ motion to approve the use of a voting trust will be denied.”

KCS decried the STB’s decision, saying it still wanted to press ahead with CN’s takeover bid instead of CP’s. “We are disappointed in the STB’s decision to reject CN’s proposed voting trust. We are working with CN to evaluate the options available to us,” KCS said in a release.

Predictably, CN also disputed the finding, claiming that its proposed merger would actually enhance competition, expand North American trade and power economic prosperity, provide new and faster routes, increase supply chain efficiency, and deliver other benefits to the public good. "We remain confident that our pro-competitive, end-to-end combination is in the public interest and that it would offer unparalleled opportunities and benefits for customers, employees, the environment and the North American economy. The combined company would create the premier railway for the 21st century and establish seamless single-line service from Canada, through the United States and into Mexico,” CN said in a release.

According to CP, however, the decision clears the way for a combination of rail networks that would benefit parties throughout the freight ecosystem. “The STB decision clearly shows that the CN-KCS merger proposal is illusory and not achievable,” CP President and CEO Keith Creel said in a release. “Knowing this, we believe the August 10 CP offer to combine with KCS, which recognizes the premium value of KCS while providing regulatory certainty, ought to be deemed a superior proposal. Today, we have notified the KCS Board of Directors that our August 10 offer still stands to bring this once-in-a lifetime partnership together.”

Looking ahead at potential next steps, the transportation industry analyst firm Baird Equity Research said that CP is now “well positioned” to acquire KCS, although the STB’s decision also meant that future merger deals among other class-one railways are “highly unlikely.”

In a note to investors, Baird Senior Research Analyst Garrett Holland said, “Voting trust rejection is the manifestation of regulatory risk and complicates the path to securing deal approval. Following this voting trust denial, we think KSU shareholders will increasingly favor the CP offer, which while lower, represents more realistic value in a combination that is still strategically compelling.”