CN, CP Jockey to Gain Advantage in Buying KCS

Canadian National and Canadian Pacific submitted dueling filings to the U.S. Surface Transportation Board on Wednesday as they jockey for advantage in their respective efforts to by Kansas City Southern.

The KCS board of directors has already agreed to a $29 billion bid from CP, but CN this week countered with a $33.7 billion offer in a cash and stock transaction.

CN notified the STB of its bid for KCS while CP asked regulators to expedite their review and approval of its purchase of the smallest Class 1 rail system in North America.

In its filing, CN said it plans to file an application seeking authority to combine with KCS.

The filing indicate that CN would seek to have the merger reviewed under the STB’s current merger rules whereas CP is seeking to have its acquisition of KCS reviewed under an exemption regulators granted KCS more than 20 years ago were it to seek a merger with another Class 1 system.

The CN filing cited “seamless service and enhanced competition” from its acquisition of KCS.

It further asserted that its proposed acquisition of KCS would be in the public interest and CN would welcome the opportunity to provide a full forum for stakeholders to comment on the proposed transaction.

CN said it is confident it will be able to effectively address any reasonable remediation concerns and ensure rail customers and other stakeholders benefit from the proposed combination with KCS.

If CN and KCS were to merger, it would create the fifth largest Class 1 North American system. Currently there are seven such systems.

“Our proposal to KCS is simple,” said CN President and CEO Jean-Jacques Ruest. “We are providing greater and more certain value, and a clear path to closing. We have a better bid. We are a better railroad. We will be a better partner for KCS and the communities it serves. And we believe the STB and our customers will recognize that CN presents the best solution for the continued growth, development and prosperity of the North American economy.”

For its part, CP claimed that CN’s acquisition of KCS would reduce competition.

It called CN’s stated benefit to acquiring KCS “illusory and inferior to the proposed CP/KCS transaction.”

CP said the STB should promptly confirm uniquely what it termed straightforward and beneficial transaction proceeding under the pre-2001 rules with no further voting trust approval required.

In a letter to regulators, CP said it “respectfully suggests that the Board should see things the same way: the only combination involving KCS that is in the public interest is the one that Canadian Pacific has proposed, and which has already garnered support from more than 400 shippers and other stakeholders.”

A CN-KCS merger, CP asserted, would “destabilize” the North American rail network balance “that has prevented further consolidation of the six largest railroads for two decades.”

If CP were to lose its friendly connection at Kansas City with KCS, it would weaken if not destroy the viability of CP’s lines through southeastern Iowa and northern Missouri and leave CP an asymmetrically disadvantaged “odd-man-out” in a six-railroad North America.

That would put pressure on CP to find a way to expand its market reach through further consolidation.

CN has argued that its combination with KCS would offer shorter, faster, and more efficient routes than tying together the CP and KCS networks.

The war of words in the dueling filing with the STB is likely to result in CP having to pony up more money for KCS, some industry analysts believe.

“We can’t rule out a full-scale bidding war,” Wolfe Research analyst Scott Group wrote in a note to clients.

Another analyst, Anthony Hatch, told Trains magazine, CP has room to increase its bid although CN is seen as the wealthier Canadian Class 1 system.

The last time Class 1 railroads got into a bidding war was in 1996 when CSX and Norfolk Southern fought over Conrail.

That battle ended with NS and CSX dividing Conrail and the railroads paying 27 percent more to buy their respective shares.

Although industry observers predict the STB would likely approve acquisition of KCS by either CN or CP, some believe a CN-KCS combination would create more regulatory challenges  because the two systems have more overlap than CP and KCS.

 “While financially superior and strategically compelling, CN’s proposal may entail a more complicated regulatory review given the larger pro forma rail network,” Baird Equity Research analyst Garrett Holland wrote in a note to clients.

Holland believes CP will submit a higher bid for CP and rely heavily on the argument that it provides better strategic value and a potentially more feasible regulatory review process.

Credit Suisse analyst Allison Landry said, though, that the ovetlap between CN and KCS is relatively small and largely confined to a handful of shippers in Louisiana.

At the same time Landry said in a note to clients that a CN-KCS deal that create a railroad larger than CSX or NS would make those carriers merger targets.

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