KCS to Consider Merger Options

Although Kansas City Southern still plans to hold a meeting of shareholders on Friday, it will adjourn the meeting to buy time to reconsider its options in the wake of a decision by the U.S. Surface Transportation Board of Canadian National’s bid to place KCS into a voting trust while a merger of the two Class 1 railroads is reviewed by regulators.

In a statement, KCS expressed disappointment over the STB decision while also acknowledging that Canadian Pacific has made a second offer to acquire KCS. The statement said KCS will consider CP’s latest acquisition offer in due course.

CP issued its own statement saying its Aug. 10 offer to buy KCS for $31 billion remains on the table.

In a conference call Wednesday morning with investors, CP CEO Keith Creel said CP has a regulatory path to approval of a merger with KCS that CN lacks.

Creel pointed to language in the STB decision contending CN overlaps KCS whereas a CP-KCS combination would be an end-to-end merger.

He also noted that the STB has already approved CP’s proposal to put KCS in a voting trust while a CP-KCS merger is reviewed under pre-2001 rules that are less stringent than those that would be applied to the review of a CN-KCS combination.

However, Creel said KCS only has until Sept. 12 to accept CP’s offer.

“Our appetite and willingness to keep that offer on the table forever does not exist,” Creel said.

If KCS accepts CP’s latest offer, then CP said it will file a merger application with the STB by late September.

A day after the STB ruled against CN’s proposal to place KCS in a voting trust, industry analysts continued to maintain that the ruling forecloses approval of a CN-KCS combination.

They pointed to a passage deep in the STB decision that suggested the agency doesn’t expect to see a transcontinental merger under its current merger review rules.

“Neither Applicants nor the Board can perfectly predict future strategic responses to a CN-KCS transaction. However, a simple geographic analysis of the rail network would suggest that a carrier in CP’s position, i.e., one that would be the smallest carrier by far after a CN-KCS combination, might need to look for potential strategic alliances, which might in turn trigger yet more strategic responses by other rail carriers,” the board wrote.

“Approval of a CN-KCS voting trust could speed up downstream consolidation movements prior to the Board even having had an opportunity to assess them based on the record yet to be developed in this proceeding.”

An analysis on the website of Trains magazine concluded that the STB fears that those “downstream consolidations” could lead to two railroad systems covering the United States and Canada.

If CP and KCS eventually merge, the analysis continued, that would result in a near perfect balance of two railroads in the East (CSX and Norfolk Southern), two in the West (Union Pacific and BNSF) and two Canadian systems that reach the Gulf of Mexico.

Yet the Trains analysis raised the prospect that such a state of affairs would also fix the advantage that truckers have in being able to move freight anywhere in North America whereas railroads can only move it to the ends of their systems before handing it off to another railroad.

“If the STB wanted to create a level playing field between trucks and trains, it would figure out a way to preserve rail-to-rail competition while allowing Class I mergers,” wrote Trains writer Bill Stephens.

He noted that Canada has had two transcontinental systems for a century and that could work in the United States if regulators would allow it.

Although railroads handle 40 percent of ton miles they earn less than $100 billion of the revenue of the $1.4 trillion U.S. surface transportation and logistics market.

If trucking companies continue to divert freight from rails to highways they might become a threat to the financial well being of the railroad industry.

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