A Fight for Shareholder Approval

Written by Jason Seidl, Matt Elkott and Elliot Alper, Cowen and Company
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Canadian Pacific, CN and Kansas City Southern have been battling for votes in KCS’s upcoming shareholder vote on August 19 to approve or reject the CN transaction. CP has been actively telling investors to vote no, while KCS and CN have been pushing for approval. It remains uncertain if there will be a decision from the STB on a CN/KCS voting trust prior to the shareholder vote. We continue to believe that there is a 60% chance of approval for the voting trust, but remain wary of the political climate.

The Aug. 19 KCS special shareholders meeting vote is the next known catalyst in these merger activities. KCS shareholders will vote on the $325 merger proposal from CN. There is a growing school of thought that this vote may come closer than previously anticipated, given the growing uncertainty surrounding the STB’s stance on the trust. A decision from the STB may come, at a minimum, after the shareholder vote.

With this in mind, CP filed a preliminary proxy statement and accompanying “BLUE” proxy card with the Securities and Exchange Commission (SEC) to be used to solicit votes of Kansas City Southern (KCS) shareholders to vote “AGAINST” the proposed CN-KCS combination at the Aug. 19 meeting.

KCS management remains confident that the STB will approve the voting, and believes the STB is looking at three main pieces: 

• The trust structure is secure, which should not be an issue, given it is the same as CP’s with the same trustee (David Starling) that was already passed.
• While KCS shares are in trust, operations can continue normally. If the STB approved CP’s voting trust on that notion, CN also should not have a problem.
• Leverage of the business is appropriate, and CN is financially fit for the assumption of debt. This is the largest unknown, given the somewhat arbitrary nature of “too much debt.”

We believe there may be a scenario in which the STB does not approve the trust, and provides a list of measures that need to be met. In that case, CN will likely quickly adapt to the necessary changes while acknowledging the February 2022 deadline, when the deal expires. If the STB rejects the trust, CN can either appeal the decision to the Board or immediately to a court of appeals. Given it would be unlikely for the STB to reverse its own decision, we believe the court option would be taken.

At the end of the day, it is apparent that the STB can proceed however it sees fit, and can alter, amend or add new stipulations to rail mergers. It remains unclear how the STB will officially identify a reduction in competition. Historically, the Board has been more concerned with 2-to-1 and 3-to-2 reductions. There appears to be 39 shippers that fall into this category, according to a call KCS held with analysts Aug. 2. Almost all of these are on or near CN’s Baton Rouge-New Orleans line, which CN has already agreed to divest. There are 25 that would go to 4-to-3 and roughly 380 that are either 5-to-4 or 6-to-5. If the board expands its scope in terms of how it views competitive reductions, things could get more complicated for the proposed deal.

We continue to believe there to be a roughly 60% chance the STB approves the CN voting trust, although we are monitoring the timing of a new Board member—Democrat Karen Hedlund—on the STB, which could switch the political leanings of the Board itself. However, a quick Senate confirmation seems unlikely, according to Cowen’s Washington Research Group. We would be more bullish on the chance for voting trust approval if not for the overall uncertainty of proverbial D.C. political winds.

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