August 10, 2021, 1:30 PM EDT: More than likely anticipating that the Surface Transportation Board will reject the CN/Kansas City Southern voting trust, and soon—prior to the Aug. 19 KCS shareholder vote to approve or reject CN’s $325 per-share offer to acquire KCS—Canadian Pacific has submitted a US$300 per-share offer to KCS that consists of $90 in cash plus shares.
Early in the afternoon of Aug. 10, closely following CP’s announcement of its new offer, the STB—in a brief statement, said: “By decision served on May 17, 2021, the Board determined that the proposed transaction between CN and KCS would be governed by the regulations set forth at 49 C.F.R. part 1180, as adopted in Major Rail Consolidation Procedures, 5 S.T.B. 539 (2001). Since then, the Board has received numerous submissions containing information and argument both in support of, and opposing, approval of the voting trust. The Board has also received many inquiries from industry stakeholders, the public, and the media as to the timing of a Board decision on the pending voting trust motion, particularly in light of the anticipated vote of the KCS shareholders on the proposed merger, which is currently scheduled for Aug. 19, 2021. In response to these inquiries and to provide as much information as is possible with respect to the timing of a decision, the Board is issuing this statement today to announce that the Board expects to issue a decision on the proposed voting trust no later than Aug. 31, 2021.”
“The Board expects to issue a decision on the proposed voting trust no later than Aug. 31, 2021.”
Railway Age Capitol Hill Contributing Editor Frank N. Wilner, whose new book, Railroads & Economic Regulation, will be published by Simmons-Boardman Books in late summer, suggests that “if STB Chairman Oberman is committed to Board-action transparency, he should issue the decision in an open voting conference during which each of the Board members faces the public through a webcast to explain their vote. Billions of dollars are in play, and stakeholders deserve to know more than a ‘yea’ or ‘nay’ from each Board member.”
CP said its cash and stock transaction offer is a “superior proposal representing an enterprise value of approximately US$31 billion, offering KCS stockholders an alternative recognizing the premium value of KCS while providing more regulatory certainty.” It represents a 34% premium, based on the unaffected KCS closing share price of $224.16 as of March 19, 2021 (KCS’s share price when CP and KCS announced their original merger, one month prior to CN’s original counter-offer) and CP’s closing share price of C$91.50, at 1.2565 the FX (foreign exchange), as of Aug. 9, 2021. Following the closing into a voting trust, which the STB approved several months ago, KCS common shareholders will receive 2.884 CP common shares and $90 in cash for each share of KCS common stock held. The proposed transaction includes the assumption of $3.8 billion of outstanding KCS debt.
“This superior proposal represents improved terms to those agreed to in the CP-KCS merger agreement entered into on March 21, 2021 that are substantially similar to those in the CN merger agreement, but offers significantly higher regulatory certainty than the proposed CN merger and significantly higher value than our previously agreed combination,” CP said, adding that it has filed a proxy statement asking stockholders to vote “AGAINST” the proposed CN-KCS combination at the KCS special meeting of stockholders on Aug. 19, 2021 “so that KCS’s stockholders avoid being locked into the CN-KCS deal and unable to consider other, better, options.
“CP continues to pursue its application process for a potential acquisition of KCS so that the STB can review the pro-competitive CP-KCS combination without undue delay. Importantly, the STB has already approved CP’s use of a voting trust and affirmed KCS’ waiver from the new rail merger rules it adopted in 2001 because a CP-KCS combination is truly end-to-end, pro-competitive, and the only viable Class I combination. Review of the CN voting trust by the STB remains pending, and the STB has already determined a CN-KCS combination would be reviewed under the new merger rules, the first time a Class I combination would be evaluated under that regulatory system. A CP-KCS combination would be a positive step toward more competition—not less—in the freight rail industry and would be better for Amtrak. It brings more competition among railways and protects obligations to passenger service.
“A CP-KCS combination offers all the same benefits—and more—to rail shippers and the supply chain as a CN-KCS combination, with none of the detriments or the need to enforce promises through more regulation. A CP-KCS combination creates single-line routes to all the markets that a CN-KCS network would reach, rings new competition to and from Upper Midwest markets dominated by BNSF or UP that CN-KCS cannot address, creates new competition vs. CN that CN-KCS actually eliminates, has a route network that does not funnel all of its traffic through the congested Chicago area, and unlocks new capacity for Amtrak passenger service, rather than interfering with passenger service between Baton Rouge and New Orleans and south of Chicago.
“A CP-KCS combination would enhance competition, create new and stronger competitive single-line options against existing single-line routes while taking trucks off the highway. A CP-KCS combination would maintain all existing freight rail gateways and maintain competition in the Baton Rouge to New Orleans corridor, while creating new north-south lanes between Western Canada, the Upper Midwest and the Gulf Coast and Mexico.
“CP is willing to host intercity passenger rail service between New Orleans and Baton Rouge, an outcome with far more operational flexibility and less risk to Louisiana taxpayers. CP has consistently received an ‘A’ rating from Amtrak, leading the industry for the previous five years-plus, in its annual host railroad report card recognizing its industry-leading on-time performance record. CP is also the first Class I railroad to complete 100% certification of its Amtrak schedules.
“Similarly, a CP-KCS transaction would diminish the pressure for downstream consolidation by preserving the basic six-railroad structure of the North American rail network: two in the west, two in the east and two in Canada, each with access to the U.S. Gulf Coast. By contrast, a CN-KCS transaction would fundamentally disrupt this balance.”
THE BLAZE PERSPECTIVE: “CASH IS KING”
“There are two strategic M&A principles that might favor a CP continuing bid offer,” observes railroad economist and Railway Age Contributing Editor Jim Blaze. “First, CP could reduce a possible value risk to the KCS shareholders if it offered a larger percentage of cash than the CN offer. More cash would increase investor interest since cash is ‘king’ in such merger deals. Why? Because there is always a possible dilution period during the merger execution.
“We saw that play out back in 1996-97 in the fight for Conrail when Norfolk Southern countered the friendly merger between rivals CSX and Conrail. So, which carrier here (CN or CP) will offer more cash for KCS?
“The second principle is that both CP and CN will want to assure investors that their respective financial offers will be accretive during the first two to three years of the actual merger implementation. Neither wants to show in their application to the STB a pro-forma post-merger financial result that dilutes shareholder ‘returns,’ Simple translation: Paying too much isn’t a good approach.
“As a final observation, CP is most likely able to increase its cash offer because it just received an approximate $700 million breakup fee resulting from the CN deal with KCS.”
The full text of the Aug. 10, 2021 letter to the KCS Board of Directors from CP President and CEO Keith Creel (Railway Age’s 2021 Railroader of the Year) outlining the proposal:
On behalf of Canadian Pacific Railway Limited (“CP”), I am pleased to submit the following revised offer (“Offer”) for CP to combine with KCS.
As we have stated previously, we understood and respected the KCS Board of Directors’ decision to explore the path to a transaction with Canadian National Railway Company (“CN”) in the exercise of its fiduciary duties. Nevertheless, CP has always believed that CN’s deal was not executable and an attempt to dismantle the unique, pro-competitive deal that CP and KCS had agreed upon. We remain confident that the Surface Transportation Board (the “STB”) will ultimately reject CN’s proposal to use a voting trust and prove that the proposed CN merger is not a viable transaction.
At the time of CN’s offer in May, we chose to not make a revised offer because we believed that engaging in a bidding war with CN would have been value destructive to CP shareholders, and we continue to stand by that decision as having been the right one. However, we believe that now is the right time for us to re-engage with KCS, as the regulatory uncertainty of the proposed CN merger has placed KCS stockholders in the unfortunate position of having to vote on the proposed CN merger and, as a consequence of approving such proposal, eliminate KCS’s ability to consider superior offers, all the while not having any level of certainty with respect to whether the STB will approve CN’s use of a voting trust. We are excited to provide KCS stockholders a significantly more attractive alternative to this situation: this opportunity to turn down the CN merger proposal and once again pursue a combination of CP and KCS—a more certain transaction which offers compelling short-term and long-term value that is actually achievable, already has the benefit of STB approval to use a voting trust and is, in our view, the only viable Class 1 merger.
Unlike a combination with CN, a CP-KCS combination will be transformational in a positive manner for the railroad industry and will serve the best interests of our respective customers, shareholders and other stakeholders and the North American economy. This end-to-end combination, with a focus on growth, would also ensure the viability of KCS’s full network going forward, without the need to address issues related to overlap as in the proposed CN merger. Bringing together CP and KCS, two railroads that have been keenly focused on providing quality service to customers, will unlock the full potential of our networks and our people, and KCS stockholders will have the benefit of participating in the upside of our combined company’s growth.
Today, well over two months following your agreement with CN, KCS stockholders are being asked to vote in favor of a transaction that has yet to receive STB approval for closing into voting trust and offers them only risk and uncertainty. During the course of our recent engagement with your stockholders, the most frequent questions we have faced have been (1) will CP be there when the proposed CN merger fails and (2) what will CP be prepared to offer KCS stockholders. It is understandable that the KCS stockholders, being presented with a transaction that is highly unlikely to close, are eager to understand CP’s actionable alternative. In response to the concerns raised by the KCS stockholders, we believe that it is imperative that KCS management, the KCS Board of Directors and the KCS stockholders understand the CP alternative.
The terms of our Offer are set forth below:
- Holders of KCS common stock will receive 2.884 CP common shares and $90 in cash for each share of KCS common stock held, representing a value of approximately $300 per common share based on CP closing market price as of August 9, 2021. This represents an increase of $25 per KCS share over the offer price at the time of our previously agreed combination and a 34% premium to KCS’s unaffected price based on the KCS closing share price of $224 as of March 19, 2021. Holders of KCS preferred stock will continue to receive $37.50 in cash for each share of KCS preferred stock held.
- This Offer is subject to the execution of a merger agreement on terms substantially as set forth in the draft merger agreement attached as Annex A hereto (the “Merger Agreement”, and the transactions contemplated thereby, the “Transaction”).
- The cash portion of the consideration will be funded through a combination of cash-on-hand and approximately $9.5 billion in new debt. In connection with this Offer, we are submitting commitment letters, by and among CP, as covenantor, and Canadian Pacific Railway Company, as borrower, and Bank of Montreal and Goldman Sachs Lending Partners LLC, as commitment parties (the “Commitment Parties”), together with the redacted fee letter related thereto, in each case executed on behalf of the Commitment Parties, and which are attached as Annex B hereto.
- In connection with KCS’s termination of the Agreement and Plan of Merger, dated as of May 21, 2021, by and among CN, Brooklyn Merger Sub, Inc. and KCS (the “CN Agreement”) in accordance with the terms thereof in order to accept this Offer and enter into the Merger Agreement, upon receiving satisfactory evidence of KCS having paid, or having caused to be paid, the Company Termination Fee and CP Termination Fee Refund (as such terms are defined in the CN Agreement) pursuant to and in accordance with the terms of the CN Agreement as in effect on the date hereof, CP will advance or cause to be advanced to KCS an amount equal to the aggregate amount of the Company Termination Fee and the CP Termination Fee Refund (the latter constituting a refund and return by CP of the “Company Termination Fee” received by CP from KCS on the termination of the prior merger agreement between CP and KCS).
Benefits of CP’s Offer for KCS Stockholders
Our Offer, which is based solely on publicly available information, represents improved terms to those we had agreed to in our previously agreed combination that are substantially similar to those in the CN Agreement, but offers significantly higher regulatory certainty than the proposed CN merger and considerably higher value than our previously agreed combination.
We believe that our Offer is superior to the proposed CN merger due to the greater regulatory and value certainty it provides KCS stockholders. CP has a clear path to closing with STB voting trust approval (a condition CN has still not been able to satisfy) already in-hand. Furthermore, the STB has affirmed that the pro-competitive CP-KCS combination would be evaluated under the pre-2001 STB merger rules, unlike the CN-KCS combination which would be scrutinized under the more stringent STB merger rules adopted in 2001. The new rules were designed to address the exact kinds of threats to competition and other issues posed by a CN-KCS combination, and they place a “heavier burden on merger applicants to show that a major rail combination is consistent with the public interest.” KCS stockholders should not assume that there is any certainty of value in the proposed CN merger given the level of uncertainty as to whether the STB voting trust approval or final approval of the combination will be obtained by CN, especially in view of President Biden’s recent executive order on “Promoting Competition in the American Economy” and the fundamental anticompetitive issues raised by the proposed CN merger that would exist immediately upon the closing of the Proposed CN Merger into voting trust due to, among other things, the overlapping and parallel character of CN’s and KCS’s routes.
On the other hand, our Offer presents a compelling strategic combination of CP and KCS, two railroads whose networks you joined us in describing as “a perfect and natural fit,” to form the first U.S.-Mexico-Canada rail network that is truly end-to-end and pro-competitive with no overlap, and which, in our view, is the only viable Class 1 combination. We remain eager and committed to bringing together the two best performing Class 1 railroads for the past three years on a revenue growth basis. We have extensive experience in successfully integrating acquired businesses and a strong track record of realizing synergies, and our similar cultures, shared focus on safety and collective commitment to providing significant positive impacts for our respective employees, customers, communities, and shareholders have not changed. CP’s leading management team has consistently outperformed CN and delivered superior results for its shareholders. CP’s proven track record of performance and its record as the safest Class 1 railroad for 15 consecutive years will serve KCS well. We will, in turn, benefit from your leadership and expertise as we grow sustainably, together. We are confident that, together with your experienced and talented team, we will be able to continue that success in a combination of CP and KCS to the benefit of both sets of shareholders.
Following the closing of the Transaction, KCS stockholders would own approximately 28% of the combined company (reflecting a 3% increased ownership as compared to our previously agreed combination). Our combined company would be well positioned for growth, bringing together the two railroads with the highest 3-year revenue CAGR and generating increased annual synergies of $1 billion within three years.
We recognize that you may not wish to take action with respect to our Offer in advance of your upcoming Special Meeting of Stockholders to vote on the proposed CN merger; however, as indicated above, we believe it is important that you and your stockholders fully understand our Offer in advance of your stockholder vote. We request that you promptly take formal action on our Offer at the earliest of receipt of the STB’s denial of CN’s voting trust or a reasonable period of time prior to your stockholders’ meeting to approve the proposed CN merger on August 19th.
In closing, we remain truly excited about once again pursuing this once-in-a lifetime partnership together and remain committed to everything this opportunity presents. These two companies have long, proud histories and an even brighter future, together.
THE COWEN INSIGHT: “A DAY OR TWO LATE, BUT WILL CP COME UP SHORT?”
“CP has said numerous times that it does not plan to get into a bidding war with CN, whose current offer still holds a higher value at $325,” notes Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl. “While CP’s $300 is still below CN’s offer, it could cause KCS investors to second-guess their votes on the 8/19 shareholder approval vote. KCS was up ~5% after in after-hours trading on Aug. 9. There is a growing school of thought that the KCS shareholder vote may come closer than previously anticipated, given the growing uncertainty surrounding the STB’s stance on the voting trust. Institutional Shareholder Services (ISS) came out in support of investors approving CN’s bid. However, a sweetened bid from CP could cause some shareholders to rethink their stance on the CN bid. Indeed, CP already was given approval for its voting trust and its transaction had zero overlapping customers while CN’s had many.
“Aside from CP’s potentially increased offer, the next two upcoming catalysts for KCS are the Aug. 19 shareholder vote, and a final STB decision on CN’s voting trust. We had originally thought the STB would announce its decision on the voting trust by mid-August; however, the Board could take longer and announce its decision after the KCS shareholder vote. We continue to believe there to be a ~60% chance the STB approves the CN trust, and await potential commentary regarding the deal from CP. KCS shares were up ~5% in after-hours trading as investors saw the potential to increase the size of their ‘backstop’ offer. The following ten days could prove eventful for the stock, and we would be unsurprised to see even more volatility.”