The merger dance that has been conducted since March 21 has morphed from the Waltz to the Mambo in “The Dance at the Gym” scene in “West Side Story” to the Twist.
As soon as the STB issued its decision granting Kansas City Southern a waiver from prevailing merger rules established about 20 years ago, KCS—following the terms of its existing merger agreement with Canadian Pacific—said it would now consider CN’s counter-offer.
KCS reported April 24 that its Board of Directors has determined that the unsolicited merger proposal it received from CN on April 20 might end up “superior” to the KCS-Canadian Pacific (CP) merger agreement announced March 21. KCS now intends to engage in discussions with CN. Both CP and CN have responded, each with language used before, reiterating points that have been expressed several times within the past week.
CN’s proposed acquisition of KCS “in a cash and stock transaction valued by CN at $325 per KCS share could reasonably be expected to lead to a ‘Company Superior Proposal’ as defined in KCS’s merger agreement with Canadian Pacific Railway Limited,” the Board “unanimously” determined, after consulting with KCS’s outside legal and financial advisors, KCS said.
On April 20, CN said its counter-offer of $325 per KCS share “represents a 21% premium over the implied value of the CP transaction and values KCS at an enterprise value of $33.7 billion.”
KCS reported on April 24 that it “intends to provide CN with nonpublic information and to engage in discussions and negotiations with CN with respect to CN’s proposal, subject in each case to the requirements of the CP merger agreement.
KCS said it “remains bound by the terms of the CP merger agreement, and KCS’s Board has not determined that CN’s proposal in fact constitutes a Company Superior Proposal as defined in the merger agreement with CP. In addition, KCS notes that there can be no assurance that the discussions with CN will result in a transaction.
“As previously announced on March 21, 2021, KCS entered into a merger agreement with CP, pursuant to which CP agreed to acquire KCS in a stock and cash transaction valued at $275 per KCS share based on the CP and KCS closing prices on March 19, 2021.”
BofA Securities and Morgan Stanley & Co. LLC are serving as financial advisors to KCS. Wachtell, Lipton, Rosen & Katz, Baker & Miller PLLC, Davies Ward Phillips & Vineberg LLP, WilmerHale, and White & Case, S.C. are serving as legal counsel.
CP President and CEO Keith Creel released this statement after KCS’s announcement:
“We fully support the board of KCS in reviewing CN’s offer. We are confident through this process that they will recognize this unsolicited bid is fraught with challenges, uncertainties and regulatory risks that are not present in the seamless, pro-competitive and pro-service CP-KCS combination.”
CP also issued these comments:
“The board of KCS is simply meeting its obligations under the merger agreement with CP and fulfilling its fiduciary duty to its shareholders by assessing the CN offer. Not only is this the correct process and one that is clearly required by the merger agreement, in fact we are encouraged that they will be taking a hard look at the details of the CN offer as soon as possible, which we believe will lead them to question the true value and deal certainty of their proposal.”
In addition, CP stated, “[a]s part of the process, CN now needs to answer important questions for the KCS Board:
• “Is its unsolicited bid for KCS real or just an attempt to thwart the agreement that KCS signed with Canadian Pacific?
• “How does CN plan to get approval to create the third-largest Class I railroad with numerous overlapping connections across the U.S. when the Surface Transportation Board in 2001 purposely changed its merger rules to prohibit such anti-competitive deals?
• “Why would KCS shareholders want to hold CN’s stock when it has been the worst performing Class I railroad over the last 10 years by total shareholder return versus Canadian Pacific, which has consistently outperformed the industry and consistently exceeded expectations?
• “Why would KCS shareholders want to hold 12% of an under-performing company versus 25% of Canadian Pacific, which is led by seasoned, expert railroaders that over-deliver?
• “Why should KCS disregard the more-than 415 customers and stakeholders who have filed letters to the STB in support of a CP-KCS combination and 48 have filed letters in opposition to the CN proposal?
• “Why should the KCS board abandon the agreement with Canadian Pacific when it is the only one that fits any of the merger conditions that the STB has set?”
CP also referred to the STB’s April 23 confirmation “that the waiver it granted to KCS in 2001 is applicable to the proposed combination of CP-KCS because it would still result in the smallest Class I railroad with the fewest overlapping routes and be end-to-end in nature.”
Following the KCS and CP announcements, CN issued a statement saying it “looks forward to engaging with the board of directors of Kansas City Southern to complete confirmatory due diligence and finalize a definitive merger agreement to combine the companies and create the premier railway for the 21st century.
“CN welcomes the determination by Kansas City Southern board of directors that CN’s proposal to combine with KCS could reasonably be expected to lead to a ‘Company Superior Proposal’ as defined in KCS’ existing merger agreement with Canadian Pacific Railway Limited.
“CN’s proposal offers a clear path to completion and is structured in a way that gives KCS shareholders both greater immediate value and the opportunity to participate in the future upside of the combined company, and CN’s plan to use a voting trust means that KCS shareholders will receive compensation upon the closing of the voting trust.”
CN President and CEO JJ Ruest said: “We are pleased that KCS has acknowledged the value that a CN-KCS combination would bring as the premier railway for the 21st century. Together, CN and KCS will connect North America in a safer, faster, cleaner and stronger way for the benefit of both companies’ stakeholders. CN looks forward to completing its confirmatory diligence and finalizing its merger agreement with KCS promptly.”
CN Board Chair Robert Pace said: “CN has operated in the United States for more than 100 years, we pioneered Precision Scheduled Railroading, and we were the first railway to articulate and invest in a North American vision. CN’s proposal is the right next step for CN, KCS and North America, and this is the right combination to bring the renegotiated USMCA to life in a meaningful way. We have extensive operating experience, including in successfully integrating acquired businesses, and a strong track record of realizing synergies in prior transactions. With KCS’ talented team, we will be able to continue that success in a combination of CN and KCS. We are confident that CN is the better proposal, better partner, the better railway and the best solution for KCS and the North American economy.”
On April 26, CN reported that 409 customers, suppliers, elected officials and other stakeholders have filed letters with the STB in favor of its proposed combination with KCS.
In a statement, CN said: “This is an overwhelming demonstration of support for CN’s pro-competitive combination, which will create a true USMCA railroad and provide numerous new connections and service options for customers, establishing a seamless single-line service to expand North American trade and power economic prosperity.”
As part of CN’s submission to the STB containing the letters of support, it noted:
“Indeed, a number of the customers whose letters are enclosed previously submitted support for a proposed CP-KCS transaction. While the letters reflect a diversity of perspectives, a few common themes emerge. Many recognize the inherent benefits of longer single-system service, and the value to rail shippers of an extended market reach. Others are enthusiastic about CN’s vision for a CN-KCS combination—a vision that is fundamentally about growing business by becoming more competitive with trucks and creating a true USMCA railroad. Others express appreciation for CN’s willingness to work within the Board’s existing merger rules without seeking a waiver.
“CN thanks each of these parties for their support and looks forward to continued conversations with our customers and other interested parties about the proposed CN-KCS combination and why it presents the best solution for the continued growth, development and prosperity of the North American economy.”
Voting Trust Update: CP-KCS, CN-KCS
If and when the CP-KCS deal proceeds, CP will establish an independent voting trust to acquire KCS shares. Former KCS President and CEO Dave Starling, Railway Age’s 2012 Railroader of the Year, has been appointed trustee. On April 26, CN submitted its voting trust formally to the STB, and has requested to name Starling as intended trustee for its unsolicited bid. “Both are plain vanilla voting trust agreements that contain provisions that have consistently been approved in the past,” CN said. “Both would use the same trustee. And both would assure no premature control of KCS can occur until the STB has carefully reviewed and approved the proposed merger.”
Download CN’s STB submittal:
CP issued the following statement on CN’s move:
“David Starling has advised us of CN’s request, and we have no objection.
“As we have said previously, Starling is a fine choice as a trustee—that is why we appointed him to this role in the CP-KCS transaction. As a former President and CEO of KCS, he knows the business well and is independent of CP. Starling’s expertise and leadership is clearly valued by both CP and CN. Should Starling agree, we are honored that CN has chosen the same trustee we have, however, the two proposals themselves are much different.
“No matter who the trustee is of the CN proposal, it does nothing to address or overcome the problems with CN’s proposed use of a voting trust. It is at best putting a Band-Aid on a compound fracture. The problem with CN’s use of a voting trust is NOT the trust agreement or the trustee, it is an entirely separate set of public interest problems:
• “CN and KCS compete head-to-head today, and as the Department of Justice has made clear, CN buying and owning all of KCS’ stock will—trust or no trust, Starling or no Starling—change the competitive incentives of both CN and KCS while the trust is pending. Both will have an incentive to pull their competitive punches against the other.
• “The regulatory complexity of a CN transaction—under the 2001 new rules and all that entails—means a successful outcome of the regulatory process is far less likely, and the STB will not want KCS to be conveyed to CN (even in trust) if there is a real possibility—as there is—of insoluble regulatory problems that result in KCS having to come back out of trust and be disposed of.
• “And these issues do not even consider the prospect that CN’s acquiring KCS and putting it into trust will itself stimulate further railroad consolidation that shippers and others do not desire, and that the STB’s regulatory processes are designed to discourage.”
Cowen Insight: ‘The Game Goes On’
“The merger saga continues between KSU [KCS], CP and CNI [CN], with two new notable developments over the weekend that have implications for the potential outcome of the deal,” reported Cowen and Company analysts Jason H. Seidl (Managing Director and Railway Age Wall Street Contributing Editor), Matt Elkott and Elliot Alper. “1) To our surprise, the STB granted KSU/CP the waiver agreement, and 2) KSU announced its decision to talk to CNI regarding their bid, a procedural move for now by the company’s Board.”
Takeaways From STB Ruling:
• “The Surface Transportation Board (STB) granted KSU the waiver which will allow for the deal to be ruled using the old rules, which will handle the merger in the more informal format. This came as a surprise to us, given the elevated scrutiny of the deal, especially after CNI joined the party. In fact, prior to the STB’s decision, we had not spoken with a single person connected to the rail industry who believed the waiver was going to be upheld.
• “The filing states that if combined, CP and KSU would appear to still be the smallest Class I railroad, based on revenues. The combination would also lead to the fewest overlapping routes when compared to a merger between KSU and any other Class I railroad.
• “This is a win for CP, in our view, given that this move by the STB de-risks the bid by the Calgary-based railroad to some extent. Indeed, this move validates CP’s position that the combination is one that is more likely to get approval from the STB. CNI has stated that under their proposal, the new merger regulations will be used, a move undoubtedly taken by them due to their size and the admission that there is some overlap with KSU that needs to be addressed.”
Takeaways From KCS’s Decision to Talk With CN:
• “KSU issued a press release stating that the Board will determine whether the bid from CNI is a ‘superior proposal.’ KSU will engage in discussions with CNI and obtain nonpublic information as they work with and negotiate with CNI.
• “We view this move as procedural for KSU; regardless of how they may feel about the bid from CNI, they legally must entertain the possibility of competing bids. This was evident, given KSU used language verbatim from their termination clause in the merger agreement that stated: ‘In addition, subject to compliance with specified process and notice requirements, Kansas City Southern may terminate the Merger Agreement in order to enter an agreement providing for a Company Superior Proposal.’ KSU’s board must undertake such a move as it has a fiduciary responsibility to its shareholder base to explore the higher, but admittedly more risky, bid by CNI.”
Editor’s Commentary: Within the space of one week, Kansas City Southern has gone from being a committed marriage partner for Canadian Pacific to an undecided object of affection considering a rival suitor, CN—at least by appearances. The merger dance described above is very-well-choreographed. Let’s leave it at that. Stay tuned. Oh, by the way: Hunter? Everyone appears to be playing at least a little bit nicer together. And let’s not forget Mike Haverty, Railway Age’s 2001 Railroader of the Year. Mike, without you and your efforts to create the NAFTA Railway back in the day, probably none of this would be taking place. – William C. Vantuono