CP pursuing NS. Game on!

Written by William C. Vantuono, Editor-in-Chief

It’s official: Canadian Pacific on Nov. 17, 2015 sent an offer letter to Norfolk Southern proposing a merger (an acquisition, really) “that would create a transcontinental railroad with the scale and reach to deliver improved levels of service to customers and communities while enhancing competition and creating significant shareholder value.” On Nov. 18, CP, in response to NS’s tepid response to the initial offer, provided “full disclosure.”

CP’s proposal, which it is calling a “business combination” (its public statement did not contain the words “merger” or “acquisition”) includes “a sizable premium in cash and stock offered to NS shareholders [that] would result in a company with the potential for faster earnings growth than either CP or NS could achieve on their own, all the while maintaining a strong investment-grade credit rating.”

CP on Nov. 18 disclosed financial details of its offer to NS shareholders, after NS late in the evening of Nov. 17 released the following:

“Norfolk Southern today confirmed that it has received an unsolicited, low-premium, non-binding, highly conditional indication of interest from Canadian Pacific to acquire the Company for $46.72 in cash and a fixed exchange ratio of 0.348 Canadian Pacific shares per Norfolk Southern share, representing a premium of less than 10% based on closing prices today.”

CP shares stood at $138.58 at the close of Nov. 17 trading on Wall Street, well below its 52-week high of $209.98, and modestly above its 52-week low of $129.83. NS shares closed at $86.97, compared to a 52-week high of $117.64 and a 52-week low of $72.10. Based on Nov. 17 closing prices, 0.348 per CP share X $138.58 = $48.23. Add that to CP’s offer of $46.72 in cash per NS share, and you get $94.95, a 9.2% premium over NS’s $86.97 closing price.

Obviously, NS considers the offer unacceptable. We’ll see what happens following  the Nov. 18 NYSE opening bell. Game on!
CP said it “strongly believes that the combined railroad would offer unparalleled customer service and competitive rates that will support the success of the shippers and industries it serves, and satisfy the U.S. Surface Transportation Board and Canadian regulators.” This would be accomplished through “key innovations”:
• “A new approach to terminal access that would change the status quo in U.S. rail transportation. In the event the new company failed to provide adequate service or competitive rates, it would allow another carrier to operate from a point of connection over the combined company’s tracks and into its terminals, providing an unprecedented alternative to the affected shipper.”

• “Give shippers the choice of where they can connect with another railroad along [the combined CP-NS] network, bringing an end to the practice of ‘bottleneck pricing’ to a large number of shippers in the U.S. while further enhancing competition.”

Essentially, these two provisions amount to open (competitive) access, which U.S. Class I railroads have bitterly opposed. I put this question to CP CEO Hunter Harrison, our 2015 Railroader of the Year, in the January issue. “The regulatory situation in Canada is a bit different than in the U.S.,” I said. “There is some form of open access, to a very limited extent, and you don’t seem to have a problem with that. Some of the U.S. railroads are fighting that tooth and nail. What’s the difference? How’s it work?” “It’s called inter-switching, which relates to some degree to the U.S.’s old reciprocal switching, pre-Staggers,” Hunter responded. “It’s one of these regs that are in place, but people don’t really take advantage of it, because there’s no need to if the individual carriers do their job. It’s kind of something that could be called a lever that you have over here, if it needed to be used. My view is, for years a lot of railroaders had been scared of the term ‘open access,’ and I don’t know why. What that says to me is, all we’re going to do is open up more competition, and with a very limited number of players in North America now, it’s important to keep that competitive balance. And if an individual carrier, CP included, provides the right type of service for the customer, at an appropriate fair price, we have nothing to worry about. If we do not provide the service, we should not be resistant to someone [else] coming and providing that service. So I think it’s different, it’s change, and people, generally speaking, their normal reaction is to resist those initial change efforts. But I think if we would look back here in 20 years, most of these things are going to be behind us, and we’re going to be settled down with those types of issues.”

Then, there’s the “Chicago problem,” one of Hunter’s favorite subjects. A CP-NS combination “would alleviate the long-standing issue of congestion in Chicago, which seized into gridlock in the winter of 2014 and hobbled economic growth,” CP said. “By channeling rail traffic away from Chicago, CP would create fluid routes through under-utilized hubs and free up much-needed capacity for other railroads that pass through the city, providing them with new, efficient and competitive service options for their own customers. In short, a combined CP/NS would create capacity for all shippers without creating the need for more infrastructure.”

This is one of Hunter’s trademarks: what he calls “sweating the assets,” and to a great degree it has worked. CP “AH” (After Hunter) is moving far more traffic than CP “BH” (Before Hunter) with 600 fewer locomotives.

Hunter is no fan of Chicago’s CREATE project, on which some $4 billion has already been spent to help alleviate freight and passenger rail congestion in North America’s busiest, most complex rail hub. “I think CREATE was broke when it started, it’s been broke ever since, and it’s created zero value in my view,” he said during a first-quarter 2014 earnings call. “You know, it’s hard enough to get two railroads to agree on something, much less seven or eight.”

This observation “may add some insight into Hunter’s thinking as to why he is pursing control of NS and not working toward joint operating agreements,” Railway Age Contributing Editor Frank Wilner observes. “Hunter does not play well with others because he is convinced others don’t play nicely.”

So, CP’s statement that it “hopes the NS executive leadership team and the Board of Directors give this offer due consideration, and looks forward to a thoughtful dialogue on creating a new industry leader” could be taken with a grain of salt.

So what comes next? If NS management and its board and shareholders, after lots of back-and-forth, say “I do,” the merger may go relatively smoothly and pass U.S. and Canadian regulatory muster, given CP’s willingness to embrace open access. (For additional perspective, and some analysis on combining two very different corporate cultures, click HERE to see Frank Wilner’s most recent blog.)

However . . .

What if NS ultimately shuns CP and Hunter Harrison and its largest shareholder, Bill Ackman, who heads Pershing Square Capital Management, and CP attempts a hostile grab for control of NS stock? I turn to Frank Wilner to lay out the possible scenarios:

1) “If NS asserts that Ackman and/or Pershing Square already have a controlling interest in CP, then a deal needs STB approval because, unlike Warren Buffett taking BNSF private, there is a second railroad involved. Should Ackman and/or Pershing Square be deemed in control of CP, they become a Class I railroad attempting control of another. What is key is what constitutes control. Pershing Square (actually the alter ego of Ackman) has a 14% stake in CP, which was enough to win a proxy fight and push Fred Green out and bring Harrison in, back in 2012. The STB has not, to my knowledge, made a ruling as to what percentage of stock ownership constitutes ‘control.’ So that could come into play.”

2) “If Ackman reaches out to other hedge funds in an attempt to build a consortium (rather than just Ackman and Pershing Square) to make a hostile grab for NS, there could be court action asserting that the consortium is Ackman’s alter ego and thus the deal is subject to STB approval, and determination of what percentage of stock ownership constitutes control.”

3) “Ackman and/or a consortium need not take NS private with a 100% buyout, because a proxy fight in their favor would vote controlling interest, assuming other major institutional holders of NS stock vote for an Ackman slate of officers that either would convince Jim Squires to play ball with CP or be shoved out in favor of another CEO. That is what happened at CP in 2012.”

4) “It was easy for Ackman with CP because most investors supported Fred Green’s ouster and replacement with Harrison. That would not be the case on NS, as NS management is respected, and, as I say in the blog, Hunter would be stretched too thin trying to run NS and CP.”

5) “If Harrison/Ackman are threatening a hostile grab of NS, why didn’t they go that route with CSX in 2014? The answer is probably a lower NS stock price. They may have deemed CSX stock at the time too expensive for that strategy.”

5) “A joint trackage rights deal may come into play as a compromise if Squires remains cool to a merger.”

OK, now that the players are more or less in position, and the pursued is in the position of having to peruse what the pursuer is proposing, let’s assume the union takes place. What should this new railroad be called? What should its logo look like? It’s not as simple as, say, a BNSF-NS combination, where all you’d have to do is take “BNSF” and drop the “B” and the “F”. CPNS? Please, not another “what’s that acronym stand for” name, like CSX (which, I think, stands for “Chessie-Seaboard-We Need Another Letter I Guess X Is As Good As Any”). And please don’t go to one of those super-expensive “branding” agencies, like the one that dreamed up “Acela” for Amtrak when tried-and-true “Metroliner” would have made perfect sense to retain (and wouldn’t have cost millions of dollars). And I certainly am not suggesting that the beaver in the traditional CP crest be replaced with a horse (or a beaver riding on a horse).

Why not stick to a traditional way of naming a railroad, which is based on simple geography? (Think “Atchison, Topeka & Santa Fe” or “Boston & Maine”.) Hmmmm . . . . Let’s see . . . . This would be an east-west transcontinental . . . . CP touches the Pacific Ocean, which is very far west . . . . NS headquarters are in Norfolk, Va. . . . .

I’ve got it!

Norfolk & Western!

Tags: , , , , , , , ,