One of Canadian National Railway's largest shareholders said May 18 its proposed $30.5 billion acquisition of Kansas City Southern is too risky, after the US railroad regulatory body rejected an expedited review process for the potential deal the day prior.
London-based hedge fund TCI Fund Management said Canadian National should back out of the deal now before it risks losing billions of dollars in possible termination fees and lost market capitalization value.
Canadian National is competing with its smaller rival Canadian Pacific to buy Kansas City Southern and create the only Canada-to-Mexico rail network in North America, that could move Canadian crude exports to the US Gulf Coast and refined products to Mexico.
KCS said May 13 it planned to terminate its $25 billion deal with CP and instead accept CN's sweetened offer in an escalation of the Canadian railroad war. CP has until May 20 to make a counteroffer. CP said it would not get into a "bidding war," but promised to respond, potentially with a counterproposal, by the May 20 deadline.
TCI owns a 3% stake in Canadian National as the sixth-largest shareholder; however, the caveat and potential conflict of interest is TCI is Canadian Pacific's largest shareholder.
The regulatory US Safety Transportation Board approved the expedited review process for Canadian Pacific to acquire KCS for $25 billion, but denied it for Canadian National's larger deal because of greater perceived anti-competitive concerns.
"CN already has a tremendous North American rail network; it does not need KCS to prosper in the future," wrote British billionaire and TCI founder Chris Hohn. "It is time to end this ill-advised misadventure."
Hohn called CN's potential deal "negligent and hugely irresponsible" in light of the STB decisions. The railroad regulatory ruling does not kill the potential deal, but it does make clear a Canadian National merger will have a more stringent path to federal approval.
The STB also, for now, denied CN's request to set up a voting trust for the deal to protect the interests of KCS' shareholders, but the rejection primarily is because CN did not yet have a merger agreement with KCS. CN can reapply when and if a deal is solidified. The STB also emphasized that voting trusts should only be authorized on rare occasions and that "use of a voting trust is a privilege, not a right."
Both CN and CP are counting on voting trusts to close their competing deals. Part of CN's argument is KCS shareholders have nothing to lose because they would be paid from the trust even if the deal fails to pass regulatory muster.
Hohn said CN must note STB's wording on the voting trust issue.
"The STB is sending a clear signal, and the CN board has a duty to listen," Hohn said. "The risk that the voting trust is not approved is too great to ignore."
Canadian National said May 18 it still expects eventual approval for the voting trust when it reapplies.
"We firmly believe we have a clear path to completion of our transaction," CN said in a statement. "Any minimal post-transaction overlap can be readily resolved, and CN is committed to proposing the appropriate remedies."
The STB previously approved both expedited review and a voting trust for CP's deal with KCS, arguing that they have no overlap, and their rail networks meet neatly in Kansas City, Missouri.
However, CN and KCS have more parallel rail routes, as well as more directly overlapping routes in Louisiana. CP has contended CN's proposal is not viable because it cannot pass regulatory muster.
If the CN-KCS deal was solidified and, subsequently, fell through, CN would owe a $1 billion termination fee to KCS, as well as paying KCS' $700 million break-up fee to CP.
REGULATORY QUESTIONS
In question are the STB's updated merger regulations from 2001 that require major deals to show they are in the public interest. Since then, no major rail mergers have come to fruition, not counting Berkshire Hathaway's 2010 acquisition of US leader BNSF, including failed flirtations from CP to merge with CSX in 2014 and with Norfolk Southern in 2016.
The STB already has said a waiver to the 2001 regulations would apply to the CP deal with KCS because KCS is the smallest major US railroad and is more regionally focused with less overlap with competitors. CP's argument is that its proposal would combine North America's sixth- and seventh-largest railroads, leaving the combined company as still just the sixth-biggest.
CN noted it would only have the fifth-largest rail network in the US if it acquires KCS. However, within all of North America, CN would grow large enough to rival the two biggest railroads, BNSF and Union Pacific.
While either of the competing deals might offer cheaper shipping rates for Canadian heavy oil sands, analysts said notably greater crude-by-rail volumes would only come if major oil pipelines are shuttered, such as the in-progress Line 3 replacement project, the four-year-old Dakota Access Pipeline and the pending Trans Mountain Pipeline expansion.
Canadian oil production has recovered to its pre-pandemic volumes of about 5 million b/d of crude oil, condensate and diluent, while US production is still down by about 2 million b/d from its pre-pandemic volumes.
However, crude-by-rail volumes have not yet recovered and may not rebound for quite some time.
