Kansas City Southern Chooses CN Bid, Terminates CP Merger Agreement

Kansas City Southern KSU has made it official: It's breaking up with Canadian Pacific CP and it's going with the merger offer from CP rival CN CNI.

The board of directors for Kansas City Southern (KCS) unanimously determined last week that CN's offer to acquire KCS was "superior."

But Friday's announcement seals the deal. As a result, KCS has terminated its merger agreement with CP and has entered into a merger agreement with CN.

The agreement calls for each share of KCS common stock to be exchanged for $200 in cash and 1.129 shares of CN common stock, according to a KCS release.

KCS said it paid a $700 million breakup fee, which CN will reimburse.

"As North America's most customer-focused transportation provider, we are excited about this combination with CN, which will provide customers access to new single-line transportation services at the best value for their transportation dollar and increase competition among the Class I railroads," said KCS President and CEO Pat Ottensmeyer. "Our companies' cultures are strongly aligned and we share a commitment to environmental stewardship, safe operations, reliable service and outstanding performance. As a larger continental enterprise with complementary routes and an enhanced platform for revenue growth, capital investment and job creation, we will be positioned to deliver on the transaction's powerful synergies, which will create new growth opportunities for our customers, employees, labor partners, communities and shareholders."

CN says the offer value is worth $33.6 billion and includes the assumption of approximately $3.8 billion of KCS debt. The railway also estimated that expected earnings before interest, taxes, amortization and depreciation could approach $1 billion annually, "with a significant proportion expected from converting truck traffic from busy interstates and highways for better fuel efficiency at a lower cost."

"We are thrilled that KCS has agreed to combine with CN to create the premier railway for the 21st century," said CN President and CEO JJ Ruest. "I would like to thank the numerous stakeholders of both companies who have demonstrated overwhelming support for this compelling combination, and we look forward to delivering the many benefits of this pro-competitive transaction to them. I am confident that together with KCS' experienced and talented team, we will meaningfully connect the continent – enhancing competition, offering more choice for customers and driving environmental stewardship and shareholder value."

Both CN and CP have been seeking to acquire KCS. CP and KCS had announced in March plans to merge, prior to CN announcing in April that it was also interested in acquiring KCS.

CP and CN are also both Canadian railways, and each merger proposal with KCS would create a railroad that has operations across Canada, the U.S. Midwest and into Mexico.

CP To Wait In The Wings

However, the story isn't over yet, according to CP.

CP contends that CN will be facing an uphill challenge in convincing STB, the regulatory body responsible for reviewing rail mergers, to approve CN's request for a voting trust.

The voting trust would be used as part of the merger process to acquire KCS, and it's a way to "neutralize" the regulatory risks associated with the merger, according to a Friday letter that CP has submitted to STB. The letter was written by David L. Meyer, an attorney representing CP.

CN has asked for a voting trust as a means to protect KCS' operations as the merger process unfolds, but STB denied CN's request on Monday, saying CN's application was incomplete because it lacked a merger agreement between CN and KCS. The board also indicated that because a merger between CN and KCS would be considered as a major merger that would need to be reviewed under newer and stricter guidelines, the voting trust and CN's application overall would need to show how a merger would enhance competition and be in the public's interest.

Since then, CN has said it plans to resubmit its application for a voting trust to STB. It said on Tuesday that CN "will show that the significant public benefits of the transaction can only be achieved through use of a voting trust, and that these benefits substantially outweigh any potential public interest harm. CN will also demonstrate that its strong balance sheet, cash flows and credit ratings profile provide certainty that CN has the financial integrity to satisfy the STB's public interest analysis.

But as a result of this potential hurdle, CP is asking the board to keep its merger application on hold should the merger between CN and KCS fall through.

STB had granted CP its request to establish a voting trust earlier this month. By keeping CP's merger application open but on hold, CP wouldn't need to re-request a voting trust structure should the CN-KCS merger fall through and a CP-KCS merger proceed.

"CP believes that CN cannot demonstrate that its proposed use of a voting trust would be ‘consistent with the public interest' for reasons CP has already summarized and will address further in its comments on CN's proposal. … Because STB voting trust approval is a condition to closing, were CN unable to use a voting trust, CN's proposed acquisition of KCS could not be consummated. KCS would then face the choice of whether to renegotiate the CN-KCS merger agreement in order to proceed with CN without the use of a voting trust," the letter said.

It continued, "Were KCS presented with the question of how to proceed following a decision by the board not to approve CN's proposed use of a voting trust, CP anticipates being available to engage with KCS to enter into another agreement to acquire KCS. … CP believes that pursuing its application is in the best interests of both KCS and the public so that the pro-competitive CP/KCS transaction can proceed to be reviewed by the board and – in the event KCS' agreement with CN is terminated or CN is otherwise unable to acquire control of KCS – a potential acquisition of KCS by CP could be implemented without undue delay, all in accord with the rulings and processes already established by the board in this docket."

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