STB is examining CN-KCS joint motion regarding proposed voting trust agreement

The pending acquisition of Kansas City Southern (KCS) by Canadian National Railway (CN) was the focus on an announcement made today by the Surface Transportation Board (STB), an independent adjudicatory and economic-regulatory agency charged by Congress with resolving railroad rate and service disputes and reviewing proposed railroad mergers, with the STB saying today it is now considering a joint motion filed by CN and KCS, regarding approving the parties’ voting trust agreement.

STB said that by a decision served on May 17, 2021, it 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,” it said. “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 August 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 August 31, 2021.”

This is the most recent development in a months-long squabble between CN and Canadian Pacific, in their respective pursuits of acquiring KCS.

As reported by LM, on May 21, CN and KCS said that they have reached a deal and have entered into a definitive merger agreement, which they said will “create the premier railway of the 21st century.”

In a joint statement, CN and KCS said that their respective Boards of Directors have signed off on the terms of the agreement, with KCS shareholders receiving $325 per common share based on CN’s $33.6 billion offer made on May 13. That figure, the companies said, included the assumption of roughly $3.8 billion of KCS debt.

As for next steps, CN and KCS said that the Surface Transportation Board (STB) and other regulatory authorities must approve control of KCS, with the completion of the acquisition expected to take place over the second half of 2022. And they added that when the deal is official that KCS will begin the integration process.

This announcement was far from certain given the myriad moving parts related to the battle between CN and CP, for KCS, going back to when CP announced on March 20 that it was acquiring KCS for $29 billion, in a deal that it said, at the time, would establish the first freight railway connecting the United States, Canada, and Mexico. CP officials said that this $29 billion deal was a stock and cash transaction and included the assumption of $3.8 billion of outstanding KCS debt and values KCS at $275 per share, representing a 23% premium, based on the CP and KCS closing prices on March 19, 2021.

One month later on April 20, CN threw its hat into the ring, making what it called a “superior proposal.” That CN proposal was comprised of a cash-and-stock offer to acquire KCS for $33.7 billion, or $325 per share, which, it said, marks a 21% premium over the proposed CP offer, coupled with an expected EBITDA close to $1 billion annually, driven largely by the conversion of truck traffic, and combined annual revenues in excess of $13 billion.

Since then, there have been punches thrown between CP and CN, mostly in the form of press releases, with CP announcing in late July that it filed a proxy statement that asked KCS shareholders to vote against the proposed CN-KCS merger and adjourn a shareholder vote so that CN's proposed acquisition can be decided at a later date, when more information will be available to KCS's stockholders. 

As for CN, in early July, along with KCS, it outlined in a joint STB filing how the proposed combination of CN and KCS will preserve and promote competition, growth and more choice for rail customers, port operators, employees, stakeholders and communities in various ways, including: delivering more choices to rail shipper customers; keeping gateways open in commercially reasonable terms; using confidential, voluntary, binding arbitration to enforce the gateway commitment; and creating greater price transparency.

What’s more, earlier this week, CP said it has submitted a new offer for KCS, which it called a “superior proposal” in a stock and cash transaction, for roughly $31 billion, adding that it offers KCS shareholders an alternative recognizing the premium value of KCS while providing more regulatory certainty.

“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 the CN merger agreement, but offers significantly higher regulatory certainty than the proposed CN merger and significantly higher value than our previously agreed combination,” said CP.

As for CN, it subsequently issued a statement, saying that CN and KCS’ agreed transaction remains superior and the best option for both companies’ stakeholders to deliver on a combination that will enhance competition and provide new servicing options for customers.

“CN and KCS’ joint voting trust application, which was filed on May 26, 2021, is currently under review by the Surface Transportation Board (“STB”),” said CN. “We await the STB’s decision following a comprehensive comment period which resulted in overwhelming support from customers, suppliers, elected officials, organized labor, local communities and other stakeholders. CN and KCS are confident that the voting trust meets all the standards set forth by the STB and believe that, after a fair and thorough review by the STB, it should be approved. KCS shareholders will receive the merger consideration immediately upon the closing of CN’s voting trust. Together, CN and KCS would create the premier railway for the 21st century, connecting ports in the United States, Mexico and Canada to expand North American trade and power economic prosperity. We will continue to take the necessary steps to deliver the many compelling benefits of this transaction to CN and KCS stakeholders.”

In a recent interview, Larry Gross, president of Gross Transportation Consulting, said that even though CN and KCS have come terms on a deal, there are still some significant questions regarding regulatory approval.

“The next hurdle is whether or not the STB will approve the placement of KCS into a voting trust, which will essentially allow the merger to proceed during the approval process, which is quite lengthy,” he said. “CN would own KCS but would be able to sort of affect its operations. Call it a state of suspended animation. It is conceivable that if the STB is uncomfortable with the deal, it may not approve it, with CN liable for a $1 billion breakup fee.

As for next steps regarding the STB, Gross said it is hard to say what the next steps may look like, calling it a considerably heavier lift, from a regulatory standpoint, for a CN deal than a CP deal.

“If the deal goes through, there will be conditions placed on the merger, and you could easily end up with a split scenario, where the STB says one piece [of KCS] goes to CN, and CP has an overlap somewhere else, and maybe co-own and operate the Mexican piece,” he said. “The biggest STB issue is that I suspect it is somewhat concerned that a CN-KCS merger is destabilizing, because it leaves CP kind of like an orphan out in the cold…and essentially a sixth railroad among five giants. It could seek inclusion in one of the other four U.S. railroads, which is potentially a destabilizing event. That may color STB’s thinking in terms of how they color the merger.”

From a shipper perspective, having either CN or CP acquiring KCS is fine, according to Gross. And, from an intermodal perspective, the cross-border market has been an underperformer and should not be the case, as it is a long-haul market that should be an intermodal sweet spot. The reason it has underperformed, he said, is that there is no single-line service, and railroads typically don’t fare well when they have to interchange.