Canadian Pacific Railways has agreed to buy Kansas City Southern for $25 billion ($28.9 billion including debt) in the largest takeover deal this year. The transaction which sees CP take over the smallest of the seven Class 1 railway operators that dominate a significant share of freight activity in the US, is the biggest in CP’s history and will create a 20,000-mile rail network including the first U.S.-Mexico-Canada railroad.
As the FT, which first reported the transaction, notes, the deal marks the latest effort to shake up a structure among the big railroads in the US and Canada that has been unchanged since CSX and Norfolk Southern — the two big operators in the eastern US — took over Conrail and divided it between themselves in 1999.
The transaction gives CP access to the Kansas City, Missouri-based company’s sprawling Midwestern rail network that connects farms in Kansas and Missouri to ports along the Gulf of Mexico. It would also give it reach to Mexico, which made up almost half of Kansas City Southern’s revenue last year, and create the only network that cuts through all three North American countries
“This transaction will be transformative for North America,” CP President and Chief Executive Officer Keith Creel said, adding that “this will create the first US-Mexico-Canada railroad . . . [and combine the] two best performing Class 1 railroads for the past three years on a revenue growth basis.”
The Calgary-based company will pay $275 per share - a 23% premium to Friday’s record close - comprised of $90 in cash and the remainder with its stock, receiving 0.489 CP shares for every share they own. To pay for the deal, CP will issue 44.5 million new shares and raise $8.6bn in debt. according to a statement from both companies on Sunday. Shares of Kansas City Southern have more than doubled in the past year. Last September, the company rejected a takeover bid from a Blackstone and Global Infrastructure Partners-led consortium that valued its shares at $21BN.
The two companies notified the Surface Transportation Board, the US freight rail regulator that will need to approve the combination, about the deal on Saturday, people with direct knowledge of the matter said.
Investors have been concerned that any further consolidation would run into problems with the STB. As it stands, there are two competing big operators in Canada (CP and Canadian National), CSX and Norfolk Southern in the eastern US and Union Pacific and BNSF in the west. Kansas City Southern, the smallest Class 1, is the only operator focused on north-south operations.
The FT also notes that Kansas City Southern’s performance has been closely tied to trade between the US, Canada and Mexico, with its main routes linking the two countries neighbouring the US. It also has extensive operations in Mexico and owns a 50% stake in the Panama Canal Railway Company. The railway sector was hit hard in the early phase of the pandemic because of restrictions imposed by the US government to contain the spread of coronavirus.
As a result, Kansas City Southern reported an 8% drop in revenues in 2020 to $2.6bn and a 23% increase in net income to $617m. But prospects have improved in recent months, as the US accelerated its rollout of vaccines and business activity picked up. Biden’s efforts to strengthen US-Mexico trade relations - especially if Mexico agrees to hold the migrants that Biden initially invited - are expected to further boost railway activity. KCS employs about 6,200 staff compared with nearly 12,000 at the Canadian group.
Canadian Pacific shares have climbed 80% over the past year and have a market value of C$63bn ($50bn). The company’s largest shareholder is Chris Hohn’s TCI hedge fund, which had an 8.4% stake, according to filings from the end of last year.
Canadian Pacific previously approached first CSX and then Norfolk Southern about potential mergers in 2014 and 2016 under Hunter Harrison, the chief executive who was installed after a campaign by Bill Ackman, the activist investor. Both bids were rebuffed and there have been no further attempts at mergers since Harrison unexpectedly resigned from CP in January 2017. Harrison joined CSX two months later, shortly before his death in December that year.
Creel will be CEO of the new company, based in Calgary, and is expected to remain at the helm until at least early 2026, according to a separate statement. The combined entity, to be called Canadian Pacific Kansas City, or CPKC, will have revenue of about $8.7 billion and almost 20,000 employees.