CP deal could be easier sell in wake of continental trade deal and pandemic’s economic shifts

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Canadian Pacific Railway Ltd. could be bidding for Kansas City Southern at an opportune time, as the proposed deal aims to create a massive North American rail network in the wake of the new NAFTA agreement and amid a pandemic that may make regional trade ties an easier sell.

Calgary-based CP and Kansas City, Mo.-headquartered KCS announced on Sunday they’d entered into a merger agreement that would see CP buy KCS for approximately US$25 billion in stock and cash.

If the deal receives approval from shareholders and the U.S. Surface Transportation Board, it would create the first rail network connecting Canada, Mexico and the United States.

“The new competition we will inject into the North American transportation market cannot happen soon enough, as the new USMCA Trade Agreement among these three countries makes the efficient integration of the continent’s supply chains more important than ever before,” CP chief executive officer Keith Creel said in a press release.

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It is those types of economic arguments that could be key selling points for a transaction that has hurdles still to clear and some tough history to overcome. For instance, CP in 2016 dropped its attempt to acquire rival Norfolk Southern Corp. after facing pushback to the takeover, including from the U.S. army.

This time around, however, the structure and timing might be more suitable, as the USMCA trade deal could present the continent-spanning transaction in a more favourable light. The COVID-19 pandemic has also provided an argument for supply chains that are closer to home, as its arrival disrupted overseas trade ties.

Raymond James analyst Steve Hansen wrote that merger timing “is always difficult in the rail industry,” but suggested that the economic backdrop is favourable for the transaction. There is the USMCA agreement, as well as “influential new investment themes impacting global supply chains (i.e. domestic near-sourcing),” which align well with the deal, Hansen wrote.

“The fact that COVID is finally fading, and the macro outlook is highly constructive, are both also deemed incremental positives, in our view,” Hansen added.

A combined network of CP and KCS would provide “dramatically expanded market reach for customers,” the railways say, and support the growth of the North American economy. The combined “Canadian Pacific Kansas City” would operate 20,000 miles or so of rail, employ nearly 20,000 workers and generate around US$8.7 billion in total revenue.

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CP and KCS also say the combined entity would provide a link to and from “premier ports” on the Gulf of Mexico and the Atlantic and Pacific oceans for customers in the agriculture, auto and energy sectors, among others. Indeed, with the Gulf included, it would give the combined network not only cost-to-coast reach, but “coast-to-coast-to-coast,” noted Clarence Woudsma, a professor at the University of Waterloo’s School of Planning.

“It’s now a firm establishment of a prior relationship,” Woudsma added.

CP and KCS already run a shared facility in Kansas City, where their respective networks connect. It’s that kind of connection that may be another selling point for the deal as well.

National Bank Financial analyst Cameron Doerksen wrote in a note to clients that the deal is a “logical combination,” with their networks essentially avoiding any overlap.

“The North-South network the combination creates would be particularly advantageous for grain, intermodal and automotive volumes,” Doerksen wrote. “With the new USMCA trade agreement and trade between Mexico and the United States expected to grow (potentially supported by increased near-shoring of manufacturing back to North America), the timing for this deal appears to be favourable.”

There could be benefits for other sectors, too. Alberta Premier Jason Kenney tweeted on Sunday that the combined rail network “will give CP direct access to the US Gulf Coast & beyond, allowing it seamlessly to transport Alberta energy directly to Gulf Coast refineries, improving the economics of crude by rail.”

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Regulatory hurdles may not be as daunting either. CIBC World Markets analyst Kevin Chiang noted that CP’s bid is a friendly one, that the combined entity would remain the smallest of the so-called Class I railroads, and that the two firms don’t compete head-to-head.

Furthermore, the Surface Transportation Board (STB) in 2001 exempted Kansas City Southern from a greater burden to show that major railway M&A is in the public interest.

“CP is assuming the STB will treat its acquisition of KCS as a minor merger and that it will maintain its waiver related to STB’s major rail consolidation decision,” Chiang wrote.

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