CP Rail-Kansas City Southern deal was inevitable: 'Railroader' author Howard Green
Canadian Pacific Railways Ltd.’s Keith Creel for years followed in the footsteps of Hunter Harrison, an industry legend whose revolutionary efficiency strategy became the standard at all the major North American railroads.
Now, the protege has a good shot at achieving a major merger -- something that Harrison, who died in late 2017 at age 73 during a turnaround effort at CSX Corp., couldn’t after several failed tries.
Canadian Pacific on Sunday agreed to buy Kansas City Southern for US$25 billion, creating the first railroad to traverse Canada, the U.S. and Mexico. If Creel, the Canadian railroad’s 52-year-old chief executive officer, can complete the deal next year as he envisions, it may very well be the last chapter in a rail-merger saga that was kicked off by deregulation in 1980s and was credited with saving a dying industry.
“This is the only merger left that could potentially be a stabilizing one and not a destabilizing one,” said Tony Hatch, a rail-industry consultant. “This is one that takes Kansas City Southern out of play and combines the two smallest railroads.”
The timing follows a global pandemic that made companies rethink the risk of having overseas supply lines. The supply chain was frozen by China’s initial lockdown last year to control the coronavirus, and the subsequent reopening created a maritime logjam at U.S. ports. A cloud over trade was lifted in July with a renegotiated trade pact among Canada, the U.S. and Mexico. Meanwhile, President Joe Biden is seen as less likely to issue trade threats by Twitter than predecessor Donald Trump.
“The stars have aligned to make this deal happen,” Creel, an Alabaman who followed Harrison to three companies, told analysts on a call Sunday.
Kansas City Southern surged 17 per cent to US$262.25 before the start of regular trading Monday in New York, on pace for its biggest closing gain since last March. The stock had advanced 93 per cent in the 12 months through March 19 while the S&P 500 index of four U.S. railroads climbed 76 per cent. Canadian Pacific was indicated down 3.4 per cent to $458 before the open Monday in Toronto.
The Next Spike
Railroads have been central to North America’s industrial development. Industry lore is almost always told from the East looking West: A “Golden Spike” united the first transcontinental railroad in the U.S. in 1869, and the “Last Spike” did the same in Canada in 1885.
Some 150 years later, Creel is writing a North-South story.
The tie-up announced Sunday would create a 20,000-mile, T-shaped network, giving Canadian Pacific access to Kansas City Southern’s sprawling Midwestern rail system that connects farms in Kansas and Missouri to ports along the Gulf of Mexico. The network would also let CP reach deep into Mexico, which made up almost half of Kansas City Southern’s revenue last year, and benefit from the 16 different automotive factories along its tracks there.
Under the deal -- the biggest Canadian purchase of a U.S. asset since 2016 -- Kansas City Southern investors will receive 0.489 of a CP share and US$90 in cash for each share they hold, valuing the U.S. railroad’s stock at US$275 apiece. That’s 23 per cent more than Friday’s record close, according to a statement from the companies.
Creel will be CEO of the new company, to be based in Calgary, Alberta, and plans to stay at the helm until at least early 2026. The new entity, to be called Canadian Pacific Kansas City, or CPKC, will have revenue of about US$8.7 billion and almost 20,000 employees. Shareholders of CP will hold 75 per cent of the combined company.
The companies -- whose boards unanimously approved the deal -- say they expect to get final approval from regulators by mid-2022. In the U.S., the Surface Transportation Board will have the biggest say.
Rail combinations reached a fever pitch in the 1990s, with some causing such chaos that the transportation board raised the bar for approving deals in 2001. But one small railroad got an exemption from stricter rules -- Kansas City Southern.
“We’ve got complete confidence in this deal and the review process,” regardless of which set of rules the STB applies, Creel said. “We think that the facts are so compelling that when the STB rules and weighs the facts, they will come to the same conclusion.”
The two networks don’t overlap and won’t reduce customers’ rail options, Creel said. The combination also will help reduce emissions by attracting freight from truck to rail, which is about four times more fuel efficient. Some 80 per cent of the production from the Mexican auto plants along the network crosses the border north to the U.S. and Canada and can be hauled in one shot by the new entity, the companies said.
The tie-up would leave Canada with two railroads that have similar coast-to-coast networks that reach down to U.S. ports on the Gulf of Mexico. The U.S. would have four railroads balanced almost equally between two larger ones in the West and two smaller ones in the East.
While it’s impossible to say never to further industry consolidation, it probably wouldn’t happen for a decade or more if at all, said Lee Klaskow, an analyst with Bloomberg Intelligence. That round of consolidation would be more complicated because companies would be jockeying not to miss out of the few deals left to be made. The Canadian Pacific offer to buy Kansas City Southern is much more straightforward, mostly because the two networks don’t duplicate track, Klaskow said.
“They interchange in one location,” Klaskow said. “It’s the easiest deal to get done.”
Mentor and Protege
But railroad deals aren’t always easy.
While Hunter Harrison was CEO of Canadian Pacific, he tried to buy CSX and Norfolk Southern. He declined to pursue a combination with Kansas City Southern at the time because of its large operations in Mexico. Harrison didn’t like the currency risk, nor the lack of legal and regulatory transparency.
Creel is betting that Harrison was wrong.
“If anybody knows Hunter Harrison and has experience with him, it’s me,” Creel said in an interview. “He’s a human being. He didn’t get everything right.
“I would just say that he wasn’t seeing these same compelling facts and this perfect time to combine these two companies, or I’m certain that he would align and agree with what we’re doing.”