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Federal regulators reject CN plan to put KCS in voting trust (third update)

By Bill Stephens | August 31, 2021

Decision may put Class I merger in jeopardy; CN says it is 'evaluating options'

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Canadian National and Kansas City Southern logos

Canadian National and Kansas City Southern logosWASHINGTON — Federal regulators Tuesday rejected Canadian National’s request to put Kansas City Southern into a voting trust, dealing a serious blow to the first merger between Class I railroads in two decades.

The Surface Transportation Board’s decision that placing KCS into a voting trust was not in the public interest may prompt the railroads to scuttle their $33.6 billion deal to create the first railroad linking Canada, the U.S., and Mexico.

The board said CN and KCS adequately explained how the voting trust would insulate KCS from unlawful control by CN while the merger is under regulatory review. “But the Board finds that the proposed use of a voting trust, in the context of their impending control application, would not be consistent with the public interest, the STB said in a unanimous, 33-page decision.

CN, in a statement issued at 10:15 p.m. EDT Tuesday, said it is “disappointed” with the decision and is “evaluating our options available to us in light of the STB’s decision.”

Placing KCS into a voting trust — a key first step in the merger process — would potentially harm the public interest in two ways, the board said. The first would be its potential impact on competition between CN and KCS while the merger is under review. The second was if CN were forced to sell KCS if the merger were rejected.

The STB said that the Class I merger rules adopted in 2001 changed the board’s voting-trust standard. But the board said that a voting trust was not essential and that CN and KCS could still proceed with a merger using different deal terms.

The board’s ruling may lead to a revival of Canadian Pacific’s efforts to combine with KCS. CP and KCS announced their $29 billion merger deal in March, only to have CN swoop in with a higher offer that KCS accepted in May. CP this month sweetened its deal to $300 per share, or $25 below CN’s offer. The board has already approved CP’s proposal to put KCS into a voting trust and would review a CP-KCS merger under the less-stringent, pre-2001 merger review rules.

CN had argued that its KCS trust proposal was identical to CP’s plan that the board approved and therefore its voting trust should receive the board’s blessing as well.

The STB disagreed, noting that the CN-KCS merger would be judged under the tougher new merger rules, while CP-KCS would be reviewed under the old rules. The STB also said the mergers are fundamentally different because CP-KCS would be a true end-to-end merger, while CN-KCS involves some route overlap.

The STB also said that approval of a CN-KCS voting trust arrangement could lead to further consolidation among Class I railroads.

“A simple geographic analysis of the rail network would suggest that a carrier in CP’s position, i.e., one that would be the smallest carrier by far after a CN-KCS combination, might need to look for potential strategic alliances, which might in turn trigger yet more strategic responses by other rail carriers,” the STB said. “Approval of a CN-KCS voting trust could speed up downstream consolidation movements prior to the Board even having had an opportunity to assess them based on the record yet to be developed in this proceeding.”

CN’s statement late Tuesday said the railroad remains confident that its acquisition of KCS “is in the public interest … We continue to believe that the combination of CN and KCS would enhance competition, expand North American trade and power economic prosperity, provide new and faster routes, increase supply chain efficiency, and deliver other benefits to the public good.”

KCS did not comment on the board’s decision Tuesday. KCS shareholders are set to vote on the CN merger proposal on Friday. It’s unclear if KCS will still hold the shareholder meeting in light of the board’s decision. The rejection of the voting trust puts CN on the hook for a $1 billion breakup fee to be paid to KCS. CN already picked up the tab for KCS’s $700 million breakup fee payment to CP.

Railroads commonly use voting trusts that allow the railroad being acquired to remain independent while the merger is under regulatory review. Absent a voting trust, it’s possible that another suitor for KCS could emerge and top CN’s bid, analysts and railroads have said.

Canadian Pacific — which has touted its proposed union with KCS as the only end-to-end Class I merger that could gain regulatory approval — welcomed the ruling.

“The STB decision clearly shows that the CN-KCS merger proposal is illusory and not achievable,” CP CEO Keith Creel said in a Tuesday afternoon statement. “Knowing this, we believe the August 10 CP offer to combine with KCS, which recognizes the premium value of KCS while providing regulatory certainty, ought to be deemed a superior proposal. Today, we have notified the KCS Board of Directors that our August 10 offer still stands to bring this once-in-a lifetime partnership together.” CP will hold a conference call with investors on Wednesday morning to discuss the situation.

But CP will have to wait a while to relaunch its merger bid: The CN-KCS merger agreement does not expire until February.

“I can’t say I’m surprised,” says independent analyst Anthony B. Hatch of the board’s decision.

The KCS voting trust decision sends a clear signal about potential downstream impacts of a merger involving two Class I systems, he says.

— Updated at 2:20 p.m. CDT to add second CP offer, information on CN breakup fee; updated at 5:05 p.m. with CP statement; updated at 9:30 p.m. CDT with CN statement.
Trains Editor David Lassen contributed to this report.

12 thoughts on “Federal regulators reject CN plan to put KCS in voting trust (third update)

  1. Cheers for the STB. CN and KCS is clearly noncompetitive unless CN unloads Illinois Central routes. Any layman without a law degree can see that on a map. CN was willing to risk a billion that some bureaucrats in DC didn’t know how to read a map either. If CN wants Mexico access, use your access to capital pals and build it.

  2. Agreed, Mr. Rice. In the same way the map shows the problem with the CN-KCS merger, it also makes you wonder just how CP will string things together if they get KCS. I’m kinda lookin’ forward to it.

    1. Charles – as I posted when CP first announced it wanted to merge with KCS, CP lacks a direct route from West Detroit to KCMO. Some sort of arrangement with Norfolk Southern would help.

  3. There are at least 3 ways CP could shorten Detroit to KC after buying KCS.
    1. Make a deal with NS to use . Butheir Detroit-Springfield, IL line in exchange for rights elsewhere. Springfield-KC could be directional and both RRs could use NS between St Louis & Mexico, Mo, which would shorten KCS’ STL-KC route.
    2. Make a deal with CN to use CN Detroit-Springfield. In exchange CN could use KCS to KC from both Springfield and STL.
    3. Make a deal with Iowa Interstate to handle CP traffic from Blue Island to Davenport, or buy IAIS. While longer than CN or NS, this is still a lot shorter than going through Savannah and Bensenville, and avoids a long slow trek from Bensenville to Indiana. Detroit-St Paul traffic would probably benefit as well.

    1. I always thought NS would buy IAIS, which would give NS a direct connection with the western roads at Council Bluffs, and IAIS’s Peoria branch could be used to bypass Chicago. Also, NS would gain a direct route to Des Moines, which is currently handled via a haulage agreement with BNSF, ever since NS’s ex-Wabash Moberly-Des Moines route was pulled up in the mid-90s. I would guess it wouldn’t be a problem for CP to gain rights on the IAIS under NS ownership, especially considering Blue Island-Bureau Jct. might be considered surplus, and possibly for sale.

      1. The problem is that the IAIS doesn’t actually connect to Blue Island. The former Rock Island line is split among three different owners. Metra from Chicago to Joliet, CSX from Joliet to Bureau, and IAIS the rest of the way, with trackage rights into Blue Island yard (and Chicago, presumably). I don’t recall exactly how CSX ended up with that portion isolated from the rest of their system, but it’s there. So it would be a bit more complicated to work out a deal.

    2. It seems like using the former Wabash would be best, as long as they can work it out with NS. They already use that to get onto the former NYC to Chicago anyway. I hadn’t thought of the IAIS. Does CP use Blue Island yard already?

  4. NS already has haulage rights to Des Moines on IAIS and can use both IAIS and BNSF to get to Des Moines, depending on origin/destination. NS’ IAIS traffic can enter the IAIS at Peoria or in Chicagoland. The line between Utica and Joliet is owned by CSX and east of Joliet by Metra, with IAIS having trackage rights. IAIS cannot give others (NS, KCS, CP) trackage rights over track they don’t own, but they can do haulage, as they do for NS,

    We are really into speculation here as the CN/KCS merger isn’t over yet. Only the voting trust is rejected, not the merger. KCS shareholders will need to vote. However a “no” vote is more likely. If I am not mistaken, KCS shareholders will now have to wait to get their money until the merger is approved, if ever. Approval is far from certain and might be more likely if CN were willing to accept a lot of conditions, such as possibly selling CP a significant chunk allowing both railroads access to Mexico. However, no one knows how the STB will rule until it does.

    Perhaps SPSF would have been approved if they had been willing to sell a significant portion of the SP to UP and DRGW.

  5. CP’s yard is at Bensenville, near O’Hare. CP trains from the East face a long, slow trip to Bensenville. I am not certain of the route but it has to cross the former RI somewhere. Not positive if Blue Island would be the place to get on the IAIS but they certainly could somewhere. Since they would bypass Bensenville, switching might have to move to Davenport. Perhaps Chicago bound cars could be dropped off at BRC or IHB.

  6. How brash, arrogant, and yet careless of CN power donkeys to think the STB would approve of the voting trust/merger proposal with KCS. Anyone that can read a railroad map knows CN/KCS didn’t have a chance. The CN bigwigs should have their heads examined. So how many executives will/should be canned by the board of directors?

  7. It continues to amaze me that Mississippi has not objected to this. The state suffered the the ICG years when that company was for all intents and purposes the only rail option in the state. A CP-KCS merger would preserve a modicum of competition; a CN-KCS union would clearly not.

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