(Bloomberg) -- After months of twists and turns, Canadian Pacific Railway Ltd. sealed a $27 billion deal to acquire Kansas City Southern, claiming a prize that would create the first railroad spanning the U.S., Canada and Mexico.
Kansas City Southern terminated a $30 billion agreement with Canadian National Railway Co. that had run aground after U.S. regulators rejected a crucial provision.
“We’re increasing competition, not reducing competition. Shippers have more options. It’s pro-growth. It’s pro-employee,” Canadian Pacific Chief Executive Officer Keith Creel said in an interview Wednesday. He is slated to have the same post at the merged carrier.
The companies valued the cash-and-stock deal at $31 billion including the assumption of debt. The merger still needs approval from shareholders, Mexican regulators and the U.S. Surface Transportation Board.
With the combination, Canadian Pacific would become the first railroad to operate in Canada, the U.S. and Mexico, where Kansas City Southern gets about half its revenue. The Canadian carrier will enlarge its network by 50% to 20,000 miles of track from Vancouver to Veracruz, Mexico.
Canadian Pacific had reached a $25 billion deal for Kansas City Southern in March, only to have it snatched away by Canadian National a couple of months later. Canadian Pacific sweetened its offer to $27 billion in August but was rejected.
That offer became the heavy favorite, however, after the Surface Transportation Board rejected Canadian National’s proposal for a voting trust to buy out Kansas City Southern’s shareholders while full approval was pending. The U.S. carrier had said it wouldn’t entertain any deal that lacked such a mechanism, which the STB had already approved for Canadian Pacific.
Kansas City Southern responded by deeming Canadian Pacific’s proposal superior and giving its larger rival five business days to improve its proposal. Canadian National declined to do so, citing regulatory hurdles.
Kansas City Southern rose almost 1% to $282.40 at 11:34 a.m. in New York. Through Tuesday, the stock had climbed 25% since Canadian Pacific’s initial deal was first reported in March. Canadian Pacific rose less than 1% Wednesday to C$87.13 in Toronto, while Canadian National advanced 3.5% to $150.80.
Canadian National won’t walk away empty handed. Kansas City Southern is paying its jilted suitor a breakup fee of $700 million for ending their agreement and will refund the Canadian carrier an additional $700 million that it had paid the U.S. railroad for killing the spring Canadian Pacific deal.
But Canadian National CEO Jean-Jacques Ruest and the railroad’s board have come under fire from prominent shareholders for their failed efforts. TCI Fund Management, one of the railroad’s biggest stockholders, has called for a special shareholder meeting to nominate a new CEO and four new directors.
Wednesday’s events vindicate a decision by Canadian Pacific’s Creel not to match his larger rival’s bid, betting that the STB would object to Canadian National’s overlapping operations with Kansas City Southern. The board did object -- in strong language -- and expressed concern that such a tie-up could spur further rail consolidation.
Even with the acquisition, Canadian Pacific will remain the smallest of the six major North American railroads. The STB’s comments have convinced many industry analysts that this could be the continent’s last large railroad acquisition.
Canadian Pacific’s added heft will help it bring balance to the industry, with Union Pacific Corp. and BNSF Railway Co. competing in the western U.S., CSX Corp. and Norfolk Southern Corp. battling in the East and now two Canadian carriers operating to the U.S. Gulf Coast.
Executing the voting trust to pay Kansas City Southern shareholders could come in the fourth quarter, although that still awaits a green light from Mexican regulators.
“We should be buttoned up, so to speak, on the U.S. side,” Creel said. “It’s just that one Mexican piece that I’m not sure. That might carry over to the first quarter.” Kansas City Southern CEO Pat Ottensmeyer is in Mexico City to help move the process along.
While the voting trust will allow Kansas City Southern shareholders to be paid, rail operations won’t merge until regulators give final approval of the merger, which could take place next year. Such approval seems likely, however, given the rulings so far.
Ottensmeyer is expected to run Kansas City Southern through the full approval. The ultimate executive team hasn’t been determined, Creel said.
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