Western Railroad Discussion > The Canadian Railroads and Kansas City Southern - Why explained

The two Canadian Railroads are fighting over KCS and both companies have offered premiums over what the Hedge/Investment Funds thought KCS was worth. Some of Trainorders readers think KCS should be left alone because it means one more smaller favorite railroad will disappear. Others are anti-Canadian. Still others think KCS should be broken up.

I am going to explain what I see is the reason why CP made the offer for KCS, why they made it now, and why CN made a counter offer. And it smacks of the Old Robber Baron days. Who doesn't love such stories as long as it doesn't hurt them.

First why CP made the offer-

CP made the offer because KCS is worth at least $20 - $22 billion dollars. But far more than that CP absolutely NEEDS KCS as a counterbalance to CN. CN is ever so slowly grinding down CP in Canada and is using the situation in Canada to its benefit. The Canadian Government sold the railroad to private investors for way less than CN was worth and with minimal debt. Second the British Columbia Government sold BC Rail to CN without giving CP a chance to bid and for less than it was worth. The last straw was the Canadian Government's Interswitching regulations saying within 30 kilometers of an interchange point your customer is my customer, that's great for shippers but CN found a way to use it as a weapon against the smaller CP. CN has a much larger area in Canada where this does not apply because CP has no interchange nearby. And then there is CN's much larger US network which will become larger still if CN gets KCS. This is also the reason that CP bought back the Central Maine & Quebec Railway (CM&Q) last year. CP saw the Port of Montreal looking like it might implode depriving CP of yet more revenue it needs. To reach the alternative ports, Quebec City or Saint John, CP was going to have to buy back a rail line sold off by Fred Green, the same guy who sold off the Kansas City line. CP chose the Port of Saint John as the best candidate.

Why now?

It is now or never, CP will never in the future have as much money or be as loan-worthy as they are now. Keith Creel is the first CEO who is thinking of CP beyond the next few years and it scares him. He is willing to look beyond what the next quarter or year's financial results will look like. 

Why did CN make a $30 billion dollar counter offer?

CN made the offer to enable it to continue to grind on CP with the prize being unchallenged control of Canadian rail traffic with CP getting only enough to maintain a veneer of competition. For the time being Canadian shippers and receivers will benefit, how long it will last depends on how long it takes CN to reduce CP's financial position to the point where it can no longer invest in its railroad to remain competitive. They are lying when they say they intend to take market share from the truckers. The only place they can earn back their investment is by taking market share from CP, it doesn't matter whether that traffic originates in the US or in Canada. 

Summary

There are three possible outcomes to this battle

1. CP loses KCS and CN slowly grinds them down until the Canadian Government wakes up and rescues the husk of a version of PC in Canada with deferred maintenance and broken down locomotives or Canada decides to drop its requirement that Canada railroads stay Canadian so that one of the big four US railroads take over CP. This does not require that CN gets KCS, just that CP does not get them.
2. CP gets KCS, but it is not enough and outcome follows as in number 1 just more slowly.
3. CP gets KCS and it is just enough to counter balance CN.

Don't believe me, why do you think that Keith Creel made the whiney statement that if CP didn't get KCS, then they would have to merge with a US railroad. That had to be very embarrassing and he wouldn't have made the remark if he didn't think it was true. Of course he could always just serve out his time and retire before the decline in CP becomes obvious to everybody else. I think Keith Creel wants people to respect what he has done at CP after he has retired or moved on.

 



Edited 4 time(s). Last edit at 04/22/21 11:40 by SOO6617.

The company I retired from had multiple production sites in Canada - all of them open to interswitching. As you note, this enabled us to play CN against CP and vice versa but, only to the extent we were shipping to a customer in Canada who could use interswitching or to a US destination served by a railroad other than CN or CP. If the Canadian customer was captive to one or the other, that dictated which railroad we could use and this resulted in captive traffic being about evenly split.

Insofar as access to interswitching, the stat that I saw repeatedly was that something like 70% of rail served points in Canada were open to interswitching. I certainly never had the impression from my dealings with either CN or CP that either felt themselves abused by interswitching and, from my experience, both made rational decisions on when to compete for business and when to take a pass. I would further postulate that given how large production sites tend to cluster near one another and that in Canada these industrial clusters are normally served by both CN and CP, I would question your theory that CP has somehow been on the short end of interswitching.

I suspect the rationale for CP making an offer for KCS has more to do with the overall size of both railroads and CP’s belief they could get the STB to consider the merger under the old merger review process using KCS’ waiver. With the comments filed by several other Class 1’s and large shipper organizations suggesting the STB should review the merger under the newer process, now combined with CN throwing their hat into the ring, I believe the STB will be forced to consider any merger involving KCS using the new review process.

Of the two offers on the table now; from a regulatory perspective I believe CP would have the greater chance of success albeit with conditions attached by the STB. I will agree with CP that were CN to get KCS, all balance in the industry flies out the window and we go where no one really wants to go, ie two North American Class 1’s that go everywhere.

Speculation is a fun pastime but, this will play out as it plays out. Most of us involved in the speculation here on TO have no real skin in this game and I’d be certain none of those who do are looking to TO for guidance, from me or anyone else. ;-)

CW

Posted from iPhone

Some years ago the CPR "merger" question came up on the CPR  biz car Van Horn ( I still have the car-named cabin key from that meeting). It was then expressed that CPR may eventually merge with its friendly connection UP and the new paint scheme would be UP yellow CPR red. I think if things go south (both in direction and pun wise for CPR it will merge with UP. Canadian laws can be changed. After all CNR was owned by the people of Canada, and now it's owned by the bastard-progeny of HH. 

Juniata Wrote:
-------------------------------------------------------
 I would question your theory that CP has
> somehow been on the short end of interswitching.

First I would suggest that not many people in a company below the level of CFO or CEO would notice early on what is happening. Financial trends are hard to spot without a good look at all the figures. Plus the figures you present to the Public have to make you look good. To achieve the goal of wrecking CP CN would have to bear a small amount of pain over a long duration. This is where captive customers will help carry your company, you charge them as much as the market will bear. Some additional customers will be located where your company has a natural advantage, a significantly shorter route via your company, you charge them an amount low enough that CP won't find it worthwhile. Then you look at customers where CP has the natural advantage, those customers a price that is high enough that you won't win the business, but low enough that CP gets less revenue. Don't think that there are more large captive customers on CN? As examples the Port of Prince Rupert, Port of Halifax, until recently the Port of Saint John. The Lumber and Paper mills between Edmonton and Prince Rupert, the mines and mills on the line north of Montreal. And finally all CN's lines in the US which have more traffic than CP's lines in the US. Then you steal the business of Teck Resources, possibly CP's largest customer, which there should have been no way for you to get. 

> I will agree with CP that
> were CN to get KCS, all balance in the industry
> flies out the window and we go where no one really
> wants to go, ie two North American Class 1’s
> that go everywhere.

I am not sure that CN getting KCS by itself would trigger the final consolidation, but certainly CP putting its railroad on the market would.

> Speculation is a fun pastime but, this will play
> out as it plays out. Most of us involved in the
> speculation here on TO have no real skin in this
> game and I’d be certain none of those who do are
> looking to TO for guidance, from me or anyone
> else. ;-)
>
> CW

Hey, I'm retired from running my own businesses for nearly forty years, what else am I going to do. I owned a small amount of KCS stock, but I sold it after the CN announcement. I was expecting a bid from someone to best CP's bid and it happened.

SOO; I get your point about people below a certain level not being privy to numbers but; interswitching has been in existence in Canada since 1986. Both carriers have been reasonably successful over the past 35 years.

Wall Street types are privy to numbers and CP’s stock performance under Harrison and Creel hasn’t been shabby. If interswitching was such a drag on CP, the stock price would reflect that.

I’ll agree CN does have a much better network in the US than CP and the addition of KCS would serve to improve that.

Beyond that; I agree. Us old guys have to do something to amuse ourselves and “solving” the problems of the rail industry is a fun distraction. ;-)

CW

Posted from iPhone



Edited 1 time(s). Last edit at 04/22/21 16:00 by Juniata.

Interesting summary of the financials of the two Canadian Class 1s.

I'm hearing more and more support for KCS becoming a very large joint facility.

Waybiller Wrote:
-------------------------------------------------------

> I'm hearing more and more support for KCS becoming
> a very large joint facility.

That's an interesting idea. Certainly it will make for much ink spent in the Financial and Rail Industry press. It will certainly benefit some shippers more than others, though initially it might remind people of the Texas chaos after UP acquired SP. I think the question that would have to be answered is how little would KCS shareholders settle for, and how much would the railroads be willing to pay. I don't think that CN's bid of $33.7 billion could be gotten from the six remaining Class One Railroads. 

I would add that CP also has been trying to grow their network for years, just to keep up with CN. That was the aim of the CSX and NS takeovers. Creel is right, eventually CP is going to need a buddy. KCS was just the only RR they could afford. 

Making KCS a joint facility is a very interesting proposal. 

I really have nothing t say about tje original post.  I'm not close enough to the situation anymore to make a judgement.

However, regarding Creel's whiny screed about CN stock: show us the money.  The vast majority of these stocks are held by insitutional invesotrs, such as pensions, mutual funds, insurers, bank trust departments and so on.

They are looking at a cuple of things.  CN's bid has $200 in cash, CP's $90.  And, if they want to hold CN stock, they won't.  They'll vote CN in the proxy contest, take the $200 cash, CN stock worth $100 and something (I think it was a set ratio and didn't feature items that would have fixed the price for KCS i.e. a ratio of x, bounded by x-10% and x+10% to give certainty to KCS shareholders that they will get $125 a share in CN stock.

The stock market has already voted. 

It is not a choice between CO's offer and no deal, it's a choice between CN's offer and CP's and CP's is losing big (KSU share are $20ish a share higher than CO's offer).

It is only a matter of time until Keith Creel realizes this, upss his offer and includes more cash.

BobE

SOO6617 Wrote:

> Don't believe me, why do you think that Keith
> Creel made the whiney statement that if CP didn't
> get KCS, then they would have to merge with a US
> railroad. That had to be very embarrassing and he
> wouldn't have made the remark if he didn't think
> it was true.

I agree with much of your original post, but CEOs are perfectly capable of playing drama queen if it suits their purposes.   He may have simply been giving the regulators some food for thought - if we dont get KCS, we may cuddle up with UP and put you in a position you most certainly don't want to be in.

Bonus acting point for saying "we may have to merge with a US rail" as a threat to justify a merger with a US rail.

BobE Wrote:
-------------------------------------------------------

> It is only a matter of time until Keith Creel
> realizes this, ups his offer and includes more
> cash.
>
> BobE

Bob, CN also has to get the STB to go along with them. I think CP made the biggest offer they could or at least nearly so, I don't think they can beat CN's offer. I could be wrong. In any case KCS will have to give CP $700 million in order to accept CN's deal.

Waybiller Wrote:
-------------------------------------------------------
> Interesting summary of the financials of the two
> Canadian Class 1s.
>
> I'm hearing more and more support for KCS becoming
> a very large joint facility.

KCS is no Conrail and it doesn't seem CP has enough cash to keep up the bidding war.

How likely is CN+KCS to pass muster with the STB, given that CN already owns the former IC?

pennsy3750 Wrote:
-------------------------------------------------------
> How likely is CN+KCS to pass muster with the STB,
> given that CN already owns the former IC?

Depends on what concessions they hand over to other rails. Neither CP or CN went into this thinking they'd likely walk away with KCS/KCSdeM unscathed as I'm 100% certain they already have a good idea what they will have to give up. If CN stated today that they would equally share all KCS/KCSdeM route structure and customers with CP, while also strategic routes (e.g., Meridian Speedway or Gateway Western) also shared with other class 1 rails, then this would be approved with ease. Whether CN or for the matter CP is willing to go down this "increased competition" path the STB will demand now, is open to debate. This is why there is increasing confidence either the STB conditions scare off continuing a merger attempt, or we are headed toward KCS broken into parts to satisfy all interests as the odds of CP or CN maintaining KCS system control is approaching zero.



Edited 2 time(s). Last edit at 04/23/21 07:35 by AaronJ.

The mud slinging continues. CN has filed a rebuddle letter over CP's comments about CN's bid for KCS. 

https://www.railwayage.com/regulatory/cn-letter-former-stb-general-counsel-weighs-in/

Canadian National is Canada's version of Conrail, formed after World War I, consisting of the Canadian Northern, Grand Trunk, Grand Truck Pacific, Grand Trunk Western, Intercolonial, National Transcontinental along with U.S. subsidiaries Central Vermont and Duluth, Winnipeg and Pacific and a few smaller lines.  Canadian Pacific was the only Canadian railway not enter into bankruptcy in the 1920 time frame.  The Canadian Government ran the CN as a Crown Corporation until it was privatized in 1995.  CP really had to only compete with CN, content with running a network that survived in spite of itself and never looked at enhancing the overall system into new markets especially in the U.S. until it was too late.  Then CN was privatized with a whole new mindset and direction with CP still maintaining the same direction in the company.  CP had plenty of opportunities to expand well prior to CN's privatization.  In the 1950s, they could have purchased the Spokane International, but turned that down.  They only gained full control of the Soo Line in 1990, had they looked to fully own the Soo, they then could have made such purchases of the Rock Island's Spine Line a big priority and considered IC, KCS and M-K-T during the 1980s as other opportunities to further enhance the network and enter new markets.  CP could have also tried to buy the former Michigan Central line between Detroit and Chicago from Penn Central to connect the CP in Ontario with the Soo Line.  They did acquire the D&H but that was restricted by Conrail and purchased the DM&E but those were not large scale mergers.  Did CP consider launching an effort to buy Conrail when CSX and NS were bidding on that?  North of the border, at the time the government was preparing to sell CN, CP attempted to merge with CN outright and when that was rejected, they looked to acquire CN's eastern lines with that also being turned down so some new objectives for network enhancement were there.  And true that they did try to merge with BC Rail but CN ended up with that under that very controversial merger arrangement with the BC government.  At the time of the privatization, did CP ever look to get at least joint access to such places as Prince Rupert, Halifax and to the GTW?  Or, away from CP, was there ever any consideration by the government to break a portion of CN into possibly into a western Canada-based railway similar to that of the CNoR in the mid 1990s and the rest a transcon?  Once CN was privatized, a new mindset was launched to form the "T" shaped railroad that they have under IC, WC and the EJ&E turning the new CN into much more of an aggressive competitor to not only CP but to U.S. railroads also.  So CP in some areas, no all, but some,  put their system in the position that it is in to today.  To stay independent, management has to make the KCS merger happen, or may have to merge with another carrier.  Only time will tell on this one.

I'll be shocked if CP doesn't eventually make a counter bid and strongly suspect they knew one of CN or NS was going to bid anyway. Then the fun of watching rails fight over who gets what and how KCS is carved up begins.

Northern Wrote:
-------------------------------------------------------

> CP could have also tried to buy the former Michigan
> Central line between Detroit and Chicago from Penn
> Central to connect the CP in Ontario with the Soo
> Line.  

That would have been an interesting acquisition, considering the MCRR from Kensington, IL and Porter, IN was all but there for the taking from the Penn Central trustee, especially with CR having direct access to Detroit from Toledo by three seperate mainline routes (MCRR, LSMS and PRR). Certainly makes more sense than the former PM via Grand Rapids (distance) or even the current NS rights via Butler, Indiana (Chicago Line congestion).

Thanks to all who have contributed to the discussion.  Fascinating.

Bill Stephens on Trains News Wire today has an interesting take on splitting up KCS - including a lot of jointly operated sections, especially south and west of Shreveport.  CP would get the KCS Kansas City to Shreveport, and Shreveport to New Orleans to keep competition in that important corridor.

May be behind a pay wall.

https://www.trains.com/trn/news-reviews/news-wire/could-canadian-pacific-and-canadian-national-split-kansas-city-southern/

Jim

 

Here comes UP with..."be very, very active and engaged in this process with the STB and, potentially, directly with the acquirers".

https://www.railwayage.com/freight/class-i/lance-fritz-on-cp-or-cn-kcs-we-will-be-an-active-participant/

In other words, UP won't let the Laredo gateway interchange deviate much, if at all. They will also protect the Shreveport interchange via Meridian Speedway and demand access to certain routes (Gateway Western).



Edited 1 time(s). Last edit at 04/23/21 15:57 by AaronJ.