CN throws its hat into the ring to acquire KCS, with a $33.7 billion proposed offer

As the freight railroad sector ostensibly was awaiting the recently-proposed Canadian Pacific (CP) acquisition of Kansas City Southern (KCS) for $29 billion, which was announced in March, the chances of that deal—marrying two Class I railroads—making it to the final station are dealing with a new issue on the tracks, with the other Class I North of the border, CN, throwing its hat into the ring today, with what it called a “superior proposal.”

That CN proposal is comprised of a cash-and-stock offer to acquire KCS for $33.7 billion, or $325 per share, which, it said, marks a 21% premium over the proposed CP offer, coupled with an expected EBITDA close to $1 billion annually, driven largely by the conversion of truck traffic, and combined annual revenues in excess of $13 billion.

CN officials said that this acquisition would create what it called the premier railway for the 21st century, seamlessly connecting ports and rails in the United States, Mexico, and Canada. And it added that it would offer up superior service, enhanced competition, and new market access to move goods safely and efficiently across North America. Other benefits it cited included: reducing traffic congestion and preventing thousands of greenhouse gas emissions from entering the atmosphere and also to focus on expanding the addressable market and provide growth opportunities focused on the USMCA network.

“Our team is very excited about this announcement and what it means for the future of both companies, our shareholders, and the bright future of the industry,” said CN President and CEO JJ Ruest on a company-hosted Webcast this morning. “KCS is the ideal partner for us at the right time. Our superior access to the capital market, stronger balance sheet, lower cost of financing and ability to realize superior and higher quality synergies allow us to make a more attractive offer to KCS shareholders. These higher quality synergies and new revenue opportunities are driven by the significant incremental benefits tied to the conversion of long-haul trucking to the more cost-effective rail intermodal supply chain.  

The top CN executive explained that CN sees significant value in the KCS team and its experience and network. Should this acquisition come to fruition, he said that CN intends to continue to operate the KCS business in the U.S. and Mexico with the KCS name and brand, and establish Kansas City as the headquarters of the combined company’s U.S. operations.  

“Overall, we are the better bid, the better partner, the better railway and the best solution for KCS and for the North American economy,” he said. “Our combination with KCS would create a company with broader reach, greater scale, and the with the ability to connect more customers to more rail destinations and ports with robust single-loader and single operator service. By competing head-to-head at lower cost and with safer service and better fuel efficiency, from Mexico to the heartland of America, the result will be a safer, faster, cleaner, and stronger railway in any of the proposed combinations with KCS.”

Ruest also pointed to CN’s initiatives reinforcing the company’s status as a leader, regarding its ESG (environmental and social guidance) efforts, which CN will bring to the KCS business.

And he also observed that CN brings its extensive operating expertise as a pioneer in precision scheduled railroading (PSR) with its premier three-coast access, with KCS to also benefit from CN’s efficiency in emissions-reduction leadership, as well as its culture of safety, efficiency, integrity, and diversity, which has been recognized by the Dow Jones Sustainable World Index for the last nine years.

CN also has a longstanding track record of accretive and acquisitive acquisitions throughout North America, which Ruest said has resulted in the successful integration of rail networks. Some of its most notable acquisitions include the 2009 acquisition of the Elgin, Joliet and Eastern Railway, giving it a structural advantage in Chicago and the Illinois Central Railway and the Wisconsin Central Railway, helping it to build three-coast access, among others.  

And the combination of CN and KCS would enhance competition and create significant new growth opportunities by connecting the North American industrial corridor, which Ruest noted would further accelerate CN’s industry-leading intermodal container growth.

“Unlike other railways, CN has a meaningful Chicago advantage when moving freight to any direction through the EJE,” he said. “It travels around Chicago, not through the heart of the city, removing the risk of seasonal and sometimes quite crippling rail bottlenecks…it saves CN, on average, between 24-to-48 hours traversing through Chicago.”

CN EVP & Chief Operating Officer Rob Reilly highlighted various benefits of this proposed acquisition on the Webcast, including:

• shorter distances than would be provided by the previously proposed combination [of CP and KCS] on many key routes such as Laredo and Dallas to Chicago, Detroit, and Montreal;
• extend CN’s reach by adding a line to Detroit and Kansas City, creating faster, safer, and more economical rail option for shippers who currently rely on trucks;
• greater access to more ports and more new markets and choice for importers and exporters and can connect to different geographies;
• CN’s access to Prince Rupert, North America’s closest port to Asia, with a container out of Asia loaded on to a CN train at Prince Rupert can travel seamlessly to any point in Canada or the American heartland;
• through the combination with KCS, Kansas City, St. Louis, and Memphis will become accessible from the Ports of New Orleans, Mobile, Lazaro Cardenas, and the Port of Montreal;
• yield revolutionary flexible trade access between any of the three coasts; and
• create the end-to-end USMCA network, facilitating trade and powering economic prosperity across North Americ

“This proposed combination is a story of growth and more specifically truck to rail conversion,” he said. “ldquo;To drive these revenue synergies, it will require a railroad that has a proven track record of intermodal growth. Over the past decade, no other railroad has grown intermodal at a faster rate than CN, with intermodal volumes growing by nearly 80%. This combination will create one of the largest intermodal networks in North America, further enabling the supply chain. CN’s proposal will drive more growth for communities across Canada, Mexico, and the U.S. thereby generating job creation for these communities…increase intermodal truck conversion and faster direct connections between the three countries and create jobs for a diverse range of unionized workers.”

Reilly also said that the CN-KCS combination will create a highly-diversified premier North American railway, with KCS’s existing business mix complimenting CN’s, while building on CN’s intermodal leadership, as well as grain, fertilizers, forest products, and automotive. And from a geographic perspective, he said KCS will grow CN’s presence and capabilities in the U.S. market, most notably offering a meaningful opportunity to expand its rail network in Mexico.

As for what this proposed deal means from an intermodal perspective, Larry Gross, president of Gross Transportation Consulting, said that the paring of CN and KCS would provide a cleaner, shorter and faster routing from the Upper Midwest/Eastern Canada to Mexico.  

“CP + KCS is probably a shorter option from Western Canada, but they only reach Vancouver, not Prince Rupert,” he said. “I think the CN transaction would be a heavier lift with the STB [Surface Transportation Board], given CN’s existing north/south presence in the U.S. market. It would exaggerate the imbalance between CN and CP which might create additional regulatory concerns both in the U.S. and Canada.”

And John Larkin, Strategic Advisor for Clarendon Capital LLC, said that this proposed deal might give the STB pause.

“Since, CN already has the Illinois Central, one could argue that north-south competition would be reduced,” he said. “One alternative that might be considered is a break up of KSU with a part going to the CP and a part to the CNI with the notion of preserving some semblance of competition.  Of course, the CP could always try to outbid CNI by raining their bid.  If that worked for CP, the CNI would have succeeded in levering up their primary competitor with more debt than originally contemplated, thereby further limiting CP’s ability to invest in strategic projects.”