Canadian Pacific hitting road blocks in merger pursuits

Company switches focus to Norfolk Southern after initially pursuing CSX Corporation.

Since mid-November, Canadian Pacific Railway Ltd. (CP), the second largest railroad in Canada, has pursued U.S. carrier Norfolk Southern Corporation (NSC) in hopes of securing a merger. The latest proposal is being reviewed by NSC, but CP’s president and chief executive officer Hunter Harrison told analysts Wednesday that the clock is ticking.

In the call, Harrison said CP initially sat down with CSX Corporation for merger talks, but was unable to strike a deal. Following the rejection, CP decided to analyze the value of a merger with NSC and found even greater value for its shareholders.

Harrison invited NSC chief executive officer Jim Squires to his farm to discuss options, but said the deal has since turned into a “street fight” environment.

“We started down the road and I guess immediately got cut off at the pass. It was not the response that we expected. We didn’t hear anything for a while and finally sent a formal proposal. Up until this time, with the exception of the meeting with Mr. Squires and me, the board has refused to meet. ” Harrison said.

“If this is going to be a street fight, then so be it,” he added, suggesting that NSC is getting bad advice from its advisors.

Morgan Stanley & Co. LLC and Bank of America Merrill Lynch are acting as financial advisors to Norfolk Southern Corporation and Skadden, Arps, Slate, Meagher & Flom LLP, Hunton & Williams LLP, and Morrison & Foerster LLP are acting as legal advisors.

NSC had previously rejected a revised, reduced proposal from CP to acquire for $32.86/share in cash and a fixed exchange ratio of 0.451 shares in a new company that would own both CP and NSC. However, NSC’s board unanimously concluded the proposal “continued to be grossly inadequate, creates substantial regulatory risks and uncertainties that are highly unlikely to be overcome.” Additionally, the board said that the proposal was not in the best interest of the company and its shareholders.

Harrison, on the other hand, has expressed confidence in the merger’s ability to gain approval. In fact, he noted that out of 144 requests the STB has received since the Staggers Rail Act was passed in 1980, 144 have been improved.

“The odds are good that we could get a trust structure approved,” he said.

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To convey confidence in the deal, the latest proposal even includes a Contingent Value Right (CVR), which would protect the NSC shareholders and give them the ability to receive additional benefit if shares were to fall during the regulatory review.

CP said this particular CVR will protect the holder's value in the event that the value of the stock in a combined CP-NS is below US$175 a share at the date of payment. Each CVR would entitle the holder to receive a cash payment from CP equal to the difference between the CP-NS share price during the relevant measurement period and US$175 per share (with no payment in the event CP-NS share price is above US$175), up to a maximum value of US$25 a share, CP said.

Under the CP proposal, the measurement period would begin on or about April 20, 2017 and would end on or about October 20, 2017 with shareholders receiving their cash payment on or about October 25, 2017. 

“In the event of a full CVR payout, the total cash payment would represent an additional US$3.4 billion and CP is confident it would maintain an investment grade rating,” CP said.

NSC said the company's board of directors will carefully consider the most recent revised proposal from CP with the assistance of its financial, legal and regulatory advisors.

“The clock is ticking and it’s ticking down. And it’s time for some of us to take some action if we are going to see this transaction through.” Harrison said.

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BNSF won’t sit idle

BNSF Railway’s executive chairman Matt Rose told Bloomberg that the company is open to proposing a competing offer for Norfolk Southern and explained that if consolidation occurs, CSX will also come into play.

While BNSF doesn’t favor more North American rail mergers, Rose said the company would not sit on the sidelines in any fresh deal making.

“If there is consolidation to be had, we would participate as well,” he added.  “We’ve never in this industry just done one merger. You do a merger and then somebody else announces it because of this issue of stabilization of the industry and parity in various markets.”

Harrison said the BNSF’s willingness to get involved shows that approval wouldn’t be difficult.

“If you can’t get a trust structure approved and if you can’t get regulatory approval, why would they care,” Harrison asked. “I think there is some reason that our friends at Burlington Northern are concerned about the transaction and what it might bring. I don’t know why they are worried about down-the-road affects if it can’t be approved.”

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