CANADIAN Pacific Railway (CP) will acquire Kansas City Southern (KCS) in a cash and stock transaction worth $US 29bn, the two Class 1 railways announced on March 21. The combined entity will be named Canadian Pacific Kansas City (CPKC).
CP and KCS described the $US 29bn as “enterprise value” that includes the assumption of $US 3.8bn of outstanding KCS debt. The transaction, which has the unanimous support of both boards of directors, values KCS at $US 275 per share, representing a 23% premium, based on the CP and KCS closing prices on March 19 (and $US 270 per share, representing a 26% premium, based on the respective CP and KCS 30-day volume weighted average prices (VWAP)).
The transaction will combine the two railways to create the first rail network connecting the United States, Mexico, and Canada. While remaining the smallest of six US Class 1 railways by revenue, CP and KCS say the combined company will be a much larger and more competitive network, operating approximately 32,000km of track, employing close to 20,000 people and generating total revenues of approximately $US 8.7 billion based on 2020 actual revenues.
The two companies informally notified the US Surface Transportation Board (STB) about the deal on the evening of March 20. The STB will need to approve the transaction. If approved, the merger will be the first Class 1 transaction of its type since the late 1990s, when Norfolk Southern and CSX acquired 56% and 72%, respectively of Conrail.
“The combined network’s new single-line offerings will deliver dramatically expanded market reach for customers served by CP and KCS, provide new competitive transportation service options, and support North American economic growth,” CP and KCS said in a joint statement. “The transaction is also expected to create jobs across the combined network. Additionally, efficiency and service improvements are expected to achieve meaningful environmental benefits.”
CP will establish an independent voting trust to acquire the KCS shares. Former KCS president and CEO, Mr Dave Starling, has been appointed trustee. Upon shareholder approval of the transaction, and satisfaction of customary closing conditions, CP will acquire KCS shares and place them into the voting trust. This step is currently expected to be completed in the second half of 2021. Following the closing into a voting trust, common shareholders of KCS will receive 0.489 of a CP share and $US 90 in cash for each KCS common share held. KCS common shareholders are expected to own 25% of CP’s outstanding common shares, “providing the ability to participate in the upside of both companies’ growth opportunities. Following final STB approval, KCS shareholders will additionally participate in the realisation of synergies resulting from the combination.”
To fund the merger’s stock consideration, CP will issue 44.5 million new shares. The cash portion will be funded through a combination of cash-on-hand and raising approximately $US 8.6bn in debt, for which financing has been committed. As part of the merger, CP will assume approximately $US 3.8bn of KCS’ outstanding debt. Following the closing into trust, CP expects that its outstanding debt will be approximately $US 20.2bn.
CP and KCS said the combination “is expected to be accretive to CP’s adjusted diluted EPS in the first full year following CP’s acquisition of control of KCS, and is expected to generate double-digit accretion upon the full realization of synergies thereafter.”
Pro forma for the transaction, CP estimates its leverage ratio against 2021E (expected) street consensus EBITDA to be approximately 4.0x with the assumption of KCS debt and issuance of new acquisition-related debt. In order to manage this leverage “effectively,” CP will be temporarily suspending its normal course issuer bid programme, and expects to produce approximately $7 billion of levered free cash flow (after interest and taxes) over the next three years. CP estimates its long-term leverage target of approximately 2.5x to be achieved within 36 months after closing into trust. The combined company “will remain committed to maintaining strong investment-grade credit ratings while continuing to return capital for the benefit of shareholders.”
The merger comes as trade between the U.S. and Mexico is expected to increase as the two North American nations are enjoying far better relations following US president Mr Joe Biden’s inauguration.
“This transaction will be transformative for North America, providing significant positive impacts for our respective employees, customers, communities, and shareholders,” said CP president and CEO, Mr Keith Creel. “This will create the first US-Mexico-Canada railroad, bringing together two railroads that have been keenly focused on providing quality service to their customers to unlock the full potential of their networks. CP and KCS have been the two best performing Class 1 railroads for the past three years on a revenue growth basis.
“The new competition we will inject into the North American transportation market cannot happen soon enough, as the new United States-Mexico-Canada (USMCA) Trade Agreement among these three countries makes the efficient integration of the continent’s supply chains more important than ever before. Over the coming months, we look forward to speaking with customers of all sizes, and communities across the combined network, to outline the compelling case for this combination and reinforce our steadfast commitment to service and safety as we bring these two iconic companies together.”
“KCS has long prided itself in being the most customer-friendly transportation provider in North America,” said KCS President and CEO, Mr Patrick J. Ottensmeyer. “In combining with CP, customers will have access to new, single-line transportation services that will provide them with the best value for their transportation dollar and a strong competitive alternative to the larger Class 1s. Our companies’ cultures are aligned and rooted in the highest safety, service and performance standards.
Creel and Ottensmeyer jointly concluded: “We have been champions for the environment recognising the important role rail plays in lowering overall transportation emissions. This combination advances our shared science-based pledges in-line with the Paris Agreement to improve fuel efficiency and lower emissions in support of a more sustainable North American supply chain.”