CP sent a letter to NS on November 17 proposing a merger between the two companies to create a "transcontinental railroad," but the following day NS dismissed CP's offer, which equated to $US 46.72 and 0.348 CP shares for every NS share it owns as "low-premium."


On December 4 the NS board firmly rejected CP's merger proposal, refuting practically every purported benefit that CP has given, and citing substantial regulatory risks and uncertainties as well as many other negatives.

While not specifically stating that NS would reject any further attempts by CP (or by any other Class 1, for that matter) to merge, NS chairman, president and CEO Mr Jim Squires informed Harrison in a long letter why the NS board feels CP's existing proposal is, essentially, a very bad idea.

Squires stresses that operationally and financially, a combined CP-NS won't work nearly as well as CP claims. "The deal presents grossly inadequate value and substantial regulatory risks," he noted. "CP's operating model would drive away service-oriented, truck-competitive traffic in an effort to lower the operating ratio. NS's current strategic plan drives an improved operating ratio, delivers double-digit compound annual earning-per-share growth and enhances long-term value."

Squires argues that pairing the smallest US Class 1 with the smallest Canadian Class 1 would create a network disadvantage. "It would not enhance NS's geographic reach to areas of freight growth," he says. "The Norfolk Southern/CP interchange is small - less than 3% of NS volume, and substantially smaller than our interchange volume with BNSF, Canadian National or Union Pacific." He also dismisses suggestions that a merger would provide any relief to congested lines in the Chicago area, arguing that it could actually add to the problem because CP "does not have efficient Chicago bypass routes."

Another issue for NS is that the current regulatory set-up for mergers of this scale is untested. There have been no major mergers since the Surface Transportation Board (STB) enacted its Major Merger Rules for Class 1 railways in 2001. NS contends that these rules "create bias against consolidation" due to "concern that any transaction would not enhance competition and cause service disruptions." Squires suggests it could take "two years or more" to complete a regulatory review of the merger, "with strong opposition expected from key stakeholders."

To evaluate the regulatory prospects of the merger and the anticipated voting trust issues, NS appointed former STB commissioners Mr Francis Mulvey and Mr Charles Nottingham to carry out a review of CP's proposal. Mulvey and Nottingham concluded that the structure originally put forward by CP is "highly unlikely" to be approved by the STB.

On December 8 CP had another go. In a letter to Squires, Harrison and and CP chairman Mr Andrew Reardon pledged to "dramatically reduce risks for NS shareholders," while increasing NS shareholders' stake in the pro forma company from 41% to 47%.

Harrison says that CP would be prepared to close the transaction into a voting trust to allay the concerns of NS shareholders who fear a long and onerous regulatory approval process. This would give NS shareholders a "substantial cash payment and shares in a new investment grade company" which would be listed on the New York and Toronto stock exchanges.

CP says NS shareholders will receive $US 32.86 in cash and 0.451 shares of stock in a new company when the transaction closes, and estimates the total value of the stock and cash consideration to NS shareholders would be $US 125-140 per share at this stage of the process. This equates to a 37-53% premium on the closing price of $US 91.52 on December 7.

NS said on December 8 that even under the terms of the revised offer, STB approval remains unlikely.

What could potentially happen next raises lots of questions. Will CP make another attempt to sweeten the deal?

Is this all part of a long-term cat-and-mouse game that will continue until NS is satisfied that CP's offer is worthy of consideration? Or will CP give up and retreat, like it did with CSX in 2014? Harrison, who many observers believe wants his legacy to be a transcontinental railway, doesn't give up easily. Neither does Mr Bill Ackman, CP's largest shareholder and principal of hedge fund Pershing Square Capital Management. If Ackman is the type to fold, he probably wouldn't be running a hedge fund. Then again, CP was an easy target for Ackman a few years ago, one that Hunter Harrison was quickly able to turn around.

NS is a different story entirely. It's a great railway with a great legacy and superb management. While there is certainly room for improvement, as Squires himself has stressed, NS does not need to be "turned around." But that's not what this merger attempt is about and one has to ask whether CP's purported merger benefits are as far off-base as NS claims.