KSU - War and - Or - Peace

Train2

Greetings;
“The rules have changed”
/TCI 5/18/21


Obstacles for Canadian National in their pursuit of KSU keep piling up, in the form of letters: DoJ, STB, VT (OK, that’s mine), (House) T&I - and now TCI...

But first, a Tweet/Mea Culpa – CSX pushed back pretty hard on my assumption of ~$2B spent on rail/adjacent acquisitions (PAR and Quality). Terms remain undisclosed; in my defense, we think we know (it’s been published) that the Pan Am cost ~$775mm and that Quality sold for ~$800mm....in 2014. But I will defer to them and wait for the (much hoped for) detailed discussion to come at some point.

Congress out of its lane: On a related point, the House Transportation & Infrastructure (T&I) Committee pledged to hold hearings on PSR & Railroads; this is DeFazio (Chairman) again, sticking his nose in where it really doesn’t belong, given that there is oversite on pricing, etc (and M&A) from the STB and, most importantly, on safety from the FRA....the 10 points listed in a letter to the GAO to review include things like train length, Capex (which I care about, of course, but for the purposes of network MoW has been stable throughout the PSR 1.0m process in the US. And, in fact, it’s the fact that there are phases in PSR (inward/cost to outward/growth) that has escaped Congress’ attention (and, to read through, the STBs). Service issues, exacerbated by the (remember?) pandemic has hurt the rail case (even as others see the pandemic operating performance and recovery as a positive); continuing service issues at an eastern carrier I am sure don’t help.

Deal implications? More cover for the STB: This, perversely, I see as a gift to CP – a true PSR pioneer, and one well into its (Phase 2 or whatever) “pivot to growth”, since the larger combination with CN could be seen as a rail power grab, have long term repercussions, and is certainly, in any event, a bigger merger when any merger is “bad for the US economy” (again, DeFazio – an elected official). DeFazio concludes, after ignoring growth plans and forecasts, and ignoring Wall Street investment in shipper industries (parcel/autos/chemicals/Ag/etc etc), “we can’t let hedge fund managers write the rules of railroading”. No, we can't; luckily they don’t. Again, this over-simplification comes from a senior elected member of the House of Representatives and a major Committee Chairman. It’s enough to make a (this) Dem see red...

CN on the ascendant, briefly: Now to the KSU saga, first from the Tweets, from Friday:

  1. KSU! CN confirms their offer post diligence; KSU (reluctantly?) admits it’s “superior”, CP
    deliberates over the next ~5 days. What not to expect? A raised offer. So...the ball is back in the
    STB’s court after all – will CN get its VT under “new rules”? Maybe they split the baby? (NOTE –
    The STB spoke, as we know).
  2. Muddling my thoughts on shipper/STB desire for RR STABILITY are succession issues; RRs w/
    young dynamic leaders include BNSF & CP. RRs w/ (forgive me) aging leaders w/o named heirs:
    KSU & CNI – & CSX, NSC & UNP. After all, in the 90s, BN+SF started over succession (Krebs); could
    succession propel a non-deal winning CP towards a US carrier?
  3. KSU#2 Beware of spin/naiveté – CP has ready access to capital (PE or otherwise), won’t raise bids
    anyway. Reports of CP+CSX as a replacement rank between VERY low odds (DESPITE above) and
    makes-no-sense (remember CP is 2/3 size); & the STB – & shippers! - want NO transcon/US
    “Big4” mergers

But, after the weekend, the tide turned - CP gained momentum behind the strong wording of the STB
and TCI. First, from the STB:

  • The STB decides that the CN proposal for KSU is under the new, undefined rules. This was, of
    course, a foregone conclusion. But....
  • The STB gave an incomplete grade to CN’s Voting Trust (VT) proposal – this was unexpected in
    timing and scope and language. There was a lot that seemed to come out of a Calgarian missive
    – worries about CN’s post-deal leverage (overblown IMHO but – a key part of CP’s
    attack). Clearly, the STB has called attaining a rail merger VT is no longer “automatic” under the
    new rules, that it would take a more cautious approach, and look at five (5), not two (2)
    measures of “public interest” (the two, under the old rules which, remember, were designed to
    protect that target and especially its shippers – not investors – were “independence” and,
    essentially, “divestiture ability/ease” in the event of deal rejection).
  • CN replies that the response is purely procedural and will amend its proposal along with the
    deal; CP spits out its Tim Hortons at that....
  • The DoJ issues another cranky letter from left field (for all their direct relevance, they might as
    well be the Department of the Navy) but – they do provide (more) cover for the STB under one
    interpretation....
  • The TCI letter....urging CNI to “abandon its (‘negligent & hugely irresponsible”) pursuit of KCS
    unless the merger agreement is amended such that it is not conditional on a VT being
    approved”. Whoa! And it is interesting that the rejection was centered around not the deal risk
    (per se) but the VT (and thus timing – and deal) risk – due to the $2B (OK, $1.7B rounded
    considerably up) risk from break-up fees...
  • TCI owns 20mm CNI shares (#6) and is the largest CP shareholder (it owns no shares of KSU and I
    don’t think anymore in CSX, the innocent bystander who keeps popping up, in DeFazio’s mind
    for example). Such a public letter is unusual in many respects. In my experience, the big fund
    owners used direct contact, not public releases; that was the realm of activists and ESG investors
    (check & double-check); so it would be interesting to hear what other major fund investors in
    CNI (and KSU) are thinking, but it’s not (as likely), especially given the Canadian sense of order
    and politesse...Cascadia’s ownership of CNI is, interestingly, reportedly in Melinda Gates’ hands;
    their support was before a lot of new information.
  • But it was the language of the TCI letter that actually had a crystallizing effect on this analyst:
    • CN’s analysis of the VT process (or process) was “misplaced”; the STB will consider “five
      factors” not two, and “’voting trust (use) is a privilege, not a right” – quoting the
      initiation of the so-called “new rules” at the turn of the century – and “available only on
      ‘rare occasions”.
    • The STB is sending a clear signal (OK, not exactly clear, but I get it); the “CN Board has a
      duty to listen”
    • “In summary, the rules have changed” (emphasis theirs) – “there is no way the CN board
      can have any confidence in how these new rules are interpreted because they have
      never been used before” (again, emphasis theirs). We have tried to emphasize the
      combination of complete lack of precedent (and the hidden desire to not set an easy
      precedent) combined with what I perceive to be the STB’s agenda could lead to
      fingering the scales a bit....
    • TCI then casts doubt in deal confidence and risk, noting that if KSU were to, post-deal
      rejection, return to its old valuation could face a loss of “US$15bn/” – holy tamales!
  • Some analysts begin upgrading CNI, which is down ~10% since the deal announcement....
  • Next up:
    • CP will on Thursday address their response to the KSU support for the “superior offer” – ETC – via a speech by CEO Keith Creel: Canadian Pacific - Keith Creel to address BofA Securities Transportation, Airlines and Industrials Conference (cpr.ca)
    • CNI says they will re-file on Friday 5/21 with answers to all 5 (not just 2) public interest concerns
    • KSU board meets at the end of the week and can address all of the events – and maybe seek changes in the offers, breakup, and reverse breakup fees? Who knows, they’re going to get sued anyway...

Other things:

  • Even the players themselves confuse and conflate “CP” and “CN”, have you noticed?
  • It was pointed out to me that over a decade ago, Berkshire Hathaway paid $33B for BNSF (plus
    the assumption of $7B of debt), which is 10X KSU
  • CN’s agreeing, as CP did, to keep Kansas City as the US HQ must have been a shock to all of the
    Chicagoans in CN’s “Unofficial HQ”. CN also guaranteed open gateways, bottleneck protections,
    etc, BTW....
  • I have often, in presentations and client calls, compared the fears of the STB, shippers, congress
    and even the US Big 4 railroads of final mergers, both now and back at the turn of the century,
    to the First World War, where consensus historian views are that none of the Great Powers
    wanted war, but felt they had to prepare if their rivals did, and backed into a tragic offensive
    war for fearful defensive purposes. To that end, see below the signature line, a related S&T
    article, if it interests you....” The Great War was both inevitable and eminently avoidable, but
    the mesh of ambition and perceived threats overcame every effort to stave off
    hostilities”. For “Great Powers” substitute UP, BNSF, NSC & CSX; for 1914 replace it with
    2025? I hope not! Will a rail CEO, in the middle of what is or still could be the “Railroad
    Renaissance”, see deals cause interventions and access and say:
    • “The lamps are going out all over the North American railway network, we shall not see them lit again in our lifetime."

 

Anthony B. Hatch
abh consulting
http://www.abhatchconsulting.com
[email protected]
Twitter @ABHatch18

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