Canadian National (CNR.TO) said on Tuesday it had offered to buy Kansas City Southern (KSU.N) railroad for about $33.7 billion, sending shares of the U.S. company soaring as investors anticipated a bidding war with Canadian Pacific (CP.TO).
Canadian Pacific had agreed a deal to acquire Kansas City Southern for about $25 billion last month. Either combination would create a North American railway spanning the United States, Mexico and Canada as supply chains recover from pandemic-led disruptions.
The acquisition interest in Kansas City Southern also follows the ratification of the US-Mexico-Canada Agreement last year that removed the threat of trade tensions, which had escalated under former U.S. President Donald Trump.
Kansas City said it would evaluate Canadian National’s offer. If it found it could lead to a better deal, Canadian Pacific will be given the opportunity to raise its bid.
Meanwhile, Canadian Pacific said Canadian National’s cash-and-stock offer of $325 per share at a 26.8% premium to Kansas City Southern’s share price at the end of Monday’s trading, was “illusory and inferior.”
The proposal was “massively complex and likely to fail” and it would reduce competition and negatively impact shippers, the company said.
“We are surprised by this move given the healthy valuation Canadian Pacific had already offered to Kansas City Southern shareholders,” Stephens analyst Justin Long wrote in a client note.
Kansas City Southern shares closed up 15.3% to $295.5, indicating most investors deemed it unlikely the company would stick with Canadian Pacific’s offer.
However, Chilton Investment Co, which has a less than 1% stake in the U.S. railroad, preferred a deal with Canadian Pacific, citing regulatory hurdles.
“There’s more overlap with Canadian National deal which makes it harder to get (regulatory) approval. The Surface Transportation Board (STB) doesn’t like overlap,” Chilton CEO Richard Chilton said.
Canadian National CEO Jean-Jacques Ruest said the two companies have “highly complementary networks with limited overlap.” They only run parallel for 65 miles, between Baton Rouge and New Orleans.
Kansas City Southern has domestic and international rail operations in North America, focused on the north-south freight corridor connecting markets in the central United States with industrial cities in Mexico. Calgary-based Canadian Pacific is Canada’s No. 2 railroad operator, behind Canadian National.
The STB updated its merger regulations in 2001 to introduce a requirement that Class I railways have to show a deal is in the public interest.
Yet it provided an exemption to Kansas City Southern given its small size, potentially limiting the scrutiny that its acquisition will be subjected to.
Canadian Pacific agreed in its talks with Kansas City Southern to bear most of the risk of the deal not going through. It will buy Kansas City Southern shares and place them in an independent voting trust, insulating the acquisition target from its control until the STB clears the deal.
Were the STB to reject the combination, Canadian Pacific would have to sell the shares of Kansas City Southern, but the current shareholders would keep their proceeds.
Canadian National said it was willing to match these terms. It said its offer does not require approval from its shareholders because of how much cash it has, eliminating a condition in Canadian Pacific’s offer.
Canadian Pacific said its rival’s proposal would create the third largest Class 1 railroad, while it would remain the smallest of the six U.S. Class 1 railroads by revenue.
Bill Gates’ Cascade Investment, which is Canadian National’s biggest investor with a 14.25% stake, said it supports the combination.
A private equity consortium led by Blackstone Group Inc and Global Infrastructure Partners made an unsuccessful offer last year to acquire Kansas City Southern.
But it was Canadian Pacific’s announcement of a deal with Kansas City Southern that spurred Canadian National into action, as it raised the prospect of losing out to its rival, according to people familiar with the matter.