CP and KCS sign merger agreement to form a single-line rail network
Canadian Pacific Railway Limited and Kansas City Southern have signed a merger agreement to form a single-line rail network linking the U.S., Mexico and Canada.
Canadian Pacific Railway Limited (CP) and Kansas City Southern (KCS) has announced that they have entered into a merger agreement, under which CP has agreed to acquire KCS in a stock and cash transaction, representing an enterprise value of approximately $31 billion1. This includes the assumption of $3.8 billion of outstanding KCS debt.
The transaction, which has the unanimous support of both boards of directors, values KCS at $300 per share, representing a 34 per cent premium based on the CP closing price on 9 August 2021 – the date prior to which CP submitted a revised offer to acquire KCS, as well as KCS’ unaffected closing price on 19 March 20212.
“Our path to this historic agreement only reinforces our conviction in this once-in-a-lifetime partnership,” said Keith Creel, CP President and Chief Executive Officer. “We are excited to get to work bringing these two railroads together. By combining, we will unlock the full potential of our networks and our people while providing industry-best service for our customers. This perfect end-to-end combination creates the first U.S.-Mexico-Canada rail network, with new single-line offerings that will deliver dramatically expanded market reach for CP and KCS customers, provide new competitive transportation options, and support North American economic growth.”
Patrick J. Ottensmeyer, KCS President and Chief Executive Officer commented: “We are glad to be partnering with CP to create a railroad that is able to compete, by providing the best value for the transportation dollar. The CP-KCS combination will not only benefit customers, labor partners, and shareholders through new, single-line transportation services, attractive synergies and complementary routes, it will also benefit KCS and our employees by enabling us to become part of a growing and truly North American continental enterprise.”
While remaining the smallest of six U.S. Class One railroads by revenue, the combined company would have a much larger and more competitive network, operating approximately 20,000 miles of rail, employing close to 20,000 people, and generating total revenues of approximately $8.7 billion based on 2020 actual revenues. The CP-KCS combination is expected to create jobs across the joined network. Additionally, the companies expect efficiency and service improvements to achieve meaningful environmental benefits.
Transaction to expand options and efficiencies for customers
A CP-KCS combination would provide unprecedented reach via new single-line hauls across a combined network, offering:
- New single-line competitive options for domestic intermodal shipments between Mexico, the U.S. Midwest, and Canada, providing a truck competitive product for time-sensitive shipments in the high-value parts, perishables, and expedited markets.
- New single-line hauls linking key automotive manufacturing and distribution centers in Mexico, the U.S. Midwest, and Canada, capitalising on CP’s best-in-class automotive compound network.
- New single-line routes linking energy, chemical, and merchandise shippers to more quickly and efficiently connect origin and destination facilities and reach new markets and global consumers.
- Unmatched access to Atlantic, Gulf, and Pacific ports, linking international intermodal shippers with North America’s largest consumer markets providing new optionality, capacity, and resiliency.
- New single-line routes allowing the efficient flow of agricultural products from CP’s origin-rich franchise to KCS’ destination-rich franchise, generating new optionality for shippers and receivers.
- Extended reach for short line and regional railroads coupled with new optionality for non-rail served customers via our extensive transload network.
Importantly, customers would not experience a reduction in independent railroad choices, as a result of the transaction. CP-KCS have committed to keep all existing rail freight gateways open on commercially reasonable terms, while simultaneously competing aggressively to attract traffic via new single-line north-south lanes between Canada, the Upper Midwest and the Gulf Coast, Texas, and Mexico.
A CP-KCS combination would preserve the six-railroad structure of the North American Class One rail network: two in the west, two in the east and two in Canada, each with access to the U.S. Gulf Coast. The two companies once combined would remain the smallest of the Class One carriers.
Improving highway traffic, environmental sustainability, and safety
The new single-line routes made possible by the transaction are expected to shift trucks off crowded U.S. highways, lowering emissions and reducing the need for public investments in road and highway bridge repairs. Rail is four times more fuel efficient than trucking, and one train can keep more than 300 trucks off public roads and produce 75 per cent less greenhouse gas emissions. The synergies created by this combination are expected to take tens of thousands of trucks off the highways annually.
CP is committed to sustainability and is currently developing North America’s first line-haul hydrogen-powered locomotive. Additionally, the combined company would maintain both CP and KCS’ pledges to improve fuel efficiency and lower emissions in-line with the Paris agreement to support a more sustainable North American supply chain.
Creating value for KCS and CP shareholders
Following the closing into a voting trust, common shareholders of KCS will receive 2.884 CP shares and $90 in cash, for each KCS common share held. Preferred shareholders will receive $37.50 in cash for each KCS preferred share held. The fixed exchange ratio implies a price for KCS of $300 per share, representing a 34 per cent premium, based on the CP closing price on 9 August 2021 and KCS’ unaffected closing price on 19 March 20213.
Immediately following the closing into trust, KCS common shareholders are expected to own 28 per cent of CP’s outstanding common shares, providing the ability to participate in the upside of both companies’ growth opportunities. Following final regulatory approval by the U.S. Surface Transportation Board (STB), KCS shareholders would also reap the benefits of synergies resulting from the combination.
The combined growth strategies of the two fastest-growing Class Ones will result in new efficiencies for customers and improved on-time performance under their respective Precision Scheduled Railroading programmes. The combined company is expected to create annualised synergies of approximately $1 billion over three years.
The combination is expected to be accretive to CP’s adjusted diluted EFPS4 in the first full year, following CP’s acquisition of control of KCS, and is expected to generate double-digit accretion upon the full realisation of synergies thereafter.
To fund the stock consideration of the merger, CP will issue 262 million new shares. Consistent with the previously announced transaction, the cash portion will be funded through a combination of cash-on-hand and raising approximately $8.5 billion in debt, for which financing has been committed. As part of the merger, CP will assume approximately $3.8 billion of KCS’ outstanding debt. Following the closing into trust, CP expects that its outstanding debt will be approximately $20 billion.
Pro forma for the transaction, CP estimates its leverage ratio against 2021E street consensus EBITDA, to be approximately 3.9x with the assumption of KCS debt and issuance of new acquisition-related debt. In order to manage this leverage effectively, CP will continue to temporarily suspend 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 24 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.
Strong stakeholder support for CP-KCS
More than 1,000 stakeholders, including railroad labor unions, shippers, and community leaders, have written letters to the STB supporting CP’s proposed combination with KCS. These letters emphasise the enhanced competition and unsurpassed levels of service, safety and economic efficiency that the transaction will bring for shippers and communities across the U.S., Mexico, and Canada that a CP-KCS combination offers.
Clear path to complete transaction and merger
On 6 May 2021, the STB approved the use of a voting trust for a planned CP-KCS merger, and the pertinent circumstances surrounding this new agreement between CP and KCS have not changed relative to those underlying the STB’s decision approving a trust. To close into voting trust, the transaction requires approval from shareholders of both companies along with satisfaction of customary closing conditions, including Mexican regulatory approvals. CP would then acquire KCS and place the KCS shares into the voting trust, at which point KCS shareholders would receive 2.884 CP shares and $90 in cash for each KCS common share held. The companies expect the transaction to close and KCS shareholders to receive their consideration in Q1 2022.
CP’s ultimate acquisition of control of KCS’ U.S. railways is subject to the approval of the STB. In April, the STB decided that it would review the CP-KCS combination under the merger rules in existence prior to 2001 and the waiver granted to KCS in 2001 to exempt it from the 2001 merger rules. In August, the STB reaffirmed that the pre-2001 rules would govern its review of the CP-KCS transaction.
The STB review of CP’s proposed control of KCS is expected to be completed in the second half of 2022. Upon obtaining control approval, the two companies will be integrated fully over the ensuing three years, unlocking the benefits of the combination.
Board, management, and headquarters
Following STB approval of the CP’s control of KCS, Keith Creel will serve as the Chief Executive Officer of the combined company. The combined entity will be named Canadian Pacific Kansas City (CPKC).
Calgary will be the global headquarters of CPKC, and Kansas City, Missouri will be the U.S. headquarters. The Mexico headquarters will remain in Mexico City and Monterrey. CP’s current U.S. headquarters in Minneapolis-St. Paul will remain an important base of operations.
 Except where noted, all figures are in U.S. dollars.
 Based on KCS closing share price of $224.16, as of 19 March 2021 and CP closing share price of $91.50 (at 1.2565 FX rate), as of 9 August 2021.
 Based on KCS closing share price of $224.16 as of 19 March 2021 and CP closing share price of $91.50 (at 1.2565 FX rate) as of 9 August 2021.
 Accretion based on adjusted diluted EPS excluding one-time advisory, financing, and integration costs as well as incremental transaction-related amortisation.
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