Canadian National Voting Trust for Kansas City Southern Deal Denied by Regulator
Surface Transportation Board says Canadian National hasn’t demonstrated that use of voting trust would be consistent with public interest
Canadian National Railway Co. CNI 7.25% ’s $30 billion bid to buy Kansas City Southern KSU -4.39% ran into a major obstacle Tuesday, with regulators ruling the Canadian railroad won’t be permitted to complete a deal using a temporary voting trust that was a crucial part of the offer.
The Surface Transportation Board, a five-member panel that must bless mergers of freight railroads, said Tuesday in a filing posted to its website that Canadian National hadn’t demonstrated that its use of a voting trust would be consistent with the public interest.
The unanimous decision, which had been eagerly awaited by the companies and investors, is the latest twist in a slow-motion drama that has gripped the railroad industry since Kansas City Southern emerged as a takeover target roughly a year ago.
Canadian National had agreed to buy Kansas City Southern in May after prevailing in a bidding war with rival Canadian Pacific Railway Ltd. CP -4.52% , which received the go-ahead from regulators for a similar trust months ago.
“In view of the heightened scrutiny that both the use of a voting trust and the proposed transaction face under the current major merger regulations, it wouldn’t be in the public interest to allow CN to own KCS until the competitive issues have been thoroughly examined,” the STB said.
It isn’t necessarily a death knell for the deal: Canadian National could still press on with its bid by challenging the STB’s ruling in court. Meanwhile, the railroad could sweeten its terms to encourage Kansas City Southern to continue recommending its offer over a less valuable but potentially less risky one from Canadian Pacific.
Canadian Pacific recently made a higher offer itself, a move that prompted Kansas City Southern to adjourn a planned shareholder vote on the deal with Canadian National until after the STB ruling. The vote was scheduled for Friday.
Canadian National said in a statement Tuesday that it is disappointed in the STB’s ruling and evaluating its options. It said it remains confident that its deal is in the public interest.
Canadian Pacific Chief Executive Keith Creel said Tuesday that its most recent offer made Aug, 10 still stands and should be deemed superior given that it provides regulatory certainty.
Kansas City Southern shares closed down 4.4% on the news. In a sign of their shifting fortunes, Canadian National shares rose over 7%, indicating investors have less confidence it will ultimately close a deal—and are relieved. Canadian Pacific shares fell about 4.5%.
TCI Fund Management Ltd., a Canadian National shareholder and a vocal critic of its bid, urged the railway operator to abandon it on Tuesday. The London-based hedge fund, which also has a significant stake in Canadian Pacific, also called for the resignation of Canadian National CEO Jean-Jacques Ruest and Chairman Robert Pace.
Before it could submit its proposal to buy Kansas City Southern for STB approval—a process expected to last into 2022—Canadian National first sought the green light from the board to put its intended merger partner into a voting trust that could control Kansas City Southern during the course of the review.
In the 33-page decision released Tuesday, the STB denied the Canadian National voting-trust application, saying that permitting it “would insulate KCS and CN from the regulatory risks and uncertainties associated with the heightened scrutiny that the proposed transaction would face under the current major merger regulations and the heightened possibility of divestiture.” The board also pushed back against the argument that approving the trust would “respect KCS’ choice of a merger partner.”
The board wrote that “Negotiation choices by private parties cannot control agency decision-making.”
The Justice Department, which could ultimately challenge any deal, said this spring that the proposed merger “raises sufficient competition concerns on first blush that the CN should be prohibited from using a voting trust.”
A set of rules the STB imposed in 2001 has essentially prevented further consolidation among the major competitors in the industry. The board and its roughly 120-person staff had mulled the voting-trust application for weeks. Observers predict that almost any ruling on a deal for Kansas City Southern could wind up in court, given the high competitive stakes involved.
Kansas City Southern is the smallest of the major freight railroads in the U.S. It plays a big role in U.S.-Mexico trade, with a network stretching across both countries, which helps explain its desirability as an acquisition target. Of the two suitors, Canadian Pacific is smaller and has less overlap with Kansas City Southern.
Whoever ultimately succeeds in closing a deal would become a bigger rival to industry heavyweights including Union Pacific Corp.