Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Canadian Pacific sure knows how to leave investors wanting more.

After an underwhelming bid last month failed to entice Norfolk Southern to entertain a merger, the railroad operator and its No. 1 fan Bill Ackman  were back with a revised proposal on Tuesday. Canadian Pacific is now offering Norfolk Southern holders $32.86 in cash and 0.451 of a share in a new combined company. That's less cash than it was previously proposing, but more equity. How much the bid is actually worth depends on who you ask.

Canadian Pacific says it's about $125 to $140 per Norfolk Southern share. That's based on its assessment of the future earnings potential of the combined company and the trading value of a voting trust it plans to set up to help overcome regulatory hurdles. Because of that, the company says the offer is ``substantially more financially attractive'' than its previous offer, which was initially valued at $95 a share.

Norfolk Southern takes a dim view of the proposed trust structure and the deal's regulatory odds, so it calculates the value of the latest bid at $91.62 a share, based on Canadian Pacific's closing price Monday. It rejected the proposal as lower and even more risky and uncertain than the previous one.

Investors seem to be siding more with Norfolk Southern on this one. Shares of the U.S. railroad sank about 4 percent as of early afternoon in New York to just under $88. It's hard to blame them. This probably wasn't what shareholders had in mind when Canadian Pacific CEO Hunter Harrison said last month he was willing to sweeten the deal with "a little more money."  

Falling Flat
Shares of Norfolk Southern fell on Tuesday after rejecting Canadian Pacific's revised takeover offer.
Source: Bloomberg

Canadian Pacific's offer requires several leaps of faith. The idea of a voting trust is an interesting one. If it works, Norfolk Southern investors don't have to wait around for a government sign-off to get their money and the companies can swiftly integrate once the deal is approved. But this structure requires regulators to first approve the trust, and then approve the merger -- neither of which is a guarantee.

On a call to discuss the deal Tuesday, Ackman, Canadian Pacific's biggest shareholder and a member of its board since he successfully waged a proxy fight to make Harrison CEO in 2012, said regulatory rejection of the trust was an "extremely remote" possibility.

Train Derailment
The threat of regulatory scrutiny has deterred large rail deals
Source: Bloomberg

Much of Canadian Pacific's confidence in this structure is tied to Harrison's own successful experience with trusts. The industry veteran was CEO of Illinois Central in 1998 when it was taken over by Canadian National, which used a trust  to facilitate its acquisition.  But as Cowen analyst Jason Seidl points out, other companies haven't been so lucky. Santa Fe Industries and Southern Pacific attempted to use a trust structure for their proposed merger in the 1980s. But regulators blocked the deal and forced the newly formed company to come up with a divestiture plan. Rio Grande Industries eventually acquired the Southern Pacific assets.

Norfolk Southern, understandably, doesn't want to open itself up to that kind of risk. And Ackman and Harrison's numerous reassurances about the trust structure don't seem to be all that reassuring to investors.

Canadian Pacific is going to have to do more to get a deal done. That could already be in the works, with Ackman suggesting a further sweetened bid was possible. The company would be willing to pay out more cash and reduce the equity component, he said.  Whatever superlatives Canadian Pacific uses to describe its next effort better ring more true. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net