Canadian Pacific Railway's latest bid for Norfolk Southern fell flat with investors, just like the one that came before it. With each underwhelming offer, the company risks getting beaten at its own game.
The railroad backed by Bill Ackman on Wednesday said it would add a contingent value right to a previous stock-and-cash proposal that Norfolk Southern had rejected as "grossly inadequate." The prior bid already involved a complicated trust structure to help win over regulators, and the CVR only makes it more complicated. Investors were unimpressed, sending Norfolk Southern down almost 1.5 percent in New York.
The CVR is meant to provide Norfolk Southern shareholders an insurance policy in case the value of the combined company is much lower than what Canadian Pacific is projecting. If the merged railroad's average price in the six-month period ending Oct. 20, 2017 is less than $175 a share, Norfolk Southern shareholders will get an extra payout of up to $25.
Here's the catch: Ackman and Canadian Pacific don't think they will ever have to actually make those CVR payments because the combined company will be worth much more than $175 a share. Ackman went as far to say the CVR was "worthless" and essentially a $3.4 billion bet by Canadian Pacific on the potential value created by this deal. What that means is the actual payout for Norfolk Southern shareholders probably didn't get all that much bigger in this revised proposal.
Of course, investors may not care that much about the CVR if the combined company trades above $200 a share like Ackman and Canadian Pacific say it will. That's their whole point. But getting to that valuation requires buying into both Canadian Pacific's ability to get regulatory approval for the trust -- which isn't a guarantee -- and the company's earnings-per-share projections for a merged railroad. So this new bid still requires a leap of faith, but gives investors a softer cushion.
There are benefits to that for some investors and they have the choice of selling the CVR to other traders before the contract closes, but the addition of the CVR is certainly not the slam-dunk proposal many have been hoping for. Ackman hinted earlier this month that Canadian Pacific may be willing to reduce the stock component and pay more in cash. Instead, shareholders got a maybe-but-likely-never extra $25 payout and more complexity.
All of this nickel-and-diming may have a cost.
Matt Rose, executive chairman of Warren Buffett's BNSF Railway, said last week in an interview with Bloomberg's Thomas Black that he was open to making a competing offer for Norfolk Southern. On a call Wednesday to discuss the new proposal, Ackman dismissed that possibility, saying BNSF lacks the management depth to pull off the trust structure Canadian Pacific is proposing and isn’t going to overpay. Still, Canadian Pacific CEO Hunter Harrison said on the same call that he didn't think Rose would be making such comments if BNSF didn't feel like the structure would be approved. Who’s to say for sure Buffett isn't willing to give it a shot?
Even if the billionaire didn't go for a trust setup, BNSF could offer enough cash in a rival bid to make shareholders willing to take on the risk of waiting out the approval process.
BNSF may be the more logical strategic suitor, anyway. Canadian Pacific operates primarily in Canada with a smaller U.S. presence mainly in the Northern Midwest. A deal with Norfolk Southern would make it essentially a coast-to-coast railroad, but not nearly of the same scale in the U.S. as a combined BNSF-Norfolk Southern.
Ackman and Canadian Pacific seem confident their bid for Norfolk Southern can succeed. But Ackman and Valeant were pretty confident at one point that they could win Allergan. The drugmaker instead sold itself to white knight Actavis.
As Canadian Pacific CEO Harrison himself said, "the clock is ticking" on this deal -- just maybe not in his favor.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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