Deals

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

Canadian Pacific's pursuit of Norfolk Southern is in limbo, and it may be time to move on. 

The $19 billion railroad backed by Bill Ackman has been trying to get its $22 billion U.S. counterpart to work with it on deal talks for months now. On Tuesday, it said it won't force the issue by pushing its own slate of candidates onto Norfolk Southern's board. But Canadian Pacific has also given no sign that it would be willing to raise its most recent proposal -- the latest in a string of underwhelming and increasingly complicated bids that Norfolk Southern has rejected. Canadian Pacific also hasn't pursued a preliminary nod of approval from regulators to clear up antitrust concerns.  

Waiting Game
Shares of both railroads are down since the takeover saga began in November.
Source: Bloomberg
Data shows Canadian Pacific's U.S. traded shares. The Canadian traded shares are down about 3 percent over the same stretch.

Canadian Pacific does plan to submit a resolution for Norfolk Southern's shareholders to vote on at the 2016 annual meeting, which will likely take place in May. It will call for Norfolk Southern's board to engage in "good faith discussions" with Canadian Pacific. This makes sense. Canadian Pacific has said all along it started this whole takeover saga in part because Norfolk Southern shareholders asked it to; now it would like them to step up and say so publicly. 

If shareholders don't back the call for dialogue, that may be the turning point that forces Canadian Pacific to call off its takeover pursuit, CEO Hunter Harrison said at a conference on Wednesday. That's a lot of pressure to put on investors contemplating a deal that still has many unanswered questions. Waiting on the outcome of the resolution also means dragging this out for another few months. 

On the issue of price, Canadian Pacific's most recent proposal in December showed signs of desperation. Instead of adding more cash to an earlier cash-and-stock proposal (as many were expecting), the company offered a contingent value right -- an insurance policy that may or may not be worthless. This kind of nickel-and-diming isn't going to get a deal done. Norfolk Southern investors will need some sign that Canadian Pacific's pockets aren't tapped out.

The bigger point of contention, though, is whether this deal can actually survive regulatory scrutiny and the uproar from politicians and other railroads. Letters have been pouring in from customers, governors and senators -- a big chunk of which are in opposition to the deal. Canadian Pacific seems to have underestimated the level of political pushback in particular -- something that has perhaps been heightened by the contentious election year.

Few and Far Between
The last major train deal was Berkshire Hathaway's purchase of Burlington Northern Santa Fe -- which didn't spark the same regulatory concerns because Berkshire wasn't a railroad.
Source: Bloomberg

To help mitigate what is sure to be a drawn-out regulatory review process by the U.S. Surface Transportation Board, Canadian Pacific has proposed putting itself into a voting trust and sending CEO Harrison to run Norfolk Southern. This way, the target's investors don't have to wait for government sign-off to get a payout and Harrison could get Norfolk Southern in better shape ahead of an eventual combination.  

Canadian Pacific says rejection of the trust by regulators is extremely unlikely, but it doesn't seem that clear cut.   First off, the trustee must be independent and the structure can't be used to assert control ahead of a merger. While Harrison would cut ties with Canadian Pacific when he moves over to Norfolk Southern, to be replaced by Chief Operating Officer Keith Creel, would this go far enough? The STB isn't naive; they know where Harrison came from. You would have members of the management team that came up with the takeover controlling both companies with a business plan that was developed at Canadian Pacific.

It isn't totally clear how the STB will rule because as the agency itself has noted, it's never approved a trust-management swap quite like this. But the structure Canadian Pacific is proposing would seem to violate the spirit of the law, if not the letter.

Canadian Pacific clearly feels differently. But if it's so confident, why won't the company seek a declaratory order from the STB on the likelihood of a trust getting approval? Canadian Pacific says that the STB isn't likely to "expend valuable time" to address this when the answer is already clear in the regulations and the issue is still hypothetical. It seems like it can't hurt to ask, though. There's a process in place for this and it could save everyone some headaches and an even more prolonged limbo period. The STB has already expended a good chunk of time responding to some of those letters. 

Canadian Pacific's own shareholders seem to be signaling it's time to pack it up. The stock jumped the most in more than six years last month after Harrison's comments about adopting a new strategy sparked speculation he could drop the deal. There are other -- and arguably better -- things the railroad could do, including share repurchases and finding ways to deal with the decline in commodities-related cargo. 

That doesn't mean Norfolk Southern is off the hook. The company has to prove to investors that it can actually improve its business on its own. It laid out the details of an ambitious cost-cutting plan in January. If Norfolk Southern's turnaround efforts fall flat, there's a chance that Canadian Pacific might have better luck at a later date with a regulatory nod in hand and a less fiery political climate.

Harrison perhaps said it best on Wednesday: ``We have to give it our best effort. But we have to understand when things are not going to happen, when the timing is not right."

He should take those words to heart and move on for now. 

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

  1. Canadian Pacific points to 144 examples of trusts avoiding a regulatory block. Norfolk Southern, in a white paper from former regulators, notes that no trusts have been reviewed since the STB rolled out tougher merger guidelines in 2001. The new rules require pre-approval for the trust structure and put the onus on the acquiring company to show the trust serves a public interest. 

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