The railroad deal that never was is officially not happening.
Canadian Pacific, the $21 billion railroad backed by Bill Ackman, announced on Monday that it's calling off efforts to strike a merger with its American counterpart Norfolk Southern. It's a bit of a formality really after a series of underwhelming and increasingly desperate-looking bids elicited only a cold shoulder from Norfolk Southern. Canadian Pacific had planned to submit a resolution simply calling for ``good-faith discussions'' at Norfolk Southern's annual meeting next month, but even that looked like a moon-shot endeavor because of huge doubts on whether a deal for the $24 billion U.S. railroad could get regulatory approval.
The merger faced stiff antitrust scrutiny, but there was also the matter of the voting trust structure that Canadian Pacific wanted to use as a way to get Norfolk Southern holders their payout early and allow Canadian Pacific CEO Hunter Harrison to take over at the target company and get it in better shape ahead of the integration. After months of dragging its heels and insisting the odds were extremely low that the trust structure would be rejected, Canadian Pacific finally agreed to seek a declaratory order on its feasibility from the Surface Transportation Board (the regulator in charge of of all things railroad).
That in itself was a bit of a half-baked effort, but things didn't even get that far because of the barrage of letters the regulator received from companies including FedEx and, more recently, the U.S. Army and Justice Department.
Here's Bill Baer, head of the Justice Department's antitrust division:
``Canadian Pacific’s voting trust proposal would compromise Norfolk Southern’s independence and effectively combine the two railroads prior to completion of the STB’s review. That makes no sense. We urge the STB to preserve its ability to review the impact of the proposal on competition and consumers before Canadian Pacific starts scrambling the eggs.''
You know when the egg metaphors come out, things are getting serious.
Clearly, Canadian Pacific CEO Harrison and his investor buddy Ackman didn't expect this level of pushback, or thought they could get around any challenges, but arguably they should have been better prepared. Rival railroads summarily dismissed the idea of further consolidation as impossible when Canadian Pacific previously tried to start up talks with CSX in 2014. The political rhetoric was only going to be more heightened in this tumultuous election year. Perhaps the answer is they were running out of better ideas.
Railroads are grappling with paltry growth (and in some cases revenue declines) as coal volumes dissipate and the plunge in crude oil prices reduces demand for rail shipments of the fuel. The most obvious response to this environment is to cut costs, but Harrison has already done that at Canadian Pacific and to some degree, risks becoming a victim of his own success. There's just not as much room for improvement. Canadian Pacific is targeting an operating ratio of below 59 percent in 2016. That's a 200 basis point drop from 2015 -- impressive, but smaller than in years past. Being an excellently run company is never a bad thing, but it makes it harder to satisfy investors' insatiable desire for ever-rising profits. A deal with Norfolk Southern would have provided ample cost-cutting opportunities, with Canadian Pacific targeting more than $1.8 billion in synergies, and a way to keep the earnings growth going.
All eyes will now be on what Harrison and Canadian Pacific plan to do next. The company had also entertained the idea of re-engaging with CSX on merger talks, though a deal seems rather unlikely any time soon given the fierce regulatory opposition. RBC analysts point to ``fast and furious'' share repurchases -- the other kind of financial engineering that can help fatten returns. Shareholders for one seemed happy about the prospect of Canadian Pacific focusing on itself, sending the Canada-listed shares up as much as 3.8 percent.
It's a good reminder that as badly as companies want these transactions to happen, they don't always get to the finish line. While this railroad mega-deal has arguably been dead in the water for some time now, its official demise comes just days after the collapse of Pfizer's $160 billion combination with Allergan, and also follows the big regulatory blow dealt to Halliburton's planned merger with Baker Hughes. Looks like the deal graveyard may be about to get more crowded.
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Canadian Pacific wanted to put itself into a trust to be run by Chief Operating Officer Keith Creel and then send CEO Harrison to run Norfolk Southern. It was a nice idea in theory, but having members of the same management team that came up with this takeover plan control both companies doesn’t exactly scream independence.
Canadian Pacific asked the regulatory body not to trouble itself with determining whether the trust benefits the public interest -- a key, and so far untested, standard implemented in 2001. This means even a declaratory order may not have given Norfolk Southern holders a ton of confidence.
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