CP-CSX merger talks are dead but the topic of railroad M&A is alive, says CP

When news broke earlier this month that Class I railroad carrier Canadian Pacific contacted CSX about a merger that would have meshed two of the largest freight railroads in North America together, it was somewhat surprising in that mergers of this size have been far from commonplace.

From the outset, various reports and industry stakeholders observed that the chances of this merger, which would have created a freight railroad operator with a market value north of $60 billion, were mostly slim for several reasons, including what the Wall Street Journal described as “intervention” from the Department of Transportation’s Surface Transportation Board (STB), with the failed 2000 merger between CP and Burlington Northern serving as a precedent. Other reasons include shipper resistance, with the thesis that fewer Class I railroads means less competition and options for shippers, as well as national security concerns given that national security officials would be expected to closely examine any proposed deal “under laws governing foreign ownership of infrastructure such as railroads that is deemed critical,” according to the WSJ.

While chances of a merger coming to fruition appeared to be slim, CP yesterday quelled any possibility of it happening, at least for now, with CP saying exploratory talks with CSX “about a possible business combination have ended…[with] no further talks planned.”

CP officials said yesterday that it had proposed an integrated coast-to-coast combination that would improve customer service, promote competition, alleviate congestion in North America - specifically the key Chicago gateway – and generate significant shareholder value.

“Such a business combination would offer creative alternatives for shippers, greater fluidity, increased capacity and improved efficiency industry-wide,” the company said.
The company added that regulatory concerns loom large for railroads vetting mergers, while noting it maintains CP believes they are worthwhile and worth pursuing in that a well-planned merger between the right players and the right structure can help to remedy shipper concerns and gain regulatory approval.

“The North American rail industry is confronted today with the challenges of moving more freight than ever and the prospect of moving even more as oil production, crop yields and consumer demand grow alongside the economy,” CP said. “CP is convinced that the significant problems that beset the industry now will only worsen over time if solutions aren’t put in place immediately. A pro-competition, customer-friendly, safety-focused railway combination is one such solution that could not be ignored on its merits by regulators.”

In a separate conference call following CP’s third quarter earnings release call yesterday, CP CEO Hunter Harrison made myriad convincing points for a merger between CP and CSX and offered up his take in general industry M&A as well.

“We did not make an offer to CSX,” Harrison said. “We contacted CSX, had dialogue with them and asked them if they would be interested in exploring opportunities that we both might share. They indicated they did, we had…three or four meetings. What we were tying to do was two things. One, we felt like it was a huge opportunity to enhance shareholder value for both sets of shareholders at both companies and at the same time improve service offerings for the two organizations and more directly impact Chicago and further [service-related bottlenecks] problems there. We had fascinating conversations about the potential merger, but it became evident that we saw the world a little differently, which is fine.”

And he said that a case could be made that a merger of two large carriers could improve service, as well as competition among carriers.

By granting access to the market, and if you are willing to make commitments to improve service, and you are willing to change traditional conventional wisdom in the rail industry about bottlenecks, and you take a look at the law as it is written, I think I can make a rational case [for a merger],” he said. “People may say it is bad timing, but when is it good timing? My experience in the rail industry has been that most mergers and transactions have been done out of weakness or a need to merge to create value or solve some issues. I would say that this is a time we need to deal with that.”

One of the main issues he explained this would help to solve is the rail congestion in and around Chicago, which he said is fragile at best and not where it should be in terms of reliable service and offers a lot of challenges.

The combination of a CP-CSX merger, he said, could help to alleviate that by taking a lot of traffic that today is going over the Chicago gateway and shifting lanes by instead using the Buffalo, N.Y. gateway or the Albany, N.Y. gateway for carrier traffic going to western Canada or the east coast or far southeast.

Tony Hatch, principal of New York-based ABH Consulting and an independent railroad analyst, wrote in a research note that CP’s Harrison sees Class I railroads’ opposition to consolidation softening, adding that CP is willing to revisit a CP-CSX merger or other options at any point, adding that while Harrison is open to further discussion, rail deals need to be friendly, which Hatch said makes Harrison a “loner in this regard.”

Hatch added that railroad M&A prospects today are different than they were in the 1990s.

“On the one hand, I agree that one of the biggest difficulties in the late ‘90s mergers was the complicated integration of the vast ‘legacy’ IT systems that ran these railways (just as IT integration made financial services, (and other sectors), M&A complex),” he wrote. “However, the newer Internet enabled services should reduce that risk a lot (how much?). On the other hand, however, Harrison’s enviable track record does not compare to the complexities of past much less future major rail deals.  It would be like speculating on a great AAA baseball hitter and trying to see how he would hit in the big leagues.  This is not – at ALL – to say Harrison is minor league – just his deals have been relative to UP-SP – or CP-CSX.  He also thinks, despite it being an end-to-end proposal, it would be operational/efficiency driven, rather than market, which does raise his odds of success while lowering maybe lowering the reasons for STB approval?”