Report says Canadian Pacific is looking into takeover of Norfolk Southern

While merger and acquisition activity (M&A) is not as prevalent in the freight railroad sector compared to other modes of freight transportation, a Bloomberg report published today suggests otherwise.

Bloomberg reported that Canadian Pacific Railway Ltd. is “exploring a takeover of U.S. carrier Norfolk Southern Corp. in a fresh attempt to consolidate the North American industry, according to people familiar with the matter.”

The report added that CP is currently raising financing and held early-stage merger talks with NS, who is currently valued at $24 billion. CP is valued at around $20 billion. And it cited the report’s sources as saying these discussions are preliminary and talks may or may not progress or lead to a deal. CP and NS representatives did not offer up comment to Bloomberg. And CP issued a separate statement saying that “there is no material news to report at this time [and] that it does not comment on rumour and speculation.”

This does not mark the first time CP has tried to make a large-scale North American railroad acquisition, though.

In October 2014, it was reported that CP approached CSX about a potential merger but talks stalled out. Save for the Berkshire Hathaway $26 billion acquisition of BNSF Railway in 2010, railroad M&A has been largely quiet on that front.

Had that deal eventually been consummated, the total market value of CP and CSX would be $62 billion, according to the WSJ. This development comes at a time when the railroad sector, despite various service-related issues, was doing very well, due in large part to the ongoing emergence of crude oil-by-rail (CBR) at the time, which had seen volume gains throughout the sector, as evidence by the U.S.-based Class I railroads generating $2.15 billion in moving CBR in 2013, which is far ahead of 2008’s $25.8 billion, according to federal data cited in the WSJ report.

This merger would have likely faced multiple obstacles if CP continued to pursue CSX, due to intervention from the U.S. Department of Transportation’s Surface Transportation Board (STB). This occurred in 2000, when a proposed merger between Burlington Northern and CP was halted due to resistance from the STB, according to the WSJ report. Other obstacles cited included 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.”

The WSJ report said CP CEO E. Hunter Harrison recently stated at an investor conference that M&A in the railroad makes sense as it would help in aiding Chicago interchange congestion issues, which is the key rail connector between East and West Coast Ports.

And with the current balance of power in North America among the Class I railroads––two in the east, 2 in the west, one in the middle, and 2 in Canada––an industry stakeholder said in a previous interview that has created a very stable playing field, but were one of the legs of this “table” to be pulled, it would require some sort of response among the other members of the supporting cast, which he said is not likely in their best interests.

What’s more, the stakeholder said that deals like this tend to have limited value, coupled with a business case not strong enough to overcome other considerations. And on top of that the freight railroad sector has shrunk from 56 Class I railroads in 1975 to seven in 2005, according to a New York Times report.

Cowen and Company analyst Jason Seidl wrote in a research note that a CP-NS merger could be beneficial for both carriers in the long-term, despite the fact that a big rail transaction typically involves a tough integration phase, while also noting that shippers may be less vehemently opposed to a merger now compared to a year ago, when service was much worse. And he also said that a merger proposal would have a better chance of succeeding today it did when CP tried to acquire CSX.

“The fall of 2014 was not the ideal time for such an effort to be launched, primarily because both shippers and regulators were disenchanted with the rail industry due to severe service and capacity issues, which emerged late in 2013 and did not start abating in any material sense until 2015. CP’s reported move to join forces with NSC will likely still trigger service concerns with shippers who will recall service challenges associated with past transactions, including those encountered by CSX in 1997 when it integrated parts of Conrail into its network after a fight over the acquisition of the company with NSC.”