STB issues decision regarding waiver provision related to CN’s move to acquire KCS

The most recent development in the competition between Class I railroads Canadian National (CN) and Canadian Pacific (CP) over acquiring Kansas City Southern (KCS) came in the form of a decision made by the Surface Transportation Board (STB) on Monday, May 17, which dealt CN a setback in its pursuit of KCS.

In its decision, the STB said that application of the waiver provision to the potential transaction between CN and KCS is not warranted.

“Per the Board’s decision, the agency’s review of the transaction will be governed by the regulations set forth at 49 C.F.R. part 1180, as adopted in Major Rail Consolidation Procedures, 5 S.T.B. 539 (2001),” said the STB. “The Board also denied CN’s motion to approve a proposed voting trust agreement as incomplete, without prejudice to filing a new motion.

After this decision was issued, CP released a statement indicating that it supports the STB’s decision to apply the newer, more stringent merger rules to CN’s proposed acquisition and its effort to obtain approval to use a voting trust in connection with its proposed combination with KCS.

“We concur with the STB's decision to apply the new merger rules to the proposed CN transaction,” CP said. “The STB explained: ‘the proposed transaction poses issues that the current merger rules were designed to address, namely the potential competitive impacts of a merged entity with some degree of overlapping routes and presently existing direct competition—characteristics that would appear to pertain to the CN and KCS systems.’ The new rules place a ‘heavier burden on merger applicants to show that a major rail combination is consistent with the public interest.’ The STB's decision has significant implications for CN's proposed use of a voting trust [VT].  The new merger rules require that the STB formally approve CN's proposed use of a voting trust.  Though CN had filed a motion seeking such approval, the STB rejected that motion as incomplete.”

CP also pointed to how the STB called CN’s arguments regarding the legal standard governing its consideration of CN’s proposed voting trusts as misplaced, adding that the STB emphasized that the new merger rules take a “much more cautious approach” to future voting trusts and its plenary authority over consolidations.

Credit Suisse analyst Allison Landry wrote in a research note that the STB’s decision to proceed under the more stringent merger review regulations isn’t a surprise given that CN has argued on multiple occasions for the current merger rules to be upheld with regard to the CP bid, and had notified the STB that it intended to file its application under the current merger rules.

“Interestingly, in its decision the Board noted that the CN merger poses the exact issues the new rules were designed to address, as CN and KSU have overlapping networks and some direct competition,” wrote Landry. “In contrast, in its decision to apply the waiver for CP, the STB pointed to a CP/KSU transaction as having the ‘fewest overlapping routes when compared to a merger between KCS and any other Class I carrier.’ While we stop short of saying that the CN/KSU deal is unlikely to garner STB approval, we do believe it is clear that there is a now a somewhat heightened degree of regulatory risk (for both the VT and the merger itself).”

Not long after the STB decision was issued, CP filed a request with the STB to establish a procedural schedule for review of the VT CN intends to use for its planned merger with KCS.

As previously reported by LM, on May 13, KCS notified CP that it intended to terminate KCS's merger agreement with CP made on March 21 and enter into a definitive agreemenrt with CN, subject to CP’s right to negotiate amendments to the merger agreement for at least five business days and the KCS board’s further determination as to whether any such amendments would cause the CN proposal no longer to constitute a “Company Superior Proposal,’” noted KCS.

CN added that its filing includes this merger agreement with KCS and that it is confident that it will gain approval for the VT and “ultimately close the combination with KCS.” The company also said that in its application to the STB, CN requested that the STB adopt a procedural schedule for a brief public comment period on CN’s voting trust agreement.

“CN’s proposed voting trust structure has been public since April 26, 2021 and has identical terms and uses the same trustee as CP’s recently approved voting trust,” the company said. “CN’s filing with the STB also includes its merger agreement with KCS.CN is preparing a renewed motion for the STB to approve its proposed voting trust to be filed on or before Friday, May 21, 2021. In this filing, CN will show that the significant public benefits of the transaction can only be achieved through use of a voting trust, and that these benefits substantially outweigh any potential public interest harm. CN will also demonstrate that its strong balance sheet, cash flows and credit ratings profile provide certainty that CN has the financial integrity to satisfy the STB’s public interest analysis.”

On May 14, after KCS made said it intended to terminate its merger agreement with CP things again became less uncertain, due to a filing made with the STB, regarding the pursuit of KCS by both CN and CP, by the United States Department of Justice (DOJ), regarding CN’s proposed use of a voting trust in connection with its proposed combination with KCS.

CP said that the company is in agreement with the DOJ’s objection to CN’s application for proposed use of a voting trust, based on its contention that a CN merger with KCS presents “greater risks to competition” than the CP-KCS agreement.

“A CN-KCS transaction poses additional dangers to competition stemming from the potential elimination of direct, 'parallel' competition on routes served by both railroads, for example between Baton Rouge and New Orleans,” DOJ stated in the filing. “CN's proposed use of a voting trust would create “threats to competition [that] would be present immediately after the CN voting trust is consummated. It is particularly important to protect the incentives of CN and KCS to compete where, as here, CN and KCS appear to compete head-to-head on multiple parallel routes. On May 6, 2021, the Board approved the proposed CP-KCS voting trust in Finance Docket No. 36500. Notwithstanding this decision, the Board should not permit the proposed CN voting trust because CN's proposed acquisition of KCS appears to pose greater risks to competition than the risks posed by a CP-KCS merger.”

And CP officials explained that the position taken by the Department of Justice is consistent with CP’s assessment that CN’s proposal is illusory and also offers what it called unattainable value to KCSs shareholders.

What’s more, they also added that: “CP remains confident its friendly agreement is the only viable merger for KCS, as already validated by two favorable rulings by the STB. The STB approved CP's use of a voting trust and affirmed KCS' waiver from the new rail merger rules it adopted in 2001 because a CP-KCS combination is truly end-to-end, pro-competitive and together they would remain the smallest Class 1 railway.”