By Hannah Farrell, Liam Ryan, Liam Smith (Trinity College Dublin), Ryan Horlick, Christina (Eugene) Lee, Britney Cheng (University of Michigan)
Overview of the deal
Acquirer: Canadian Pacific Railway Ltd
Target: Kansas City Southern
Implied Equity Value: $29 billion
Total Transaction Size: $25.2 (-$3.8 billion)
Closed date: H2 of 2021 (expected)
Acquirer advisors: BMO Capital Markets and Goldman Sachs
Target advisors: Bank of America and Morgan Stanley
On the 20th of March, the merger between Canadian Pacific and Kansas City Southern was announced. The merger would result in the first freight-rail network spanning across Canada, the United States, and Mexico. Under the deal, Kansas City Southern common shareholders will receive .489 of Canadian Pacific stock and $90 in cash for each share held, valuing Kansas City Southern at $275 per share. Kansas City Southern shareholders are expected to own 25% of Candian Pacific’s outstanding common shares, and Canadian Pacific will issue 44.5 million shares and raise about $8.6 billion in debt to fund the transaction.
As for some background information on the companies: Canadian Pacific is Canada’s second-largest railroad operator while Kansas City Southern has domestic and international rail operations in North America. The merger is highly complementary, as both companies highlighted the environmental benefits of the deal as it would help shift trucks off highways and subsequently cut emissions. This transaction came into play after multiple failed bids and merger negotiations with several other large networks across the United States. Additionally, this would be the largest deal ever involving two rail companies.
Company Details: (Acquirer - Canadian Pacific Railway Ltd)
Canadian Pacific Railway (CP) is a Canadian Class I railway that provides both rail and intermodal transportation services over a 13,000 mile-long network. The company owns and operates a transcontinental freight railway in Canada and the United States, serving business centers from Montréal, Québec to Vancouver, BC, and the U.S. Northeast and Midwest Regions. CP transports items including bulk commodities, merchandise freight, and intermodal traffic.
Founded in 1881 as the Canadian Pacific Rail Company, headquartered in Calgary, Alberta, Canada
CEO: Keith Creel
Number of employees: 12,000
Market Cap: $47.78B (as of 03/26/2021)
EV: $55.40 billion
LTM Revenue: $6.16B
LTM EBITDA: $3.51B
LTM EV/Revenue: 8.99x
LTM EV/EBITDA: 15.78x
Company Details: (Target - Kansas City Southern)
Kansas City Southern (KCS) is a pure transportation holding company with railroad investments in the United States, Mexico, and Panama. Their rail network includes about 6,700 miles of track in the U.S. and Mexico. Its primary American holding is the Kansas City Southern Railway, a Class I Railroad that operates through 10 states.
Founded in 1887, headquartered in Kansas City, Missouri, United States
CEO: Patrick J. Ottensmeyer
Number of employees: 6,655
Market Cap: $23.06B (as of 27/03/2021)
LTM Revenue: $2.63B
LTM EBITDA: $1.33B
LTM EV/Revenue: 10.27x
LTM EV/EBITDA: 20.31x
Projections and Assumptions
Canadian Pacific Railway has provided railway access to a portion of the North American region for upwards of five decades, delivering bulk commodities, merchandised freight, and intermodal traffic. Through their merger with Kansas City Southern, they are now immediately afforded access to a majority of American railway transportation ports, entirely new segments of customers, and South American markets as well.
In the immediate future, this deal automatically makes clear the market leaders in the railway industry’s competitive landscape. With a broader range of customer access, newly streamlined services, and a domain in most major railway ports, it is Canadian Pacific’s game to lose. Immediate consequences of their new place atop the market will include the creation of jobs; improved highway traffic, safety, and environmental sustainability; and an exponentially increased efficiency for the grain, automotive, auto-parts, and energy industries.
Financially speaking, KCS shareholders are expected to receive 25% of Canadian Pacific’s outstanding common stock. Following Canadian Pacific’s announcement of the US acquisition, their stock price dropped $22 showcasing investor distress over KCS’s immense debt, now held by Canadian Pacific. However, the company has ignored the backlash, claiming $780M in synergies, exposure to new markets, and already-existing infrastructure in Kansas City should assuage investor concerns.
The deal conducted with Canadian Pacific and Kansas City Southern is expected to operate approximately 20,000 miles of railway track and to employ close to 20,000, as well as generating about $8.7 billion in revenue based on 2020 results. The new company will operate under the name Canadian Pacific Kansas City and while it will be the smallest of the six U.S. Class 1 railroads by revenue, it will create the first U.S.-Mexico-Canada railway network. The deal will allow for the efficient integration of the continent’s supply chains – with Kansas City’s existing network linking Mexico’s largest industrial cities and ports to the Midwest and the new deal linking the US, Mexico, and Canada. CEO of Canadian Pacific, Keith Creel, has said the deal will provide a transportation solution for manufacturers seeking to bring factories back to North America after the pandemic exposed risks of relying on overseas supply chains. The deal also has environmental benefits – with the new routes reducing the number of trucks used in freight transportation and cutting emissions.
Risks and Uncertainties
Few long-term risks exist with most commentators agreeing that the deal will present a great opportunity for consolidation and growth for Canadian Pacific as they create a stretch of railroad that connects the US, Canada, and Mexico for the first time. However, the deal will come under a lot of regulatory scrutiny from the Surface Transportation Board, the US regulatory authority in the industry, who may oppose the deal based on anti-competitive grounds. Recently proposed acquisitions by Canadian Pacific of CSX and Norfolk Southern were blocked through fears the deals would be rejected by regulators, so a strong precedent exists in the industry towards blocking further consolidation. A lot of the upsides on the deal centre around the potential for increased trade between the US, Canada, and Mexico in the future, following on from the North American Free Trade Agreement and President Biden’s liberal trade stance, this makes the deal very attractive. However, the potential for future more protectionist style governments to increase trade barriers will be a concern for the Canadian Pacific. The $29B price tag will mean trade between the three nations will need to be plentiful over the long run to justify the premium paid by Canadian Pacific Ltd and so the deal bears a lot of political risks.
“CP and KCS have been the two best performing Class 1 railroads for the past three years on a revenue growth basis. The new competition we will inject into the North American transportation market cannot happen soon enough, as the new USMCA Trade Agreement among these three countries makes the efficient integration of the continent’s supply chains more important than ever before.” - Keith Creel, CEO (Canadian Pacific)