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CP Rail merger with Kansas City Southern a 'transformational opportunity': analysts

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·3 min read
CP Rail merger with Kansas City Southern a 'transformational opportunity': analysts
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Canadian Pacific’s (CP.TO) proposed US$25.2 billion takeover of Kansas City Southern (KSU) is being touted by analysts as a “transformational opportunity” that will offer long-term growth as the first railway to connect Canada, the United States and Mexico.

The two companies announced Sunday that they had entered a merger agreement that will see CP acquire KCS in a stock and cash deal. CP has agreed to pay US$90 per share, as well as 0.489 shares of CP, to each KCS shareholder. That offer values the deal at US$275 per share, a 23 per cent premium compared to KCS’ closing price on Friday.

If the transaction is approved by the U.S. Surface Transportation Board, the resulting company would be the first railway to operate more than 32,100-kilometres of rail track connecting Canada, the U.S. and Mexico. CP and KCS expressed confidence that the deal would be approved by mid-2022. Both companies are currently the smallest of North America’s seven Class 1 railways, and the merger would still leave the combined company as the smallest.

Analysts have called the proposed merger a “compelling” combination with potential for long-term growth opportunities.

“We view the proposed marriage as a historic and transformational opportunity, one where the unrivaled, synergistic footprint of the combined network is expected to co-mingle with one of the most accomplished management teams in the industry to deliver best-in-class growth for years to come,” Raymond James analyst Steve Hansen wrote in a note to clients on Monday.

“We like this setup, and argue it positions CP to be one of the highest growth Class 1 railroads over the next decade.”

RBC Capital Markets analyst Walter Spracklin wrote in a note to clients on Monday that the deal is particularly favourable because it will diversify CP’s customer base as well as the geography it serves.

“Notable is the level of merchandise exposure KSU brings to CP, which represents (approximately) 70 per cent of KSU’s revenue, but only 36 per cent for CP. The combined entity would have merchandise at 46 per cent of the mix,” Spracklin wrote.

“Similarly the geographic mix of adding the US and Mexican revenue streams of the KSU to CP makes for in our view a better geographic mix by reducing CP’s Canada exposure from 76 per cent to 53 per cent and increasing materially its exposure to the US (from 24 per cent to 33 per cent) and Mexico (from 0 per cent to 14 per cent).”

The creation of a network that spans three countries would be especially advantageous for grain, automotive and intermodal volumes, National Bank Financial analyst Cameron Doerksen wrote in note on Monday.

“With the new USMCA trade agreement and trade between Mexico and the United States expected to grow (potentially supported by increased near-shoring of manufacturing back to North America), the timing for this deal appears to be favourable,” he said.

This is not the first time that CP has attempted to combine with another railway. In 2015, under the leadership of former CEO Hunter Harrison, the company tried to combine with Norfolk Southern but ultimately abandoned the attempt. At the time, Norfolk Southern had called the CP’s initial proposal “grossly inadequate” and raised concerns about regulatory approvals.

This time around, analysts do not appear to have concerns about regulatory approvals.

“With no overlap in their respective networks, there will be no negative implications for shippers,” Doerksen wrote.

“In fact, the combined entity will provide much better single-line service to more regions and key ports, which will be positive for shippers.”

CP's stock closed the day down 5.4 per cent at $448.60. Kansas City Southern (KSU) closed up nearly 11 per cent at $248.35.

Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.

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