28 Billion Rail Deal Faces Hurdles

   (FROM THE WALL STREET JOURNAL 11/19/15) 
   By Ben Dummett and Tripp Mickle 

Canadian Pacific Railway Ltd.'s proposal to buy Norfolk Southern Corp. for about $28 billion would create a rail network stretching across most of North America.

But the pact would need to satisfy the U.S. Surface Transportation Board's rules on mergers -- and that could be a tough sell.

The rules, which were passed in 2001 following decades of industry consolidation, required future merger applicants "to bear a heavier burden to show that a major rail combination is consistent with the public interest" by enhancing competition.

CP would have to submit a tower of paperwork including a so-called "Service Assurance Plan" providing information on how the companies would be integrated, including training plans, information technology systems, service disruption contingencies, labor issues and other matters.

Experts estimate that approval would take a minimum of 18 months and could take even longer because of the size and scope of the deal.

The regulator wouldn't only review the CP-Norfolk Southern merger but also evaluate whether or not it would trigger further industry consolidation.

Even so, a deal would likely spur others. "There would be a temptation for other railroads to merge," said Steven Ditmeyer, a former federal railroad official who teaches railway management at Michigan State University. He thinks companies like CSX Corp. and Canadian National Railway Co. would also explore a merger to remain competitive.

Rail competitors CSX, BNSF Railway Co. and Canadian National Railway declined to comment on the potential merger.

In an email, a spokesman for Union Pacific Corp. -- another major competitor -- said, "We oppose rail industry mergers, generally, and believe the regulatory hurdles for future consolidation would be significant."

To try to pre-empt competition concerns, CP said the combined railroad company would allow other railroads to operate on its tracks and in its terminals if the merged company couldn't provide adequate service or competitive prices. CP said it also would give shippers the choice of where they could connect with other railroads on its network.

The so-called open access plan is something competing railroads have opposed and would likely spark opposition to this deal, said Anthony Hatch, a railroad analyst with ABH Consulting.

He added that the plan would reduce incentives for railroad companies to invest in their infrastructure, which could be problematic for regulators.

"Why would you build a new terminal if you thought someone else would use it?" Mr. Hatch said. "The answer, as we've seen around the world, is you won't."

Calgary, Alberta-based CP -- which hasn't launched a formal bid -- is offering $46.72 in cash and 0.348 share of the merged company for each share of Norfolk Southern.

Norfolk Southern, based in Norfolk, Va., has said it would evaluate the bid, describing it as an "unsolicited, low-premium, nonbinding and highly conditional indication of interest."

The two sides differed on the value of CP's proposal, signaling that they are far apart on a potential combination. CP, in a letter to Norfolk Southern that was made public Wednesday, said a merger would allow the companies to achieve more than $1 billion in cost savings, boosting the ultimate value of the deal to as much as $42.64 billion.

Norfolk said the stock component of the offer is based on CP's share price, which would put the value of the offer much lower.

CP's stock rose 5.8% to $146.65 Wednesday, while Norfolk Southern gained 6.4% to $92.49.

CP made its proposal public after a meeting last week between its chief executive, Hunter Harrison, and Norfolk Southern CEO James Squires, at which CP got a cool reception, according to a person familiar with the matter.

According to a person familiar with the matter, CP is making the move in part because it believes its management could greatly boost the margins at Norfolk, along the same lines that Mr. Harrison has done since taking over CP in 2012.

That followed a successful proxy battle by New York activist investor William Ackman to replace directors and management at CP, one of Canada's oldest and most storied companies.

Mr. Harrison believes he can get to a combined operating ratio in the mid-50% level, compared with Norfolk's approximately 70% ratio at this point, the person said.

The lower a railroad's operating ratio, the more efficiently it runs and the more profitable it can be.

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David Benoit contributed to this article.

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November 19, 2015 02:47 ET (07:47 GMT)

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