'Ready to roll': CP Rail preparing for KCS merger, ruling expected within weeks

With the final decision by a U.S. regulator just weeks away, Canadian Pacific Railway Ltd.'s CEO says the company is "ready to roll" on its proposed merger with U.S. railroad Kansas City Southern.

Keith Creel, head of the Calgary-headquartered railway, made the comment during a conference call with analysts earlier this week, in which he confirmed a ruling by the U.S. Surface Transportation Board (STB) is expected sometime this quarter.

"It's going to be a very special year for our two storied companies," Creel said. "We can't wait to get to work on combining these two great companies and creating value for our customers, our employees in the North American economy."

The STB's decision is the final hurdle CP must clear in its bid to purchase KCS for US$31 billion — a deal which would create the only single-line railroad linking the United States, Mexico and Canada.

If the STB gives the go-ahead, the merged railway will be named Canadian Pacific Kansas City (CPKC). Creel will be CEO, and Calgary will serve as global headquarters for the new entity. Kansas City, Mo., will be the U.S. headquarters, and the Mexican headquarters will be in Mexico City and Monterrey.

While CPKC will remain the smallest of six large railways operating in the U.S. by revenue, it will operate nearly 33,000 kilometres of rail — extending from Canada, into the U.S. and all the way to Mexico — and employ nearly 20,000 people.

"I can't get ahead of the STB. The STB is the authority here and we need their stamp of approval," Creel said, adding if the decision goes CP's way, the company plans to host an investor day in June to provide more details about the future of the merged railroad.

It's been a long and bumpy route to get to this point. Both CP and its competitor, Montreal-based Canadian National Railway Co., were interested in acquiring KCS, and fought a testy battle behind the scenes for months before CP and the U.S. railway announced a friendly offer in March of 2021.

KCS then switched alliances a month later by declaring CN's cash-and-stock bid valued at US$33.6 billion as superior.

However, KCS renewed its support for CP and its bid later on after the U.S. transportation regulator denied CN's use of a voting trust for KCS, saying it would be bad for competition.

CP, which already had permission to use a voting trust under older rules, was able to close its proposed deal in December of 2021. Since then, the shares of KCS have been in a voting trust that allows the U.S. railway to operate independently while the U.S. Surface Transportation Board completes its review.

CP Rail has said the merger will build a more efficient and competitive rail network, and provide customers with a more reliable and economical transportation option serving critical north-south trade flows.

However, CN has urged the STB to require the merged company to divest some of its KCS rail lines if the deal is permitted to go ahead.

The anti-trust division of the U.S. Department of Justice has also expressed concerns over the proposed merger, warning in a recent letter to the STB that the deal poses a threat to competition and that the regulator must "scrutinize any transaction that could weaken our freight system."

For its part, CP Rail has said customers will not experience a reduction in railroad choice as a result of the transaction and has pledged to keeping all existing freight rail gateways open on "commercially reasonable terms."

CP also said the merger will be good for the environment. It has said the new combined railway will reduce greenhouse gas emissions by helping freight shippers shift more than 64,000 trucks annually off of highways.

On Tuesday's conference call, CP's chief marketing officer John Brooks said the railway and KCS have already been conducting test runs in advance of the STB's decision, running trains from the U.S. Midwest to Mexico on an inter-line basis.

"These markets are 100 per cent served by trucks today and present a tremendous conversion opportunity for the combined CPKC," Brooks said.

"We've done some work with the customers to identify the greenhouse gas emission savings at about 60 per cent to 75 per cent versus their current mode on those specific moves."

CP has said the deal, if it goes ahead, will be accretive to its earnings in the first year. In a note to clients this week, RBC Capital Markets analyst Walter Spracklin said while economic uncertainty and the potential of a recession this year pose threats to the rail transport sector, the "structural nature" of growth at CP insulates the railroad against macro factors "like no other railroad, in our view."

"Moreover, we see integration benefits as real, and likely to be revised upwards," Spracklin said.

Raymond James analyst Steve Hansen said in a note to clients that the STB decision could come as early as mid-February, with a "pathway to full CP control" of KCS expected by mid to late March.