Megamerger Between Kansas City Southern (KSU) and Canadian Pacific Railway (CP) Gets Thumbs Up from Analysts

March 22, 2021 10:49 AM EDT
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In the largest merger deal so far this year, Canadian Pacific Railway (NYSE: CP) agreed to buy Kansas City Southern (NYSE: KSU) in a deal with an enterprise value of $29 billion.

This deal, which will involve both shares and cash, will create the first rail network connecting the United States, Mexico, and Canada, betting on a pick-up in North American trade.

Under the terms of the agreement, shareholders of Kansas City Southern will receive 0.489 of a Canadian Pacific share and $90 in cash for each KCS common share owned. The proposed deal values Kansas City Southern at $275 per share, representing a premium of about 23% to Friday’s closing price of $224.16.

“This transaction will be transformative for North America, providing significant positive impacts for our respective employees, customers, communities, and shareholders,” said CP President and Chief Executive Officer Keith Creel.

“This will create the first U.S.-Mexico-Canada railroad, bringing together two railroads that have been keenly focused on providing quality service to their customers to unlock the full potential of their networks. CP and KCS have been the two best performing Class 1 railroads for the past three years on a revenue growth basis.”

Two companies will now work together to overcome any regulatory issues, a process that could take between 4 and 6 months, according to JP Morgan analyst Brian Ossenbeck.

“CP will set up a voting trust to acquire KCS in a process that could take 4-6 months. We expect the structure will gain STB approval as it should keep KCS independent of CP while meeting the public interest standard,” the analyst wrote in today’s memo.

“The approval of control by the STB and formation of CPKC will be influenced by whether or not KCS’s exemption will hold, interested parties cannchallenge that status within 10 days of the pre-filing notification. We expect KCS’s exemption will be challenged by a shipper or another carrier considering CPKC plans to introduce new service offerings that compete directly with CN, UP and BNSF. However, we do not expect the CPKC announcement will trigger other proposed rail mergers in response, which is also a consideration of the revised regulatory review.”

Ossenbeck upgraded KCS to “Overweight” from “Neutral” as a play on a shorter-term payback of the transaction with a target equivalent to the offer. He also raised the price target to $275.00 per share from the prior $231.00.

Similarly, Stephens analyst Justin Long believes the deal “makes a lot of sense” strategically for both companies as will allow them to accelerate already attractive long-term growth profiles.

“However, the proposed transaction price reflects fairly healthy valuation multiples and the regulatory approval process is expected to take over a year (and probably isn't a lay-up). Net/net, we are putting our ratings and price targets for both companies under review as we take a deeper dive into this deal, with a focus on the regulatory review process and the assumptions within the financial guidance. But at this time, we expect this deal to be completed,” Long said in a note.

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