TORONTO — Canadian Pacific Railway Ltd.'s largest shareholder has called on CN Rail to drop its bid for Kansas City Southern because of the sizable break fee CN Rail would be forced to pay if its voting trust is not approved by the U.S. railway regulator.
Britain's TCI Fund Management — which also owns a three per cent stake in CN Rail — made the appeal in a letter to CN's board after the U.S. Surface Transportation Board ruled Monday that its proposed US$33.6-billion deal with KCS must be based on stricter merger rules.
TCI claims CN's board of directors would be "negligent and hugely irresponsible" to risk C$2 billion of shareholders' money based on STB's still-to-come decision on approving the voting trust for the CN-KCS transaction.
That figure includes a US$1 billion break fee if the STB fails to approve the trust and the US$700 million break fee on the CP deal that CN says it would cover.
TCI argues CN should abandon its pursuit of the U.S. railway unless its merger agreement is amended so that it is not conditional on a voting trust being approved.
Unlike CP Rail, whose proposed takeover of KCS received an exemption from strict merger rules enacted in 2001, the regulator says CN would face a tougher standard, adding that the “use of a voting trust is a privilege, not a right” and will be available only on “rare occasions.”
"The STB is sending a clear signal and the CN board has a duty to listen. The risk that the voting trust is not approved is too great to ignore," said the TCI letter to CN's board.
CN Railway didn't directly address TCI's comments in a news release Tuesday except to say it is confident of gaining approval for the voting trust and closing the deal with KCS.
"CN’s board believes its pro-competitive combination with Kansas City Southern is in the best interest of CN’s shareholders and other stakeholders."
The Montreal-based railway said the STB's other decision to defer consideration of a voting trust was only because the merger agreement had not yet been filed. CN says such an agreement has since been negotiated and was filed with the regulator on Tuesday.
TCI says CN's board can't have any confidence in how the new rules will be interpreted because they've never been used before.
"Making what is essentially a C$2 billion bet with company money on this one, unknowable, decision would be extremely reckless."
Even if the voting trust is approved, TCI says CN could face a C$18 billion liability if the transaction is not approved and the trust has to sell KCS under potentially distressed conditions.
"This would almost wipe out CN’s entire shareholders’ equity that it has taken over 100 years to accumulate. It could also seriously jeopardize the future of the company."
While the risk for CN exists, it likely wouldn't be a dire as has been portrayed, suggested Craig Jerusalim, portfolio manager at CIBC Asset Management.
"There's likely to still be bidders for the rail whether it's CP that comes back into the fold or private equity at that point," he said in an interview.
"So I think the risk to CN is not massive although I would agree totally that the risk that CN is denied is much higher than the risk that CP is denied."
Meanwhile, some railway unions have told the STB that they're concerned that a bidding war between Canada's two largest railways could be bad for shippers and workers.
"There is a likelihood that innocent bystanders — employees of CP, CN and KCS, and shippers which use those carriers — will pay a price for this exercise in one-upmanship," said several unions that together are referred to as the Allied Rail Unions.
"The successful bidder, having spent more than what was anticipated and what is reasonable would likely seek to recoup its excess expenditures by seeking so-called cost-cutting 'efficiencies' from railworkers; and it would likely seek to reduce other costs, which, in turn, would diminish service."
Jerusalim said the deals as they stand are strategically worth a lot to either CN or CP and shouldn't result in excessive cost-cutting. But he added the union has a fair argument that being forced to pay more, including by adding debt, does raise worries.
"The more the winning party is going to have to find ways of extracting that value for their own shareholders and that's either through higher pricing or cutting costs and you could see why unions would not be in favour of that."
This report by The Canadian Press was first published May 18, 2021.
Companies in this story: (TSX:CNR, TSX:CP)
Ross Marowits, The Canadian Press