Billion Dollar Mergers: Derailed, On-Track, or Blowing Smoke?

Trains are the future of a greener and more interconnected economy. In March 2021, Canadian Pacific Railway (“CPR”) and Kansas City Southern Railway Company (“KCS”) publicly announced that they would merge, a move that highlighted the railroad industry’s potential to modernize American commerce. (Dan Ronan, Transport Topics). With its promise to create the first United States-Mexico-Canada rail network, the deal inspired hope in easier trade and localized networks across North America. Id. Shortly after the merger announcement, in April 2021, KCS abandoned this deal for a more lucrative merger with Canada National Railway (“CN”), a competitor of CPR. (Greg Roumeliotis, Reuters). The new $33 billion deal outshines CPR’s original $29 billion offer but aims to accomplish similar outcomes. (Dan Ronan, Transport Topics). CN will cover the $700 million breakup fee that KCS must pay to CPR. (Greg Roumeliotis, Reuters). Ultimately, both deals are celebrated for their planned creation of a US-Mexico-Canada rail connection. (Greg Roumeliotis, Reuters). This post will discuss the benefits, drawbacks, and similarities of the two deals.

The largest railroad companies in North America are referred to as “Class 1” and account for 98% of freight rail revenue in the United States (“U.S.”). (The Journal of Commerce Online). All three railroads at issue here are defined as Class 1. (Statista). Of the seven largest railroads in North America, CPR and KCS rank sixth and seventh based on revenue. Id. A merger of the two entities would result in the smallest Class 1, a testament to the enormous size of the top 5. (Jordan Blum, S&P Global). CN, however, is much more profitable than CPR, and its merger with KCS would result in the third-largest Class 1 railroad company. (Statista) In both scenarios, shippers in the grain, automotive, auto-parts, and energy industries stand to benefit. (Canadian Pacific Railroad). A strong motivation for either merger is the creation of the first ever U.S.-Mexico-Canada railroad, an important development given the new USMCA Trade Agreement (“USMCA”).

Under the initiative of Former President Trump and his administration, the USMCA Trade Agreement replaced the North American Free Trade Agreement (“NAFTA”). (Holland & Knight LLP, Lexology). The USMCA emphasizes local manufacturing and supply chains, especially regarding agriculture and manufacturing. (Office of the U.S. Trade Representative). The goals of the USMCA are similar to those of NAFTA, and include updated provisions to lower tariffs and worker protections. (NAPS). With the USMCA, the U.S., Mexico and Canada hope to mitigate some of the risks associated with distant supply chains. (Lance Fritz, Fortune). Recent events have highlighted some of these risks. For example, the global pandemic caused a shortage of medical equipment and subjected supply chains to worldwide protectionist government responses. Id. Expansive supply chains further revealed their uncertainty throughout the pandemic as nations and companies altered manufacturing strategies, employment structures, and shipping routes. (PWC). Similarly, the blockage of the Suez Canal by The Ever Given disrupted the movement of 12% of the world’s global trade. (Emily DeCiccio, CNBC). As a result, globalized supply chains are facing skepticism at the same time localized freight routes are catching attention. (Brooke Sutherland, Bloomberg).

In the original transaction, CPR and KCS had no overlapping routes but met at a single point in Kansas City, MO. (Lauren Hirsch, New York Times). Motivations for the merger included the recent USMCA and lifted pressure relating to the global pandemic due to a recovering economy. Id. The proposed merger faced little opposition, with 76% of shippers reporting support, and numerous railroads reacting favorably to the news. (Jeff Stagl, Progressive Railroading). Reports touted the deal as a way to “get trucks off the road” and help transition the U.S. to a greener economy. (Lauren Hirsch, New York Times). An obstacle facing both potential mergers is the required approval from the Surface Transportation Board, an independent federal agency that has expressed concerns about anti-competitive behavior. Id. A main concern is that shipper service options are reduced when overlapping routes are consolidated. (Jeff Stagl, Progressive Railroading).

Although CPR and KCS have essentially zero overlap, the concern stands because any merger stands to set a new precedent. (Mike McGinnis, Successful Farming). Favoring the original CPR merger, however, was the fact that the resulting company would have remained the smallest of the Class 1 railroads. Id. However, railroad mergers have essentially been prohibited by the Board since 2000, and this would be the first major railroad merger in over 20 years. (Lou Whiteman, The Motley Fool). Although the resulting company would have a relatively small market share as discussed above, its novelty could cause a huge disruption in the industry by creating a trans-continental trade network unlike any other. The benefits, however, are potentially numerous. For example, the CEO of CPR expressed hope that such a vast rail network will introduce new routes, new markets, and new competition to the industry. (Jeff Stagl, Progressive Railroading).

The newest offer from CN is similar in purpose and impact to the proposed merger with CPR. However, CN officials claim that CN can provide a broader reach and greater scale, because of its status as a bigger Class 1 railroad. Id. Skeptics point out that KCS and CN have significant overlap, and thus the merger will reduce customer options and is anti-competitive. Id. Unlike KCS and CPR, KCS and CN overlap via a 70-mile rail line in Louisiana. (Reuters). However, CN stated that as part of the deal the overlap will be divested. Id.  

The future of either merger is still uncertain and CPR maintains that its offer remains the better deal. (Greg Roumeliotis, Reuters). Ultimately, consumers and the environmentally-conscious should approve of either transaction. The interconnectedness that both deals offer between the three largest North American nations suggests future collaboration and smoother supply chains. With an eye on climate change, skeptics of the deals should find comfort in either merger’s potential to move the U.S. towards a greener future. Rail transportation is four times as fuel efficient as trucking, and one train can keep 300 trucks off the road, resulting in significantly lower emissions. (Railway Association of Canada). Additionally, railroads on average can move one ton of freight more than 470 miles on a single gallon of fuel. (Association of American Railroads). The reality is that many hurdles remain before CN and KCS become one, but the allure and excitement of what a merger could one day bring are alive and well.