The decision was a blow to the deal that would create the first direct railway linking Canada, the U.S. and Mexico.

The voting trust would temporarily own Kansas City Southern without CN exerting control. It would have allowed KCS shareholders to receive and keep the $325 per share in cash and stock CN was offering, even if the combination was subsequently rejected by the regulator, the U.S. Surface Transportation Board (all figures US$ except where noted).

The STB said it left the door open for the companies to seek full review of their proposed merger. Regulatory experts said the process would be uncertain and could last more than a year. The companies did not immediately respond to requests for comment on their next steps.

KCS has an alternative suitor, Canadian Pacific Railway (CP), whose $25 billion deal to buy the company in March was later trumped later by CN.

Canadian Pacific’s proposed voting trust was approved in May, and this month the company presented a new $27 billion cash-and-stock bid for Kansas City Southern, confident the STB would reject CN’s voting trust.

CP did not immediately respond to a request for comment, but CP CEO Keith Creel said in a release that the company’s Aug. 10 offer to KCS “still stands.”

The STB’s ruling, Creel said, “clearly shows that the CN-KCS merger proposal is illusory and not achievable” and “knowing this, we believe (CP’s offer) recognizes the premium value of KCS while providing regulatory certainty (and) ought to be deemed a superior proposal.”

KCS shares closed on Tuesday down 4.39 per cent at $280.67. CN shares closed up 7.36 per cent at $148.40, indicating relief from shareholders that the acquisition now looks unlikely. CP shares dropped 4.55 per cent to C$86.69, highlighting trepidation among its shareholders over paying up for a deal with KCS.

After the STB decision, a CN shareholder, hedge fund TCI Management, sent a letter to the company’s board urging it to cancel its deal with KCS and replace CEO Jean-Jacques Ruest with Jim Vena, a veteran of both CN and Union Pacific. Vena could not be immediately reached for comment.

“The board must take responsibility for the company’s recent underperformance and failure,” TCI said in the letter. The fund, run by hedge fund veteran Chris Hohn, has a 5.2 per cent stake in CN and is also CP’s largest shareholder.

The STB said that even though the overlap of CN’s and KCS’s networks was confined to about 113 km between Baton Rouge and New Orleans, the two railways operated parallel lines in the central portion of the U.S. and could be under less pressure to compete if the voting trust was approved.

“The board finds that applicants have not demonstrated that their use of a voting trust would be consistent with the public interest,” the STB said in a statement.

U.S. President Joe Biden has issued sweeping executive orders aimed at promoting competition in the U.S. economy. One order encouraged the STB to consider Amtrak’s statutory rights when assessing whether a rail merger is in the public interest.

Passenger railroad Amtrak, majority owned by the U.S. government, had opposed CN’s voting trust, saying its pledge to divest the Baton Rouge to New Orleans line will harm future passenger service in Louisiana.

— Reporting for Reuters by Shreyasee Raj and Abhijith Ganapavaram in Bangalore and Greg Roumeliotis in New York. Includes files from Glacier FarmMedia Network staff.

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CP had agreed a deal to acquire Kansas City Southern for about $25 billion last month (all figures US$). Either combination would create a North American railway spanning the United States, Mexico and Canada as supply chains recover from pandemic-led disruptions.

The acquisition interest in Kansas City Southern also follows the ratification of the Canada-U.S.-Mexico Agreement (CUSMA) last year that removed the threat of trade tensions, which had escalated under former U.S. President Donald Trump.

Kansas City said it would evaluate CN’s offer. If it found it could lead to a better deal, CP will be given the opportunity to raise its bid.

Meanwhile, CP said CN’s cash-and-stock offer of $325 per share at a 26.8 per cent premium to Kansas City Southern’s share price at the end of Monday’s trading, was “illusory and inferior.”

The proposal was “massively complex and likely to fail” and it would reduce competition and negatively impact shippers, the company said.

“We are surprised by this move given the healthy valuation Canadian Pacific had already offered to Kansas City Southern shareholders,” Stephens analyst Justin Long wrote in a client note.

Kansas City Southern shares closed up 15.3 per cent to $295.50, indicating most investors deemed it unlikely the company would stick with CP’s offer.

However, Chilton Investment Co., which has a less than one per cent stake in the U.S. railroad, preferred a deal with CP, citing regulatory hurdles.

“There’s more overlap with Canadian National deal, which makes it harder to get (regulatory) approval. The Surface Transportation Board (STB) doesn’t like overlap,” Chilton CEO Richard Chilton said.

CN CEO Jean-Jacques Ruest said the two companies have “highly complementary networks with limited overlap.” They only run parallel for about 105 km, between Baton Rouge and New Orleans.

Kansas City Southern has domestic and international rail operations in North America, focused on the north-south freight corridor connecting markets in the central United States with industrial cities in Mexico. Calgary-based CP is Canada’s No. 2 railroad operator, behind CN.

The STB updated its merger regulations in 2001 to introduce a requirement that Class I railways have to show a deal is in the public interest.

Yet it provided an exemption to Kansas City Southern given its small size, potentially limiting the scrutiny that its acquisition will be subjected to.

CP agreed in its talks with Kansas City Southern to bear most of the risk of the deal not going through. It will buy Kansas City Southern shares and place them in an independent voting trust, insulating the acquisition target from its control until the STB clears the deal.

Were the STB to reject the combination, CP would have to sell the shares of Kansas City Southern, but the current shareholders would keep their proceeds.

CN said it was willing to match these terms. It said its offer does not require approval from its shareholders because of how much cash it has, eliminating a condition in CP’s offer.

CP said its rival’s proposal would create the third largest Class 1 railroad, while it would remain the smallest of the six U.S. Class 1 railroads by revenue.

Bill Gates’ Cascade Investment, which is Canadian National’s biggest investor with a 14.25 per cent stake, said it supports the combination.

A private equity consortium led by Blackstone Group and Global Infrastructure Partners made an unsuccessful offer last year to acquire Kansas City Southern.

But it was CP’s announcement of a deal with Kansas City Southern that spurred CN into action, as it raised the prospect of losing out to its rival, according to people familiar with the matter.

— Reporting for Reuters by Shreyasee Raj, Ankit Ajmera and Nivedita Balu in Bangalore; additional reporting by Greg Roumeliotis in New York.

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