CN now has until the end of Friday to submit a better offer or lose its deal with KCS. At stake is the creation of the first direct railway linking Canada, the United States and Mexico.

KCS’s change of heart came after the U.S. Surface Transportation Board (STB) rejected a temporary “voting trust” structure last month that would have allowed KCS shareholders to receive the $325-per-share cash-and-stock consideration under the deal with CN without having to wait for full regulatory approval.

CP has had its proposed voting trust cleared by the STB. The regulatory certainty this provided convinced KCS’s board to switch to a deal with CP, even though its offer was lower than CN’s, according to people familiar with the deliberations.

There is a silver lining for KCS. The CP offer it now plans to accept, worth $300 per share in cash and stock, is better than the $275 per share cash-and-stock deal that the two companies had clinched in March, before CN gatecrashed it and entered into an agreement with KCS in May (all figures US$).

Were CN to lose out to CP, it would receive from KCS a $700 million breakup fee and would be reimbursed for another $700 million it paid KCS to pass on to CP as a breakup fee for terminating their March deal. CP has said it will cover the cost of this $1.4 billion that KCS would owe CN.

CN has also faced pressure from some of its investors, including hedge fund TCI Management, to abandon its pursuit of KCS.

CN did not immediately respond to a request for comment on its next steps.

The STB said last month that even though the overlap of CN’s and KCS’s networks was confined to 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 for that deal was approved. It added that it was not making a final determination on whether the competitive issues that the deal faced could be resolved under a full regulatory review.

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 proposed voting trust, saying its pledge to divest the Baton Rouge to New Orleans line will harm future passenger service in Louisiana.

CP reiterated Sunday that its merger with KCS would maintain all existing freight rail gateways and maintain competition in the Baton Rouge to New Orleans corridor, while “creating new north-south lanes” between Western Canada, the U.S. upper Midwest and the Gulf Coast and Mexico.

Also, CP said, its deal with KCS would create a route network that “does not funnel all of its traffic through the congested Chicago area.”

— Reporting for Reuters by Radhika Anilkumar in Bangalore and Greg Roumeliotis in New York. Includes files from Glacier FarmMedia Network staff.

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The Canadian rivals have been locked in a takeover battle for the U.S. railroad operator for two months to create the first railway spanning the U.S., Mexico and Canada, as they stand to benefit from a recent pick-up in trade.

Kansas City Southern last week accepted CN’s $33.6 billion offer, upending a $29 billion deal with its competitor CP (all figures US$).

The U.S. railroad on Friday said it paid CP a breakup fee of $700 million, which would be reimbursed by CN.

CP said Friday it was willing to re-engage with Kansas City, hoping that the rival bid would be shot down by the U.S. Surface Transportation Board (STB), a regulator that oversees railroad companies.

CN’s deal has recently run into regulatory hurdles, with the STB having denied its motion for approval of a voting trust earlier this week. The U.S. Department of Justice had also said last week that CN’s bid for Kansas City appears to pose greater risks to competition.

CN and Kansas City said they expect to gain all the required regulatory approvals, including that from STB.

Kansas City said the deal is expected to close in the second half of next year, following which its shareholders will own 12.6 per cent of the combined company.

— Reporting for Reuters by Arathy S Nair and Sanjana Shivdas in Bangalore.

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Hohn’s TCI Fund Management, which has a 2.93 per cent stake in CN, said the company should not go ahead with its plan to create a voting trust structure for the takeover.

“CN regularly engages with and welcomes constructive input from its shareholders. CN’s board believes its pro-competitive combination with Kansas City Southern is in the best interest of CN’s shareholders,” a spokesperson for CN in a statement.

CN and Canadian Pacific Railway are seeking to buy U.S. railroad Kansas City Southern to create a North American railway spanning the U.S., Mexico and Canada.

Kansas City last week accepted CN’s $33.6 billion acquisition offer, upending a $29 billion deal with CP (figures US$ except where noted).

“We think it is negligent and hugely irresponsible for the CN board to commit C$2 billion of shareholders’ money on whether the STB will approve the voting trust for the CN-KCS transaction,” TCI said in a letter to CN chairman Robert Pace.

The C$2 billion stems from the $700 million breakup fee CN would pay CP on KCS’ behalf for upending its deal, and the $1 billion it would pay KCS if the U.S. Surface Transportation Board (STB) shoots down the voting trust.

A voting trust is a temporary ringfenced structure that CN would use to hold KCS after the deal closes without exercising control over it, until the STB approves or rejects the acquisition.

U.K.-based TCI is also the largest shareholder of CP, with an 8.38 per cent stake, according to Refinitiv data.

“It is now clear that CN should abandon its pursuit of KCS unless the merger agreement is amended such that it is not conditional on a voting trust being approved,” TCI added.

TCI said it believes the STB reviewing CN’s bid under the new rules makes approval for the deal uncertain.

— Reporting for Reuters by Sanjana Shivdas in Bangalore.

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The development comes as KCS on Thursday accepted CN’s $33.6 billion acquisition offer, upending the $29 billion deal with CP (all figures US$).

“A CN-KCS transaction poses additional dangers to competition stemming from the potential elimination of direct, ‘parallel’ competition on routes served by both railroads, for example between Baton Rouge and New Orleans,” the DOJ said in a filing with the U.S. Surface Transportation Board posted on CP’s website.

CN did not immediately respond to a Reuters request for comment.

CP said the company remained confident its friendly deal with the U.S. railroad was “the only viable merger.” It has five business days to make a new offer for KCS, and a bidding war could ensue if the company tables a new bid.

Both companies are seeking to create a North American railway spanning the U.S., Mexico and Canada.

— Reporting for Reuters by Sanjana Shivdas in Bangalore.

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Last week, the U.S. Surface Transportation Board (STB) granted a waiver to CP’s $25 billion agreed bid for Kansas City Southern, which means the deal would not be subjected to the tougher railroad merger rules the regulator put in place in 2001 (all figures US$).

CP won the exemption based on its smaller size, and analysts and shareholders have said that STB’s ruling reduces the regulatory risk to CP’s deal.

CP and larger rival CN are in a race to take over U.S. railroad Kansas City Southern (KCS), which would create the first direct railway linking Canada, U.S. and Mexico.

Either combination is seeking to benefit from the expected pick-up in trade after the Canada-U.S.-Mexico Agreement was ratified last year.

In its argument filed with the regulator on Friday, CP said CN’s offer to acquire KCS should be cause for concern because of its size.

“A combined CN/KCS would greatly expand the size of the fifth largest U.S. Class 1 railroad, vastly increasing the gap between CN/KCS and… CP,” Canadian Pacific said.

CN said it has voluntarily agreed to have its transaction with KCS reviewed by the STB under the current rules to demonstrate the pro-competitive nature of the deal and to address any competition concerns.

KCS did not immediately respond to a request for comment on CP’s filing to the regulator.

CN launched an unsolicited cash-and-stock offer valuing KCS at about $29.55 billion, after CP agreed to buy KCS for about $25 billion in March.

CP has previously said it was not considering increasing its offer. KCS previously said its board has determined that CN’s competing offer could be expected to lead to a “superior proposal.”

— Reporting for Reuters by Shubham Kalia in Bangalore.

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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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In letters to the CEOs of the railroads, dated Friday and posted Monday on the U.S. Surface Transportation Board’s (STB) website, the regulator requested locomotive and employee numbers, and asked whether the railroads have sufficient numbers of each to meet demand.

The STB said last week it would start meeting with customers next month, signaling the agency could be open to new paths to relieve shipper pain.

The letter signed by STB acting chairman Ann Begeman and vice-chairman Deb Miller cites the regulator’s “increasing concerns regarding service across the rail network,” and asks for a service outlook for the near term and for 2018.

“Please discuss your expectations for service demand in 2018, ability to serve this demand, and whether internal projections for demand in 2018 have been accurate based on actual volumes year-to-date,” the letters said, among other requests.

The letters were sent to the CEOs of Union Pacific, BNSF Railway, CSX, Norfolk Southern and Kansas City Southern. They were also sent to the CEOs of Canada’s two major railroads, Canadian National Railway and Canadian Pacific Railway, which have significant U.S. operations.

A spokesman for CN said the railroad has “acted aggressively to address service issues… that have developed in the face of significant volume increases across our business.” It said those included leasing locomotives and raising planned 2018 capital expenditures by $500 million, to $3.2 billion.

A Norfolk Southern spokeswoman said the railroad would “respond directly to the STB.”

CSX has been reporting weekly service data to the STB since August following disruptions last summer and a spokesman said the railroad has consistently shown “significant improvements across all key metrics.”

The other railroads did not immediately respond to requests for comment.

As U.S. economic growth has revved up, railroads and truck fleets have not expanded capacity to keep pace — a decision applauded by Wall Street.

The drive for cost cuts and higher margins at U.S. trucking and railroad operators is pinching their biggest customers, forcing the likes of General Mills and Hormel Foods to spend more on deliveries and consider raising their own prices as a way to pass along the costs.

— Nick Carey is a Reuters correspondent based in Detroit.

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Customers have complained of longer transit times, unreliable switching operations, inefficient car routings and poor communications with CSX customer service.

CEO Hunter Harrison, who implemented cuts when he was appointed to the job in March, defended his strategy of “precision scheduled railroading” at a hearing at the U.S. Surface Transportation Board (STB) in Washington.

The session marked the first public forum for shippers and trade groups to air grievances and give Harrison the chance to defend his strategy. The STB has been reviewing the railroad’s performance weekly and acting as intermediary between CSX and disgruntled customers.

Since he took over, Harrison closed CSX rail yards, lengthened trains, mothballed locomotives and slashed overtime pay and hundreds of jobs. He also changed the way rail cars are sorted in yards and replaced “unit” trains carrying a single commodity like coal or grain with trains carrying diverse freight.

He apologized to shippers for service disruptions, which he blamed on derailments and internal mistakes, including closing too many yards.

Speaking after Harrison, Cargill vice-president Brad Hildebrand asked the STB to publish minutes of its weekly calls with CSX management and asked CSX to return resources to its network.

“In a nutshell, (precision scheduled railroading) means having to do with less,” he told the regulators.

While some customers have noted improvements, others said CSX’s disruptions continue to create costly logistical headaches for companies from the chemical and agricultural sectors to the automotive industry and steel producers.

Their supply chains, plants and distribution channels rely on CSX’s rail network across the eastern U.S.

Harrison said his strategy was critical to his previous turnarounds of two Canadian railroads — Canadian Pacific Railway and Canadian National Railway — and said the “best is right around the corner.”

“We’ve made some mistakes. This is not a failure of precision scheduled railroading,” he said.

Harrison told the STB his turnaround plan has been implemented across CSX’s system but requires “fine-tuning.” He hinted at more possible layoffs and other yard changes.

Chemours Company asked the STB to require a “flight plan” from CSX outlining future system changes and how they will affect shippers.

In what could be a distant threat to CSX’s revenues, Chemours and trade groups renewed their calls for changes to federal regulations to allow shippers served by CSX to gain greater access to other operators.

Two trade groups asked the STB to require a service recovery plan from CSX with granular performance data and penalty-enforced deadlines.

Dow Chemical’s supply chain vice-president Greg Jozwiak urged the STB to improve rules to expedite relief during disruptions.

“The reality is the procedures take too long,” Jozwiak said. “We need a service remedy counted in days, not weeks or months.”

— Eric M. Johnson is a Reuters correspondent based in Seattle.

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In a letter released by the regulator on Monday, CSX CEO Hunter Harrison laid out the tenets of his “precision scheduled railroading” approach, which he said would improve service, cut costs and better use the railroad’s assets.

But the CEO of the Jacksonville, Fla.-based railroad adopted a much more conciliatory tone than in recent communications over service issues at CSX.

Previously, Harrison had responded to criticism of service issues at CSX by blaming pushback from employees to his new plan.

In mid-August, 44 trade groups asked federal regulators to investigate “chronic service failures” at CSX which they said had rippled out across North America’s rail network.

Harrison responded to that with another letter saying those claims were “grossly exaggerated.”

In his Aug. 24 letter to the U.S. Surface Transportation Board (STB), CSX’s CEO said that this month the railroad had placed “personnel at challenged field locations to bridge communications gaps and target concerns at the local level.”

The company has also resumed operations at a yard in Avon, Indiana, as CSX “pursue(s) optimal processing efficiency to best serve our customers.”

Harrison is a railroading legend who previously served as CEO of Canadian Pacific Railway and Canadian National Railway (CP, CN) where he dramatically boosted profits with his “precision scheduled railroading” approach.

“I remain confident that as CSX implements its PSR model, customers will receive a markedly superior service model,” Harrison wrote in his letter to the STB.

— Reporting for Reuters by Nick Carey.

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In mid-November, CP disclosed a $28 billion offer for the Virginia-based company, which has rebuffed all advances from the railroad (all figures US$).

CP proposes sending its CEO, Hunter Harrison, to run Norfolk Southern as part of that trust. But the rules of the U.S. Surface Transportation Board require the companies to run independently of each other while it reviews any deal.

The Justice Department said in a statement that it had told the STB that the voting trust would also fail to preserve the companies’ independence during the review.

Calgary-based CP, Canada’s second-largest railroad, has said a merger would result in savings of more than $1.8 billion annually. It did not immediately respond to a request for comment on Friday.

If Norfolk Southern accepts CP’s bid, this would be the first such review by the STB since the regulator’s merger rules were rewritten in 2001. The new rules are tougher and include additional regulatory hurdles.

The letter comes in response to a March 2 petition from CP to the STB seeking a “declaratory order” on its voting trust proposal.

In its statement, the Justice Department said that by effecting a management change in Norfolk Southern, CP’s proposal “is even more pernicious in its failure to preserve competition than a typical voting trust.

“The STB should find that the proposal fails under each prong of the revised regulatory requirement — it creates unlawful control violations and is against the public interest,” the statement said.

Experts had said the voting trust structure CP proposed would face tough scrutiny from the STB.

On Thursday, the U.S. Department of Defense also raised concerns with the STB over CP’s proposed voting trust.

Last Tuesday, Rep. Bill Shuster, chairman of the U.S. House of Representatives’ transportation and infrastructure committee, also stated his opposition to CP’s proposal.

“I do not believe it is in the best interests of the U.S. freight transportation system, railroad employees, rail shippers and the short line railroads,” he said in a statement. “I believe it is time for all parties to move on from hypothetical merger proposals.”

— Reporting for Reuters by Nick Carey in Chicago and Timothy Ahmann in Washington, D.C.

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