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Regulators reject CN’s proposed voting trust to acquire KCS

Denial by Surface Transportation Board puts CN-KCS merger in limbo

The Surface Transportatiom Board has rejected CN's proposed voting trust, which would be used to acquire Kansas City Southern. (Photo: Jim Allen/FreightWaves)

The Surface Transportation Board voted unanimously Tuesday to reject the proposed voting trust that CN would use to acquire Kansas City Southern, making the $33.6 billion merger’s prospects unclear. The STB said the trust “is not consistent with the public interest standard under the Board’s merger regulations.”

“The Board finds that using a voting trust, in the context of the impending control application, would give rise to potential public interest harms relating to both competition and divestiture,” the agency said in its decision.

Rivals CN and Canadian Pacific are both seeking to acquire KCS. CP and KCS announced in March their plans to merge, but then CN put forth a competing bid and KCS opted in May to go with CN’s bid instead.

What remains uncertain is how KCS (NYSE: KSU) shareholders will handle the STB’s decision. Shareholders are scheduled to hold a vote Friday on whether to approve the merger agreement between KCS and CN.

CN (NYSE: CNI) issued a response late Tuesday: “We are disappointed in the STB’s decision regarding the joint voting trust application filed by CN and KCS. We are evaluating the options available to us in light of the STB’s decision. We remain confident that our pro-competitive, end-to-end combination is in the public interest and that it would offer unparalleled opportunities and benefits for customers, employees, the environment and the North American economy.”

CP (NYSE: CP) CEO Keith Creel said Tuesday afternon that “the STB decision clearly shows that the CN-KCS merger proposal is illusory and not achievable. Knowing this, we believe the August 10 CP offer to combine with KCS, which recognizes the premium value of KCS while providing regulatory certainty, ought to be deemed a superior proposal. Today, we have notified the KCS Board of Directors that our August 10 offer still stands to bring this once-in-a lifetime partnership together.”

Voting trust needs to further explain how merger would enhance competition: STB

In its decision issued, the agency said the voting trust didn’t meet a more stringent federal standard governing major mergers between Class I railroads. These standards, adopted for mergers occurring after 2001, require applicants to “affirmatively demonstrate” that the use of the voting trust under a pending merger context must be consistent with the public interest, even if any perceived deficiencies are “curable.”

The board also said CN’s proposed trust focused more on how the trust would benefit shareholders than the public.

“The Board recognizes that CN, like any merger suitor, has a legitimate interest in making a strong offer to KCS’s shareholders. But that ‘interest’ is for the private benefit of the suitor, and standing alone, carries no public benefit,” STB said.

“Moreover, a voting trust is just one of several deal terms available to achieve CN’s stated purpose of conferring greater certainty to the acquisition target pending regulatory approval. … Although Applicants may prefer that the proposed transaction move forward with a voting trust, a voting trust is plainly not ‘essential’ to unlock the claimed public interest benefits of the proposed transaction; similarly, an acquisition target’s preference that a merger agreement have a condition precedent of a voting trust is not a ‘public benefit’ … and therefore cannot be a component of the Board’s ‘public interest’ calculus,” STB continued.

The agency also contended that a voting trust could insulate the proposed merger from regulatory scrutiny.

“Placing KCS in trust would insulate KCS and CN from the regulatory risks and uncertainties associated with the heightened scrutiny that the proposed transaction would face under the current major merger regulations and the heightened possibility of divestiture — an advantageous scenario for KCS shareholders and CN at the expense of the public interest in mitigating risks to competition and the stability of the rail network.”

The board said concerns about competition beyond the 70 miles of tracks that overlap between Baton Rouge, Louisiana, and New Orleans also need to be further addressed.

“The Board emphasizes that it is not making a final determination regarding the extent of these competitive issues or whether they can be resolved. It is simply finding that, in view of the heightened scrutiny that both the use of a voting trust and the proposed transaction face under the current major merger regulations, it would not be in the public interest to allow CN to own KCS until the competitive issues have been thoroughly examined,” STB said.

According to KCS, the merger agreement calls for CN to acquire KCS in a stock-and-cash transaction valued at $325 per common share, based on CN’s May 13, 2021, offer, implying a total enterprise value of $33.6 billion. This would also include the assumption of approximately $3.8 billion of KCS debt. Under the terms of the agreement with CN, KCS stockholders will receive $200 in cash and 1.129 shares of CN common stock for each KCS common share.

Earlier this month, CP revised its offer and presented KCS with a stock-and-cash bid worth an estimated $31 billion. The proposal, which KCS subsequently declined, valued KCS at $300 per share.

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Joanna Marsh

Joanna is a Washington, DC-based writer covering the freight railroad industry. She has worked for Argus Media as a contributing reporter for Argus Rail Business and as a market reporter for Argus Coal Daily.