NS board to CP: Buyout offer is 'grossly inadequate'

Norfolk Southern Corp. this morning announced that its board has unanimously rejected Canadian Pacific’s buyout offer.

With help from financial and legal advisors, NS completed a comprehensive review of CP's proposal to acquire NS for $46.72 per share in cash and a fixed exchange ratio of 0.35 shares in a new company that would own both railroads. The board concluded that the unsolicited offer is "grossly inadequate, creates substantial regulatory risks and uncertainties that are highly unlikely to be overcome, and is not in the best interest of the company and its shareholders," NS officials said in a press release.

Board members believe the offer substantially undervalues NS and would be detrimental to the Class I's customer base and communities since CP's unilateral open access proposal would degrade service and dis-incentivize investment. In addition, the merger wouldn't help ease congestion issues in Chicago because CP is the smallest Class I operating in the Windy City and handles less than 5 percent of all traffic there — "volumes that are too small to impact Chicago rail traffic," NS officials said.

Moreover, the merger would face substantial regulatory risks that likely couldn't be overcome and there's no certainty the Surface Transportation Board (STB) would approve CP's proposed voting trust structure, they said. The voting trust is unprecedented and is highly likely to be rejected by the STB because CP's management team would control or be substantially involved in NS' operations prior to the transaction receiving regulatory approval, NS officials believe.

"There is a high probability that, after years of disruption and expense, the proposed combination would be rejected by the STB," said NS Chairman, President and Chief Executive Officer James Squires. "Even if the proposed combination were ultimately to be cleared, it would be subject to a wide range of onerous conditions that would reduce the value of the stock consideration that has been proposed.”

Another reason the board rejected CP's offer: NS is successfully executing its business-growth strategy, said Squires. For example, the management team is instituting a number of revenue growth initiatives focused on pricing discipline and exploiting merchandise and intermodal opportunities, he said.
 
“We believe in our ability to generate greater shareholder value … [by] delivering efficient and superior service to build a more profitable franchise based on price and volume growth, implementing efficiency measures, and increasing returns on capital to strengthen our financial performance, all while maintaining our disciplined capital return strategy,” said Squires. “Specifically, we expect to achieve an operating ratio below 70 in 2016 with additional improvements over the next five years resulting in increasing return on investment and an operating ratio below 65 by 2020. By maximizing our asset utilization, we believe we can achieve double-digit compounded EPS growth over this period."
 
Ultimately, CP's "short-term, cut-to-the-bone strategy" could cause NS to lose substantial revenues from its service-sensitive customer base, said Squires.

"Any strategy that hurts our customers and the broader community is highly unlikely to receive regulatory approval and is inconsistent with the delivery of shareholder value over the long term," he said.

CP officials expressed disappointed with NS' rejection of the buyout proposal. They also take exception to "the claims, misdirection and mischaracterization" of its offer, and the potential benefits for customers, shareholders, the industry and the public, CP officials said in a press release issued Friday afternoon.

"CP is committed to this transaction and looks forward to engaging with the NS leadership team, its board and its shareholders," they said.

The Class I plans to hold a conference call Dec. 8 to discuss its offer and provide clarity, context and detail to the proposed transaction. CP officials also expect to address concerns about timely regulatory approval raised by NS.

But based on the detailed explanation offered by NS, Robert W. Baird & Co. Inc. analysts believe a merger with CP is highly unlikely.

Although NS' rationale effectively eliminates CP as a potential acquirer at nearly any offer price, the board's fiduciary responsibility and focus leaves the door open for possible combinations with other Class Is, the analysts said in a Baird Equity Research transportation/logistics report.

That said, publicly stated appetites regarding mergers and acquisitions among Class Is still appears low, they said.

"Given the remaining Class Is previously stated reluctance to pursue industry M&A, we view further rail consolidation for the time being as unlikely," the analysts said.

Editor's note: This article has been updated since its initital posting.