McMurtry Investment Report Newsletter – May 2021
How should we position our investments in CP and CNR regarding their respective bids for Kansas City Southern?
Many of you are wondering what to make of these two competing offers for the same US railway company. Many strategists are trying to predict the probability of one company’s offer winning over the other and the ultimate financial consequences for both Canadian rails. Some have even suggested going long one and shorting the other. My investment style is never to short anything, so I am clearly not in favour of this latter strategy.
Canadian National’s market capitalization of its shares is $95 billion CDN, while Canadian Pacific’s is only $61.7 billion CDN. For comparative purposes CSX, Norfolk Southern and Union Pacific have market capitalizations of $76.8 billion, $77.06 billion and $148.97 billion US respectively. Kansas City Southern is considerably smaller with a market cap of only $26.82 billion US and this has obviously risen sharply recently with the two offers.
Taking into consideration that Canadian National has a market cap that is almost 54% larger than CP, the company feels they are in a much stronger bargaining position than their smaller domestic rival. It is interesting to see the dynamics of the two CEO’s. Keith Creel, CP’s current CEO seems to have an axe to grind having worked previously as Chief Operating Officer for Canadian National. Jean-Jacques Ruest, CN’s current CEO worked directly with Keith Creel, but was ultimately selected for the top job. The difference between the two men is striking with Mr. Creel much younger at 53 years old compared to Mr. Ruest at 66 years old.
Comparison of two offers
CP’s offer is a combination of cash and stock valuing Kansas City stock at a value per share of $275 US. This offer represented a 23% premium over Kansas City’s share price on March 19, 2021. The offer assumes the assumption of $3.8 billion US of Kansas City’s debt and consists of $90 US in cash and 0.489 of a CP share for each share of Kansas City held. The offer is expected to be accretive to CP’s adjusted EPS in the first year after acquisition and even more accretive after the long-term synergies are realized.
CNR’s offer is materially better than CP’s at a value per share of Kansas City of $325 US with the cash component being $200 US. This offer represents a 43% premium over the closing price on March 19th of Kansas City shares.
On paper CNR’s offer is clearly superior in dollar terms to CP’s, both in valuing Kansas City shares at a value of $50 US per share higher with a significantly higher cash component.
Which offer has a higher probability of being approved by the US regulators?
Canadian National ‘s offer is bound to be considered more attractive to the Kansas City shareholders with its higher implied valuation. However, this does not mean that CP’s offer is dead in the water as some believe.
CP’s CEO, Keith Creel has been quite eloquent in his condemnation of CN’s higher offer, implying that his company’s is much more likely to be granted approval from the US regulators with basically no overlapping of any of its rail lines with Kansas City. On the other hand, CN and Kansas City’s rail operations have a an approximately 70-mile overlap in the southern US that would need to be sold off before any approvals from the regulators would be granted.
Is CP likely to increase its bid for Kansas City?
Keith Creel and CP’s Board have chosen not to increase their offer at this time. He has chosen to talk about the regulatory issues that CN would face, making their offer unlikely to be approved. The other factor that may be stopping Mr. Creel from raising CP’s offer is the fact that the company is considerably smaller than CN and does not have the financial clout to be able to absorb a much higher offer.
While both offers are accretive to EPS, a bidding war would make any deal much less accretive for both rails and would most likely hurt CP more than CN in this regard.
Conclusion and Recommendation
First of all, I like the industry fundamentals for all the North American rail companies at this time. They are cyclical plays on a recovering economy.
Secondly, I like both CP and CNR as investments regardless if they are successful in acquiring Kansas City.
If either company wins in the takeover of Kansas City, their profits will be enhanced. However, the loser will still continue to do just fine in this economic environment favouring a cyclical resurgence in the economy.
Given all these factors, I recommend continuing to hold both CP and CN in equal proportions.
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