2. Resource Center
  3. Member Spotlight
  4. Articles by Tony Hatch
  5. KSU Match- CN gets hit with a Combination

KSU Match- CN gets hit with a Combination

Tony Hatch - ABH Consulting
CN Logo

Greetings;

This long CP or CN and KSU boxing match is approaching the later rounds…..

CNI sees its Voting Trust application for KSU rejected (no real surprise; unanimously – now that was surprising), a blow that (in its wording) may have stopped its KSU proposal in its tracks. While shaking off that punch, CN then got hit with a roundhouse from TCI which confirmed that it would go “activist” (and with whom) in a letter calling for leadership change now. Like announcers at ringside, let’s analyze this brutal combination one punch at a time:

 

  1. Pow!  The STB lands a stiff jab – perhaps we could have seen it coming but this was painful nevertheless…..The  STB rejects the VT, on the last day of its self-imposed August 31 deadline – my initial tweet reaction:

At last – and as generally expected - the STB, citing semi-confused logic, denied CNI-KSU Voting Trust (yesterday) due to "public interest" & "downstream effects". Language strong enough to likely (we’ll see) deter CN continuation (& CERTAINLY another railway M&A) and may allow CP to proceed under " old rules."

 

  • CP‘s “political strategy” is being validated and after early-round body blows look strong as we get closer to the bell.
  • Rope-a-dope logic?  OK, that is way too harsh (hard to come up with a boxing analogy that isn’t hard-core).  I am no lawyer, but the STB seems to conflate the VT with the merger – with only “the greater probability of a divestiture” as a potential public interest event – yet, it is odd/untrue to be overly concerned about selling KCS later - we know that there will be interest (although remember, the STB is disdainful of financial firms owning railroads as if bankers would be Chief Mechanical Officers (etc), that Brookfield owns GWR and Berkshire Hathaway owns BNSF  (etc) and that by some definitions many financial firms (asset managers) own most railroads).
    • The STB is also concerned about “downstream effects” – which makes sense but that seems to me, anyway, to be about the merger application and not the VT….but I am not on the Board.
    • They also stated that competitive issues extended beyond Louisiana (again, merger app concerns – and ignores the Interstate Highway System and the Mississippi River) – also a signal to any other railroad considering mergers (a club of zero members, but, still….).
    • The Board suggests that the premium offered (45%) would lead to further debt (note rating agencies didn’t seem concerned) and that would “create incentives for CN to charge higher prices or decrease investment in CN’s network” – which is good old Alberta bull-poop.  CN (and CP) both spend much more Capex on a %/revenue basis than their American peers; railroads don’t need debt-service to incent them to charge market prices (and how interesting that TCI in its presentation – below, page 9 – states that “CN has a pricing problem” meaning they aren’t charging enough!  See “unintended consequences”, below….).
    • Also confusing is that statement that KCS won't or might not fully compete with CN (and vice versa) - that is what a trust, done properly, ensures, and it’s an affront to the leadership and to Dave Starling to infer otherwise….
    • But it was commonly thought (see my report from the ASLRRA meeting in KC) that the STB wanted to draw a line in the sand on M&A but didn’t want to spend a year (plus) doing so, and this fits that theory and frees up the Board fairly soon to interfere with the railroad in other ways (reciprocal switching, demurrage, short line deals – you name it they got it).

 

  1. Bang!  Perhaps this one was also signaled but not with the speed, timing, and power with which the TCI letter landed.  TCI’s letter was harsh, but as I was told on my first day on the Street, “if you want a friend, get a dog”.  The fact that I don’t like dogs wasn’t taken into consideration.  Their letter is attached, their presentation here: Canadian National (tcifund.com).  TCI notes CN’s under-performance and calls for a change in top (CEO and Chairman) leadership, and introduces Jim Vena (ex CN and UNP COO and CEO-in-waiting) as their champion in Knightly Combat (appropriate for Sir Chris Hohn of TCI), and old friend Gil Lamphere as a board representative.  They also call for a change in management strategy.  Some thoughts – many of them picky, this situation in the last day has left me a bit punch-drunk - on the TCI presentation:
  • CN has the best network?  And Jim Vena signed off on that?  I bet there is a whole lotta “WTH?!?” going on in Omaha!  They might also wonder if their own CEO played a role in their turnaround….
  • The CN “brain drain” (what I call the diaspora from the CN PSR “Mothership”) is true, and has been consistently cited by CP – but some of the folks were “drained” by retirement (Harris) or lured out of retirement or elsewhere to become or attempt to become CEOs (Creel/Foote/Vena), or spell their name without an “e” (Cory).
  • The metric comparisons of CN to the industry are impossible to deny, although some of it is that run of “CN luck” and strategic decisions & mix (see below).
  • TCI does not state explicitly that they want to refocus on margins instead of growth as some of the analyst community seems to be saying on their behalf, but such a strategy would be “on the wrong side of history”:
    • The secular mix shift to higher-service commodities up to and including eCommerce goes the other way (supported by recent CN – and also CP – M&A).
    • The regulatory environment in the US goes completely in the other direction, noting the STB and the House T&I Chairman noting rail headcount reductions, short term focus, lack of resiliency, congestion, Street influence, etc (admittedly a CN without KSU would “only” have 2/3 of its system subject to any STB oversight).

 

Some other thoughts on this developing situation:

  • CN is in many ways a victim here of poor timing and the run of bad luck we have discussed going back to pre-pandemic (the indigenous peoples' blockades, etc).  in this case, CNI’s M&A attempt comes at a time when the STB is at peak-activist mode; DC in its bit “trust buster” mode having issued an Executive Order (although that has been over-emphasized in analyst reports); when rails in specific and supply chains, in general, are struggling; and when “New Rules” come into effect.  It is thought by some that CNI’s Board, rather than management, was the initiator and if so that was an issue; CNI also voluntarily went under the new rules, a tactical error when the talking-point advantages of being subjected to deeper scrutiny backfired (however, I think that this Board, in any event, would not have granted CN an exemption if they applied, as they did allow it for CP).  There was, on purpose, no way for anyone to achieve “clarity” on the new Rules without testing them….
  • Activists are 3-0 in the modern era of railroading (TCI vs CSX; Pershing Square vs CP; Mantle Ridge vs CSX, the latter two featuring E. Hunter Harrison.
  • CNI 2021 is not CSX nor pre-EHH CP – their OR gap can be explained in part by conscious strategy (the M&A to “feed the beast” – TransX alone is said to add 100bps to the OR) and mix – they are a much bigger IM player than CP.  And in ROIC they trail CP (as does everyone) but they are well ahead of their peers….The three-year ~1400bps improvement TCI cites (averaging the EHH-initiated success at CP and CSX) is too much to expect for a railroad with a 60% OR, no?
  • This could get ugly and fast - It is thought that if 20% of the shareholders request a special Board meeting, CN must grant it and not wait till the usual spring date; TCI has 5% (just as an FYI Cascade has ~15%).
  • TCI has friends – in the CSX case, its shares and voting power was perhaps doubled by allies, followers, and assorted hangers-on.
  • Wall Street is actively supportive of such efforts (see all of the raised ratings on CNI from the Street - and it appears at least two analysts are promoting TCI policy (call me if you want to know what I really think).
  • Peace in the valley?  This process has been more personal than I have experienced, but it gets worse under activist attack (I was a casualty in the CSX battle).  It may not matter, but in finding out that the great leadership group that came from the EHH/CN “Mothership” is less “Band of Brothers” and more like that other HBO series, “Game of Thrones”, with the common belief, rightly or wrongly, that the Creel and Vena factions are akin to the Houses of Lannister and Stark….
  • The long-awaited return of Jay Gould?  What does it mean when one concern (owned perhaps by one man) is the largest shareholder of two railroads that not only compete for business but are in a heavyweight bout in M&A?  It seems that TCI favors the CP (presentation slide 25 – “TCI has been a strong supporter of CP & its Management team” – “supporter” in this case is equivalent to “investor”).

 

 

  1. Neutral Corner:  what happens now?  Apollo Creed stated, “There ain’t gonna be no rematch” (and Rocky Balboa answered “Don’t want one”) – But we know how that turned out….
  • On the breakup fees, from an expert:
    • “If KSU changes to view CP’s bid as superior now, terminates with CNI and signs with CP, the $700m that CNI paid to KCS (which KCS paid to CP) gets repaid and CNI gets paid another $700m termination fee.
    • if KSU keeps its recommendation for CNI’s deal but the KCS shareholders vote it down, then only one $700m term fee is payable by KCS to CNI assuming after the vote fails, KCS then enters into an agreement with CP within 12 months. CP has agreed to reimburse KCS for this….”
  • CP reiterates its (“firm”) offer, sees validation in its underdog, “political strategy” and echoes TCI in some of its commentary on CN: PowerPoint Presentation (q4cdn.com); they also reaffirmed their September 12 deadline and reminded us that their original “Notice of Intent” indicated they would file by 9/23 (although that can be extended).
  • CN does not throw in the towel: “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. The combined company would create the premier railway for the 21st century and establish seamless single-line service from Canada, through the United States, and into Mexico”.  Their merger agreement with KSU at present expires in February….they could appeal (ask your lawyers) or raise the bid or both or….
  • KSU expressed “disappointment” and will “adjourn” the September 3 Special Meeting of Stockholders.
  • A CP-KSU deal, or NO deal, is more stabilizing for the overall railroad industry, as the STB pointed out (no isolated, and dangerous CP out  thinking up trouble, as it were) BUT:
  • Future deals appear to be highly unlikely – in fact maybe outright dead barring the (Matt) Rose Rules – failing carrier (nope) or shippers demand consolidation to achieve the extra capacity unlocked from single-line service (we are far from being out of capacity given the dividends here (PTC) and in the future (technology, service improvements).  The STB (and thus the Senate) is dead-set against - the wording on the VT was clear and concerned about “downstream effects” (Big 4 consolidation) and the STB retains, to date, the ambiguity on “New Rules” mergers (“enhanced competition” and so forth).
  • Rule of unintended consequences – consider that the STB has publicly stated that railroads are in the pockets of Wall Street; are overly concerned with margins and headcount reductions; treat shippers poorly – yet their actions this week have given impetus or at least strategic support for a “back to the future” strategy for CN to focus on margins over growth….the perils of tactical as opposed to strategic thinking….
  • CN management needs to articulate a strategy fast.

 

Also:

 

 

Anthony B. Hatch 
abh consulting
http://www.abhatchconsulting.com 
abh18@mindspring.com
Twitter @ABHatch18

Previous
RRs - Back to School Update
Next
RRs - Still Waiting but Meanwhile...