KSU - That was the Week that Was

Greetings from Chicago – first trip of the year, to the railway hub.

So….the rails M&A fighters must have a stern talking-to in church (or Temple or whatever) before the past week because, while the “War of the Words” continued, for the past week or so relative civility has reigned. The key remains in the hands of the STB – can they review the two deals completely separately – and, especially, the Voting Trust(s) issue - under separate (old vs. new) rules? Can a VT be denied to CN? Is a VT a signal of deal approval or a normal piece of pre-review business? Can the STB decide in time (month-end) to allow KSU’s board to have all of the relevant facts (ie, whether there is one VT, or 2 – the latter of which suggests the high bidder CP is marshaling its support argument (and a cover for the STB) in the forms of expert analysis, etc. CN counters with their own paper blizzard….But….

First, from the Twitter file (sign up!):
RRs - upbeat ending to earnings period as NSC beats expectations & BNSF would have, if not for, you know, Warren. In fact, BNSF outdoes UNP in “Premium”, Ag- even coal, as well OR progress (though still higher overall, as mix impacts at least some of that number). WSJ Weekend notes the transports stock surge/DJTA boom, citing fundamentals, increased post-C19 economic hopes & the Dow Theory (but - not M&A!).

Next, tomorrow is Union Pacific’s long-awaited Investor Day! Report to follow….There will be more reinforcement for the positive case for PSR, some push-back on my BNSF thoughts, and at least some discussion of M&A (CEO Lance Fritz was quite eloquent on the importance of stabilization for the industry and of his intent to help ensure that…).

DesJardins/abh Webinar Takeaways – I have attached Monsieur Poirier’s write-up of our webinar, with almost complete agreement (save for my being a bit more skeptical than portrayed on “near-sourcing” - see may “Manana” report) though 100% agreed on this deal not leading to further consolidation - unless we see a loser pull a “Samson-in-the-temple” M.A.D. move….

Back to the salt-mines (KSU deal), Starting with the CN Q1/21 earnings call….Well, I didn’t expect that! After an increasingly bitter “war of (the) words” – see attached – Canadian National’s Q1/21 earnings webcast and opportunity to fire off at CP was actually….calm and measured. They raised their points again, with good maps and calm voices. Have we hit the eye of the KSU storm?

Some initial questions:

• Why was this web meeting concluded in an hour? That is faster than normal! I webcast the calls, removing me (as you know, tech-challenged) from Q&A (unlike like events, you will recall) but where was everybody??
• Why is COO/Rob Reilly answering intermodal (etc) marketing questions? Asking with full respect to all concerned….where’s the two-headed CMO, Keith & James? The official answer is there was so much to discuss between earnings and the proposal that they decided to keep it simple with only CEO, COO, and CFO – along with CN’s (war) time consigliere Sean Finn – on the call. In the past, and in other places, such signaling often had multiple meanings….
• Which leads to a thought I had – one thing that fits with CP’s proposal is succession - Pat’s retirement in a year or two, Keith running the bigger show = clear succession; what happens here? Is CN signaling that if they win, longer-term it’s Rob?
• Meanwhile, they did report earnings – adjusted/diluted earnings essentially in line with expectations (+1%), OR only up a bit (60bps) but still, as was noted in the Q&A, the highest in the group. That’s not a normal spot for CN; intermodal strength plays a part (but M&A expense all came in Q2). The Operating Metrics came in pretty well, despite February (4:1:1 – car velocity up 5%). Instead of maintaining Guidance after a rough-ish start, CN raised it (from “high single” to “low double-digit” EPS growth F21).
• “ESG” mentioned 5X in the sides, over a third, “DSR” twice….they ordered 75 locos (preproposal, a sign o’the expected volume strength, notably in Ag). They didn’t spend a long time on energy (noting that CBR was not reliable enough to build a deal around); CN does cite their long and successful history of end-to-end M&A (starting with the IC that brought – more letters – EHH). But remember that KC (Keith Creel) was on board with ever-increasing responsibility for much of that…
• ESG is perhaps table-stakes – both carriers are at the forefront of recognition on this score; maybe a slight lead to CP with labor’s support (if it comes through post-CN entry); tech has them both solid industry leaders – I mean, CO is developing hydrogen-powered locomotives on their own! But here the edge with go to CN, I think, with their new hire, their early discussion of track/car inspection automation, etc. Intermodal, tied to both, is a CN game but a cynic could argue that if you took out Rupert, what then? An even bigger cynic would counter – why take out Rupert? The Bulls wouldn’t have been great without Jordan – but they did have him.

Then, the week that was:

• There will be a new STB member to replace former Chairman Begeman – but when is a hazardous guess, so she will still play a major role. The last newbie’s vociferous objection to the CP-KSU exemption was most interesting; former Chairman Begeman I would venture to guess would be supportive of rail stability and perhaps prefer no deal at all – which one could interpret as more likely to lean Calgary than Montreal. But that is a guess and we don’t know how much longer she will be voting on this (but I also guess through the crucial early parts such
  as the VT).
• The CN sues the STB! CN is suing the STB. Yes. My very first thought was the James Gang suing Judge Roy Bean over their jaywalking charge before the big train robbery trial. The sale of the upstate NY short line was actually approved 2-1 by the STB but the conditions imposed were too much (this is a key point for the long term IMHO). In this particular case, the conditions were about “paper barriers” – contractual agreements biding traffic between seller and buyer, a long-time bugaboo for the STB. CN wouldn’t agree to the deal under those conditions – and now is suing….crazy? or fou like a renard? Perhaps the consigliere is seeing justice (a pro-competitive deal) denied and trying to set a precedent…..
• Bill Gates and Cascadia (a 14% owner) support CN – this, like the papering of the war of the Words with “ESG” everywhere (both sides), is virtue signaling. We know Gates’ bonafides, but remember CN doesn’t need shareholder approval.
• The rating agencies see too much debt – this echoes Keith Creel’s arguments on his fiery earnings call – but the RAs cite both carriers.
• Wars of surveys (Cowens shows shippers supporting CP) and letters of support form shippers and/or stakeholders.
• Those who worked on the CN/IC deal recall a lot of C1 interest in the IC lines in Louisiana – to which these days add in Infrastructure Funds. If CN wants to divest that shouldn’t be hard.
• And as for all that malarkey about non-rail, of financial buyers being bad – it plays to the “RRs in bed with Wall Street” poppycock – remember that financial buyers would keep management experts – see GWR and Brookfield.
• NEARS – (North East Association of Rail Shippers) was timely: Keith spoke, shippers were still cranky, and the Jason & Tony “Show” is available on tape (but why would you want to watch when we can tell you what we said!):
  
  
  • Keith said no bidding war (the headline); he stated that before and his take on leverage also makes that a hard thing to walk back.
  • “Shippers – NOW is the time to speak!:
  • “If divestiture (in LA) is being discussed that means it’s (CN’s proposal) a BIG deal.”
  • The STB can look at CN’s proposal, and their VT differently – there is NO precedent.
  • KC also sort of walked back the M.A.D scenario – they can compete with a now leveraged, bloated CN if they lose.
    
    
• Warren B wonders what’s so special about KSU, though noting there will be some harm to his BNSF and to UNP and that they, too, will “protest their interests….
• CP produced an expert’s white paper from an MIT Ph.D. in economics and former DoJ antitrust official, calling the CP-KCS a true end-to-end merger but the CN-KCS would be “largely horizontal”, using preliminary analysis of confidential waybill samples; it sees 31 corridors seeing 3:2 service option reduction and another 31 falling under the dreaded 2:1….it makes for interesting reading.
• The same day (5/1) CP filed a “Formal Objection to CN using a Merger Waiver” (which truth be told I had thought was a moot point); they lay out six reasons, 5 of which we have heard. 1) CN is much larger than CP 2) CN/KCS overlaps across much of the KCS’s US system (see above); 3) The potential downstream impacts of CN’s deal are material – i.e.; de-stabilizing; 5) CN’s proposal would kill the CP/KSU deal and all the benefits (well….yeah); and 6) CN has already committed itself to the new merger deal (see point, moot). This leaves #4 – an interesting one: “CN’s acquisition premium (itself) should cause the STB concern”- emphasis mine….
• A rail HoFer, player in these very matters, suggested that the US overlap will lead to a Conraillike split (in some ways so any – far-future duopoly isn’t favored over the other).
• CN issues an “Open Letter to the KCS Community” this morning – stating its strengths, superior proposal, its submission to the “new” (“enhanced competition”) rules (see point, moot), keeping gateways open, keeping KC itself important, etc.
• Roughly 20 minutes later (!) CP issues a release noting 110 customers (+/- after all time flies) not only support CP-KCS but over CN’s proposal – a response in part to KC’s cri de couer from NEARS. This is the sort of cover CP needs to provide the STB to have a hope of winning the political game….

More to come. Of course. But the big news will come not from Canada but from DC. The question is….when? And what?

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