Canadian National proposes Louisiana rail divestiture to smooth Kansas City Southern acquisition

Canadian National Railway said it plans to sell a segment of its Louisiana network to help assuage regulatory concerns of its planned $30.5 billion acquisition of Kansas City Southern after it submitted a second application on May 26 for approval of a critical voting trust considered necessary to close the deal.

The deal would create the only Canada-to-Mexico rail network in North America, that could move Canadian crude exports to the US Gulf Coast and refined products to Mexico.

That combination is expected to prove more beneficial thanks to the revised United States-Mexico-Canada Agreement trade deal. With only CN having rail routes stretching from Alberta to the US Gulf Coast now, adding KCS would allow CN to further dominate the crude-by-rail market.

The anticipated June response from the US Surface Transportation Board for the voting trust could determine whether the biggest North American rail deal in more than 20 years come to fruition. Kansas City Southern broke its $25 billion merger with Canadian Pacific Railway in favor of the bigger, but riskier, offer from CN that regulators say presents more anti-competition concerns and overlap.

"We are confident our filing will demonstrate why our combination is pro-competitive, that it will provide economic growth and that it will realize multiple network benefits across the continent," said CN CEO JJ Ruest, speaking May 26 at a transportation industry conference.

Both CN and CP were counting on voting trusts for their competing deals. Part of CN's argument is KCS shareholders have nothing to lose because they would be paid from the trust even if the deal fails to receive regulatory approval. CN and KCS said the plan is to close the deal within the voting trust in the third quarter, but not combine until 2022 upon full STB approval. If the merger falls through, CN would owe KCS a $1 billion breakup fee.

The STB already approved a voting trust for CP, but rejected it for CN, arguing that CN did not yet have an acquisition agreement in place with KCS, so the second application was jointly filed May 26.

If the trust is rejected, then the merger could still fall apart, Ruest acknowledged.

"In the outside chance, if this was going to happen, then we will reconvene within CN. We'll have a dialogue with KCS. And then we'll decide at that time what's the appropriate decision at that moment," he said when asked about the potential voting trust denial.

While Canadian Pacific and KCS have no rail overlap and meet neatly in Kansas City, Missouri, CN has a lot of north-to-south parallel routes with KCS, but the only direct overlap is in Louisiana.

So CN said it would sell the roughly 70-mile stretch of its Louisiana network between New Orleans and Baton Rouge to help defuse antitrust concerns.

CN's rail network moves crude to the refining hub of St. James, Louisiana, but KCS additionally offers more direct access to hubs along the Texas Gulf Coast and into Mexico.

Regulatory questions

In question are the STB's updated merger regulations from 2001 that require major deals to show they are in the public interest. Since then, no major rail mergers have come to fruition, not counting Berkshire Hathaway's 2010 acquisition of US leader BNSF.

The STB already waived the 2001 regulations to the now-defunct CP deal with KCS because KCS is the smallest major US railroad and is more regionally focused with less overlap with competitors. But the waiver was rejected for the CN-KCS deal, meaning the more stringent regulatory process applies.

CN noted it would only have the fifth-largest rail network in the US if it acquires KCS. However, within all of North America, CN would grow large enough to rival the two biggest railroads, BNSF and Union Pacific.

While the deal might offer cheaper shipping rates for Canadian heavy oil sands, analysts said notably greater crude-by-rail volumes would only come if major oil pipelines are shuttered, such as the in-progress Line 3 replacement project, the four-year-old Dakota Access Pipeline and the pending Trans Mountain Pipeline expansion.

Canadian oil production has recovered to its pre-pandemic volumes of about 5 million b/d of crude oil, condensate and diluent, while US production is still down by about 2 million b/d from its pre-pandemic volumes.

However, crude-by-rail volumes have not yet recovered and may not rebound for quite some time.