UPDATE: NS slams door on 'disruptive' CP offer

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Norfolk Southern's and Canadian Pacific's relative traffic volumes
Rick Johnson
NORFOLK, Va. — Norfolk Southern today slammed the door on Canadian Pacific’s merger offer, calling it “grossly inadequate,” highly unlikely to win regulatory approval, and a bad fit that would put the combined railroads at a long-term disadvantage.

“We believe in our ability to generate greater shareholder value through execution of our strategy,” NS CEO James Squires said in a conference call this morning.

CP CEO E. Hunter Harrison says that the $28 billion cash and stock offer was merely a starting point for his railroad’s unsolicited bid. While dismissing the initial offer as “grossly inadequate,” Squires suggested that price wasn’t the issue and that NS wasn’t open to further discussion with CP. “At any price the regulatory risks...remain the same,” he says.

And those regulatory issues mean a CP-NS combination would never get out of the starting gate, NS contends.

“The hurdles are very, very significant to this proposed combination,” Squires says.

The regulatory review process would take two years or more, putting NS in limbo and interrupting the railroad’s focus and momentum, Squires says. Plus, the way CP wants to structure the deal – with NS in a voting trust and CP management effectively in charge – would require two periods of public comment, with opposition expected from shippers, other railroads, labor, and communities.

The U.S. Surface Transportation Board would be unlikely to approve the voting trust arrangement because it would violate regulations that bar premature control of the acquisition target, NS says. A voting trust like what CP is proposing has not been approved in the past 50 years, NS notes, and as head of Illinois Central Harrison unsuccessfully tried this approach as part of an ill-fated IC-Kansas City Southern merger.

With the STB’s 2001 merger rules biased against industry consolidation, NS believes there’s almost no chance the board would rule that a CP-NS merger was in the public interest. “The public benefits of this are hard to see,” Squires says. The NS board consulted with former STB commissioners and staff members, who said a CP-NS combination would face “insurmountable” regulatory hurdles.

In the unlikely event that the combination were approved, it would come with so many strings attached that it would reduce the value of the combined railroad, NS contends. Community and environmental mitigation would result in operational restrictions and drive up costs, while labor-protection provisions would be expensive. And steps to enhance competition — including open access — may apply only to the combined CP-NS system.

The open access CP has proposed would put 60 percent of existing NS traffic up for grabs, Squires says, while degrading service, discouraging capital investment, and adversely affecting financial performance. NS also pointed out that as recently as 2014 CP management — including Harrison — said that open access would harm service and drive up costs.

Squires also says that CP and NS simply aren’t a good merger match.

He criticized CP’s “sweat the assets” approach to railroading and questioned Calgary’s $1.8 billion merger synergy figure. “We believe they are overstated...and not achievable in our view,” Squires says.

“We believe that Canadian Pacific’s short-term, cut-to-the-bone strategy could cause Norfolk Southern to lose substantial revenues from our service-sensitive customer base,” he says, noting that it’s crucial to be truck-competitive in the Eastern U.S.

“We are notably more truck-competitive than Canadian Pacific and we are proud of this advantage,” Squires says.

The proposed merger of the smallest major U.S. railroad with the smallest major Canadian railroad would create a long-term network disadvantage for a combined CP-NS system, Squires says.

CP-NS interchange represents less than 3 percent of NS volume and is substantially smaller than traffic NS exchanges with BNSF Railway, Canadian National, or Union Pacific. A Wall Street analyst told Squires that almost sounded like NS was soliciting an offer from another railroad.

“I’m not going to speculate on other transactions,” Squires responded.

NS says CP’s claims that a combination would ease congestion in Chicago were pie in the sky, particularly since CP accounts for less than five percent of traffic moving through the Railroad Capital. Less than one train per day of current CP-NS interchange traffic could be rerouted around Chicago, NS says, and moving their connecting service to other points would incur extra miles, cost, and transit time.

“We anticipate...the combination of Canadian Pacific and Norfolk Southern would increase rail traffic congestion in Chicago,” Squires says.

CP says it is reviewing Norfolk Southern’s response.

UPDATE: Dec. 4, 2015, 10:34 a.m. Central time. Comments from Norfolk Southern from a news conference early Friday morning. Background on preview Hunter Harrison merger efforts. Additional details on the CP proposal and NS' rejection. New traffic comparison chart.
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