By Nick Carey
CHICAGO, Dec 17 (Reuters) - Canadian Pacific Railway Ltd's
CP.TO $27 billion bid for Norfolk Southern Corp (N:NSC) NSC.N risks
coming unstuck due to regulatory scrutiny of its impact on the
U.S. rail market, in particular the possibility it could spark
competition-crushing rival deals, according to former regulators
and analysts.
Led by enigmatic, septuagenarian railroad legend Hunter
Harrison, Canadian Pacific has assured investors that what it
proposes - especially putting the transaction in a voting trust
- has been approved in the past.
Canadian Pacific made its first bid for Norfolk Southern
last month, arguing that it would improve competition and boost
its target's performance that has flagged recently due to
declining coal volumes.
But assuming the hostile bid makes it through a long and
nasty proxy fight - "If this is going to be a street fight, so
be it," Harrison said on Wednesday - the Canadian railroad would
be in uncharted territory.
This would the first deal judged by the Surface
Transportation Board, the U.S. rail regulator, since the
regulator rewrote the merger rules in 2001.
That followed major mergers in the 1990s resulting in severe
service disruptions that "caused a great deal of heartburn,"
former STB vice chairman William Clyburn told Reuters. Clyburn
was on the board from 1998 to 2001.
STB's chief concern at that time was that the number of
major railroads in North America had dwindled to just seven from
35. The most controversial part of the new rules was the board
had to "look around the corner" at what any proposed merger
would mean for whole sector, Clyburn said.
No. 1 U.S. railroad Union Pacific Corp (N:UNP) UNP.N has said in
regard to Canadian Pacific's bid that it will act in the "best
interests of our customers and our shareholders."
According to several former STB commissioners, that could be
seen as an implication that Union Pacific could get involved in
a merger frenzy, but would not be firm enough for the STB to
take notice.
But a red flag for the STB would be comments from Matt Rose,
chairman of No. 2 U.S. railroad BNSF, owned by Warren Buffett's
Berkshire Hathaway (N:BRKa) Inc BRKa.N , that BNSF could bid for Norfolk
Southern or for No. 3 U.S. railroad CSX Corp (O:CSX) CSX.N rather than
be left at a competitive disadvantage.
"We believe that if a combination of any of the major
railroads in North America were to occur, it would trigger the
final round of consolidations and BNSF would be actively
involved," Rose said in a statement this week.
This is the key stumbling block for Canadian Pacific's bid,
according to analysts, railroad executives and former
regulators. The main concern is that a series of mega-mergers
would result in just two railroads and leave customers stuck
with no competition.
Clyburn, who did not wish to discuss individual cases, said
any major railroad threatening further consolidation "is very
significant news and the STB would pay very close attention to
what the next move may be."
An STB spokesman said the board could not comment on
Canadian Pacific and Norfolk Southern because there was no case
before it.
CHALLENGES ABOUND
There are a number of other potential pitfalls.
Chief among them is the voting trust Canadian Pacific
proposes, which the STB would need to approve before beginning
the merger review process.
Canadian Pacific proposes sending CEO Harrison to run
Norfolk Southern as part of that trust. But the STB's rules
stipulate there can be no "common control" of the railroads
during the review process - meaning they have to run
independently of each other and not according to a joint plan.
Skeptics have said that having Harrison run the railroad he has
worked to acquire would not pass the STB's "smell test."
"You don't want a situation where you have Railroad A
acquiring Railroad B with a voting trust and you have somebody
from Railroad A running Railroad B," Clyburn said.
Norfolk Southern declined to comment for this story.
During merger reviews in the 1990s, significant space was
given to labor groups and railroad customers. Under the new
rules where "public interest" is paramount, Clyburn said they
would be allotted a lot of time at public hearings.
In a survey published Dec. 7, Cowen & Co found 71 percent of
shippers opposed a merger of Canadian Pacific and Norfolk
Southern.
Input from elected officials will also matter. Democratic
U.S. Senator Dick Durbin and Democratic House members from
Illinois - the two railroads meet in Chicago - have written to
the STB stressing concern over a possible merger.
And because Norfolk Southern handles traffic for the U.S.
military, a potential takeover by a foreign entity is expected
to garner attention from the Department of Defense.
Canadian Pacific says a deal would reduce congestion in
Chicago as it could reroute traffic through the merged
railroads' networks - a debatable claim as the two railroads
interchange little traffic in Chicago.
But rerouting traffic would be subject to an environmental
review that could last years. Towns along the proposed routes
could object. The STB could approve a merger with conditions
mandating infrastructure investments to mitigate the effect of
rerouting traffic - which could involve large sums of money.
Stacked up, all these issues - above all the probable
consolidation of the entire industry - have many analysts and
observers believing a deal will not win approval.
"My view is the STB will not let this go through," said Jim
Corridore, an equity analyst at S&P Capital IQ. "What we're
likely to see is a costly proxy battle that will ultimately
prove futile."