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Bend the rail

22 March 2021 By Lauren Silva Laughlin

A mega-train merger is barreling full steam ahead. Canadian Pacific Railway agreed to buy rival Kansas City Southern for $25 billion to create the first fully North American route stretching from Vancouver to Mexico City. The companies are pumping promising growth prospects, the sort of hype that should attract the U.S. President Joe Biden’s attention.

Kansas City Southern’s market value has more than doubled in a year, far outpacing the S&P 500 Index. That’s before accounting for the 23% premium Canadian Pacific is paying in cash and stock. The deal unveiled on Sunday values the target at more than 17.5 times expected EBITDA for this year, notably higher than the roughly 14 times at which rival Union Pacific trades.

Canadian Pacific can justify the combination with a hefty uplift in expected revenue. It figures that roughly three-quarters of the anticipated $780 million in annual synergies will come from the top line. It’ll need every dollar, according to Breakingviews calculations, to make up for the $5 billion in value it agreed to give Kansas City shareholders.

That is also where the iron wheel meets the tracks. Those kinds of benefits often come from squeezing more out of customers by, say, raising prices and leaving them with few alternatives.

Trains don’t have a great history in terms of mergers and monopolies. The vast infrastructure required makes it hard for new entrants. It was John D. Rockefeller’s control of the railways that led to the breakup of Standard Oil. This Canadian Pacific deal isn’t that, of course, partly because there are highways now. And while other companies, such as Union Pacific and Burlington Northern Santa Fe, have some similar routes, no single operator completely traverses the continent.

Supply chains are getting closer scrutiny these days, however, and the combined company would be the second from north of the U.S. border to own a network running through the heart of the United States. Canadian Pacific might be willing to make concessions to appease the U.S. Surface Transportation Board, but the Committee on Foreign Investment in the United States also is likely to take a look. Given all the significant competitive concerns, it’s important that Washington not get railroaded.

 

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