Regulatory risk in corporate takeovers is never fun for shareholders. The merger between U.S. telecoms firms Sprint and T-Mobile US, for example, took nearly three years to complete. In Canadian Pacific Railway’s $25 billion takeover bid for Kansas City Southern, shareholders will get their money upfront – ahead of a regulatory review – as a result of a trust structure put in place. It solves one problem and creates another.
Most big U.S. mergers require approval from the U.S. Department of Justice, but train deals are slightly different. They are regulated by the U.S. Surface Transportation Board. The DOJ often makes recommendations to the STB, but the STB has broader considerations, including the impact the merger has on national defense, employees, and the environment.
The merger between CP and KCS, on the face of it, is of lesser concern than other types of rail deals. Rather than putting together two railways with overlapping routes, CP and KCS are mostly complementary, with CP in Canada and the northern United States and KCS spread from the Midwest to Mexico. Yet putting these types of railroads together can create problems, too. If they are the only efficient way for transcontinental shipment of goods, they can glean significant pricing power. And the STB hasn’t approved a merger between two Class 1 railways – or those who have revenue of more than $505 million a year – since 1999.
While the combined company would remain the smallest Class 1 railroad, there still could be a lag between the deal announcement and regulatory approval. But CP will give shareholders cash and its own stock even before that while putting KCS’s shares into a trust. That in effect closes the merger financially, though operationally the companies will be left separate. These structures can also raise regulatory flags, too, though. While KCS and CP won’t technically integrate until after regulatory approval, each will have an interest in the other’s success, which softens both companies’ incentives to compete.
These issues will be carefully considered by the STB. Still ultimately if the deal between the two large railroad companies isn’t approved, CP – and KCS shareholders who took its stock – will have to unwind the trust. That requires either relisting KCS’s shares on the stock market or finding another buyer. But CP has paid a rich price, and so it will be difficult to find another buyer to pay as much, especially without triggering similar regulatory concerns. It may regret being so quick to put the merger wheels in motion.