The railroad that cannot be bought

In journalism we call it a slow news day, and at such times we try to think of anything we can write about. I don’t know the term securities analysts use on these occasions, but it obviously was such a day last week for two Canadian analysts, who suggested in separate notes to clients that Canadian Pacific or Canadian National should buy Kansas City Southern.

I’m here to tell you it ain’t gonna happen.

According to Canada’s Financial Post, one of the sinners is Walter Spracklin of RBC Capital Markets (RBC being the former Royal Bank of Canada). Spracklin said KCS would give Canadian Pacific a straight shot between Vancouver, B.C., and Mexico. “Simply put,” he wrote, “CP’s franchise ends where KSU’s [that being the ticker symbol for KCS] begins, and combining the two would transform CP from a Canadian and U.S. Midwestern railroad into a truly North American carrier.” CP and KCS meet in Kansas City, by the way.

So there you go. Mr. Spracklin has learned to play with maps! We can all do that. Wouldn’t Canadian National be the perfect match for BNSF Railway? How ’bout BNSF/CN and then Norfolk Southern? Gosh, let’s overlay Union Pacific and CSX—what a powerhouse! Then put those two together with Canadian Pacific. Awesome! Oh yeah, then the two big bears can each eat half of Kansas City Southern. We have just solved all the problems of this world!

The difficulties begin when you set aside your map overlays and reenter the real world. Even if CN or CP could convince KCS to lay aside its ambitions and agree to a buyout, so much could go wrong.

And not to be outdone, analyst Benoit Poirier of Desjarkins Securities writes that either Canadian railroad should make a bid for KCS. He writes: “We believe both companies have a significant opportunity to create shareholder value by gaining access to the Mexican market through a takeout of Kansas City Southern.” He goes on to say the upswing in Mexican manufacturing makes the timing right for either CN or CP.

I don’t disagree with the reasoning of either gentleman. I just think they’re stupid. Let me explain why.

Everyone loves KCS. Name a North American railroad that would not like to buy KCS. BNSF or UP would benefit as much from owning KCS as either Canadian road, and NS is already a partner of KCS between Meridian, Miss., and Shreveport, La. The KCS franchise in Mexico has turned into a proverbial pot of gold. It is also benefitting from the crude oil boom brought about by hydraulic fracturing of shale rock and horizontal drilling, and stands to benefit a whole lot more as time goes by.

So reason one it ain’t gonna happen for CN or CP is that the other railroads won’t let it happen; they will fight it legally and politically or swoop in with counteroffers. I adore CP chairman Hunter Harrison, but his pockets are nowhere near as deep as Warren Buffet’s, whose Berkshire Hathaway owns BNSF Railway.

Reason two is that KCS isn’t on the block. After decades of struggle, it is finally emerging as a premier railroad property, smaller than the other six Class I freight haulers but every bit as profitable and successful. If anything, it’s KCS that might like to buy Norfolk Southern or Canadian Pacific. Just because you’re smaller doesn’t mean you can’t swing a deal like that.

Reason three is that CP, for one, cannot afford Kansas City Southern. Neither can the other railroads, but I’ll use CP as my example. A securities analyst I know, who goes by the name Slim, ran the numbers for me. Let’s presume CP, which needs all the cash and borrowing power it has, buys KCS in an all-stock transaction, offering a 20 percent bonus of CP stock to KCS shareholders. If this were to go through, CP’s 2015 earnings (based on current estimates for 2015) would plummet from $9.57 per share to $8.84. CP shareholders wouldn’t stand for this and would vote no.

Reason four is that the Mexican gold mine may be robbed. The lower house of Mexico’s legislature has approved a bill that would throw open the two major railroads of that country to open access by other railroads. I happen to think that this legislation will not pass the upper legislative house in anywhere near this form, or be signed by Mexico’s president if it does. But to enter into merger talks with KCS at this point in time would be for CN or CP like playing Russian roulette with their cash. What a disaster if this legislation did become law and you were now the owner of a KCS worth so much, much less. Imagine the shareholder lawsuits for reckless executive conduct.

Reason five is . . . do you need more reasons? You folks reading this could probably supply any number of reasons without my help. Go for it. — Fred W. Frailey