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Canadian Pacific Sweetens Offer for KCS

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Canadian Pacific Sweetens Offer for KCS
Posted by Convicted One on Tuesday, August 10, 2021 10:02 PM

Canadian Pacific jumped back into the bidding war for Kansas City Southern Tuesday with an increased $31 billion offer for the U.S. railroad, but its latest bid remains lower than the rival $33.6 billion offer from Canadian National that Kansas City Southern accepted back in May.

 

https://abcnews.go.com/US/wireStory/railroad-bidding-war-back-canadian-pac-ups-bid-79377506?cid=clicksource_4380645_1_heads_hero_live_headlines_hed

I found it interesting where the article states that CN has pledged to suspend stock buy backs in order to focus on paying down the KCS debt it would inherit

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Posted by kgbw49 on Tuesday, August 10, 2021 10:59 PM

Corporations typically don't have just one large debt such as an individual with a home mortgage. They typically have multiple bond issuances with different maturity dates and different interest rates depending on what the bond market conditions were when they sold the debt and what their bond rating was at the time of the bond sale.

Often times corporations will not retire debt but instead roll it over because they calculate that they can use the cash to get a larger return than the interest expense they are paying. If you can borrow at, say, 3% interest but then can earn, say, a 10% return by investing that cash, you are money ahead.

In the case of CN and KCS, one would expect that they would look at outstanding debt of both entities and retire anything that had higher interest rates, so that in the long run they reduce interest expense and generate higher net income in future years.

It is very important for any company, just like an individual, to not get over-leveraged. It is possible to carry more debt in good times because more revenue and operating  profit can support higher debt payments, but in a prolonged economic downturn the drop in revenue could result in insifficient operating profit to make all the debt payments.

In those situations that is how a company ends up in bankruptcy.

CN wanting to pare down debt by suspending stock buybacks will be a prudent defensive move because it will mean they are in a stronger position after retiring some debt to weather any prolonged economic downturn should one happen.

Please note I am speaking in somewhat "rule of thumb" generalities. There are always exceptions to every rule. But for corporations, generally carrying some debt is good and appropriate and prudent, and carrying too much can get them in trouble in slow economic times. So the "art" of corporate financial management is figuring out the "Goldilocks" amount of debt - not too little, not too much, but just right.

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Posted by CMStPnP on Wednesday, August 11, 2021 3:26 AM

^^^ Also, CN has the marginal line sale to WATCO which raises immediate cash and probably cuts the loss in lean years.    Line consolidation and line sales post merger will do the same.   

Also, I am fairly confident the Canadian government would stand behind either CP and CN vs allowing either to ever go to liquidation.    Eventually, at some point the Canadian government would fork over money direct from the Treasury.    I think at their current size and dominance in Canada both railroads are too big to fail.

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Posted by Ulrich on Wednesday, August 11, 2021 6:27 AM

Both the STB and the Biden Administration have come out in favor of more competition, not less.  CN and CP will therefore have to show how any merger with KCS would enhance competition..

 

 

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Posted by SD60MAC9500 on Wednesday, August 11, 2021 8:26 AM
 

Ulrich

Both the STB and the Biden Administration have come out in favor of more competition, not less.  CN and CP will therefore have to show how any merger with KCS would enhance competition..

 

 

 

There's plenty competiton. I don't believe our government understands the modal competition that exist between road and rail.. The lane that stands to benefit most from this merger is the NAFTA corridor. CN is the preferred merger partner in my eyes. A better route requiring less circuitry, assets and the least amount of trackage rights.. The I-69 corridor is currently dominated by truck competition. Better rail access in this lane would be competition.

 
Rahhhhhhhhh!!!!
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Posted by Ulrich on Wednesday, August 11, 2021 8:50 AM

I guess the question would be how a merger would improve rail access. The tracks are already there.. the trains are already there.. I don't think combining two railways will somehow magically "unlock" alot of rail capacity, and no shipper is now going to say "wow.. look at that.. we can now ship to Canada by rail!". CN/CP and the KCS can effectively work together TODAY to compete with over the road traffic.. they don't need a merger. As it stands now KCS, as an independent entity, can work effectively with both CN and CP. That would change if KCS were to be bought up by either CN or CP.

 

 

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Posted by Convicted One on Wednesday, August 11, 2021 10:31 AM

kgbw49
Corporations typically don't have just one large debt such as an individual with a home mortgage.

Just to assure clarity, the reason I mentioned KCS debt singularly, was because which ever railroad ends up with the prize, along with it will come $3.8 billion in current KCS outstanding debt (over 10% of the purchase price)

Coupled with that, from the article: "regulators also questioned whether the level of debt Canadian National plans to take on to buy Kansas City Southern would undermine the financial stability of the railroad".   CN chose to reply to the regulators that it would prioritize paying down the debt, with the assurance that it would suspend the practice of stock buy back to facilitate this pay-down.

 

We've had some fun discussions here in the past on the topic of debt vs stock repurchase, so I just thought that aspect deserved emphasis. Wink  

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Posted by beaulieu on Wednesday, August 11, 2021 11:33 AM

SD60MAC9500
 

There's plenty competiton. I don't believe our government understands the modal competition that exist between road and rail.. The lane that stands to benefit most from this merger is the NAFTA corridor. CN is the preferred merger partner in my eyes. A better route requiring less circuitry, assets and the least amount of trackage rights.. The I-69 corridor is currently dominated by truck competition. Better rail access in this lane would be competition.

 
Your statement is true if you are only considering traffic to Eastern Canada. For traffic moving between Western Canada and points on KCS, CP would have the mileage advantage and would be able to avoid congestion in Chicago.
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Posted by charlie hebdo on Wednesday, August 11, 2021 11:40 AM

I'm not sure there is much value added by either merger/purchase.  Just a reshuffling of the deck chairs. 

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Posted by Ulrich on Wednesday, August 11, 2021 12:49 PM

charlie hebdo

I'm not sure there is much value added by either merger/purchase.  Just a reshuffling of the deck chairs. 

 

 

Yup.. or just painting 10 deck chairs and telling people there's now more room to sit down. 

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Posted by SD60MAC9500 on Wednesday, August 11, 2021 2:05 PM
 

Ulrich

I guess the question would be how a merger would improve rail access. The tracks are already there.. the trains are already there.. I don't think combining two railways will somehow magically "unlock" alot of rail capacity, and no shipper is now going to say "wow.. look at that.. we can now ship to Canada by rail!". CN/CP and the KCS can effectively work together TODAY to compete with over the road traffic.. they don't need a merger. As it stands now KCS, as an independent entity, can work effectively with both CN and CP. That would change if KCS were to be bought up by either CN or CP.

Rail access equals single line service and no interchange friction. Would you rather deal with multiple freight bills? Or one? That's the point of mergers. Streamline the pricing and movement of freight. 

 
Rahhhhhhhhh!!!!
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Posted by Ulrich on Wednesday, August 11, 2021 2:20 PM

Then they need to hire me.. I can do that for them for $24.95. One easy to read invoice for the entire month's transportation spend.. that's what I do. Not sure if interchange friction is such a huge cost factor.. and again, if it is, I would be available to fix that for the right price which would be less than $33 billion.. 

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Posted by SD60MAC9500 on Wednesday, August 11, 2021 2:20 PM
 

beaulieu

 

 
SD60MAC9500
 

There's plenty competiton. I don't believe our government understands the modal competition that exist between road and rail.. The lane that stands to benefit most from this merger is the NAFTA corridor. CN is the preferred merger partner in my eyes. A better route requiring less circuitry, assets and the least amount of trackage rights.. The I-69 corridor is currently dominated by truck competition. Better rail access in this lane would be competition.

 

 

 
Your statement is true if you are only considering traffic to Eastern Canada. For traffic moving between Western Canada and points on KCS, CP would have the mileage advantage and would be able to avoid congestion in Chicago.
 

Any mileage advantage CP would have from Western Canada is minuscule. If it even has one. Not only that CP will have a much harder operating profile compared to CN which can run down the relatively flat and much less circuitous Illinois Central. Just because a railroad has less milage compared to a competitor doesn't mean it has the best route or the lowest grade route...Also CN does avoid Chicago. It's called The J..

 
 
 
Rahhhhhhhhh!!!!
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Posted by Juniata Man on Wednesday, August 11, 2021 2:46 PM

SD60MAC9500
 

 

 
Ulrich

I guess the question would be how a merger would improve rail access. The tracks are already there.. the trains are already there.. I don't think combining two railways will somehow magically "unlock" alot of rail capacity, and no shipper is now going to say "wow.. look at that.. we can now ship to Canada by rail!". CN/CP and the KCS can effectively work together TODAY to compete with over the road traffic.. they don't need a merger. As it stands now KCS, as an independent entity, can work effectively with both CN and CP. That would change if KCS were to be bought up by either CN or CP.

 

 

Rail access equals single line service and no interchange friction. Would you rather deal with multiple freight bills? Or one? That's the point of mergers. Streamline the pricing and movement of freight. 

 
 

Unless you have your contracts set up as Rule 11's, you ARE receiving a single invoice. In through rates one carrier issues the invoice - typically the origin carrier - then settles up with other carriers in the route through inter line settlement. If your contracts are Rule 11, you've grnerally set it up deliberately in that manner so you can negotiate individual rates with each of the carriers in a route. In most cases, this will result in an overall lower freight cost and, since most freight invoices are handled electronically anyhow, really no extra hassle either.

Streamlined pricing only benefits the carrier and the notion of improved service from mergers is pretty much Class 1 PR BS. In theory it should be faster but, it simply doesn't work out that way.

CW

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Posted by kgbw49 on Wednesday, August 11, 2021 8:20 PM

Looking at the CN and KCS financial statements for 2021 Quarter 2, and not attempting to do any currency exchange calculations (CN reports in Canadian dollars and KCS reports in US dollars), here are some debt and interest expense numbers.

Per their 2021 Quarter 2 Financials, at June 30, 2021, CN had $12.14 billion of outstanding long term debt and KCS had $3.78 billion of outstanding long term debt, for a total of $15.92 billion between the two entities. Both the CN debt amount and the KCS debt amount was fairly flat with their December 31, 2020 year end financials

Interest expense paid by CN for the first half of 2021 was $288 million (this imputes to an interest rate of 4.74% on an annualized basis) and interest expense for KCS for the first half of 2021 was $78 million (this imputes to an interest rate of 4.14% on an annualized basis), for a combined total of $366 million between the two entities. Assuming continuing interest payments at that level, interest expense would total an estimated approximately $732 million for all of 2021 between the two entities.

CN is financing the KCS purchase with a combination of debt and issuance of new stock and the assumption of the KCS debt, which will remain on the books of the combined company.

Of the $33.7 billion transaction value, subtracting out the $3.8 million assumption of debt, that leaves $29.8 billion to fund.

CN is going to issue $19.2 billion in debt and $10.6 billion in new stock to the KCS shareholders, giving them about 28% ownership of the combined companies.

Adding the $19.2 billion in debt to the $15.9 billion of existing debt of the two companies, the combined company will have approximately $35.1 billion in outstanding debt upon completion of the transaction.

I don't know the interest rates of the outstanding debt issuances of the two companies, but if the new debt has similar interest rates to the existing debt, then the annual interest expense would theoretically increase from $766 million combined for the two existing companies to somewhere in the range of $1.4 billion to $1.7 billion in the first full year of combined operations.

Again, this is just rough estimating from reading their financial June 30, 2021 financial statements and then imputing forward. There are quite likely other factors that are not readily apparent in those financial statements that could make the actual long term debt position quite different from this rough estimate.

What I am not getting my head around, and I certainly don't claim to be an expert, is that KCS is on pace to have net income for the full year of around $450-$500 million, so in theory, new CN would have $450-$500 million more profit in the first full year.  But if this goes through, the annual interest expense of new CN would increase by a new layer of around $850 million annually, assuming the additional debt is borrowed at roughly the same rate as the existing debt.

I must be missng something - maybe that is where the "synergies" come in to show that net income goes up by more than the increased interest expense from the $19.2 billion in new debt so that new CN comes out ahead.

It will be interesting to watch to see what happens.

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Posted by Convicted One on Wednesday, August 11, 2021 8:43 PM

kgbw49
Of the $33.7 billion transaction value, subtracting out the $3.8 million assumption of debt, that leaves $29.8 billion to fund.

Isn't that backwards? They are paying $33.7 billion for the company, assets, liabilities, and net worth. Lock, stock and barrel.

So, after they pay to buy the company, the $3.8 billion debt they acquire in the process will be owed on top. 

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Posted by kgbw49 on Wednesday, August 11, 2021 9:48 PM

The KCS $3.8 billion assumption of debt by CN is part of the "enterprise value of the company". So cash paid, plus stock in New CN given, plus relieving the former KCS owners (stockholders) of $3.8 billion of debt is all a net gain to the former KCS owners (stockholders). I hope that makes sense.

For example, let's say that you bought a $20,000 car with $10,000 cash (your equity) and a $10,000 loan. I come along and say "That's a really cool car. I'll pay you $20,000 cash for it and take over your loan." That deal costs me $30,000 - the $10,000 cash paid for your equity in the car, $10,000 cash premium I paid you because I thought your car was so cool, and $10,000 that I will pay to retire the debt obligation that I took over. $30,000 is the total transaction cost to me, and your financial gain is $20,000 - $10,000 for the cool car premium you received from me and $10,000 for not having to pay the debt off. I also paid you $10,000 for your $10,000 ownership stake in the car.

Yes, the $3.8 billion of existing KCS debt that will be transferred to the books of "New CN", along with $12.14 billion of existing CN debt, plus the $19.2 million of new debt issued by CN as part of the payment to the stockholders of KCS, will all be the debt on the books of "New CN".

So the total financial transaction of $33.7 billion value to "Old KCS", whose owners are the stockholders, is $3.8 billion of "Old KCS" debt that they no longer are responsible for, $19.2 billion of cash payments, and stock in New CN worth $10.7 billion.

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Posted by MidlandMike on Friday, August 13, 2021 9:34 PM

SD60MAC9500
 

 

 
Ulrich

Both the STB and the Biden Administration have come out in favor of more competition, not less.  CN and CP will therefore have to show how any merger with KCS would enhance competition..

 

 

 

 

 

There's plenty competiton. I don't believe our government understands the modal competition that exist between road and rail.. The lane that stands to benefit most from this merger is the NAFTA corridor. CN is the preferred merger partner in my eyes. A better route requiring less circuitry, assets and the least amount of trackage rights.. The I-69 corridor is currently dominated by truck competition. Better rail access in this lane would be competition.

 
 

While there is certainly competition between rail and truck, nevertheless, much of what goes by truck is not competitive by rail, and in fact rail has shed most short and intermediate hauls.  Rail's competition is really other railroads.  

KCS's lease of the Mexico lines was not that big of a deal, as KCS has a small footprint in the US.  A lot of the business off KCS/Mexico goes to UP.  However, the class I with a large service area who gets KCS will will be a big deal.  CN is only interested in the Mexico connection, and will eliminate KCS other than what they need to connect to the border (as the do with any acquired duplicate lines).  I think in any merger, KCS de Mexico should be spun-off, perhaps as a joint terminal company open to any RR that wants to buy a percentage from KCS.  Any deal that seeks to grab KCS de Mexico for exclusive use is non-competitive.

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Posted by kgbw49 on Friday, August 13, 2021 10:14 PM

MidlandMike, interesting point. Any thoughts about the Mexican Goverment stepping in to regain control of the KCS de Mexico franchise?

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Posted by Juniata Man on Friday, August 13, 2021 10:39 PM

Keep in mind that KCSM holds a lease of sorts from the Mexican government - not ownership. The STB really has no authority to dictate what happens with KCSM.

I also harbor doubts that CN ownership of KCS would be anti-competitive in terms of cross border traffic. I've read in recent months that KCS handles only about a third or so of traffic crossing at Laredo with UP handling the rest. Now, UP ownership of KCS would be anti-competitive were that under consideration. 

CW

 

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Posted by beaulieu on Saturday, August 14, 2021 9:23 PM

SD60MAC9500

Any mileage advantage CP would have from Western Canada is minuscule. If it even has one. Not only that CP will have a much harder operating profile compared to CN which can run down the relatively flat and much less circuitous Illinois Central. Just because a railroad has less milage compared to a competitor doesn't mean it has the best route or the lowest grade route...Also CN does avoid Chicago. It's called The J.. 

 

Shreveport to Winnipeg via CN routed through Jackson, MS is 1807 miles based on CN and KCS ETT

Shreveport to Winnipeg via CP routed through Kansas City is 1554 miles based on CP and KCS ETT

That's 253 miles which is not miniscule. That's at least one additional crew district if you can space them out to best advantage. That is calculated using IC's Edgewood cutoff to minimize CN's distance. Southbound grades on CP and KCS are about 1.3% from Ottumwa and over Rich Mountain. for CN and KCS it's 1.3% over Byron Hill south of Fond du Lac, WI and a bit over 1% over Anding Hill, south of Yazoo City, MS.

Toughest grades are northbound via either route, for CP it's Rutledge Hill out of Ottumwa, IA at 1.7%, and for CN it is Steelton Hill out of Superior, WI at 2.2%.

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Posted by MidlandMike on Saturday, August 14, 2021 9:24 PM

Juniata Man

Keep in mind that KCSM holds a lease of sorts from the Mexican government - not ownership. The STB really has no authority to dictate what happens with KCSM.

I also harbor doubts that CN ownership of KCS would be anti-competitive in terms of cross border traffic. I've read in recent months that KCS handles only about a third or so of traffic crossing at Laredo with UP handling the rest. Now, UP ownership of KCS would be anti-competitive were that under consideration. 

CW

 

 

STB does not regulate KCSdM, but they do regulate US RR companies and could still make a spin-off a condition of merger. 

UP gets the lions share of KCSdM export traffic because they serve many more destinations.  CN also serves many destinations, and as a single line service would probably grab much of that traffic from UP, and all of the traffic that formerly went to CP at KC.

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Posted by MidlandMike on Saturday, August 14, 2021 9:40 PM

kgbw49

MidlandMike, interesting point. Any thoughts about the Mexican Goverment stepping in to regain control of the KCS de Mexico franchise?

 

Mexico nationalized its oil production just before WWII, although I think something like that is less likely post-NAFTA.  Not sure if the lease agreement has some claw-back provision.

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Posted by SD60MAC9500 on Saturday, August 14, 2021 11:39 PM
 

beaulieu

 

 
SD60MAC9500

Any mileage advantage CP would have from Western Canada is minuscule. If it even has one. Not only that CP will have a much harder operating profile compared to CN which can run down the relatively flat and much less circuitous Illinois Central. Just because a railroad has less milage compared to a competitor doesn't mean it has the best route or the lowest grade route...Also CN does avoid Chicago. It's called The J.. 

 

 

Shreveport to Winnipeg via CN routed through Jackson, MS is 1807 miles based on CN and KCS ETT

Shreveport to Winnipeg via CP routed through Kansas City is 1554 miles based on CP and KCS ETT

That's 253 miles which is not miniscule. That's at least one additional crew district if you can space them out to best advantage. That is calculated using IC's Edgewood cutoff to minimize CN's distance. Southbound grades on CP and KCS are about 1.3% from Ottumwa and over Rich Mountain. for CN and KCS it's 1.3% over Byron Hill south of Fond du Lac, WI and a bit over 1% over Anding Hill, south of Yazoo City, MS.

Toughest grades are northbound via either route, for CP it's Rutledge Hill out of Ottumwa, IA at 1.7%, and for CN it is Steelton Hill out of Superior, WI at 2.2%.

 

Thank you for the mileage correction. However Rich Mountian southbound is almost 1.5%. Yet before the Quachita Mountains KCS has to cross the Boston Mountains. Neosho begin of 1.5%, After Noel 1.5%, and again at Gentry. Along with two more grades in excess of 1.1%..

Northbound through the Boston Mountains. 1.5% at Watts, followed by two hills in excess of 1.1%, with 1.5% coming out of the Elk River Valley. CN still has the better operating profile north and south.

 
 
 
 
 
Rahhhhhhhhh!!!!
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Posted by SD60MAC9500 on Saturday, August 14, 2021 11:46 PM
 

MidlandMike

While there is certainly competition between rail and truck, nevertheless, much of what goes by truck is not competitive by rail, and in fact rail has shed most short and intermediate hauls.  Rail's competition is really other railroads.  

Say what? 

 
Rahhhhhhhhh!!!!
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Posted by MidlandMike on Sunday, August 15, 2021 8:49 PM

SD60MAC9500
 

 

 
MidlandMike

While there is certainly competition between rail and truck, nevertheless, much of what goes by truck is not competitive by rail, and in fact rail has shed most short and intermediate hauls.  Rail's competition is really other railroads.  

 

 

Say what? 

 
 

Your map shows the only rail dominated market is the coal going east from Powder River Basin.  Trucks dominate all other land routes with the exception of overlap on the Southern and Central corridors, and there they only give the aggragate summary.  The only waterway shown is the Ohio/Lower Mississippi.  Your map seems to reaffirm the compartimentalization of different types of freight into different modes.

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Posted by Leo_Ames on Wednesday, August 25, 2021 5:22 AM

Out of curiousity, have CNR or CPR mentioned proceeding with the extension to Alice Texas in any of their STB filings?

Mike Haverty made it out like the Rosenberg - Victoria shortcut would be such a financial win for KCS that the logical next step would be to acquire and rebuild the Victoria to Alice segment. But then the talk went silent. 

I'm curious if the deeper wallet of both suitors might make that plan a reality and enable them to avoid ~100 miles of UP trackage rights.

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Posted by CatFoodFlambe on Sunday, August 29, 2021 4:07 PM
Just from a lack of knowledge on my part - why did CP bother to sweeten their offer at this point? Just to "keep their hand in" and discourage other potential bidders by means of a "we're still interested" statement) if the STB vetoes the CN acquisition?
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Posted by kgbw49 on Sunday, August 29, 2021 6:33 PM

The STB has already approved the CP-KCS voting trust using the pre-2001 rules. That is important because the pre-2001 rules were pro-merger.

The STB has not yet approved the CN-KCS voting trust, and several US Government agencies as well as the House Transportation Committee have come out against it.

So CP sweetening the deal to the KCS stockholders gives them a chance for a decision either taking  more "bird in hand" cash and a merger with an easier path to approval (CP-KCS) versus one with additional money but a much bigger risk that it will never happen (CN-KCS).

We may yet see red locomotives labeled Canadian Pacific de Mexico.

Here is a web site where Canadian Pacific makes their case for their merger proposal:

https://futureforfreight.com/

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Posted by beaulieu on Monday, August 30, 2021 12:35 AM

CP's offer only makes sense if the STB rejects CN's application for a Voting Trust. If CN's Voting Trust is denied then there is a much higher probability that the STB will deny CN's attempt to merge with KCS. If CN's Voting Trust is denied at best KCS's shareholders will have to wait at least a year for their money, and they are risking serious losses if CN's deal is completely rejected. If the CN Voting Trust is rejected KCS could take CP's offer and get their money much sooner, perhaps in as little as a month or less.

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