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.
kgbw49Of 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.
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.
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.
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.
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
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.
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.
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.
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..
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..
charlie hebdo I'm not sure there is much value added by either merger/purchase. Just a reshuffling of the deck chairs.
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.
kgbw49Corporations 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.
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..
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..
^^^ 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.
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.
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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