Norfolk Southern Corp.'s board yesterday unanimously rejected Canadian Pacific Railway's (CP) proposed $28.4 billion buyout of the U.S. railroad, calling the proposal financially inadequate and detrimental to shippers, and saying it would create substantial regulatory risks that would be hard to overcome.

Calgary-based CP said it would hold a conference call on Tuesday to discuss the offer and clarify what it claimed the "misdirection and mischaracterization" of its offer. In a sign that the battle had just begun, CP said it is "committed" to the transaction. The combination would form a rail giant with an end-to-end network stretching from western Canada to the northern tip of Florida. It would create North America's largest rail system and be the continent's first transcontinental rail merger.

The deal would have to be approved by U.S. and Canadian regulators, presuming Norfolk Southern's shareholders approve it, which, based on the comments of its board, seems like a dicey proposition—at least at the current price tag.

James A. Squires, Norfolk, Va.-based Norfolk Southern's chairman, president and CEO, said that the Surface Transportation Board (STB), the U.S. agency that oversees what's left of rail regulation, including mergers and acquisitions, would take at least two years to review the transaction, and after an extended period which would effectively leave Norfolk Southern in limbo, the agency would likely reject it. Even if the STB approves the combination, it would be laden with so many onerous conditions that it would dilute the value of the transaction, Squires said.

Norfolk Southern sharply criticized CP's cost-savings estimates, calling them "overstated," and warned that CP's short-term, "cut-to-the-bone" strategy would sharply curtail needed network investments and damage service. "Any near-term cost savings that might result from applying Canadian Pacific's short-term focused operating model on Norfolk Southern would be offset by traffic diversions, service deterioration, and loss of service-sensitive customers," Norfolk Southern said.

Operating synergies between the railroads are limited because they only connect at five points, Norfolk Southern said. Canadian Pacific and Norfolk Southern networks serve entirely separate regions. The combination would also increase congestion at the already-slammed Chicago chokepoint, where all seven North American Class I railroads come together, Norfolk Southern said. Only 15 percent of the two rails' connecting traffic could be efficiently rerouted around Chicago, and CP would try to boost revenues by converting interline traffic between Norfolk Southern and the two western U.S. railroads, BNSF Railway Co. and Union Pacific Corp., to single-line traffic on the proposed combined entity.

Because most of the interline traffic with BNSF and UP currently avoids Chicago, and because CP doesn't have a way to efficiently bypass the city, much of that rerouted freight would be forced to go through Chicago, Norfolk Southern said. "Not only do the lines of Canadian Pacific and Norfolk Southern not physically connect in Chicago, but neither company's traffic can be moved to other Canadian Pacific-Norfolk Southern connecting points without all constituencies incurring substantial extra miles, cost, and time," Norfolk Southern said.

Norfolk Southern also attacked a CP proposal to provide "open access" to other railroads to operate over the combined entity's tracks and terminals in the event the entity failed to provide adequate service or offer competitive rates. Such a strategy would degrade service, discourage investment, result in lost revenue, and increase operating costs, Norfolk Southern said.

The CP proposal would allow another railroad to operate from a point of connection over the combined company's tracks and into its terminals. In addition, shippers of the combined company could decide where their freight could interline with another railroad along that carrier's network. CP said it would end a practice in the U.S. under which an origin railroad dictates where it interchanges a customer's freight with another carrier, even if other interchange points are more advantageous to the shipper. The practice is illegal in Canada.

The CP proposal resembles what the National Industrial Transportation League, a group of industrial shippers that are heavy rail users, has sought since it first proposed to the STB "reciprocal switching" rules in July 2011. Under reciprocal switching, a railroad, for a fee, moves a car between its interchange tracks and a customer's private or assigned siding on another railroad for loading and unloading. The NIT League proposal allows a captive shipper or receiver to gain access to a second rail carrier if the customer's facility is located within a 30-mile radius of an interchange where regular switching occurs. The proposal is strongly opposed by the rail industry, which argues that the switching railroad would suffer revenue loss, that the STB has established a proven pathway to bring grievances over competitive access issues, and that it would be tantamount to reregulating the industry. Norfolk Southern has been one of the most fervent of the measure's rail opponents.