UPS' thumbs-down of CP-NS deal could be telling blow for transaction

Big Brown has dealt a severe blow to Canadian Pacific Railway's (CP's) $28 billion bid to acquire U.S. eastern railroad Norfolk Southern Corp. (NS).

UPS Inc., the largest transport company in the U.S. and one of the nation's biggest users of intermodal services, has asked the Surface Transportation Board (STB), the federal agency that would have to approve a CP-NS merger, to reject the proposal on grounds that it will lead to diminished service levels and higher costs. UPS also warned that the acquisition would result in a spree of rail-industry consolidation that would impair intermodal service reliability even more.

UPS' concerns, raised in a Feb. 9 letter to the Board, are no different from those already voiced by competing railroads, shipper groups, and members of Congress. However, UPS' size, influence in the marketplace and within official Washington, and reputation as arguably the industry's premier operator could carry enormous weight with regulators.

Atlanta-based UPS has been moving goods via the intermodal system for nearly 40 years, and during many of those was considered the rail industry's largest individual customer. It is also a very demanding user. Legend has it that in the 1970s and 1980s, a time when railroads struggled badly with intermodal service reliability, UPS would position its tractor-trailers as close to intermodal yards as possible to grab equipment containing its customers' goods quickly.

Despite UPS' opposition, CP still plans to pursue the merger, according to Martin Cej, a spokesman for the Calgary, Alberta-based railroad. On Tuesday, CP disclosed that it would introduce a nonbinding resolution later this year at NS' annual meeting that would call for NS' board to discuss the deal with CP. The following day, E. Hunter Harrison, Canadian Pacific's CEO, told an investor conference that Canadian Pacific would abandon the deal if the resolution were defeated.

The resolution doesn't require Norfolk Southern's board to meet with CP, and in a statement after CP's announcement, NS said it saw no reason to meet again with CP unless the Canadian railway could present an offer that was financially adequate and not fraught with regulatory and legislative risk. NS and CP have met once since CP floated the first of three merger proposals in mid-November. Norfolk, Va.-based NS' board has rejected all three.

John G. Larkin, transport analyst for investment firm Stifel, said CP is likely to do nothing until NS shareholders vote on its resolution. Larkin added that if the economy remains in slow-growth mode, the STB is likely to scotch the deal because it doesn't want to risk making life harder for rail shippers than it already is.

In an effort to allay regulatory concerns, CP has proposed to place itself in a voting trust to insulate it from financial control of NS. CP and NS would operate as an integrated entity while STB evaluated the combination, a process that could take up to 22 months. Harrison would run Norfolk Southern, while his second-in-command, Keith Creel, would run Canadian Pacific. The STB would need to approve a voting-trust proposal.