Facing a battle it seemed destined to lose, Canadian Pacific Railway (CP) said today it would end its efforts to acquire Norfolk Southern Corp. (NS) for US$28 billion to create North America's first end-to-end transcontinental railroad network.
In a terse statement, Calgary-based Canadian Pacific said it would also withdraw a resolution it was to present May 12 at NS' shareholders meeting to call for Norfolk Southern's board to engage in good-faith merger talks with CP. Canadian Pacific CEO E. Hunter Harrison had said CP would withdraw its merger bid if the nonbinding resolution failed to win NS shareholder approval.
Canadian Pacific did not state a specific reason for ending its quest for Norfolk Southern. But it may have been triggered by the U.S. Justice Department's announcement Friday urging the Surface Transportation Board (STB), the U.S. agency that oversees rail mergers, to reject a CP proposal to place itself in a voting trust in an effort to insulate itself from controlling NS while the STB evaluated the merits of the integration. Under the CP proposal, Harrison would have run NS, while his-second-in-command, Keith Creel, would have headed CP. Justice said the proposal would "fail to preserve the independence of the merging railroads" prior to regulatory review by the STB, a process that could take as long as 22 months.
"We have long recognized that consolidation is necessary for the North American rail industry to meet the demands of a growing economy, but with no clear path to a friendly merger at this time, we will turn all of our focus and energy to serving our customers and creating long-term value for CP shareholders," Harrison said in the statement calling off the deal.
Norfolk Southern's statement was equally terse and bereft of any explanation. The railroad said it was on track to execute its five-year plan of hitting a 65-percent operating ratio— a company's operating expenses as a percentage of its revenue—by achieving $650 million in annualized productivity savings by 2020. Its fourth-quarter operating ratio stood at 74.6 percent, one of the highest in the industry. For 2015, NS posted an operating ratio of 72.6 percent.
Canadian Pacific, which had made three buyout offers for Norfolk Southern since mid-November, faced stiff opposition from the start. Several railroads, as well as lawmakers, unions, and shippers said the merger and subsequent integration would severely disrupt a continental rail network that has faced its share of service challenges during the past two years. There was also concern that merger approval would further reduce competitive options for shippers, and perhaps trigger a final round of consolidation among the remaining large North American railroads that would leave as few as four left.
CP maintained that it could dramatically improve NS' operating efficiency, leading to more efficient service both on the new network and across the continent's rail system in general. To allay fears that rail shippers would be harmed by the deal, it proposed that if the combined CP-NS failed to provide adequate service or offer competitive rates, it would allow another railroad to operate from a point of connection over the combined company's tracks and into its terminals. Shippers of the combined company could also decide where their freight would interline with another railroad along that carrier's network. CP also 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 decision to withdraw its merger proposal is the second blow to CP's efforts to consolidate North America's rail system through mergers and acquisitions. CP had begun very preliminary efforts in late 2014 to acquire NS' chief rival in the East, Jacksonville, Fla.-based CSX Corp., but quickly withdrew the offer after being rebuffed. Harrison then turned his attention to Norfolk Southern, and seemed to be far more determined to consummate this deal, despite the NS board's repeated rejections.
Harrison has said for some time that consolidation is the only logical path to alleviating network congestion, which will only get worse as volumes continue to grow.
On Thursday, CP released a white paper arguing that its approach to "precision railroading," which it defined as the constant monitoring and optimization of every asset across the entire organization, could be successfully applied to wring efficiencies out of what it called an "underperforming" NS.