Rail deal is $29bn bet on trade pact between Canada, US and Mexico

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Car parts from Monterrey to Detroit. Propane from Alberta to Texas. Corn from Iowa to Mexico.

Canadian Pacific Railway’s proposed takeover of the Kansas City Southern railroad is a $29bn bet on smooth commerce between Canada, the US and Mexico after the three countries replaced their contentious old trade pact with a new one. 

The smallest of North America’s seven major freight railroads on Sunday announced plans to merge their companies to form a 20,000-mile network stretching across the continent, from the port of St John on Canada’s Atlantic coast to the Mexican port of Lázaro Cárdenas on the Pacific. 

Executives pointed to the US-Mexico-Canada trade agreement — a revamped version of the North American Free Trade Agreement championed by former US president Donald Trump — as a rationale for the combination. 

The USMCA pact came into force last July. The agreement brought to a close a tense period of tariffs and threats between the US and its two neighbours. US exports to and imports from Canada and Mexico were projected to increase under the deal, according to a 2019 analysis by the US International Trade Commission. 

The countries are now on course for a steady trade relationship for at least the next 16 years, said Patrick Ottensmeyer, Kansas City Southern’s chief executive. 

“The USMCA agreement has created trade certainty and just a wonderful opportunity for North America to become an even more powerful trading bloc in the world,” he told the Financial Times. 

North American railroad merger to create 20,000-mile network

Trains already cross North American borders but long hauls often require switching locomotives and crews between railroads. Calgary-based Canadian Pacific’s tracks currently end at the Kansas City, Missouri, rail yard it shares with Kansas City Southern, which runs across the Rio Grande river to industrial cities and ports in Mexico.

Executives said the merger would create “single line” service for commodities such as grain from the US Midwest and petroleum products from Canada that could reach the Gulf Coast and Mexico without interruption, as well for as intermodal trailer vans. 

John Brooks, Canadian Pacific’s chief marketing officer, noted that Kansas City Southern served 16 Mexican car factories. “The new franchise will essentially tie the auto belts of Ontario, the Upper Midwest and Mexico,” Brooks said. 

The deal comes as rail traffic rebounds from the early blow of the pandemic, with North American carloads up 2.8 per cent year on year in the first 10 weeks of 2021, according to the Association of American Railroads. 

The Canadian takeover of a US company would require approval from the Committee on Foreign Investment in the United States, an intra-agency panel that can block deals on national security grounds, as well as competition authorities in Mexico and the US, executives said. 

The US Surface Transportation Board, which reviews whether mergers will benefit railroad customers and the public, was notified of the proposed merger at the weekend, a person close to the agency said. 

Jennifer Hedrick, executive director of the National Industrial Transportation League, said the shipper group’s members had “outstanding relationships” with the two railroads and were optimistic about the venture.

But she added: “Any merger in this industry and on this scale will be viewed with healthy scepticism based on prior history and experience of rail mergers.” 

Todd Tranausky, vice-president of rail and intermodal at FTR Transportation Intelligence, said the transaction was likely to be the first real test of enhanced merger rules that the Surface Transportation Board put in place in 2001. He said shippers could oppose the deal out of concerns that service would decline. 

“There has never been a well-integrated rail merger and there has always been some level of disruption to the service levels that shippers have experienced moving their freight during the immediate aftermath of a successful rail merger,” Tranausky said. 

The railroads’ executives downplayed concerns about competition, noting that their networks had no tracks in parallel. “As an end-to-end combination, we see this as very pro-competitive,” Ottensmeyer said. 

Kansas City Southern rejected in September a buyout offer from a consortium led by Blackstone and Global Infrastructure Partners that valued its shares at $21bn. The private equity groups were convinced that their offer had a better chance to win regulatory approval because they were not direct rivals of any existing player.

The consortium of investors is unlikely to propose a rival bid, said one person who closely follows the sector.

Canadian Pacific tried to acquire eastern US railroads CSX and Norfolk Southern in recent years but both attempts were blocked partly over concerns that the deals would not win regulatory approval.

The combined companies would have a workforce of 20,000. Some initial redundancies will be followed by an increase in headcount between 2023 and 2025, said Nadeem Velani, Canadian Pacific’s chief financial officer. 

“We expect volume growth, and as a result of that, we expect job growth,” said Keith Creel, Canadian Pacific’s chief executive.

The combined company, to be called Canadian Pacific Kansas City, would be able to increase annual revenue by $800m, about 9 per cent more than the companies’ combined revenues in 2020, Velani said. 

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