CN and KCS seek to divest 70 miles of track in Louisiana

Canadian railway CN (NYSE: CNI) and Kansas City Southern (NYSE: KSU) plan to divest of about 70 miles of Kansas City Southern (KCS) track in Louisiana as part of the effort to secure regulatory approval to merge and create an “end-to-end” network that spans from Canada to Mexico.

The proposal to divest of the track is part of CN’s and KCS’ application before the Surface Transportation Board (STB) to form a voting trust as part of the merger process. The board is responsible for overseeing the rail merger.

KCS formally decided to merge with CN last Friday. CN and competing railway Canadian Pacific (NYSE: CP) were both seeking to merge with KCS. But KCS also said last Friday that it would break its existing merger agreement with CP now that it has accepted CN’s bid to acquire the railroad for $33.6 billion.

Wednesday’s application is almost identical to the one CN filed previously but that STB had denied because it was incomplete. However, the new application includes plans to divest 70 miles of KCS track between Baton Rouge and New Orleans in order to make the CN-KCS network an end-to-end network. The divested track, which would happen only after the merger has been approved, consists of less than 0.7% of the approximately 27,000 route-miles that the two companies operate, according to CN.

CN would work to secure an independent third party to acquire the 70-mile KCS rail line and it would “step into the shoes of KCS” for any related haulage agreement, according to Wednesday’s filing. CN-KCS would retain local and overhead trackage rights to provide single-line service to customers on the KCS line, and it would seek additional approval from STB once an agreement for the divestiture is in place, CN said.

“We believe our early commitment to eliminating the minimal rail overlap and to laying out the case for a CN-KCS combination should allow the STB to approve our voting trust,” CN President and CEO JJ Ruest said in a Wednesday statement. “A trust is an essential step so KCS shareholders can receive the full value of their shares while the STB considers our case for a combined, end-to-end rail network and the significant public benefits of connecting the continent. This combination will promote growth and compete with the trucking industry for long-haul movements. It offers more choice for rail customers, port operators, employees, stakeholders and communities.”

STB could open up a brief period for comments regarding CN’s application for a voting trust sometime this week and then it could issue a decision on the trust sometime in June. Should the voting trust be approved, the process to review the proposed merger would begin.

“Combining KCS with CN is compelling for our customers, employees, shareholders and the local communities in which we operate,” said KCS President and CEO Pat Ottensmeyer. “We urge the STB to fully consider the benefits of this combination and to respect KCS’ judgment about its preferred merger partner so that we can realize the tremendous public interest advantages of the CN-KCS partnership on behalf of our stakeholders, many of whom have expressed overwhelming support.”

Observers anticipate STB’s review process could take months since the merger would face newer and higher benchmarks for regulatory approval. CN and KCS would have to show that their merger would enhance competition and be in the public interest.

CN says the voting trust is needed as a safeguard against premature control of KCS and as a way to protect KCS’ financial health. Indeed, KCS shareholders have said the merger cannot proceed between the two companies unless CN can garner STB’s approval for the voting trust.

In countering concerns about the proposed CN-KCS merger, CN has said it is committed to continuing to provide cross-border gateway access, including in areas where Union Pacific (NYSE: UNP) has access to Mexico via KCS. The railway has also said other areas where there might be concerns about parallel lines are in places where those lines serve different markets and where shippers also have access to competing Class I railroads and to trucks and barges.

CN has expressed confidence that it can meet the regulatory hurdles, and it has said that the proposed merger has garnered more than 1,100 letters of support from customers and stakeholders that have been sent to STB.

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