Railroads and shippers have plenty of questions about how the potential merger between Canadian Pacific and Kansas City Southern might upend the railroad industry. In this commentary, FTR will try to examine some of the biggest issues.
Rail service always at the forefront
It is impossible to have a railroad merger discussion without talking about the potential impacts on service. The reason for that is because there has never been a Class I railroad merger in history that was integrated well and without hiccups noticed by shippers.
This transaction is unlikely to buck the historical trend. While there are no overlapping lines that existed in past mergers, there are two different operating philosophies operating in a whole new geography if the transaction is approved. This will undoubtedly cause hiccups in service for shippers even if the transaction is integrated as smoothly as possible.
Carriers are coming off of a period of relatively high service levels in 2020. After taking a bit of a step backward early in 2021 on widespread winter weather, how much further deterioration will shippers accept before complaining to the Surface Transportation Board about the merger’s effects on their ability to move goods? That is anyone’s guess, but it is probably not a return to 2019 service levels or worse. Many in the industry still remember the chaos that ensued after the split of Conrail between Norfolk Southern and CSX and the acquisition of Southern Pacific by Union Pacific, and they are unlikely to willingly sign up for a repeat performance.
A regulatory loophole exempted any transaction involving KCS from the STB’s 2001 merger rules. The National Industrial Transportation League and four Class I railroads have filed statements to the STB saying that the exemption is no longer appropriate for or intended to be used by a transaction of this size. It is important to note that when the exemption was enshrined into law, KCS did not have full control of KCSM, which did not occur until 2005.
The carriers – as any carriers would in the same situation – want to use the exemption to speed the regulatory approval process. But it is not surprising that railroads and shippers can make a compelling case that the situation involving KCS has materially changed since the exemption was adopted.
It appears that even the carriers involved understand this argument as the initial investor presentation focused heavily on the pro-competitive nature of the CP/KCS combination. The transaction being pro-competitive is one of the core tenets that must be satisfied if the transaction is to pass regulatory muster under the board’s 2001 rules.
Downstream effects of the transaction
The board’s 2001 merger rules allow the board to consider so-called “downstream effects” of the transaction. This would essentially mean the board could evaluate whether any additional mergers would happen as a result of the CP/KCS transaction.
It is our view that if the board determined such an outcome was likely, it would effectively kill the transaction’s chances of being approved. While we do not feel that other carriers necessarily have to respond to a CP/KCS combination, there has never been a Class I merger consummated in isolation. Even some of the railroad filings in opposition to the use of the exemption hint at such an eventuality, saying that having a transaction go to completion under the full 2001 merger rules could be beneficial to all parties. What the carriers mean is that it could provide a roadmap for how to get a subsequent transaction approved in the future if carriers seek to effect the last great round of railroad mergers.
The CP/KCS transaction will dominate industry water coolers for well over the next year, but its greatest legacy could be what it foretells about the future of the industry and how it is regulated between carriers and shippers for decades to come.