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Why Canadian National Stock Is Up This Week

By Lou Whiteman – Sep 3, 2021 at 12:58PM

Key Points

  • Canadian National's application to form a voting trust to facilitate its $33 billion purchase of Kansas City Southern was rejected by regulators.
  • While the regulators didn't officially rule on the deal, the trust rejection makes final approval an uphill climb.
  • Investors shrugged off the news, possibly preferring Canadian National to focus its energy on internal improvements.

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The railroad's megadeal might be off, but investors don't seem to mind.

What happened

Regulators appear skeptical about Canadian National's (CNI -0.49%) planned $33 billion deal for Kansas City Southern (KSU), and investors welcomed the skepticism. Shares of Canadian National traded up nearly 16% for the week as of Friday at noon EST on speculation that the deal won't get done.

So what

Canadian National's bid for Kansas City Southern always seemed destined for close regulatory scrutiny, and the U.S. government has not disappointed. The Surface Transportation Board (STB) on Aug. 31 rejected a bid by Canadian National to form a voting trust to help facilitate the deal, saying the combination "would create a combination of potential harms to the public interest."

A Canadian National train cuts through a mountain pass.

Image source: Canadian National.

Canadian National earlier this year stepped in to break up a pending deal between Kansas City Southern and Canadian Pacific (CP -0.19%). The deal is expensive, with Kansas City Southern trading nearly 50% above where its shares were a year ago, prior to the deal talk. But the potential benefit of the deal is substantial, creating a railroad that would span all of North America and seamlessly connect U.S. and Canadian population centers with Kansas City Southern's deepwater port in Mexico.

Although the STB's ruling was technically only a rejection of the voting trust, it is hard to read the 33-page decision without concluding that Canadian National's chances of getting the deal approved are slim. The STB issued a moratorium on large-scale railroad consolidation two decades ago that remains in effect, and the White House earlier this year called railroad mergers a threat to the U.S. economy.

Now what

The STB decision was not a surprise, but the Canadian National share reaction is a bit of one. Investors appear relieved that the deal might be derailed, perhaps worried about the troubles railroads have had integrating past mergers or thinking that Canadian National was overpaying. Citigroup analyst Christian Wetherbee upgraded the stock to a buy from neutral midweek on the prospects of Canadian National abandoning the deal and focusing on improving internal operations as well.

Kansas City Southern shareholders were set to vote on the Canadian National deal today, but the company instead adjourned the meeting until Sept. 24 while it considers its options. Kansas City Southern is reportedly set to reopen talks with Canadian Pacific, a much smaller suitor than Canadian National. Canadian Pacific has already won STB approval to establish a trust, an indication the regulator is more open to that combination.

This merger saga is not over yet, but given the stock reaction, it seems unlikely that Canadian National will further sweeten its bid or try another tactic to entice Kansas City Southern not to switch its allegiances. If so, Canadian Pacific appears to be best positioned to win Kansas City Southern. But, based on the stock reaction, Canadian National shareholders are happy to be done with the drama.

Citigroup is an advertising partner of The Ascent, a Motley Fool company. Lou Whiteman has no position in any of the stocks mentioned. The Motley Fool recommends Canadian National Railway. The Motley Fool has a disclosure policy.

Stocks Mentioned

Canadian National Railway Stock Quote
Canadian National Railway
CNI
$127.83 (-0.49%) $0.63
Kansas City Southern Stock Quote
Kansas City Southern
KSU
Canadian Pacific Railway Stock Quote
Canadian Pacific Railway
CP
$82.35 (-0.19%) $0.16

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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