Canadian Pacific Railway Limited (TSX:CP)(NYSE:CP) just launched a bid to buy Norfolk Southern Corp. (NYSE:NSC), and investors are wondering if this is a signal to board the train.
Big rail deal
Hunter Harrison, CP’s CEO, has long held the opinion that consolidation in the North American rail sector is not only necessary, but also inevitable. His US$28 billion bid to purchase Norfolk Southern might be the first step in that transformation.
The deal is being pitched as a 50-50 stock-and-cash bid that would result in Norfolk Southern’s shareholders owning about 41% of the combined company.
The merger of the two rail operators makes sense in that it would help reduce traffic that currently has to go through the rail bottleneck in Chicago, but analysts are concerned the deal might not get approval from the U.S. Surface Transportation Board (STB).
Back in 2000, Canadian National Railway Company tried to buy Burlington Northern Sante Fe, which is now owned by Warren Buffett, but the deal was blocked on competition concerns.
CP believes a deal with Norfolk Southern could clear regulatory hurdles because shippers would still have access to competitive routes and other carriers. The company said it would allow shippers the choice of where to connect with another railroad along its routes.
Cost-savings potential
Harrison has transformed CP since he took control in 2012. The company’s operating ratio, which is a measure of how much revenue the company is spending to run the business, has dropped significantly. Norfolk Southern is not as efficient, but there would be huge opportunities for cost savings if the two companies merged.
CP says a deal would produce at least $1.8 billion per year in operating synergies.
Should you buy CP?
The market appears to like the bid, although Norfolk Southern’s reaction has been less than enthusiastic.
The process to get a deal done is likely to be a long and bumpy one. There is also a risk that it could become a distraction for CP’s management at a time when the rail company is facing some serious economic headwinds.
Nonetheless, CP remains a very profitable company with a strong management team. As a long-term investment, the stock looks attractive.
Existing shareholders should continue to hold the name, but new investors might want to wait for the market to settle down a bit before stepping in.
