Canadian Pacific Inks $29B Deal To Acquire Kansas City Southern

Canadian Pacific Railway Limited has agreed to snap up Kansas City Southern (KCS), a transportation holding company, in a stock-and-cash deal worth $29 billion. The combined company will be named Canadian Pacific Kansas City (CPKC).

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Through the combination of two railroads, the first rail network connecting the US, Mexico, and Canada will be formed. The merger will connect customers via single-network transportation offerings between points on Canadian Pacific’s (CP) system throughout Canada, the US Midwest, and the US Northeast and points on KCS’s system throughout Mexico and the South Central US, the company said.

The price tag, which comes in at $275 per share, represents a 23% premium to Kansas City Southern’s (KSU) closing price on March 19. To fund the transaction, Canadian Pacific is planning to issue 44.5 million new shares, with the cash portion to be funded through a combination of existing cash and debt issue of $8.6 billion. The enterprise value includes outstanding debt worth $3.8 billion to be assumed by the railway company.

The deal is expected to create annualized synergies of $780 million over three years. Also, Canadian Pacific’s adjusted EPS accretion is anticipated in the first full year, following the company’s control of KCS. Furthermore, the merger is expected to generate double-digit earnings accretion upon the full realization of synergies thereafter. (See Canadian Pacific stock analysis on TipRanks)

Per the terms of the deal, shareholders of Kansas City Southern will receive 0.489 shares of Canadian Pacific common stock and $90 in cash for each share held. Preferred shareholders will be paid $37.50 in cash for each KCS preferred share held.

The transaction is likely to close after the completion of the US Surface Transportation Board (STB) review and approval, which is expected by the middle of 2022.

Upon completion of the transaction, existing KCS shareholders will own 25% of the combined entity. Additionally, following the final STB approval, shareholders of KCS will be entitled to the realization of synergies resulting from the combined entity.

The transaction is likely to increase competition and provide better service for customers, as well as boost North American economic growth. Per Canadian Pacific’s statistics, though remaining the smallest of six US Class 1 railroads by revenue, the combined entity will be a much larger and more competitive network, operating around 20,000 miles of rail, employing 20,000 people, and making total revenues of $8.7 billion based on 2020 actual revenues.

Canadian Pacific CEO Keith Creel said, “The new competition we will inject into the North American transportation market cannot happen soon enough, as the new USMCA Trade Agreement among these three countries makes the efficient integration of the continent’s supply chains more important than ever before. Over the coming months, we look forward to speaking with customers of all sizes, and communities across the combined network, to outline the compelling case for this combination and reinforce our steadfast commitment to service and safety as we bring these two iconic companies together.”

On Feb. 25, Evercore ISI analyst Jonathan Chappell downgraded the stock to Hold from Buy, but increased the price target to $386 (18.6% downside potential) from $382.

Chappell “has made his initial update to Q1 and full-year 2021 EPS estimates to reflect the volume and cost impact of the widespread winter weather and incorporated updated views from the firm’s Autos team on the potential production impact of the semiconductor shortage, all of which results in Q1 forecasts that have come down materially, and now sit well below the average Street projection.”

“Noting that most investors are already looking to next year for normalized EPS,” the analyst “is shifting his price target and rank file analysis to 2022 forecasts.”

Wall Street analysts are cautiously optimistic on the stock’s outlook. The Moderate Buy consensus rating breaks down into 11 Buy ratings versus 5 Hold ratings. The average analyst price target stands at $396.67 and implies upside potential of 4.8% to current levels. That’s after shares jumped 18.4% over the past six months.

Canadian Pacific scores a 9 out of 10 from TipRanks’ Smart Score rating system, indicating that the stock has strong potential to outperform market expectations.