Business Context and Reporting Period
This Form 6-K, filed on December 8, 2015, by Canadian Pacific Railway Limited (CP) and Canadian Pacific Railway Company, details a revised proposal for a business combination with Norfolk Southern Corporation (NS). The filing serves as a communication to shareholders regarding the strategic value of the merger, contrasting CP's offer with NS's newly announced standalone plan. The document outlines the mechanics of a proposed voting trust structure to facilitate regulatory approval by the Surface Transportation Board (STB).
Key Financial Metrics and Offer Terms
The filing focuses on the valuation and financial structure of the proposed merger rather than reporting CP's standalone quarterly results. Key financial figures presented include:
- Revised Offer Terms: NS shareholders would receive 0.451 shares in the new combined company (CP-NS) and US$32.86 in cash upon closing into a voting trust in May 2016.
- Premium: The offer represents a 77% premium to the unaffected NS share price of US$79.14.
- Projected Synergies: CP estimates total value creation of US$1.8 billion, split into US$1.26 billion in pre-merger operational improvements (72%) and US$495 million in post-merger combination synergies (28%).
- Debt and Leverage: Projections indicate the combined entity would deleverage from 4.0x leverage at trust closure to 1.6x by 2020, with an expected credit rating of BBB/Baa rising to BBB+/Baa+ by 2017.
- Revenue Base: The combined company is projected to have a total revenue base of US$14.6 billion (based on 2014 data), compared to CP's US$5 billion and NS's US$9.6 billion.
Material Changes and Strategic Shifts
The filing highlights a significant shift from CP's initial offer to a revised structure designed to accelerate value delivery and mitigate regulatory risk:
- Offer Structure Change: The new offer increases the equity component (from 0.348 to 0.451 shares) and provides immediate cash (US$32.86) upon trust closing in May 2016, rather than waiting until December 2017 for STB merger approval.
- Management Change: The proposal includes the appointment of CP CEO E. Hunter Harrison to lead NS operations immediately upon trust approval, severing his ties with CP to satisfy STB independence requirements.
- Operational Improvements: CP asserts that 72% of the projected synergies (US$1.26 billion) are achievable through pre-merger operational improvements (fuel efficiency, velocity, asset utilization) regardless of whether the final merger is approved.
Guidance, Outlook, and Risks
Outlook and Management Commentary: CP argues that its operating model, proven at Illinois Central, Canadian National, and CP, can reduce NS's operating ratio from the low-70s to the mid-60s, significantly outperforming NS's standalone guidance of a 65% operating ratio by 2020. The filing projects a fair value per NS share of US$125 (if STB approval is not granted but trust closes) to US$140 (if full merger approval is granted).
Risks and Contingencies: The filing explicitly lists numerous risks associated with forward-looking statements, including:
- Failure to obtain required regulatory approvals from the STB.
- Inability to agree on transaction terms or recognize anticipated financial benefits.
- General economic conditions, commodity price fluctuations, and energy costs.
- Operational disruptions due to severe weather, derailments, or labor disputes.
- Uncertainty regarding the timing of capital projects and pension plan liabilities.
Unusual Items: The filing addresses NS's criticism that the merger would be "cut to the bone" on costs, countering with historical data showing CP's model improves safety and service while reducing costs. It also notes that Pershing Square Capital Management, a major CP shareholder, is involved in the solicitation.
Important Facts for Investor Verification
- Regulatory Approval: The transaction's full value realization depends on STB approval of both the voting trust and the final merger, which could take up to 18 months.
- Management Independence: Verify the STB's acceptance of the proposed voting trust structure, which requires E. Hunter Harrison to sever all economic ties with CP while leading NS.
- Valuation Assumptions: The projected fair values (US$125-US$140) rely on specific assumptions regarding revenue growth (3% post-2018), operating ratio targets (58% for CP, 68% for NS), and tax rates (below 30% for the combined entity).
- Standalone Alternative: Compare CP's offer against NS's new standalone plan, which targets a 65% operating ratio by 2020 but lacks the immediate cash component and management overhaul proposed by CP.
- Non-GAAP Measures: Note that many financial metrics presented (e.g., adjusted operating ratio, free cash flow) are non-GAAP measures and should be reconciled with GAAP figures in CP's annual reports.