Canadian Pacific Railway proposes merger with U.S.-based Norfolk Southern

MONTREAL – Canadian Pacific Railway formally proposed a merger with U.S. rail company Norfolk Southern on Tuesday in the hopes of creating a transcontinental railway, a deal that would extend the already vast reach of Canada’s second-largest railway.

The proposal was announced after markets closed Tuesday and includes a sizable premium in cash and stock, the Calgary-based railway said, although details weren’t immediately available. It also came hours after the chief operating officer for Canadian Pacific said consolidation in the rail industry in North America was inevitable.

In announcing the merger, CP said it was confident it could satisfy the concerns of regulators on both sides of the border, adding that the proposal could create a company with the potential for faster earnings growth than either railway could achieve on its own.

“CP strongly believes that the combined railroad would offer unparalleled customer service and competitive rates that will support the success of the shippers and industries it serves, and satisfy the U.S. Surface Transportation Board and Canadian regulators,” CP said in a news release.

CP (TSX:CP) also said the merger would alleviate congestion in Chicago by using underutilized hubs that would free up capacity for other railways operating through the city without the need for more infrastructure.

“An efficient end-to-end freight shipment solution will also improve safety, reduce highway congestion, and allow the rail industry to play an even greater role in the revival and sustained recovery of the North American economy.”

CP said it plans to take a new approach to terminal access, including giving shippers the option to connect with another railroad if the merged company fails to provide adequate service or competitive rates.

Neither CP nor Virginia-based Norfolk Southern could be reached for comment after the announcement. But CP said it hopes the board of directors for Norfolk Southern will give the offer “due consideration” and engage in a “thoughtful dialogue on creating a new industry leader.”

CP CEO Hunter Harrison has long advocated consolidation in the rail industry to ease congestion and transport goods more efficiently across the continent.

Earlier Tuesday, CP chief operating officer Keith Creel told a conference that an industry pause on mergers will eventually end.

“When it comes to consolidation, it’s not if, but when,” he told a Scotiabank transportation conference in Toronto.

He acknowledged that CP’s affinity for mergers — it tried but failed in its overture to Florida-based CSX Corp. a year ago — isn’t popular with some competitors.

“But it’s the inevitable thing and we’re not going to stick our head in the sand.”

Industry observers say a merger with Norfolk Southern would be good for both companies, but it would face significant regulatory hurdles.

The Surface Transportation Board placed a short-term moratorium on mergers in late 1999 following a proposed deal between CN Rail (TSX:CNR) and BNSF of Texas that was eventually called off.

Analyst Fadi Chamoun of BMO Capital Markets said regulators are probably loathe to ignite a flurry of mergers that could harm the competitiveness of other railways and hurt shippers.

But Creel said mergers can be done if the participating railways and their customers speak with a “common voice” to demonstrate that the change will improve service. That requires a friendly transaction.

CN Rail declined to comment on CP’s proposal but chief marketing officer Jean-Jacques Ruest told the Scotiabank conference that the current system works well for most railways in good economic times and bad.

Although the Montreal-based company is open to acquisitions of small, short-line operators, he said larger alternatives are constantly being considered and the railway will adjust to any changes.

“We like the environment that we have today. It doesn’t mean that we can’t deal with situations as they evolve,” Ruest said. “None of us are static and especially coming from a marketing background, you always expect chaos and out of the chaos you do something out of it.”

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