“Take Canadian Pacific (CP) CEO Hunter Harrison out of the equation and CP's offer to Norfolk Southern (NS) and its shareholders would have little chance of getting anywhere, in our opinion,” said Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl.
According to Cowen and Company, CP's touted 77% premium is based on a pro-forma valuation of an entity that may not exist for up to two years, and it places only $32.86 per share in cash, or 38% of NS's Tuesday closing price, in shareholders' pockets in May 2016.
“The real selling point is management change, inherently a tough pill to swallow for NS's current management but could have some traction with many shareholders considering Harrison's record,” Seidl said. “The proposal calls for CP potentially being placed in a voting trust, with Harrison leaving the company to take over NS if the trust is approved by the Surface Transportation Board (STB). Harrison would then work his magic in slashing NS's operating ratio over the 18-month STB review process, achieving 72% of the operating efficiencies he believes he can garner for the eastern carrier. If the STB review concludes with a favorable decision, the two companies would merge, and the remaining 28% of operating efficiencies would follow.”
“We expect the back and forth between the two companies' management teams to continue in the coming days, with CP potentially sweetening the deal modestly if it senses that would get NS's management on board,” Seidl said. “We believe a face-to-face meeting between the carriers may be in the best interest of their shareholders at this point. But if that does not cut it, we fully expect CP to launch a proxy fight with the help of Pershing Square Capital, which is no stranger to such undertakings. Both Hunter Harrison and Pershing's Bill Ackman indicated that they already had the backing of some large NS shareholders, but more shareholder support may require an improved offer, in our opinion. CP hinted that it could improve the offer modestly.”
NS shares reacted negatively to CP's offer on Dec. 8, 2015 as investors had clearly expected more. That said, Cowen and Company expects the shares to at least find a floor at these levels while the story continues to unfold. Additionally, any other carriers that may be viewed as potential targets for future consolidation, namely CSX and Kansas City Southern (KCS), may see their shares outperform peers, Seidl adds.