'Game of chess' could see CP Rail boost bid up to US$35.8 billion, says analyst

MONTREAL – Canadian Pacific Railway has room to raise its bid for one of America’s largest railways by nearly US$8 billion, or as much as 26 per cent, an industry observer says.

The company has said its initial offer for Norfolk Southern, which would create the biggest railway in North America, was just a starting point. Scotiabank analyst Turan Quettawala said the Calgary-based railway can go as high as US$120 per share in cash and stock or US$35.8 billion.

“If Norfolk Southern’s board is willing to play ball, it will definitely have to be at a price which is above the approximately US$95 (per share) which CP has suggested so far,” he wrote in a report Monday.

The Virginia-based railway rejected CP Rail’s (TSX:CP) offer Friday as “grossly inadequate.” It also assailed CP’s “cut-to-the-bone strategy” and suggested the U.S. regulator is unlikely to approve a takeover deal at any price.

Canadian Pacific CEO Hunter Harrison and activist investor Bill Ackman of Pershing Square Capital are scheduled to hold a conference call Tuesday morning to respond in detail and “correct every inaccuracy” raised, the railway says.

Quettawala described the takeover battle as a “game of chess.”

Moving first with a takeover bid is risky, but it puts CP Rail in a commanding position to benefit from any consolidation in the rail industry by choosing a target that will deliver the most savings and offering concessions that could win regulatory approval, he wrote.

He also questioned whether the deal would lead to other mergers.

“If this were to be the only merger, then it may end up being the deal of the century in the railway world.”

While U.S. regulatory approval is uncertain, Quettawala said there is a low risk of Canada objecting. But that could change, he said, if CP is required during negotiations to make concessions to move the headquarters to the U.S. or change the company’s name.

The combined company would initially have more than 44,000 employees with about 53,000 kilometres of track — greater than the circumference of the Earth — stretching from the Pacific to the Atlantic Ocean and south to the Gulf of Mexico.

Already, some U.S. politicians have expressed concerns about railway mergers.

Democratic U.S. Sen. Amy Klobuchar and Republican Sen. David Vitter have introduced legislation to repeal a measure that exempts railways from anti-trust laws, even in cases where mergers of railways are determined to harm competition and American consumers.

The senators said the bill introduced in June, before CP submitted its merger proposal, is designed to promote fairness and competition in the railroad industry.

Currently, the Surface Transportation Board has the sole authority to approve large railway mergers if it finds them to be “consistent with the public interest.” The Justice Department, which oversees anti-trust legislation, only has an advisory role, Klobuchar said in a letter to the attorney general and the railway regulator.

Klobuchar said increased prices and diminished service have “burdened” the shipping industry and those that rely on freight rail. She said that’s costly for her state of Minnesota, which is the third largest for agricultural exports.

She also raised concerns about CP Rail’s proposal for a voting trust, saying it raises concerns about the independence of the two railways since the Canadian railway would gain operational control of Norfolk Southern before the Justice Department has weighed in on the merger and the Surface Transportation Board has determined if it is the public interest.