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January 4, 2016 2:00 AM, EST

Norfolk Southern Turns Down Third Acquisition Offer, Calling Canadian Pacific’s Bid ‘Grossly Inadequate’

Andrew Harrer/Bloomberg News
This story appears in the Jan. 4 print edition of Transport Topics.

Canadian Pacific Railway Ltd. is weighing options such as a proxy fight after Norfolk Southern Corp.’s board of directors for the third time rejected an acquisition offer as “grossly inadequate” and unlikely to pass regulatory muster.

Virginia-based Norfolk Southern’s Dec. 23 statement came one week after the Calgary, Alberta, carrier enhanced its offer with a financial tool known as a contingent value right to add as much as $3.4 billion to its earlier offer worth $27.4 billion. Canadian Pacific’s other offer components remain at $32.86 in cash and 0.451 CP share for each Norfolk share.

“It is apparent that neither the executive leadership at NS nor its board of directors are willing to sit down in an open and constructive dialogue about this transformational opportunity and that the interests of the NS board are not aligned with the best interests of NS shareholders,” said the Canadian Pacific statement, also on Dec. 23.

Earlier in December, Canadian Pacific CEO Hunter Harrison and board member William Ackman, who led a successful effort to oust CP’s former management, sketched out an effort to either force Norfolk’s board to negotiate or run a new slate to oust the incumbents.

“It would be inconsistent with the duties of the board to pursue a risky and uncertain offer that substantially undervalues the company,” said the NS letter from CEO James Squires and lead independent director Stephen Lear. “We also note your repeated public statements that you are not willing to increase your offer regardless of whether we were to meet.”

The Canadian railroad has targeted $1.8 billion in savings, with lower operating costs and tax savings. CP most recently had an operating ratio of 59.8, 10 percentage points better than NS’ industry-worst level among Class 1 railroads. Norfolk in its earlier comments has rebuffed the Canadian offers, saying that the U.S. company has its own plan to lower operating costs and boost profits.

Operating ratio measures expenses as a percentage of revenue.

Norfolk also attacked other features of Canadian Pacific’s proposal, including its plan to put CP in a voting trust and shift Harrison to the CEO’s chair at Norfolk, while also disputing the Canadian carrier’s push for face-to-face talks.

“There is no basis to meet until you both make a compelling offer and address the regulatory issues, which you have the ability to do by seeking a declaratory order,” Squires and Lear said.

The Canadian carrier has said the U.S. Surface Transportation Board declaratory order process to determine whether a voting trust is suitable for the deal isn’t needed because there already is a pattern of the agency’s approval of voting trusts such as the one CP is planning to create.

The voting trust approach has been used in prior merger cases at STB to prevent a buyer from exercising control over multiple companies while the agency is reviewing the case. Norfolk contends that CP’s voting trust approach is flawed because CP will, in effect, be in control of both companies by having Harrison at NS and the rest of CP’s management in place at the Canadian railway.

Harrison last month noted that 144 voting trusts have been approved, and none has been rejected.

The two sides each have cited experts to address regulatory questions connected to the first major rail merger proposal since 1999.

In that year, Canadian National Railway and BNSF Railway agreed to combine, but abandoned their plan in the face of opposition from STB, shippers and other railroads.

Norfolk also announced cutbacks in coal operations, including the shutdown of a loading facility in Ashtabula, Ohio, and consolidation of thermal coal shipments from Ohio, West Virginia and Maryland at a dock in Sandusky, Ohio. The Ashtabula move is a response to coal business that has fallen off for both Norfolk and eastern U.S. competitor CSX Corp. as a result of low natural gas prices and other factors. NS coal revenue in three quarters of this year is down nearly 25%.

The coal pier changes are affecting 34 jobs in Norfolk’s workforce, or about one-tenth of 1% of its total workforce. Capital and operating costs also will be reduced, but the statement didn’t say by how much.