Canadian National Railway Co. dropped its pursuit of Kansas City Southern, clearing the way for Canadian Pacific Railway Ltd. to clinch a takeover deal as a monthslong battle for the highly coveted railroad drew to a close.
The $27 billion deal, if completed, would be the first major merger in the industry in the U.S. in about two decades and would create the first freight rail network linking Canada, the U.S. and Mexico.
Canadian Pacific and Kansas City Southern had clinched a $25 billion deal in March before Canadian National submitted a roughly $30 billion topping bid. That prompted Kansas City Southern to switch partners , before a regulatory panel that must bless railroad mergers denied Canadian National's plans to use a temporary voting trust , a key element of its proposal.
In the wake of that decision, Kansas City Southern on Sunday said it favored a sweetened cash-and-stock offer from Canadian Pacific, which had already received the go-ahead for a similar trust. Canadian National then had five business days to improve its offer or walk away.
In a statement on its decision not to continue pursuing the deal, Canadian National said the U.S. regulatory landscape has become more challenging for major railroad mergers since its bid was launched. It referred to an executive order from President Biden in July that focused on maintaining and increasing competition in key sectors, including the largest railroads, and suggested the shift could pose an issue for Canadian Pacific.
The decision to back away could appease one of Canadian National's major shareholders, TCI Fund Management Ltd., the London hedge fund that owns a 5% stake in the railroad. On Monday, it threatened a proxy fight to replace board members and Canadian National's chief executive. (TCI owns an 8% stake in Canadian Pacific, which it favors as a merger partner for Kansas City Southern.)
Canadian National will receive a $700 million termination fee as well as a $700 million reimbursement of a previous termination fee it covered.
Kansas City Southern and Canadian Pacific said Wednesday that their planned deal will create a railroad with roughly $8.7 billion in annual revenue, based on 2020 figures, and 20,000 employees. They said it would still be the smallest of the six major railroads in the U.S.
If the deal is approved, Canadian Pacific's chief executive, Keith Creel, will lead the combined company, which will be renamed Canadian Pacific Kansas City.
The smallest of the major freight railroads in the U.S., Kansas City Southern plays a key role in U.S.-Mexico trade. Its trains bring autos and other industrial products up from factories south of the border into Texas and the Midwest and haul U.S. farm goods back to Mexico. It also runs a rail link along the Panama Canal.
The combined company will create "a network that will never be replicated," Mr. Creel said in an interview. He said he expects more shippers will shift from clogged U.S. ports to less-busy ones in Mexico when shipping goods to the U.S.
The deal values Kansas City Southern at $300 a share based on closing stock prices Aug. 9, the day before Canadian Pacific unveiled its improved offer. Shareholders would receive 2.884 Canadian Pacific shares and $90 in cash for each Kansas City Southern share, and are expected to own 28% of the new company's outstanding common shares.
Canadian National shares closed up 2.1% on Wednesday, while Canadian Pacific rose 1%. Kansas City Southern shares were little changed, closing at $281.48.
The transaction, which requires signoff from both sets of shareholders, involves a two-step process. First, a voting trust would acquire Kansas City Southern shares and, assuming necessary approvals are granted, the companies would then merge. Canadian Pacific received approval for the trust from the regulatory panel, the U.S. Surface Transportation Board, in May.
Mr. Creel said he expects regulatory reviews to be completed by the end of 2022. The company plans to file a merger application in mid-October to the STB, which requires major railroad combinations to be in the public interest and enhance competition.
A separate review in Mexico, where Kansas City Southern operates a large network, won't likely be completed until near the end of next year, Mr. Creel said.
The companies see the deal as adding to Canadian Pacific's adjusted earnings per share in the first full year after the acquisition.
Kansas City Southern emerged as a takeover target about a year ago when it drew interest from a group of buyout investors including Blackstone Inc. Kansas City Southern rejected a roughly $20 billion takeover offer at the time, arguing it undervalued the railroad.