CN Railway (TSX:CNR): Why Investors Hate the KSU Deal

Canadian National Railway (TSX:CNR)(NYSE:CNI) stock rallied after its KSU deal failed. Why is that?

| More on:

Image source: Getty Images

Canadian National Railway (TSX:CNR)(NYSE:CNI) went on an impressive rally recently. After news broke that its Kansas City Southern (NYSE:KSU) deal structure was rejected, the stock proceeded to rise 10.7% in just two trading days.

What on earth happened here?

When you hear about a company’s M&A deal getting rejected by regulators, you’d normally take it as a negative. The company tried to do something and failed — that’s a loss, right?

Well, not necessarily. As it turns out, a lot of big CN shareholders think that the KSU deal isn’t worth it, and that CN would be better off without it. Some of these investors are even trying to get CNR’s management ousted, to replace them with executives they think are better. In this article, I’ll explore several reasons why major CNR shareholders hate the KSU deal, and share my own thoughts on the proposed acquisition.

The winner’s curse

One thing you need to keep in mind when considering the CNR-KSU deal is the economic phenomenon known as the “winner’s curse.”

This is a phenomenon that occurs in auctions when several parties aggressively bid up the price of an asset and end up offering too much. In the end, the auction winner pays a premium price for what might just be a lemon.

There may be a bit of a winner’s curse thing going on with CN’s KSU bid. You see, the company didn’t just come up with the idea to buy out KSU out of nowhere. It was actually Canadian Pacific Railway (TSX:CP)(NYSE:CP) that first bid for Kansas City, offering $29 billion. This got CN smelling an opportunity. It then began a bidding war with CP rail that ended with CN offering $33 billion — a price that CP couldn’t match. So, CN won the bidding war … but at a heavy cost.

KSU is very expensive at CNR’s offer price

Based on the price CNR offered for KSU, it looks like the former is paying a princely price. The implied valuation multiples based on a $33 billion price tag are as follows:

  • Price/sales: 12
  • Price/earnings: 53
  • Price/book: 7.5

Put simply, these are very high valuation multiples for a railroad. CN itself only trades at 27 times trailing 12-month earnings, for example. It’s paying almost twice that multiple for KSU. And Kansas City doesn’t have the kind of growth that would justify a premium price tag. Over the last five years, KSU has grown revenue by 3.5% annualized and seen its earnings decline. That’s not a great look. And yes, CN could find some synergies between itself and KSU that could increase shareholder value. But enough to make up for this negative long-term trend? It’s not a sure thing.

Foolish takeaway

If the CN/KSU saga can teach us anything, it’s this: a win is not always a win.

If a company pays too much for an asset, it may find itself a loser, even if it “won” in the auction sense. It looks like that’s what happened with CN and KSU. So maybe investors should be grateful the deal got blocked.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button owns shares of Canadian National Railway. The Motley Fool recommends Canadian National Railway.

More on Dividend Stocks

funds, money, nest egg
Dividend Stocks

The Best Way to Make $1 Million When a Bull Market Returns

Here are five quality TSX stocks investors can buy and hold for the long term, allowing them to increase their…

Read more »

Gold medal
Dividend Stocks

3 Undervalued Winners Just Begging to Be Invested in Today

Three undervalued stocks from three underperforming sectors are winners and screaming buys today.

Read more »

Man data analyze
Dividend Stocks

3 Top Dividend Stocks I Can’t Wait to Buy in 2023

Top Dividend Aristocrats are worth buying in almost every market, especially if you hold them long term. However, weak markets…

Read more »

financial freedom sign
Dividend Stocks

Buy 2,911 Shares in This TSX Stock for a Shot at $1 Million in 32 Years

You might not see insane growth overnight, but you won't see insane drops either from this TSX stock offering a…

Read more »

Dividend Stocks

A Dividend Heavyweight I’d Buy Over Enbridge Right Now

BCE Inc. (TSX:BCE) is a dividend heavyweight I prefer over Enbridge Inc. (TSX:ENB) due to its value and impressive income…

Read more »

Hour glass and calendar concept for time slipping away for important appointment date, schedule and deadline
Dividend Stocks

2 Best Monthly Dividend Stocks for March 2023

There are plenty of monthly dividend stocks to buy right now, but prospective investors should take a closer look at…

Read more »

A bull and bear face off.
Dividend Stocks

The 3 TSX Stocks to Buy Before a Long-Term Bull Market Begins to Build

The TSX may not go bullish for a while, even when the economy recovers from a recession, but investors should…

Read more »

Various Canadian dollars in gray pants pocket
Dividend Stocks

TFSA Investors: Make $200 in Monthly Passive Income With This 1 TSX Dividend Stock

Here’s an attractive dividend stock TFSA investors can buy now to earn $200 in monthly passive income.

Read more »