“Mad Money”

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CNBC, November 18, 2015, Transcript



"Mad Money"



Jim Cramer: Should Norfolk Southern, the terrific railroad company just say no to Canadian Pacific's $95 per share takeover offer announced yesterday, given the stock was trading as high as $117 at this point last year or should they take the money and run? Since the stock was trading in the 70s only a month ago should they try to hold out for a higher price? Right now it sounds like Norfolk Southern wants nothing to do with this offer or at the very least the company wants something much higher if it's going to sell out to Canadian Pacific at all and I can't blame them. Right now the railroads are caught in the grips in a huge decline in coal, the bedrock cargo for this business and it seems like it will get worse not better short term considering the much lower cost of natural gas as a feed stock for utilities, but at a certain point not every utility can switch and coal will eventually bottom out and the company has a thriving intermodal business that is just getting stronger. And while Norfolk Southern does ship some oil, a business that's now in severe decline given the price of crude, it's actually Canadian Pacific that's been the bell cow of using trains to transport oil which is why they need Norfolk Southern to make up for the lost traffic.



It seems to me as though Canadian Pacific is taking advantage of the decline in one particular cargo that might be at rock bottom, coal, in order to virtually steal Norfolk Southern to what's less than it's worth. Their takeover bid is reminiscent from another deal from another time, the hostile bid $70 bid made by Air Products for its cross region rival Airgas five years ago, an offer Airgas management argued was absurdly low at the time. How prescient given that yesterday Airgas delivered a $143 takeover bid for a French competitor Air Liquide, a huge premium to the $106 price the stock was trading at a day before and fully 49 points higher than the $94 level Airgas has fallen to last week. The Airgas story is relevant from Norfolk Southern because like Canadian Pacific has made several overtures to Norfolk Southern, Air Products pursued Airgas for ages, raising its hostile offer which was initially $60 to $70, prices Airgas was confident it could do better than, even though the stock was almost $20 lower from their first $60 bid. The CEO of Airgas expressed confidence he could do better. Air Products was getting the company on the cheap because of the great recession. He was confident of a quick bounce back.



Isn't it possible Canadian Pacific is doing the same because of its coal exposure? Or should shareholders of Norfolk Southern be glad to get any sort of premium in this difficult market? I usually advise managements to do the right thing, take the money for shareholders please. In fact, the only time I've ever violated that was in the Airgas hostile takeover. I sided with management that day because unlike so many CEOs, Peter McCausland had actually built the company himself and owned 10% of it. He had been on the show and had traced out a multiyear vision that had the stock going well above 100 but hadn't had a chance to get it there. Because he was no hired hand, he knew better than anyone what his business was worth. I came out hard for him over multiple weeks endlessly. I'm thrilled to say Peter thanked me for helping him turn the tide against the Air Products hostile bid so he could live to play again. This week's $143 bid for Airgas is a far cry from the $70 Air Products offered them in 2010. And McCausland, who is now Chairman will get almost $1 billion because of his patience and perseverance, he's actually earned it and you've made a pretty penny if you've stuck with him.



So should Norfolk Southern play hard to get? Should it reject the bid out of hand? Unlike Air Product, the current management in Norfolk Southern didn't create the company. Nevertheless they can make a compelling case like Airgas did that this is a cyclical trough and worth hanging on for higher prices. Hmm, maybe this is the incredibly rare takeover bid that's simply worth rejecting out of hand and if I were Norfolk Southern, I'd take a page from Airgas' book and just say no.







Forbes, November 18, 2015



Canadian Pacific Could Ride Hundreds of Millions in Tax Savings with Norfolk Southern Deal



By Antoine Gara



There's a good chance Norfolk Southern NSC +5.49% may wind up becoming the Burger King of railroads. And to make the analogy sound less crazy, the Norfolk, Va.-based company's suitor, Canadian Pacific, would be the Tim Hortons of tracks, terminals and rail yards.



How so? A prospective of Norfolk Southern by Calgary-based Canadian Pacific could generate the kinds of tax savings for the combined company that the merger of Burger King and Ontario-based Tim Hortons yielded when it closed in late 2014. On Tuesday evening Canadian Pacific telegraphed a bid for Norfolk Southern and this morning it laid out the full offer.



Canadian Pacific is offering a little over $97 for Norfolk Southern in a bid that consists of $46.72 in cash and 0.348 shares in the combined company, which would be listed on the New York and Toronto Stock Exchanges, similar to Restaurant Brands International, the parent of Burger King and Tim Hortons.



The deal also comes with clear strategic benefits, and may strengthen a disruptive force in the rail industry.



Norfolk Southern operates rail lines almost exclusively in the southeast, northeast, Appalachia and the rust belt of the United States, including rail yards in Chicago, Cleveland, Detroit, Newark, St. Louis, Newark, among others. Canadian Pacific, by contrast, in one the biggest railroad operators in Canada, with track that connects the country's port city Vancouver with western oil economies in Calgary and Edmondton and eastern cities such as Toronto and Montreal. The company does have track in the U.S., which access major cities in the Midwest, in addition to New York City.



Canadian Pacific said a combination would allow for increased competition in rates and change status quo in U.S. rail transport. It is offering a new way of looking at terminal access where operators would have to provide competitive rates its tracks or else risk losing connections to a superior operator.



The combined company would also give shippers the choice of where they can connect with another railroad along its network, ending a practice of "bottleneck pricing," thus enhancing competition. Canadian Pacific also said its strategy would help alleviate congestion issues in Chicago by channeling cargo to other cities, for instance Kansas City, Mo.



Wednesday morning, it quantified just what this strategy might entail for investors, projecting a whopping $1.8 billion in annual operating synergies, in addition to up to 45% pro-forma earnings per share accretion when including those run rate synergies. Given the cash and stock nature of the bid, Canadian Pacific expects to have pro-forma debt of four times EBITDA, with the ability to delever to 2.5x within two years.



But there is one aspect that Canadian Pacific didn't quantify, which could play a major piece of the deal.



By acquiring a larger U.S.-based railroad, Canadian Pacific could realize hundreds of millions in tax savings. In 2014, Canadian Pacific paid an effective tax rate of 27.5% on its $1.4 billion in profit, while Norfolk Southern paid an effective tax rate of 36% on its $3.1 billion in profit.



The merged company could adopt Canadian Pacific's tax rate, potentially generating well over half a billion in annual savings if synergy targets are met. About potential tax savings, Canadian Pacific says a merger would yield "substantial tax savings."



Robert Willens, an independent tax expert, says anytime a U.S. company becomes a subsidiary of a foreign corporation there is the ability to shift income ordinarily taxed at U.S. rates to a lower foreign rate through transfers of intercompany debts. "Such income shifting reduces the newly created group's effective tax rate below the "expected" tax rate resulting from simply combining the two corporation's current tax rate," says Willens by email.



Perhaps, at a time when lawmaker in Washington are focusing on corporate income tax rates, some will find objection to Canadian Pacific's deal.



Rail industries in Canada and the United States are also both highly regulated and face substantial antitrust issues given how the industry has consolidated over the past 20-years. Some analysts believe a deal could take upwards of two years to approve, and on Wednesday morning Norfolk Southern indicated it would reject the offer.



Burger King and Tim Hortons found itself the subject of a Senate subcommittee hearing this year into tax-focused M&A activity. The company, controlled by Brazilian PE giant 3G Capital, counts Warren Buffett and Bill Ackman as major investors, and is seeking to upend the global fast food industry. The merger, structured as an inversion, moved Burger King's headquarters to Canada, generating some flak for Buffett. Canadian Pacific's deal is simply a straight takeover, with no inversion calculus, thus making it hard to block a deal on tax grounds. But the tax saving are similar.



One other point.



Could Canadian Pacific's bid for Norfolk Southern prod a recent spat between Ackman and Berkshire Hathaway, which culminated last week with the hedge fund activist's criticism of Buffett's holding of Coca-Cola at a 50th anniversary celebration of his conglomerate?  It appears the orbits of both investors are, again, tethered together.



Canadian Pacific, under CEO Hunter Harrison, appears emboldened to disrupt the North American rail industry. Rail is one of Buffett's biggest investments after Berkshire's acquisition of Burlington Northern in 2010, and Wednesday's merger bid comes with classic signs of Ackman's involvement. Canadian Pacific's takeover proposal for Norfolk Southern tries to peg a future value on the combined company's shares, putting out a fair value of $270.68 a share. That makes the future value of shares received in the merger bid worth $94.16.



This is undoubtedly Ackman's kind of math.



Ackman is a board member of Canadian Pacific after winning a proxy battle and hiring Harrison as CEO. Despite a turn in Canadian Pacific's share price in 2015, the rail company stands as one of Ackman's most acclaimed activist moves. And Wednesday's deal underscores the ambition of Canadian Pacific as it seeks to capitalize on a souring of the rail market amid today's commodities rout.



It is perhaps one of boldest merger bids in today's M&A boom, which truly could transform a major industry. But those kinds of efforts generate backlash and controversy.



Opposition to Canadian Pacific's merger bid could be most acute among its competitors, risk-averse regulators, or even some customers skeptical of the company's disruption pitch. It's hard to know yet whether Canadian Pacific is trying to bite off more than it can chew. Nonetheless, a continued lull in railroad shares could play to Canadian Pacific's hand, and its Ackman-appointed CEO is known as maverick.



"If there is one person that is capable of overcoming all of these challenges, it would be Hunter Harrison – and we think it would be naïve to underestimate his ability to effect change," Credit Suisse analysts said on Wednesday.



Canadian Pacific shares were gaining over 5% in early trading, while Norfolk Southern shares were gaining by over 7%.