DBRS Comments on Canadian Pacific Railway’s Ratings Revised Business Combination Proposal with Norfolk Southern Corporation

DBRS Limited (DBRS) today notes Canadian Pacific Railway’s (CP or the Company) announcement of a revised proposal for business combination with Norfolk Southern Corporation (NSC). Under the revised proposal, CP will propose a voting trust structure for approval by the Surface Transportation Board (STB) in the United States pending final merger approval. Upon STB’s approval of the voting trust structure estimated by CP to be obtained by May 2016, CP will offer 0.451 shares in the combined company and will pay USD 32.86 in cash for every NSC share, compared with 0.348 shares and USD 46.72 in cash in the previous offer. The final merger approval is expected to be a more lengthy process and will take until December 31, 2017, to obtain.

The revised proposal was made after NSC announced on December 4, 2015, that its board had rejected CP’s previous offer made on November 17, 2015. NSC also commented on December 8, 2015, that the revised proposal has remained inadequate and that it does not believe that the voting trust structure will be approved by the STB in the United States. DBRS notes that, with initial rejection and subsequent comments, the likelihood of the companies reaching an amicable agreement in business combination remains remote.

DBRS maintains its view that the business combination with NSC could provide only an overall modest to limited enhancement to CP’s business risk profile as elaborated on in DBRS’s press release published on November 18, 2015. However, if the revised proposal were accepted by NSC’s shareholders and regulatory approval of the voting trust structure were obtained as planned, CP’s cash payments to NSC’s shareholders and related debt financing could happen as early as May 2016. Although there are still limited details on CP’s specific financing plan, the Company estimates in its analyst presentation that its pro-forma debt-to-EBITDA could increase to 4.0 times (x) at the time of cash payment in May 2016 and could reduce to 2.8x as at the end of 2017. DBRS notes that these pro forma financial metrics will deviate from the Company’s internal leverage target (unadjusted debt-to-EBITDA ratio of 2.5x or lower) and will not be consistent with those required for its current BBB (high) rating. DBRS believes that the much weaker financial metrics could potentially outweigh the moderate benefits in CP’s business risk profile.

At this stage, DBRS believes that there is still ample uncertainty about CP’s ability to conclude a sale and purchase agreement with NSC and its shareholders and about the likelihood of regulatory approval of CP’s plan. DBRS reiterates that CP’s rating could be placed Under Review with Negative Implications when a sale and purchase agreement for the transaction is reached and the regulatory approval process is initiated. DBRS could consider downgrading CP’s ratings by one or more notches when regulatory approval of the voting trust structure is obtained and the transaction is financed as planned. Conversely, the ratings could be confirmed in the event that the proposed acquisition does not materialize. In the meantime, DBRS will monitor the extent to which the continued efforts to acquire NSC could cause management distraction and affect CP’s own operations.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Companies in the Railway Industry, which can be found on our website under Methodologies.