I’ll give it a shot.
KCS is generating earnings and cash flow. That money will soon go to CP. That money supported the investment in the KCS and will continue to do so when KCS is part of CP.
What CP needs to do is cover the premium it paid for the KCS with new business and new efficiencies. It does not have to cover the entire cost (which is rather large) out of increased earnings.
CP is borrowing $8.5 billion to cover the cash portion of the $31 billion, is assuming $3.8 billion KCS long term debt, and is issuing CP stock for the other $18.7 billion.
In 2020 KCS earned $616 million in net income on revenue of $2.632 billion.
In 2020 CP earned $2.444 billion in net income on revenue of $7.710 billion.
Combined and not adjusting for foreign exchange to Canadian dollars, that is $3.060 billion on revenues of $10.342 billion.
Very simplistically, CPKC thinks they can drop another $1 billion to the bottom line annually three years after the merger. That would be about a 33% increase in net income after covering added operating costs, interest expense on the debt, and taxes, to bring net income up to $4 billion, or more if they exceed their plan targets.
At 12/31/20 CP had $8.585 billion of outstanding debt so they will about double their long term debt to about $17.1 billion with this transaction, plus assume $3.8 billion of KCS debt for a total of $20.9 billion long term debt at the transaction completion.
Again simplistically, if CPKC earns $1.0 billion each year over and above CP and KCS “normal” net income of $3.0 billion, and the former KCS continues to contribute $600 million of net income that now comes to CP, then in theory after about 8 years CP would have received more added net income, at about $1.6 billion more annually, than the amount of borrowing they had done and the amount of debt they had assumed from KCS to purchase KCS. ($12.3 billion divided by $1.6 billion is about 8)
Again, very simplified to give a general idea of the major considerations.
kgbw:
Thanks for that back of the envelope explanation. What I didnt realize (and should have looked up) was the structure of the purchase…cash/debt/equity.
What will be interesting to watch is:
Can the new entity increase revenue? In other words, will the new route map lead to new traffic? If so, what will be the mix? Intermodal which is low margin or the good stuff?
The new entity will have debt to revenue ratio of roughly 2.02 to 1. In other words $2 of debt for each $1 of revenue. Compare to CN - .86 to 1. CP is obviously leveraging their balance sheet. If CP can maintain their current profitability, then the debt can be serviced. However, at 5% interest on debt, that would consume $1B per year. Free cash flow will obviously cover this, but will restrict dividend growth, share repurchase, cap ex, etc.
The OR for CP in 2020 was 57.1% adn KCS was 60.7%. It will be interesting to see how much lower that can go. Obviously there can be non operating expense cut, which do not affect the OR, but $1B per year? They are obviously counting on something else than cutting the OR into the 40’s…arent they?
These are just my thoughts on this purchase.
Full disclosure…long term CN shareholder and not disappointed that we were not the “winner” of this.
Ed
MP173
[Y][Y]
It sure will be fun to watch. The Jiffy Pop (with butter) is on the burner and starting to puff up!
Maybe CPKC would spin-off Kansas City-Springfield. Maybe CN would buy it back (ex-ICG).
Is it possible UP could be interested in the route? According to this Trains article from two years ago, they wanted trackage rights between KC and Springfield over the Wabash line. I’m not sure if they got the rights or if it fell through, but is it possible they may end up wanting their own route rather than rights over someone elses tracks? Pure speculation on my end, please correct me if that’s an unrealistic idea.
Could be a possibility if CPKC could work a “Wabash Speedway” deal with NS.
Or, perhaps it could form directional running along with the Wabash in a “Wabash Speedway” deal.
Fun to “war game” the different theoretical possibilities and then see what really happens!
My question in all of this is: How much ‘stuff’ (consumer goods) goes to eastern Canada (GTA & Quebec) from Mexico?
It’s been mentioned, auto parts from Mexico to the auto plant in Ontario (I presume GTA stands for greater Toronto area). They are currently extending I-69 to be part of a “NAFTA” corridor between the Mich.-Canada border to the Texas-Mexico border, and they expect a lot of trucks to use it.
Yes. There’s a lot of auto manufacturing in the area.
Perishables, Finished Autos, Appliances… Eastern Canada holds over 60% of the country’s population.
My next question is: How many trackage rights trains does CP field east out of Chicago to eastern Canada via NS/CSX? Between CBR, intermodal, finished autos and mechandise it’s at least a half dozen.
There is a pair of intermodal which runs Chicago to Buffalo via CSX and crosses.
NS has several (perhaps 3 each way) of combo general freight/auto.
Also a frequent ethanol movement via NS…not sure if trackage rights or hand off.
So, the usual count is 6-8 scheduled freights plus the ethanol.
Ed
Thank you. (I forgot the ethanol.)
And so the next questions: How much KCS/KCSdeM traffic to the Windsor-QC corridor will get single-line service with the new CPKC? Some is already there with interchange from UP/BNSF to CP at Chicago and will continue to ride on trackage rights over NS/CSX. But will they be able to pry traffic away from CN? How many more ton/miles will NS/CSX want to deal with on what is arguably their heaviest use corridors?
Actually, that is one of the reasons I think there might someday be a chance for a Wabash Speedway deal.
CP could run IM on the Wabash from KC and the Nickel Plate to Buffalo, with blocks for Detroit if necessary. This would give NS more capacity on their former NYC and they would get trackage rights fees that they otherwise would not get.
NS could barter that into potentially a Twin Cities Speedway deal of some type to access the one large Midwest metro area (5 million souls) that it does not serve and for which it’s parade of trucks every day leaving for cities south and east in NS territory could possibly ride NS trains.
I should like to think, based on recent actions by CP, they intend to consolidate their operations to the least amount of trackage possible. There is one fly in the ointment: the close confines of the Detroit River Tunnel. If they do finally get a full clearance route then KC-Detroit-GTA-Montreal becomes a very attractive possibility. Trackage rights to Buffalo shouldn’t be necessary after that. There will still be a need for a Chicago-Detroit route but that already exists.
Regarding CHI-DET, CP once used CSX’s ex-PM route thru Grand Rapids. Could be an alternate for the more crowded corridors. CSX has sold much of their other Michigan track, maybe they would also part with this trackage.
Perhaps CP can convince the Ontario Teachers Pension Fund to make an investment in that doublestack-capable tunnel under the St. Clair River. CP will need some help on major capital projects for a while until their volume increases to allow them the cash flow to service more debt than the $20 billion they will be carrying after the KCS purchase is completed.
CP used to run intermodal trains between Chicago and Kansas City, but dropped them a few years ago. Why does the company think it can make that route succeed now?
It will be a while before the peavine that is the former Milwaukee Road to KC becomes a robust route for IM, for sure. It is more a bulk traffic line now.
Perhaps CP is thinking that connecting all the consumer goods manufacturing in Mexico and Texas with all the markets in the Upler Midwest and Eastern Canada, as well as automotive parts traffic back and forth between Ontario and Mexico, will produce growth in IM traffic on CPKC.