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Canadian Pacific joins Buffett to reject railroad consolidation and narrow merger prospects

Two major rail operators pulled out of the merger race that has gripped industry in the last month. This has reshaped the competitive landscape, and raised the stakes on the proposed $85 billion union between Union Pacific and Norfolk Southern.

Canadian Pacific Kansas City, along with Warren Buffett's BNSF Railway BNSF Railway, publicly rejected any consolidation of the rail industry in the near future on Tuesday.

This move reduces the likelihood that a $85 billion merger proposed last month by top U.S. railroad operator Union Pacific with Norfolk will lead to further corporate marriages.

The merger will create the first east-west U.S. rail operator and reshape the movement of goods across the nation, from grains to automobiles. The merger sparked concerns over market concentration, and heated speculation that rivals might need to combine forces in order to stay competitive.

REGIONAL DUOPOLY

In recent decades the U.S. railroad industry has undergone significant mergers, going from dozens to just six major class 1 railroads.

Four major U.S. carriers dominate the U.S. rail freight industry - two are located in the west, and two are in the east. This means that shippers only have two options when it comes to the origin point.

Union Pacific, a major railroad company in the West, has proposed joining Norfolk, a railroad with ties to the East. Initially, it was speculated that the two other U.S. railroad operators – BNSF Railway (in the west) and CSX (in the east) – could merge in order to remain competitive against a giant coast-to-coast.

The game has changed dramatically in recent days. BNSF, backed by Buffett, dropped out first.

In the United States, two large Canadian railroads also operate. Canadian Pacific would be the only company with a trinational network that could merge with CSX. The announcement on Tuesday left CSX with no viable partner to merge large.

RISE IN REGULATORY RISE

Union Pacific's plan to purchase Norfolk and expand coast-to-coast faces increased regulatory risks.

If this were the only transaction being reviewed by the U.S. Surface Transportation Board regulators will be more concerned if this is the only deal under review by the U.S.

Last month, expectations were very different. Board officials were preparing to review megamerger proposals when Union Pacific and Norfolk Southern announced they were in discussions last month.

It is anticipated that the review will take between 17 and 22 months.

The Canadian Pacific

Canadian Pacific issued a statement in which it said that additional consolidation was not necessary. It also warned against a merger across the continent, saying this could "trigger a permanent restructuring" and "an unnecessary surge of rail mergers."

In a statement, CEO Keith Creel stated that "any major rail merger presents unique and unprecedented risk to customers and rail employees as well as the wider supply chain."

Berkshire Hathaway confirmed that Buffett and Berkshire Hathaway vice chairman Greg Abel had met privately on August 3 with CSX CEO Joseph Hinrichs, but they made it clear they weren't pursuing a merge, Berkshire said in an email following a CNBC article.

The two companies instead announced a new coast-tocoast intermodal service, signaling their preference for operational co-operation over consolidation.

CEO Creel stated that "many of the benefits claimed in support of transcontinental fusions can be obtained through new and expanded industrial partnerships."

He said that Canadian Pacific continues to pursue opportunities such as the recently announced collaboration between CSX and the Southeast Mexico Express, which links the U.S. Southeast with Mexico.

Canadian Pacific shares the same stance as BNSF which, on Monday, also ruled out participation in a merger, citing similar concerns over industry disruption and regulatory uncertainties.

Union Pacific is a dominant force in the western two thirds of the U.S., with Norfolk's 31,400-km (19,500-mile) network which primarily spans the eastern states.

Norfolk said Union Pacific will pay a $2.5 billion termination fee in cash if the contract is terminated under certain circumstances.

CSX announced on Tuesday that it is continuing to investigate additional options for improving transcontinental service.

The company stated that the board and management of CSX are committed to exploring all possible opportunities to increase shareholder value. This is illustrated by the recent intermodal service contract with BNSF. (Reporting and editing by Dawn Kopecki, Richard Chang and Sabrina Valle from New York)

(source: Reuters)