(The following Reuters article was published in the New York Times on April 21.)
MIAMI — U.S. railroad Kansas City Southern Industries Inc. (KSU.N) on Monday struck a deal with the biggest rail operator in Mexico to buy control of the country’s main rail-freight line to the U.S. border.
Under the deal, Kansas City Southern Industries will change its name to NAFTA Rail, which will be a U.S.-listed holding company, the company said. Kansas City Southern will pay $412 million in cash and equity to Grupo TMM (TMMA.MX) (TMM.N) of Mexico for its stake in Mexican railroad Grupo TFM.
“It’s opportunistic on the part of Kansas City Southern,” said Rick Paterson, transport analyst at UBS Warburg. “TMM is in a degree of financial distress, andis using that to enlarge their stake in TFM.”
TFM, which is now 41 percent owned by TMM, 39 percent owned by Kansas City Southern and 20 percent owned by the Mexican government, has a concession to operate through the year 2047 the sole Mexican freight line to Laredo, Texas. Laredo is by far the busiest U.S. entryway for Mexican rail freight.
The deal, which must be approved by shareholders and regulators, was greeted by a selloff in Kansas City Southern’s shares on Wall Street.
The companies said in a news release that the boards of both companies have approved agreements which will place Kansas City Southern Railway Co., the Texas Mexican Railway Co., and TFM, S.A., de C.V. under the common control of a holding company. Texas Mexican Railway is a U.S. railroad partly owned by Kansas City Southern.
DEAL WOULD GIVE KANSAS CITY A KEY TRADE LINK
Paterson, who owns no shares in either railroad, said the deal would benefit Kansas City Southern over the long term and would leave the company with a key transport role in the NAFTA corridor created by the early 1990s North American Free Trade Agreement among Mexico, Canada and the United States.
The new company with three railroads would have 6,000 miles of lines reaching as far north as Omaha, Nebraska, and further south than Mexico City.
But Paterson said Kansas City faces several financial hurdles, including securing $200 million in cash to pay for 41 percent of TFM it is buying. He also said the company could be obliged to later this year pay $470 million to the Mexican government for its 20 percent of TFM under a put agreement.
“That, and the possibility the company may have to issue shares, is what is hurting the stock,” Paterson said.
Shares of Kansas City Southern closed off 6 percent, or 71 cents, at $11.06 on the New York Stock Exchange. The company also said on Monday that its first-quarter earnings due out on April 29 had been hurt by poor volumes. Grupo TMM ended up 3 cents at $3.74, after going as high as $4.34.
Executives said the deal calls for a subsidiary of Grupo TMM to receive 18 million shares of NAFTA Rail worth an estimated $211.9 million representing approximately 22 percent of the company.
Grupo TMM, which is also partly owned by Mexico’s government, will also get $200 million in cash and would be eligible for an incentive payment ranging from $100 million and $180 million based on the final decision in a long-running tax dispute with the Mexican government now in Mexico’s courts.
Paterson said settlement of the Mexican value-added-tax dispute could yield $800 million to $900 million for Kansas City Southern, an amount which would wipe away any financial uncertainties created by the deal.
A week ago, Mexico City-based TMM said it would raise $120 million by selling a stake in a ports and terminals unit in a campaign to reduce its debts. Grupo TMM, which runs Mexico’s largest railroad, is in danger of defaulting on $177 million in debt due in May.
Executives said the agreements must be approved by shareholders of both companies as well as the federal Surface Transportation Board in the United States and commissions in Mexico overseeing both anti-trust matters and foreign business ownership. Mexican regulatory approval was expected in a few months and within six months to a year in the United States, according to the executives.
Kansas City Southern executives said the deal would immediately add to earnings once it closed but that credit rating agencies may downgrade the company’s debt issues because of likely changes in its capital structure. Such ratings changes raise interest expenses for companies.
In addition, the Kansas City Southern executives said they expected to complete the TMM transaction on their own but would not rule out taking on a financial partner.
A call to Kansas City Southern was not returned.