(The following story by Sinclair Stewart, Jacquie McNish and Andrew Willis appeared on the Globe and Mail website on July 18. With files from reporters Eric Reguly, Boyd Erman and Lori McLeod.)
NEW YORK, TORONTO — A private equity consortium led by Brookfield Asset Management Inc. is preparing a takeover offer for Canadian Pacific Railway Ltd. that, if successful, would represent one of the largest leveraged buyouts this country has seen, according to people familiar with the matter.
Sources said Brookfield, in partnership with Goldman Sachs & Co. and the Caisse de dépôt et placement du Québec, had expressed interest in a possible acquisition bid in April, but those advances were rebuffed. Instead, the board of the Calgary-based railway operator authorized a massive buyback of up to 10 per cent of its stock that some observers interpreted as an attempt to thwart a takeover.
However, the stock repurchase program has not deterred Brookfield from pushing ahead, according to a handful of people close to the matter. They said the prospective buyout group recently asked for another meeting with CPR’s directors to highlight the merits of a going-private transaction.
As of a few days ago, both Goldman and the Caisse were still partnering with Brookfield on the effort, the sources said, although they stressed the group is being “circumspect” and does not want to mount a hostile bid. It is understood CPR has hired financial advisers to spearhead its defence.
Spokespeople for CPR and Brookfield declined to comment on the matter.
At the end of trading yesterday, CPR was worth about $12-billion.
But analysts have suggested the company could fetch closer to $15-billion from private equity suitors, who would ratchet up debt levels to help finance the purchase and generate returns.
That would make it the second-largest leveraged buyout in Canadian history, second only to the pending $35-billion takeover of BCE Inc. by the Ontario Teachers’ Pension Plan and a pair of U.S. private equity firms.
It would also place it among an expanding group of blue-chip Canadian companies, including Inco Ltd., BCE and Alcan Inc., which last week agreed to be bought by London-based Rio Tinto PLC, that have been swallowed up in a feverish spate of merger activity.
Like CPR, BCE had no initial interest in yielding to a private equity buyer, and instead was said to be favouring a recapitalization.
But its ability to fend off a trio of suitors quickly dissipated after Teachers put the company in play through a regulatory filing that sent its stock soaring and enticed other bidders out of the shadows.
If Brookfield does make a bid, the CPR board of directors is expected to initiate a full-scale auction for the company by canvassing for other potential buyers. The most likely strategic buyer is Union Pacific Corp., the largest U.S. railway.
Australia’s Macquarie Bank Ltd., a heavyweight in the world of infrastructure investments, has modelled a possible CPR transaction and is said to be interested in the company, according to investment bankers, although it has not formally made an approach.
Sources said Brookfield was working on a plan that would split the 120-year-old railway operator into two separate entities: an operating company that actually runs the trains, and a real estate company that holds the tracks and rail yards. CPR operates a 22,000-kilometre rail network that stretches from Montreal to Vancouver, and includes branches in the midwestern United States.
The real estate division would be an infrastructure play, Brookfield’s specialty, and would be able to shoulder a great deal of debt.
“By leveraging the infrastructure assets, Brookfield or any other private equity buyer can juice up the returns they make on their initial investment,” said one investment banker who has modelled a CPR buyout in the past.
Another banker said that by including a tax-exempt pension fund in the private equity consortium, CPR’s new owners could structure a tax-efficient sale and lease-back of the railway’s real estate, with the pension fund owning the tracks and leasing them back to the railway division.
“Given [CPR’s] attractive fundamentals and appealing structural characteristics, we can see how it might be an interesting consideration for a private equity player,” said a recent report by analyst Walter Spracklin at RBC Dominion Securities. However, he also said CPR was not an ideal buyout candidate, as cost-cutting opportunities are limited and regulatory barriers are high.
If a private equity buyer steps up, Mr. Spracklin estimated it would pay $93 a share, or $14.3-billion, to take over CPR.
There are clear merits to a strategic transaction as well, though these have been obscured somewhat by regulatory uncertainty.
CPR and Union Pacific have networks that fit well together and the pair already enjoy a number of commercial ties. CPR and Union Pacific discussed a merger in 2000, when rivals Canadian National Railway Co. and Burlington Northern Santa Fe Corp. announced plans to marry.
That deal was blocked by U.S. regulators, and analysts say there is still strong resistance to rail mergers from customers and regulators.
CPR’s bonds show signs that investors were wary of a buyout that might include heaps of new debt. The company’s 5.75-per-cent bonds due in 2033, which have an investment-grade rating of triple-B from Standard & Poor’s, have plunged by about 10 cents on the dollar since February, driving up the yield by about three-quarters of a percentage point.
Bond investors dislike leveraged buyouts because they usually involve big new loans that lead to cuts in credit ratings for target companies.
Brookfield, Goldman Sachs and the Caisse formed a consortium to explore a potential bid for CPR in March, according to people familiar with the matter. Brookfield has a close working relationship with Goldman, while the Caisse, in addition to having deep pockets to help with financing, has historical ties to CPR. In 1982, the Caisse held a 10-per-cent stake in the company, making it the railway’s largest single investor.
Brookfield has aggressively stepped up its pursuit of private equity investments, particularly in areas like infrastructure and real estate, as part of its continued reinvention. The company changed its name from Brascan Corp. in 2005, and set to work shedding its reputation as a conglomerate that housed a variety of disparate assets. Under chief executive officer Bruce Flatt, the low-profile company now manages $70-billion (U.S.) worth of assets for itself and other institutional investors.