Burlington Northern Drops as Wall Street Questions Merger Plans

Its proposed grouping with Canadian National would create the largest railroad in North America.
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Updated from 2:40 p.m. EST

Wall Street questioned Monday whether the proposed merger of

Canadian National Railway

(CNI) - Get Report

and

Burlington Northern Santa Fe

(BNI)

would prove beneficial for Burlington's shareholders.

The deal, which would create the largest railroad in North America, was portrayed by the companies as a merger of equals with significant benefits. But Burlington shareholders, who would own about two-thirds of the combined company, were less optimistic than their Canadian National counterparts.

Shares of Burlington Northern Santa Fe dropped 3 9/16, or 13%, to close at 24 13/16. Canadian National's shares closed down 11/16, or 2%, at 29 1/16 after trading higher throughout the morning.

As a result of the selloff in Burlington, there was a spread of about 17% between its stock price and Canadian National's. The terms of the deal, however, imply that the spread should be only 5%.

"Usually, the acquirer's shares tend to go down." said Terry Gardner, an analyst at

Deutsche Banc Alex Brown

, referring to Canadian National. "But investors see that Canadian National is getting their franchise enlarged without spending a whole lot of cash."

On the other side of the tracks, the market view is that Burlington Northern is being acquired with no additional premium, Gardner added. "Shareholders of Burlington are not seeing the immediate benefit of the merger."

Under the terms of the deal, Burlington shareholders will get a share of the new combined company, to be known as

North American Railways

, and one Canadian National voting share that will trade together as one security.

Conversely, the shareholders of Canadian National will receive, for each of their shares, 1.05 Canadian National voting shares and either 1.05 shares of North American Railways common stock or 1.05 shares of Canadian National stock exchangeable for 1.05 shares of North American Railways common stock. The Canadian National voting share will trade together with the Canadian National exchangeable share as one security and will be Canadian property for investment, dividend and tax purposes.

The deal is expected to be completed by mid-2001 and result in savings of about $500 million to $600 million over the first three years after the merger closes, according to the companies. Based on Monday's closing stock prices, the combined company would have a market value exceeding $17 billion.

North American Railways will have 50,000 miles of track and have combined revenues of $12.5 billion. "In three to five years, this will be the premier freight railroad in North America," Gardner said. "But the issue here is time." Deutsche Banc Alex Brown has not underwritten any offering from either company. Gardner rates Burlington Northern a market performer and Canadian National a buy.

On the management side of the agreement, Robert Krebs, chairman and chief executive of Burlington, which is based in Fort Worth, Texas, will become non-executive chairman of North American Railways and Canadian National. Paul Tellier, president and chief executive of Canadian National, will hold the same offices for North American Railways as well as Canadian National. The combined company will have its headquarters in Montreal, where Canadian National is based.

"The combination uses a new model for railroad consolidation," Krebs said in a statement. The new company will grow revenues through common marketing and operating plans with new single-line service for shippers of goods and commodities.

A new model is what some farm associations are hoping for. They had watched their farm products rot in rail yards after the 1996 merger of the

Union Pacific

and the

Southern Pacific

railroads led to severe service disruptions.

Doug Wilson is the

Illinois Corn Grower Association

chairman and an eastern Illinois corn and soybean farmer who sends most of his grains over the railway system to Oklahoma and Arkansas. "I'm really not enthused about the history of rail mergers," said Wilson, who has farmed for 22 years. "When Union Pacific and Southern Pacific merged, they had a lot of problems with incompatible software, two different sets of employees, and their conductors didn't get along. You had a lot of settling issues that lasted longer than they should have."

Krebs said North American Railways would cut costs through buying in larger quantities, using trains more productively, using e-commerce and implementing the best practices of the two merging companies.

Gardner of Deutsche Banc Alex Brown explained that each time there is a hand-off between trains, the railroad incurs higher costs and longer delivery times. "Their new synergies are achievable; it's just a matter of time when."

This planned merger comes while Burlington Northern is overcoming its own integration problems after completing its merger with

Santa Fe Pacific

in 1995, creating the biggest competitor to the

Union Pacific Railroad

.

A wider implication of the merger nags Paul Bertels, an official of the

National Corn Growers Association

. "What's fueling this merger is that they're going after a little more lucrative materials like car parts, and containers filled with just about anything," he said. "In effect there will be less power, or locomotives, available for grains. Every year we're seeing this pattern, and it's accelerating. It's getting more expensive for corn to move across those tracks and this is going to be at the expense of grains."

Burlington and Canadian National said that workforce reductions would come from "normal attrition" as a result of minimal overlap of operations.

The combination is subject to approval by regulators of both countries.