CP Canadian Pacific Kansas City Limited

By Ben Dummett 

Canadian Pacific Railway Ltd. made a cash-and-stock proposal to merge with Norfolk Southern Corp. worth about $28 billion, but said in a letter to its rival made public Wednesday that the deal could ultimately be worth much more.

Calgary, Alberta-based CP, which hasn't launched a formal bid, is offering $46.72 in cash and 0.348 shares of the merged company for each share of Norfolk Southern. If the two companies achieve more than $1 billion in cost savings by merging, the offer could end up being worth as much as $42.64 billion, CP said in a letter to Norfolk Southern chief executive James Squires that it released Tuesday.

The two sides are already differing on the value of the proposal, signaling that they are far apart on a potential combination.

Norfolk, based in Norfolk, Va., said the stock component of the offer is based on CP's share price, which makes the offer's value worth a lot less based on the Canadian railroad's projected valuation of the deal. In a release late Tuesday, Norfolk said it would evaluate the bid, describing it as an "unsolicited, low-premium, nonbinding and highly conditional indication of interest."

The proposal is meant "to start a conversation," that would lead to a deal, CP spokesman Marty Cej said. Norfolk Southern declined to comment further on Wednesday.

CP made its proposal public after a meeting last week between its chief executive, Hunter Harrison, and Norfolk's Mr. Squires, at which CP met with a cool reception, according to a person familiar with the matter.

A merger between the two railroads would create an industry giant and a rail network that would stretch from the Canadian West Coast to the Gulf of Mexico and U.S. Atlantic Seaboard.

CP said in its letter that the combined company could generate more than $1.8 billion in annual cost savings over the next several years as well as substantial tax benefits. CP didn't provide specific cost or tax savings in the letter.

According to a person familiar with the matter, CP is making the move in part because it believes its management could greatly boost the margins at Norfolk, along the same lines that Mr. Harrison has done since taking over CP in 2012. That followed a successful proxy battle by New York activist investor William Ackman to replace directors and management at CP, one of Canada's oldest and most storied companies.

Mr. Harrison believes he can get to a combined operating ratio in the mid-50% level, compared with Norfolk's approximately 70% ratio at this point, the person said. The lower a railroad's operating ratio, the more efficiently it runs and the more profitable it can be.

According to the text of the letter, CP said the merged company would be listed on both the New York and Toronto Stock exchanges, with Norfolk Southern shareholders owning 41% of the new company.

"We are ready to begin working with you and your team immediately on this transformational opportunity and are prepared to commit whatever resources may be necessary to complete the proposed transaction expeditiously and in a manner which both recognizes and fairly addresses any social considerations related to the successful integration of our two great companies," CP said in the letter.

Such a deal would face regulatory hurdles, and CP sought in its letter to outline steps it could take to show regulators that a combination could boost the North American rail network's competitiveness.

Laura Stevens and David Benoit contributed to this article.

Write to Ben Dummett at ben.dummett@wsj.com

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(END) Dow Jones Newswires

November 18, 2015 11:54 ET (16:54 GMT)

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