30 January 2008
CP Rail Finds Missing Links in DM&E
When Dakota, Minnesota, & Eastern Railroad Corp. went up for
sale last year, Canadian Pacific Railway Ltd. banked a big part of its future on winning the prize.
"If you had asked CP what sort of regional railroad they would have coveted absent of an auction, it would have been
DM&E" said Steve Michell, RBC Capital Markets managing director of corporate finance, who helped structure the
US$1.48-billion deal for Canada's No. 2 railway last September.
Not only did the DM&E connect to CP's existing lines, there was also the gem in its portfolio - a possible expansion plan into the
coal-rich region of the Powder River Basin. While CP has yet to give the project a green light, it could be a major
revenue driver for years to come if it goes ahead.
Currently, the basin is only served by two railroads, Burlington Northern Sante Fe Railway, and Union Pacific. Mr. Michell has a long
history with CP, having worked with the railway since it became an independent entity in 2001. Still, he said he was impressed with the
speed with which CP assembled a crack team to determine that both BNSF and UP's lines were nearing capacity, while demand for the
thermal coal from the region continued to grow unabated.
Citibank and Merrill Lynch ran the highly competitive auction in the early part of 2007, sending out more than 50 books to potential
buyers, including both railways, and private equity players.
CP was very interested in the DM&E lines because of the potential synergies with it own operations, and the fact that they link up
with almost all of the major North American railways. The regional railway was also situated near several planned ethanol plants, which
it would eventually end up feeding.
"We think it was a coup," Mr. Michell said. "The rail industry, everybody knows, is a mature industry. There's not very
many opportunities left."
Primary on the list of concerns, however, for Mr. Michell's team at RBC and their counterparts at Morgan Stanley was to ensure that CP
didn't get caught holding the bag for a possible expansion plan, which many analysts have projected could cost upwards of $4 billion to
complete, if they even decided to go ahead with it.
"They looked at it somewhat cautiously, because when you have a project that is not built. What's the value of it? It's hard to
assess," Mr. Michell said.
While it was a competitive auction, CP agreed to pay a price tag of nearly US$1.5 billion, with another US$1 billion in contingency
payments should it go ahead with the Powder River project and begin moving certain volumes of coal out of the region along the
DM&E lines.
"So if CP is paying out any money to the seller," said Bill Volk, RBC's managing director of M&A, "It will only be
if they're making money."
The DM&E was purchased with a combination of a cash and debt from its owners, including Pittsburgh-based L.B. Foster
Co. and two London-based firms, Electra Private Equity PLC, and Candover Investments PLC, through a bridge financing that
RBC subsequently syndicated and sold into the bank market successfully.
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