Canadian Pacific looks to coal future in $1.48B purchase of DM&E

Canadian Pacific looks to coal future in $1.48B purchase of DM&E

Canadian Pacific Railway Ltd. (TSX:CP) is expanding in the U.S. Midwest by paying at least US$1.48 billion for the Dakota, Minnesota & Eastern Railroad Corp., a move that will help CP Rail extend its coal and agriculture business.

“It complements what we do and creates a new footprint for growth,” chief executive officer Fred Green told a conference call Wednesday.

DM&E’s grain franchise complements CP’s $1-billion grain franchise, the two companies’ industrial products businesses have common products and customers and DM&E’s “fast-growing ethanol business is one we’ve been seeking to participate in.”

The deal, announced late Tuesday, will have Canadian Pacific take assume US$240 million of debt owed by DM&E. It also includes contingent future payments of up to US$1 billion based on progress on a long-term DM&E expansion to carry coal from the Powder River Basin of Wyoming.

The $6-billion project involves rebuilding almost 1,000 kilometres of track across South Dakota and Minnesota and adding 400 kilometres around the southern end of the Black Hills to the Wyoming coal fields. The rebuilt railway would haul low-sulphur coal eastward to power plants.

Green described the Powder River Basin development an “extraordinary growth prospect.”

“The growth of demand for low-suplhur coal from the PRB has been very strong,” he said. “Today this is a 470 million tonne market and its projected to grow significantly over the coming decades. The opportunity to participate in a large, rapidly growing market is rather unique.”

If the development goes ahead, it will effectively add a third railroad to the region and add coal-hauling capacity. It will also establish a dedicated, more direct route for coal from the basin to midwest energy markets.

But it has aroused strong opposition in some communities along the route, especially in Rochester, Minn., where the DM&E tracks pass close to the Mayo Clinic.

Calgary-based Canadian Pacific said the acquisition of DM&E, which runs through eight states, will expand its network by 4,000 kilometres and increase its access to U.S. Midwest markets for farm products, coal and ethanol.

Over the next several years, Canadian Pacific intends to spend $300 million on further upgrades of the U.S. regional railway, which is headquartered in Sioux Falls, S.D.

Green says Canadian Pacific considers the PRB development a realistic option, but structured the deal so that future payouts will be contingent on the success of that project.

“Its important to our shareholders that we don’t make unsubstantiated wild bets,” he said, adding that he expects a plan for the Powder River Basin to be in place within 12 to 36 months.

The deal caused Canadian Pacific to suspend its stock buyback, which has repurchased and cancelled 3.2 million shares this year.

Kevin Schieffer, DM&E’s chief executive officer, described CPR as “our natural partner.”

The 1,000-employee DM&E, described as the largest regional railroad in the U.S. and the only Class 2 railway connected with all seven Class 1 railroads, links with Canadian Pacific at Chicago and at Minneapolis and Winona in Minnesota.

Shares in CPR dropped $2.65 or 3.61 per cent to $70.82 in trading on the Toronto Stock Exchange.

The future contingent payments include US$350 million if construction starts on the Powder River Basin expansion before the end of 2025. Additional payments of up to US$700 million would become due if specified volumes of coal are moving from Powder River before that date.

In the meantime, Green said the DM&E acquisition will add to earnings per share next year.

“There are natural synergies between our two railroads which make this a very attractive transaction,” he stated.

With 7,200 rail cars and 150 locomotives, DM&E track runs through Illinois, Iowa, Minnesota, Missouri, Nebraska, South Dakota, Wisconsin and Wyoming.

Its 2006 freight revenue was US$258 million, expected to grow nine per cent to US$280 million this year.

Chief financial officer Mike Lambert added that CPR has lined up fully committed acquisition financing, and permanent financing for the purchase and expansion “will be structured to preserve appropriate debt and coverage ratios for our investment-grade rating.”

Canadian Pacific, which had C$392.1 million in cash at June 20, said its earnings outlook in 2007 is unchanged at C$4.30 to $4.45 per share excluding non-recurring items.

The takeover is expected to close in 30 to 60 days, subject to approval by the U.S. Surface Transportation Board.


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