How Likely Is a Merger Between CP and Kansas City Southern?

                                                Photo courtesy of Kansas City Southern

By Michael Hooper

The U.S. Surface Transportation Board will review the proposed sale of Kansas City Southern (KSU) to Canadian Pacific Railway (CP).

The STB has broad economic regulatory oversight of railroads, including rates, service, the construction, acquisition and abandonment of rail lines, carrier mergers and interchange of traffic among carriers.

Based on my previous coverage of these issues, I expect the STB will examine whether the deal improves or harms service and competition. Former Surface Transportation Board member Deb Miller spoke at length about railroad mergers in this 2014 article I wrote during her time on the board. Hunter Harrison had tried to get some merger activity going at CSX (CSX) with Canadian Pacific in 2014 but without much luck.

At that time, she said, the STB would look hard at whether any merger would improve service and competition.

"We would be very reluctant to do anything to make service issues worse," Miller told me.

I don't see any reason for major shipping delays as a result of the merger of CP-KSU. They don't overlap. 

Mergers were common in the rail industry in the 20th Century. It was either get larger or die trying to compete. Yet mergers haven't been so frequent in the past 20 years. Now there are just seven Class 1 railroads.

There is no guarantee the Surface Transportation Board will approve a merger. In 1999, BNSF Railway and Canadian National Railway (CNI) proposed a merger that would have created the largest transcontinental railway in North America. The Surface Transportation board imposed a 15-month moratorium on new rail mergers. Months later the two railroads called off the merger. Back then shippers complained that past mergers -- Union Pacific's 1996 acquisition of Southern Pacific Rail Corp. and 1999's splitting of Conrail Inc. between Norfolk Southern Corp. (NSC) and CSX -- had caused massive delays and poor service.

The CP acquisition of Kansas City Southern is unique because it involves trade between three countries, Mexico, the United States and Canada. KSU owns Kansas City Southern de Mexico, based in Monterrey. Canadian Pacific will be expanding its global reach across the Midwestern United States and Mexico and giving KSU access to points in Canada and the North and Northeast. This is strategically a good move for CP and generally a win-win for both companies. There is no overlap in rail, no duplication. Indeed, a single-line company moving product over three countries is opening up new markets. 

CP and KSU are among the many beneficiaries of the North American Free Trade Agreement, which eliminated all tariffs and quotas on US exports to Mexico and Canada.

The CP-KSU combination would not eliminate competition. A primary competitor in the NAFTA business is Union Pacific, which has the most connections with Mexico of any railroad in the U.S. UP serves the six border crossings of Brownsville, Texas; Laredo, Texas; Eagle Pass, Texas; El Paso, Texas; Nogales, Ariz. and Calexico, Calif.

In a way, the proposed CP-KSU merger reminds me of the Canadian National Railway acquisition of the Illinois Central in 1998. That acquisition gave CN ownership of a Chicago-New Orleans route, thus giving CN access the Gulf Coast waters along with already longtime historic connections to the Pacific and the Atlantic in Canada.

On March 21, Canadian Pacific and Kansas City Southern announced they have entered into a merger agreement, under which CP has agreed to acquire KCS in a stock and cash transaction representing an enterprise value of approximately USD $29 billion, which includes the assumption of $3.8 billion of outstanding KCS debt. The companies said they were offering 23% premium, based on the CP and KCS closing prices on March 19, 2021, but CP's price fell 7% after the deal was announced while KSU stock was up 10%.

Shareholders of KCS will receive 0.489 of a CP share and $90 in cash for each KCS common share held, according to a joint company statement.

Joining in Kansas City, Mo., the statement said the combined company will connect customers via single-network transportation offerings between points on CP’s system throughout Canada, the U.S. Midwest, and the U.S. Northeast and points on KCS’ system throughout Mexico and the South Central U.S., the companies said. 

The combined company will operate approximately 20,000 miles of rail, employ close to 20,000 people and generate total revenues of approximately $8.7 billion, the companies said.

The companies expect synergies of approximately $780 million over three years.

To fund the stock consideration of the merger, CP will issue 44.5 million new shares. The cash portion will be funded through a combination of cash-on-hand and raising approximately $8.6 billion in debt, for which financing has been committed. As part of the merger, CP will assume approximately $3.8 billion of KCS’ outstanding debt. Following the closing into trust, CP expects that its outstanding debt will be approximately $20.2 billion, the companies said.

Stockholders betting on a merger are taking a calculated risk. This deal does not have much overlap in rail lines and will create longer single-line delivery methods for customers. CP will gain valuable access to Midwest US and Mexican rail lines, giving customers more destinations for delivery.

As of this writing, KSU stock was trading at a 6% discount to the acquisition price. We may see a trading discount due to the long regulatory process typically involved in a deal of this scale. Whether the deal goes through, I think shareholders are wise to hold onto their assets. There aren't many Class I railroads available for public ownership, so it's best to own what we can. Margins have improved in recent years in the rail sector, making them attractive investments. 

If KSU stock gets folded into CP, that is one less investment possibility in the rail investment world. And for investors like me who like railroads, that will be a disappointment. Nevertheless, I give the CP-KSU merger a 51% possibility. This deal will create new shipping options for customers because one company will cover three countries under the North American Free Trade Agreement. This deal could lead to new or expanded markets for customers.

Editor's note: The Author owns shares in UNP, NSC, CNI and BRK.B.

Railroads Haul More Containers in Q1

BNSF Railway Shops, Topeka

By Michael Hooper

A review of the weekly volume reports at BNSF Railway, Union Pacific and Norfolk Southern (NSC) shows that while carloads may be down so far in Q1, container and trailer volume is up. Ports have been backlogged with ships waiting to unload containers.

At Norfolk Southern (NSC) intermodal volumes -- containers and trailers -- were up 5% Year To Date through Week 9, ended March 6.

At BNSF Railway (owned by Berkshire Hathaway (BRK.B), container and trailer volume were up 14% YTD through Week 10, ended March 13. For many months there has been a backlog at the Los Angeles and Long Beach ports, where BNSF Railway and Union Pacific pick up freight and haul to Chicago and other places.

The ports in Los Angeles and Long Beach have been dealing with delays since June 2020, according to Ian Putzger in the Loadstar.

Container and trailer traffic at Union Pacific was up 8% YTD through Week 11, March 20.

Winter storms slowed down volumes of freight for the railroads in February, this harsh weather event, that included many days of freezing weather, will most likely affect first quarter earnings.

Union Pacific is trading with a 27 P/E ratio and a forward P/E of 19.9. The dividend yield on this stock is 1.82%. Historically, the yield on the stock is around 2% to 2.5%.

I expect volumes should be improving into the summer months.

Union Pacific, BNSF Railway, Canadian National Railway and Canadian Pacific will be the beneficiaries of all that freight coming into the west coast ports from Asia. Norfolk Southern and CSX (CSX) benefit from freight on the East Coast ports.

Railroad margins have improved in recent years, making these attractive investments. Net profit margins at Norfolk Southern (NSC) and Union Pacific (UNP) are around 26%.

There's so much pent-up demand among consumers; this demand will translate into more freight and merchandise being moved over rail and road. Financial metrics such as P/E ratio, yield and price-to-book ratios indicate these railroad stocks are trading above their historic averages, but there is a good reason to hold. There are just seven Class I railroads in the United States and Canada. Only six of them are publicly owned. With the potential for Canadian Pacific (CP) acquiring Kansas City Southern (KSU), there will be one less publicly-owned Class 1 railroad stock if the deal goes through.

Conclusion

I am bullish on rail stocks. Shippers will move steady-to-growing amounts of freight as we head into the summer months. These railroads are big cash machines with the ability to ebb and flow with the economy. The economy contracted during the pandemic of 2020, yet these railroad stocks were up. Railroads remain profitable and did not have to cut their dividends. I recommend holding these railroad assets for dividend income and modest growth in 2021.

Editor's note: The author owns UNP, NSC, CNI, BRK.B.

Brad Garlinghouse Fights SEC Lawsuit Over Crypto Sales

Brad Garlinghouse speaks at Topeka High School in 2017

By Michael Hooper

Brad Garlinghouse, CEO of Ripple Labs Inc., plans to file a motion to dismiss a lawsuit against him by the Securities and Exchange Commission over the sale of his XRP cryptocurrency.

Garlinghouse, a graduate of Topeka High School, has been fighting this lawsuit for two and a half years.

"After a 30-month investigation and after the production of more than 200,000 pages from the defendants and third parties, the best the SEC can do is allege that Mr. Garlinghouse was generally aware of the risk that some digital assets could possibly be deemed to be securities but that he worked hard to ensure that XRP did not even appear to have those features," says a letter by Matthew Solomon, on behalf of Brad Garlinghouse.

The SEC alleges Garlinghouse sold over 357 million of his XRP for approximately $159 million and that these transactions occurred at various digital asset trading platforms. Garlinghouse also directed sales of some of his company's XRP. Garlinghouse attorney Solomon says those platforms alleged by the SEC seem vague and seem to obscure what the SEC knows but merely hints at with passing reference to Mr. Garlinghouse's worldwide sales. The truth is that the vast majority of Mr. Garlinghouse's XRP sales were made on foreign exchanges and those transactions do not and cannot violate the federal securities law, Solomon wrote.

Yesterday on Brad Garlinghouse Twitter account, he posted a tweet saying, "Today, a letter was filed on my behalf indicating my intent to file a motion to dismiss in response to the SEC's amended complaint against me. Simply put the SEC's allegations are regulatory overreach."

The SEC says that XRP is a security and should have been registered with the SEC as such. The SEC says XRP is a security because of "an investment contract."

Yet Solomon says the SEC fails to understand the XRP market for the past eight years. XRP, he says, is a digital asset used to make faster, cheaper, and more efficient payments and money transfers. That is the business model at Ripple.

Garlinghouse has said Ripple sells a blockchain technology to banks and payment providers to do real time settlement between banks. He says the current banking system for settlement between U.S. and foreign banks is lengthy and time consuming.

I know Bitcoin is considered a commodity by the SEC. Why would XRP be any different? XRP is listed as one of the top cryptocurrencies in the world by market capitalization on the top cryptocurrency websites, such as coinmarketcap.

Garlinghouse, the son of Kent and Susan Garlinghouse of Topeka, is a graduate of University of Kansas and Harvard Business School.

When XRP was trading around $2.50 to $3.00, Forbes published an article in January 2018, saying Garlinghouse was worth $9 billion. But XRP fell from those highs to $0.47 cents in recent trading.

Brad Garlinghouse was inducted into the Topeka High School Hall of Fame in 2017. Here is an article about that event.

Two Prolific Artists: O'Keeffe & Picasso

Pablo Picasso in his 20s in Montmartre, the golden age of his early years in Paris.

Corn, Dark I, by Georgia O'Keeffe

By Michael Hooper

Trying to stay warm this winter, I have sat by the fireplace reading biographies about two great artists: Georgia O'Keeffe A Life by Roxana Robinson, and Picasso Creator and Destroyer by Arianna Stassinopoulos Huffington. I couldn't have picked two more fascinating and independent people, O'Keeffe is escaping from patronizing men into an independent feminine mystique while Picasso the raging bull has extensive relationships with multiple women. Both artists lived into their 90s yet made their mark at various stages in their lives. 

Georgia O'Keeffe became known for a very distinctive style of color patterns of nature, especially in the Southwest where her views of the desert landscape and big sky were evocative and much loved. She was also known for her enlarged flowers that had a sexuality about them.

O'Keeffe was married to Alfred Stieglitz, the famed photographer and gallery promoter who sold her work. Some of her paintings sold for thousands of dollars in the 1930s. Stieglitz photographed O'Keeffe nude and exhibited the photographs as art. O'Keeffe painted leaves, branches or bones she found on walks. She worked in a studio that was a former shack on the Stieglitz family farm at Lake George, N.Y.

O'Keeffe moved out west for the back half of her life, settling at Ghost Ranch, New Mexico. Eventually one of her hired hands Juan Hamilton takes control with power of attorney over her finances and inherits most of her money through changes in her will. Her estate was worth $70 million. Her family sued and received a settlement.

At one time O'Keeffe had a chance to be introduced to Picasso but she declined the offer because she said they wouldn't be able to speak to one another, according to Robinson's book.

Pablo Picasso was a precocious child prodigy from Malaga, Spain, who could draw anything and excelled beyond his father who was an art teacher. When Picasso was almost 19 years old, he arrived in Paris speaking no French and having no place to stay but quickly found an art studio and fell into Parisian life of cafes and shows, artwork and brothels. He learned to speak French and lived in France most of his life. 

Picasso emulated multiple styles and was an inventor of styles like his African-influenced period and his cubism. He was good at every style he worked in. Picasso's Rose Period, his Blue Period and his Cubism all are so fascinating. I saw his Old Guitarist at the Guggenheim. Picasso was quick to draw and paint canvases; he produced tens of thousands of works of art, sculpture and drawings.

Yet Huffington spends much of her book on the woman's point of view, the day-to-day living with this insufferable man with a raging passion for sex. Picasso would find a model and then keep her around and sleep with her and sometimes marry her or just put her on the payroll. Dora Maar is a good example of a model with a sexual relationship with him while he was still attached to another woman. His infidelity would drive women crazy. Yet his life with them was often brilliant with encounters with Henri Matisse and Gertrude Stein and other interesting people of the day. Dora Maar was not the same person after Picasso got rid of her.

Huffington depends largely on the published works and interviews with Francois Gilot, Picasso's former former lover and mother of Claude Pierre. Gilot published a memoir, "Life With Picasso" in 1964 with author Carlton Lake.

I enjoyed reading about Pablo Picasso in his 20s in Montmartre, the golden age of his early years in Paris. Before long, he had met Gertrude Stein in Paris, and many other artists. Picasso had his gang of friends. They would go to bull fights. Somehow he became a member of the Communist Party. It's kind of a strange trip in the end, very sad when he shuns his children and grandchildren.

With the O'Keeffe book, I got a sense of O'Keeffe's feeling and intuition in art. The Picasso book was a very good book too, but felt it could have provided more discussions and photographs of his artworks and how Picasso was so influential with certain artworks. Both books are enriching and entertaining. Both Picasso and O'Keeffe led long and prolific lives.

Huge Opportunity in Coinbase Stock

By Michael Hooper

The opportunity to own stock in Coinbase Global Inc. is huge. The company plans a direct listing of shares on March 14 on the NASDAQ. Once shares begin trading I plan to buy them. This company is the leading trading platform for Bitcoin and other crypto currencies. I've used Coinbase successfully to buy and sell Bitcoin and ethereum since 2017.

The direct listing price of the stock will likely be very high. The trading ticker for Coinbase is (COIN). Anyone with an account at a stock brokerage can buy the stock after the direct listing. On Thursday Feb. 25, 2021, the company made a filing of S-1 Prospectus with the Securities and Exchange Commission.

There was a private sale of 127,000 shares at $373 per share which works out to a valuation of $100 billion, according to Axios.

Due to increasing popularity of Bitcoin and other cryptocurrencies, I expect the direct listing of Coinbase to generate huge support.

Coinbase states that it currently has about 43 million retail users, 7,000 institutions, and 115,000 ecosystem partners in over 100 countries.

As of Dec. 31, 2020, the platform had executed $456 billion in trading volume since its inception and stored over $90 billion worth of assets. In May 2020, the company with 1,200 employees became “a remote-first company,” which means they work remotely first with no headquarters yet maintain some physical offices.

Coinbase reported $322 million of profits on $1.28 billion in revenue for 2020, compared to a $30 million net loss on $534 million in revenue for 2019.

The largest single owner of Coinbase stock is Marc Andreessen at 24.6% of stock. Brian Armstrong, CEO, owns 21% of Coinbase stock.

Critics complain of Coinbase's high fees for transactions. There are other trading platforms like uniswap that may prove to be more competitive.

There are other risks. What if the crypto markets suffer a crash and a long bear market? There will be ebbs and flows of people in and out of it. But long term I think crypto is here to stay.

Kansas Gas Service Says Customers Can Expect Higher Bills

This chart from macrotrends shows the Henry Hub natural gas spot price rose from $2 to $23.86 on Feb. 17.

By Michael Hooper 

Natural gas prices soared to unprecedented levels during the extreme cold spell in February. Customers of Kansas Gas Service can expect their bills to be much higher than normal. The spot price of Henry Hub natural gas prices climbed from $2 per mcf to $23.86 by Feb. 17 during the cold weather event.

"Due to the historically low temperatures that remained below freezing over an extended period of time, we experienced much higher natural gas demand that resulted in a significant increase in natural gas market prices on a portion of the supply purchased during this period," said Dawn Tripp, manager of public relations for Kansas Gas Service. "Customers should prepare for higher natural gas bills because of the increased usage for home heating."

ONE Gas (OGS), of Tulsa, owns Kansas Gas Service and also serves customers in Texas and Oklahoma.

"Many of our service areas haven’t seen such low temperatures in more than 100 years," Tripp told Thoughtful Investor. "The higher amount of gas used will be reflected on customers’ bills. We do not set the price, nor mark up the price we pay for the gas. We purchase the gas from suppliers and then deliver it to customer homes. The price we pay the suppliers for gas is the price customers pay."

A review of natural gas prices show the price was for many years between $2 and $4 per million BTU. One million BTU is approximately equal to 1,000 cubic feet of natural gas. A unit of 1,000 cubic feet of natural gas is one mcf. It's not uncommon for a household to use 1 mcf in a single day of heating in the cold weather months. When the price of one mcf soared from $2 to $23.86 on Feb. 17 during the cold weather spell, companies that needed gas would have to pay the spot price on the open market and then pass it onto their customers.

It's difficult to speculate here, but it's possible customers will see their bills rise 3 to 10 times over their normal bills. That is quite a variance but Kansas Gas Service would not provide hard numbers.

Tripp said Kansas Gas Service is working with the Kansas Corporation Commission on "options related to the impact to customer bills associated with the significantly high natural gas market prices during the cold weather event."

She said the KCC had issued an order that authorizes natural gas and electric utilities to defer any extraordinary costs incurred associated with ensuring that customers continue to receive service during the cold weather event.

She said Kansas Gas Service will make a filing with the KCC which includes a plan to minimize the financial impact of the cold weather event on customers over a reasonable period of time.

The KCC on Feb. 15 issued on Emergency Order authorizing natural gas and electric utilities under KCC jurisdiction to defer any extraordinary costs they incurred associated with ensuring that customers continued to receive service during the cold weather event. The utilities are tracking those costs and are required to make a filing with the KCC. That filing must include a plan to minimize the financial impact of the cold weather event on customers over a reasonable period of time. There is no specific due date set for those filings yet, said Linda Berry, spokesperson for the KCC.

My 20-Stock Value Play

The U.S. stock market crashed in March 2020, but quickly recovered and then went onto to reach new all-time highs. The investment, SPDR S&P500 ETF Trust (SPY), is one of my core holdings.

By Michael Hooper

The secret to my portfolio is owning fairly conservative value-play stocks with strong balance sheets, along with index funds, ETFs and bonds. Diversification is important, especially during downturns and crashes.

I have averaged an 11.5% annual return on my investment portfolio since 2009, according to numbers generated by Charles Schwab's performance tab. I am happy with this return. I could have done better by putting the entire portfolio in the S&P 500 Index, which generated a 15.2% annual return since 2009, but that increases risk and volatility.

About 62% of my portfolio is invested in income producing securities such as dividend paying stocks, ETFs, bonds and mutual funds. My equities include a balance of railroads, consumer stocks like PepsiCo (PEP), and S&P 500 ETFs. When quarterly income flows into my investment accounts, I buy more stock.

Berkshire Hathaway (BRK/B) represents 38% of my portfolio, partly because I've been an investor since 1997 and our original investment is up more than 10 times. Berkshire Hathaway is like a mutual fund because the holding company owns over 100 great businesses, such as Geico and BNSF Railway. And it has over $145 billion in cash and a strong balance sheet. Warren Buffett, CEO, won't be around forever but I'm sure the company will continue to do well long after he's gone. He's set it up that way. Berkshire Hathaway is currently trading at 1.38 times book value, that's at the high end of a trend that began in spring 2020 when it bottomed around 1.2 times book value. When it was trading that low in 2020, the company bought stock back because management thought it was so cheap.

The S&P 500. I like SPDR S&P 500 ETF Trust (SPY). The S&P 500 index is the standard by which all large cap investors are measured. Most managers cannot beat the index so why not just own the index. Every investor should own some of the S&P 500. I used to put my entire 401K into the S&P 500 at my employer. This strategy worked out pretty well. Right now the S&P 500 represents about 9% of my portfolio. But another 6% of my portfolio is in a similar investment, The Proshares S&P 500 Dividend Aristocats ETF (NOBL) is an ETF that pays a quarterly dividend yielding more than 2%.

I like Union Pacific (UNP), Norfolk Southern (NSC) and Canadian National Railway (CNI). These three are domineering railroads in their regions. They represent about 10% of my portfolio.

I like Google (GOOG), Apple (AAPL). These two assets represent 2% of my portfolio.

I own United Airlines (UAL), Expedia (EXPE), and Southwest Airlines (LUV). These three assets represent less than 1% of my portfolio. I'm betting travel will come back some day after the Covid-19 crisis subsides. I already have big gains in these stocks, but I think they have more to go.

About 10% of my portfolio is in PepsiCo (PEP) Coca-Cola (KO), Church and Dwight (CHD), Hershey (HSY). I like these companies for their steady earnings and dividends. My favorite is Church and Dwight, the company produces baking soda, condoms, oral hygiene products and vitamins. Sales of its vitamins have boomed during the Covid-19 pandemic.

Another 3.6% of my portfolio is in utilities including Evergy (EVRG) and Dominion (D). The utilities have paid dividends but haven't grown in value for the past year.

I own quite a bit of ishares Core US Aggregate bond index (AGG). And I own some railroad bonds from BNSF Railway and Union Pacific Railway. In total, the bonds represent about 20% of the portfolio.

I also have small positions in Aphria (APHA), Casey's (CASY) and MGP Ingredients (MGPI). I think the cannabis industry has a lot of potential and Aphria is a good bet.

In March 2020, I wrote an article calling on all young people to invest in the stock market after it crashed 20% because of the Covid-19 pandemic. The stock market recovered quickly, so anyone who invested at the bottom made 20% to 70% returns. I bought Apple in March 2020, and it's up 121%.

Stock prices are at all time highs but they could still go higher before they fall again. I expect a 10% correction sometime. If the majority of people get vaccinated, and Covid-19 numbers continue to drop, then perhaps we will see a reviving economy and opportunities for more job growth.

Editors Note: The author owns shares in all the stocks mentioned in this article.