The combination, which faces a lengthy regulatory review, is a long-term wager on an interconnected North American economy. The three countries are reopening at different speeds after the novel coronavirus pandemic disrupted supply chains and upended global trade. Rail volumes, which plunged last year, have rebounded though backlogs at California ports have delayed imports from Asia and stalled some U.S. factories.
It marks the third major U.S. railroad that the Canadian company has targeted in its quest to create a transcontinental network. Canadian Pacific abandoned the two prior efforts—in 2014 and 2016—amid resistance from the takeover targets themselves as well as opposition from rivals, shippers and U.S. regulators.
Keith Creel, chief executive of Canadian Pacific, said lessons were learned from the failed bids. He expects Kansas City's support for the proposed merger and said the lack of rail-line duplication between the two companies will minimize potential regulatory concerns. "You have two like-minded companies that are committed to this and see the value," he said.
Patrick Ottensmeyer, CEO of Kansas City, said the new U.S.-Mexico-Canada trade agreement, which replaced Nafta in July 2020, creates a unique opportunity to ship freight through the three countries as their economies recover from the pandemic.
"This company is going to have a North America rail footprint that is truly unmatched," Mr. Ottensmeyer said in an interview. The combined railway could reduce the need for trucks to link production sites and allow cargo to avoid congested California ports.
If approved by regulators, the deal would unite the two smallest of the seven major North American freight carriers, linking factories and ports in Mexico, farms and plants in the Midwestern U.S. and Canada's ocean ports and energy resources.
The transaction will need approval from the U.S. Surface Transportation Board, which requires major railroad combinations to demonstrate they are operating in the public interest by enhancing competition. The merger partners said they expect the STB review to be completed by the middle of 2022.
The combined company, to be renamed Canadian Pacific Kansas City, would have about $8.7 billion in annual revenue and employ nearly 20,000 people. It would be run by Canadian Pacific's Mr. Creel. Kansas City investors would own about 25% of the combined entity's shares. Mr. Creel said there are no plans to reduce staff if the merger is approved.
Mr. Creel said talks were initiated late last year after he called Mr. Ottensmeyer to propose a merger that Kansas City had rebuffed in previous years. At the time Kansas City's board was reviewing overtures from private-equity firms seeking to take it private.
Kansas City in September rejected a takeover bid valued at roughly $20 billion from Blackstone Group Inc. and Global Infrastructure Partners, The Wall Street Journal reported.
The Kansas City directors ultimately approved Canadian Pacific's offer because shareholders would retain a minority stake in the merged company, people familiar with the matter said.
The companies said Sunday their boards agreed to a deal that values Kansas City at $275 a share in a combination of cash and stock. Kansas City investors will receive 0.489 of a Canadian Pacific share and $90 in cash for each Kansas City common share held.
Kansas City is the smallest major freight railroad in the U.S. but plays a key role in U.S.-Mexico trade. Its network mainly runs up the length of Mexico through Texas to its namesake city.
Canadian Pacific has long sought a union with Kansas City to extend its reach into its busy freight routes that stretch from Mexico through southern and Midwestern U.S. states. Canadian Pacific's major rail lines run across Canada, some northern U.S. states and south to Chicago.
The Canadian railway's leader, Mr. Creel, worked closely with former chief Hunter Harrison, who made a number of unsuccessful overtures to buy Kansas City. Mr. Harrison died in 2017 after taking over and revamping another U.S. operator, CSX Corp.
Railway mergers face significant regulatory hurdles in the U.S. Under Mr. Harrison, Canadian Pacific abandoned a $30 billion pursuit of Norfolk Southern Corp. in 2016 after the STB expressed concern about reduced competition and potential safety issues. Canadian Pacific also made two unsuccessful overtures to combine with CSX, which like Norfolk operates mostly in the eastern U.S.
Kansas City and Canadian Pacific currently have a single point where their two networks connect, in a Kansas City, Mo., facility they jointly operate. The merger could allow trains traveling north and south to avoid having to interchange cars and potentially bypass Chicago, a busy and often congested hub in the U.S. freight system.
The merger partners said the proposed combination wouldn't reduce choice for customers since there is no overlap between their systems. They said the possibility for single-line routes would shift trucks off U.S. highways, reducing congestion and emissions in the Dallas-to-Chicago corridor.
The companies outlined a two-step process for the deal. Canadian Pacific would create a trust to acquire Kansas City shares later this year, if shareholders bless the deal. Kansas City shareholders would be paid by the trust, and the company would continue to be run by Kansas City's board and management until the STB review is completed. If the regulator rejects the merger, the trust will divest its Kansas City shares under a plan to be approved by the regulator.
The combined company's global headquarters would be in Calgary. The U.S. headquarters would be in Kansas City, Mo., while the Mexico headquarters would remain in Mexico City and Monterrey. The proposed deal must also be approved by officials in Mexico.
To fund the transaction, Canadian Pacific said it would issue 44.5 million new shares and raise about $8.6 billion in debt. Canadian Pacific would assume about $3.8 billion of Kansas City's debt. The company expects to have about $20.2 billion in outstanding debt when the deal closes.
The merger partners said they expect the proposed deal would create annual revenue gains and savings of about $780 million over three years. Canadian Pacific expects the deal to add to its earnings in the first full year after it takes control of Kansas City.