There’s nothing like the threat of “nuclear winter” to spur Canadian Pacific Railway to become more profitable faster than planned.
That’s the type of proxy war activist investor William Ackman promised CP directors if they don’t replace the railroad’s current chief executive with E. Hunter Harrison, former Canadian National Railway CEO. Ackman, principal of Pershing Square Capital Management, told directors CEO Fred Green has a “very poor track record,” while Harrison helped CN become one of the most profitable North American railroads.
“We will take the largest public hall available in Toronto, and we will make a presentation to the shareholders and the public … about management and board failures of the last 10 years at CP,” Ackman wrote in an e-mail he leaked to The Globe and Mail.
The odds are against Ackman, who owns 14 percent of the railroad, considering only about a third of proxy fights in 2011 went to a vote, according to FactSet SharkWatch. Ackman’s cause, however, is helped by his vow to increase profitability at the railroad for the medium term by gaining a minority slate on the board, rather than aspiring for full control and then a prompt sell-off.
The distinction shows how more investors are seeing railroads as long-term investments to nurture instead of as just another acquisition to improve quickly and spin off. For instance, Warren Buffett’s Berkshire Hathaway purchased the already profitable BNSF Railway in 2009 with the plan to invest in the railroad and reap profits far down the line.
Whatever the outcome of shareholders’ vote at the railroad’s annual meeting in May, CP will be on a faster track to profitability, much in the same way, some analysts argue, a proxy fight at CSX in 2008 sped up needed changes. Not only will shareholders likely hear from both sides on how their plan to increase profitability is best, but the debate also will illuminate CP’s challenges and differences from larger rival CN.
“On the one hand, in CN you have a railroad that was built by Canadian taxpayers with twice the proportion of sidings and double track and that, therefore, benefits from significantly enhanced operating flexibility. On the other hand, CP has to contend with greater geographic challenges,” wrote CP board member Ed Harris, who served as an executive on the operations side for both railroads.
Still, the geographic differences, including not having access to the rapidly growing British Columbian port of Prince Rupert, weather challenges and a smaller footprint in the United States, don’t account for the gap in profitability between CP and other Class I railroads, said Tony Hatch, an independent rail analyst in New York.
CP ranks last among the six major North American railroads in terms of operating ratio, according to Moody’s Investors Service. The railroad’s ratio of 75.8 percent in the third quarter was 16.5 percentage points worse than CN’s ratio.
CP “isn’t in a bad state. It’s just that the railroad renaissance has been going on, and it hasn’t been participating,” Hatch said.
CP Chairman John Cleghorn said the railroad is on track to reach an operating ratio in the low 70s within the next three years. The railroad’s recent decision to raise its capital spending goal to up to $1.2 billion signaled CP’s commitment to improving profitability. The move also showed how the looming proxy fight could spur action.
Cleghorn wrote to investors that Ackman’s goal to bring the ratio down to 65 is at a “pace never before achieved by any railway management team.” To do this, Ackman wants to bring on Harrison, appoint two Pershing Square representatives to the board and add two to four members who are independent of CP and his hedge fund.
Harrison, who more than tripled CN’s profit when he ran the railroad for seven years, said he is willing to take on the job for however long it takes to turn around his former competitor, according to Bloomberg. Harrison, whose potential new move would be like going from “one side of the cold war to the other,” would find a strong potential team at CP, Hatch said.
He said veteran rail executives Tony Ingram and Harris, who recently joined the CP board, have voiced confidence in Green, but they could be invaluable allies to Harrison if a shakeup goes through. The appointment of Ingram and Harrison, both of whom have had success in improving the operations of other railways, helped the CP board fend off criticism from Ackman.
“If they name Harrison CEO, he could hire (Ingram) and (Harris) and get the band back together,” Hatch said.
And even if Ackman loses the proxy fight and Harrison stays retired in Florida, CP will likely be playing a more profitable song with a quicker beat.