Canadian Pacific's downtown yard in Calgary - Date unknown Canadian Pacific Railway.

31 October 2011

Reinventing CP Rail Won't be Easy

Calgary Alberta - A Canadian Pacific Railway Ltd. rally faded Monday after analysts said an activist U.S. hedge fund stalking the historic company would face obstacles in any campaign to force radical changes.
 
CP closed at $61.61 in Toronto, down $2.19, after the stock gained more than 3.5 percent in pre-market trading on anticipation of moves to boost shareholder value.
 
The stock jumped late on Friday after a U.S. regulatory filing disclosed that New York City-based Pershing Square Capital Management LP had invested US$1.1 billion over six weeks to amass a 12.2 percent stake.
 
But CP shares dropped through Monday's regular session in a declining market after analysts said a sale to another company such as Warren Buffett's Berkshire Hathaway or a rival railway is unlikely due to impediments including federal ant-trust regulations and CP's heavily unionized workforce.
 
Pershing in its filing disclosed a 20.6 million share stake that includes 2.65 million call options, calling CP "undervalued" and an attractive investment.
 
It said the fund would seek a meeting with management and CP's board for talks on all aspects of the business.
 
Pershing failed to indicate what changes it would pursue and a spokesman did not immediately respond to a request for comment.
 
CP declined comment as well, though it told employees in a memo that "we will speak with Pershing Square to hear their input into our plan, already targeted at realizing greater efficiency and improved service reliability."
 
Industry observers called Pershing's founder and chief executive Bill Ackman a formidable activist investor who by his mid 40s had forced shakeups at major public companies including Wendy's, which spun off Tim Hortons Inc. in 2006 under pressure from Pershing.
 
But they said Ackman does not initially seek major changes, preferring to assemble material positions and then approach management with demands to increase shareholder value.
 
If the collaborative approach fails, the process can escalate to include demands for board representation, senior leadership changes, asset divestures, strategic partnerships, debt reduction, or an outright sale.
 
CP, Canada's second major railway after Canadian National Railway Co., rebuffed as inadequate a takeover overture in 2007 from a group led by Brookfield Asset Management.
 
Analysts noted that CP is pursuing a productivity and efficiency campaign across its operations in Canada and the U.S. after rail lines were hampered this year by severe winter weather and extensive spring flooding.
 
CP's second-quarter earnings report last week showed a drop in profits from a year ago as operating expenses jumped on nearly 90 weather-related outages during the three-month period ended 30 Jun 2011.
 
Chief executive Fred Green said the railway, founded in 1881 as part of Canada's nation building exercise, is taking steps to ensure that equipment and personnel are in place to limit future impacts from inclement weather.
 
CP shares have under performed rivals including CNR, although the stock has risen from a year low in September on managements' assertion that a turnaround in operations was on track.
 
RBC Capital Markets' Walter Spracklin said Ackman's unfamiliarity with the railway and lack of insight into customer contracts would limit the degree of change the billionaire investor could force.
 
Spracklin nevertheless raised his price target on CP stock to $80 from $66 and said in a note to investors that the company could command a $90 price if a sale were to proceed.
 
"We expect the share price to increase, fueled by follow-on buying from investors supportive of Pershing Square's efforts, particularly in expectation of further potential catalysts (including a possible sale of the company at some point)," he wrote.
 
"Pershing's interest in a more aggressive operational turnaround does not surprise us," added UBS analyst Tasneem Azim. "Next steps could include a shake-up of senior management, sale of non-core assets, and more aggressive pricing."
 
She said a 1 percent fall in CP's operating cost ratio would trigger roughly a 25 cent per share bump in earnings.
 
"That said, this may well be a case of much ado about nothing if it emerges that sufficient marketing and operating initiatives to drive [operating ratio] improvement are already in place," she said.
 
Michael Lewis.