A Canadian Pacific mixed freight rounds Morant's curve - 20 Feb 2006 Photographer unknown.

18 January 2012

CPR Endures Rough Ride

Calgary Alberta - There are some people from a certain generation who will remember a particular television commercial from the 1970s showcasing the different business segments of CP Limited.
 
As the TV screen filled with images of ships, planes taking off, hotels, falling lumber, coal mining, and oil wells running, the voice over tag line boomed:  "A picture is worth a thousand words."
 
Since CP ceased to be a holding company in 2001, when the five subsidiaries were spun off into separately traded corporate entities, there remains but one business from that TV commercial, Canadian Pacific. It is arguably one of Canada's iconic corporations, and it's currently under siege courtesy of a New York-based hedge fund manager.
 
Unlike its arch rival, Canadian National Railway, CP does not have any ownership restrictions. If someone ultimately wants to pay a price for CP, it can go to the highest bidder. The only hurdle a deal would have to clear is whatever might be presented by Investment Canada.
 
Even then, with news this week that the Investment Canada Act isn't even under review as former industry minister Tony Clement said it would be, one wonders if it will be used to block potential takeovers, as it was with Potash Corp. in 2010, and MacDonald Dettwiler and Associates Ltd. in 2008. Not that we haven't seen this shareholder activist movie before.
 
TransAlta Corp. fended off a similar assault from the Luminus Group in 2007. Its plan to boost TransAlta's returns was to layer up the debt by $4 billion to buy back more shares. It ultimately failed.
 
But the CP situation raises a mess of questions, not to mention illustrates the chutzpah of Bill Ackman, the head of Pershing Square Capital who is pushing for changes at both the board and management of the railway.
 
What confounds longtime players in the investment world, on both the buy and sell side, is that being successful at "running money" such as managing a hedge fund doesn't equate to having the necessary management experience to run a company that actually makes something tangible.
 
Not that Ackman wants to take up occupancy in CP's C-Suite. He thinks former CN CEO Hunter Harrison is the guy to turn CP around. But does one management style fit every company?
 
History suggests it doesn't always work that way.
 
Paul Tellier, who was at the helm of CN when it went public and deserves a bunch of credit for turning around the sleepy Crown corporation, didn't last all that long at his next stop, Bombardier.
 
It's also worrisome that some of these players believe that because they hold a certain number of shares it entitles them to circumvent a process in place that is part of any corporation's governance practices and gain a board seat through the back door.
 
In the case of CP, Ackman appears to be trying to usurp the board's duty of choosing the successor to the company's current chief executive by putting forth his own candidate.
 
While Harrison left CN a much stronger company than when he took on the job in 2003, and is thus a known quantity in the railway world, it still doesn't mean he should not be subject to the same process as any other candidate deemed to be a potential successor to Fred Green. Furthermore, Tellier arguably sowed the seeds of Harrison's success when he bought Illinois Central in 1998, a move that was seen as instrumental in boosting CN's efficiency.
 
The reason CP is on Ackman's radar screen is because he sees a company that is an under performer relative to its peers. Of the seven so-called Class 1 railroad companies in North America, it's the one analysts say has the biggest room for improvement, which is a nice way of saying it's lagging.
 
The key focus, aside from share price performance, is its operating ratio. According to re-search published by CIBC World CPR CP's OR in the third quarter was 75.8 percent, while CN's stood at 60.1 percent. A one percent improvement in CP's OR is worth 10 to 15 cents in earnings per share.
 
The issue with CP is primarily its cost structure, and more specifically, the labour unions. Then again, when CN was being tarted up to go public, which it did in 1995 at $27 per share, it received a $900 million equity infusion from the federal government to clean up the balance sheet.
 
Another challenge is CP's rail routes, which are much more challenging to navigate than CN's network.
 
The CP network predates that of CN's, thus passing through a more difficult mountain route, which includes the avalanche-prone Rogers Pass area in British Columbia.
 
When the CN routes went through the mountains, it was west of Edmonton and virtually downhill all the way to Vancouver.
 
But in situations as complex as these, there is more than one way to look at what is going on.
 
This could also be seen as representative of the way the finance world works today, one in which capital is global, not local, and where the focus is on transactions, not relationships.
 
And is it the end of the world that a hedge fund manager, who has succeeded in pushing management at companies such as Wendy's, J.C. Penney, and McDonald's to wring out more value from their assets by doing things differently, is pushing CP to effectively increase its productivity?
 
Mike Percy, a business professor at the University of Alberta and the former dean of its School of Business, doesn't think so.
 
"I like activist shareholders in the Canadian context because of the productivity issue. They do push companies to re-examine their operations," Percy said, pointing to the fact the Canadian economy is being held back because its workforce is not as productive as it is in the United States and other countries.
 
The hedge fund players and activist shareholders are today's manifestation of the green mail players of the 1980s and 1990s.
 
What's going on at CP is as much about the old guard, as represented by the distinguished business individuals sitting on CP's board, being replaced by the new guard, as represented by those like Ackman running hedge funds.
 
Every one of the other CP subsidiaries is now being run by a more entrepreneurial group. Is it time for Canadian Pacific to join that club?
 
In railway terms, what Ackman is trying to do is "spike the switch" for change at CP. In railway jargon this means driving a heavy spike into a wooden railroad tie at the switch point to stop the switch from moving.
 
The question is whether the company's shareholders will agree.
 
Deborah Yedlin.