A Canadian Pacific potash train works its way west through the mountains - Date unknown Chris Bolin.

19 January 2012

CP's CEO Battle:  Harrison vs Green

When Hunter Harrison says he can turn around an under performing railroad, it's hard to imagine that offer being unwelcome. The railroad maven began as a gear-oiler in 1964 and climbed the ranks to serve as CEO at both Illinois Central Railroad and Canadian National Railway. Both companies experienced huge growth under his leadership, with CN more than tripling its net income before Harrison retired to Florida in 2009 to raise horses. So who'd doubt his ability to do it again?
 
Not activist investor Bill Ackman. His company, Pershing Square Capital Management, is Canadian Pacific Railway's largest shareholder at 14.2 percent, and he wants the railroading legend to replace CP's current CEO Fred Green, believing Harrison would be able to cut costs and boost earnings by more than $1 billion a year. Specifically, he wants Harrison to drive down CP's operating ratio, a key efficiency metric, because it's currently the worst among North America's major railroads. Harrison pushed CN's ratio down to about 67 percent over his tenure from a starting point of 76 percent (about where CP's ratio sat in the third quarter of 2011). "Hunter says the business could be run better, and he's willing and able to run it. He's not doing it because he needs a job, but because he wants to prove a point," Ackman says.
 
But Ackman now finds himself planning a proxy battle, because CP's board and its chairman John Cleghorn have so far resisted the notion of Harrison as white knight. A public letter issued by Cleghorn on the board's behalf says it's in the company's best interest to keep Green, whose current approach the board expects to lower CP's operating ratio to the low 70s by 2015. "Despite the absence of a credible, detailed plan," Cleghorn wrote, "Pershing Square has stated to CP that an improvement in OR from 78 in 2010 to 65 in 2015 is achievable. This pace of improvement, from this starting point, has never been achieved by any railway management team."
 
There may be other reasons for the board's reluctance, one being that change could come at the expense of safety. While CP may be the least efficient railroad on the continent, the U.S. Federal Railroad Administration has named it the safest Class 1 railroad in North America 11 of the last 13 years.
 
And safety is one of the few areas that actually suffered at CN under Harrison's control. The Cheakamus River near Squamish, B.C., for one, is nearing the end of a decade-long, $5.3-million restoration plan after a CN train derailed on the site in 2005, spilling over 40,000 litres of caustic soda. Among other incidents, a derailment caused a forest fire in Wisconsin, and 800,000 litres of heavy oil gushed into Lake Wabamun, west of Edmonton. This last offence earned CN a $1.4-million fine and the Alberta government's insistence that CN update its emergency response system to industry standards.
 
There is even some skepticism that the Precision Railroading model, that is, planning each individual customer's shipment by using more precise time calculations, that Harrison used at CN would offer a solution for CP, with operations in the Rocky Mountains that contend with the uncertainty of steep mountain grades and severe weather.
 
What's more, the board would be trading a long-term approach with the 55-year-old Green for the hope of a short-term fix from the 67-year-old Harrison, who surely won't stick around for as long. Still, as Edward Jones analyst Brian Yarbrough says, "The reason we put a Buy on this thing is that CP has been the poorest run railroad, and we believe there's a lot of low-hanging fruit to run it more efficiently."
 
This is shaping up to be one of the nastier boardroom battles in recent Canadian history. Witness the increasingly frustrated noises coming from Ackman, who has a history of bending to his will the boards of companies like McDonald's Corp. and Borders Group. He thinks the CP board is holding up necessary changes, and for unsound reasons. "In my experience, once you have a board that's overseen an under performing company for a long period of time, they actually don't want someone new to come in and fix the business quickly because it makes them look bad," he says. "The best thing for them is if the business doesn't improve quickly. And I'm beginning to believe that that's what this fight is about."
 
Still, Ackman takes CP's rising share price as a sign of investor enthusiasm. "The stock was $45 when we started buying it [a few months ago]. Now it's $70. The only thing that's different is the potential for a change in leadership." Whether Green or Harrison ends up CEO, the CP shareholder meeting in May that should decide the matter looks to get bloody. But Ackman remains confident he'll get the change he wants. "Let's put it this way," he says, "I wouldn't have invested $1.5 billion in this if I thought we weren't going to be successful."
 
Jacqueline Nelson.