3 May 2012

Historic Coup at CP Rail

Toronto Ontario - Ackman may have institutional accomplices in Pershing's proxy raid.
 
Later this month in Calgary, Canadian Pacific Railway, a national history-maker since 1881, appears set to make history again. At the company's annual meeting on 17 May 2012, the betting is that CP's board of directors and management will be overthrown by a U.S. hedge-fund operator. But he won't be operating alone. Canada's institutional investors may be providing cover.
 
In the annals of cozy Canadian corporate governance, coup d'etats are rare historic events. A veteran observer of Canada's ingrown corporate culture says the last knock-down corporate coup of significance he can recall is the 1990 raid by Ian Delaney on the offices of nickel refiner Sherritt Gordon. Armed with less than 5 percent of Sherritt Gordon shares, Mr. Delaney and a couple of associates orchestrated a proxy fight that removed existing top management and installed themselves as the controlling minds of a company that went on to make it big doing business with Castro's Cuba.
 
At the time, the Delaney squeeze on Sherritt was seen as a possible precursor to many more proxy battles that would shake up Canada's often complacent management and governance regimes. The trend never materialized.
 
But now comes William Ackman's Pershing Capital Management Ltd., the New York hedge-fund manager that has rattled the cages at JC Penny and other U.S. corporate giants. Pershing owns 14.1 percent of Canadian Pacific, but with that relatively small holding appears set to effectively seize control of the 130-year-old railway operator, recalibrate its board of directors, and install a new CEO.
 
Most observers say the Ackman train has been coming down CP's tracks for months and it's already too late, the company has been losing the battle for investors. That battle looked even grimmer for CP Thursday with the release of a sarcasm-laden report from a leading U.S. proxy advisory firm that said shareholders should join the revolution. It urged investors to vote with Pershing and against the existing CP corporate team headed by former Royal Bank of Canada CEO John Cleghorn.
 
Proxy advisors have free reign in their reports, telling shareholders, individual and institutional, how to vote based on short, terse, and highly opinionated reports. In CP's case, ISS left few qualifications in its cutthroat advice:  Vote out core members of the existing board, including Mr. Cleghorn, its chairman, and appoint replacements, including Mr. Ackman. Also to be voted off the board is Fred Green, the company's CEO for the past six years.
 
ISS's view of CP is that the Cleghorn-Green regime failed to lower the railroad's operating performance, thereby abandoning shareholders. While revenue-to-expenses ratios at other railways were reduced toward 70 percent, Canadian Pacific never made it much below 80 percent. Return to shareholders over five years was negative before Pershing came along to agitate for a coup. Meanwhile, Canadian National and other railroads produced big returns.
 
In the world of maximizing shareholder value, CP was failing. The Pershing view, endorsed by ISS, is that CP's board and management maintained a corporate culture that left shareholders behind. A sample from ISS's advisory:
 
The (Ackman) dissidents have raised a larger question of culture, which is not measured directly by, but is embedded within, both TSR [total shareholder return] and the income statement. This is worth exploring further, as it appears to speak to the root cause of the problem.
 
One helpful signal that a corporate culture may lack accountability might be the impulse, when faced with a potential proxy contest over poor performance, to hire a consultant, five senior partners, shareholders have been soberly informed, working more than 5,000 hours over four months, to measure what is impossible to achieve, then use those results to explain why management and the board cannot be held accountable for under performance.
 
The most compelling conclusion one can draw from the episode of the consulting study, in fact, is exactly the point the dissidents have made from the start. If the point of the study was to clarify for management exactly what was not expected, a useful take away might be that it's not always worth clarifying how low the expectations can be set.
 
CP says the ISS report is "wrong" and accused the advisory firm of issuing a "perfunctory analysis." Whether CP is as off the corporate mark as Pershing and now ISS claim is certainly a good debate, but it may be a debate that CP has already lost.
 
The key issue is whether Pershing has the support of Canadian institutional investors. Some say it does, and some go further. It may be that major investors were major instigators of Pershing's move to stage a coup at CP. They want a return on their investment and are not inclined, nor equipped, to mount a major proxy battle to change the control regime at a major Canadian corporate icon. An outsider was needed. Since Pershing's nominees for the board of directors include Paul Haggis, a former head of Ontario's municipal pension giant, an institutional link exists.
 
When Ian Delaney took control of Sherritt Gordon in 1990, he said he got the idea from Eric Sprott, the Toronto investment/gold whiz, who felt Sherritt was under performing and badly managed. Whoever put the idea in Mr. Ackman's head to go after CP has set in motion a corporate transformation the likes of which Canada has never seen.
 
It would probably be too much to predict that the Ackman raid on CP will set a new proxy trend. But it is almost certain that corporate history will be made at CP's annual meeting later this month.
 
Terence Corcoran.