Greed versus Goody Two Shoes

An insider in these matters says that to understand the strange turn of events at CSX, the big eastern railroad, you need to watch the last five minutes of Scarface. So I did, and OMG. I’ll get back to that in a minute. First, let’s run the numbers.

E. Hunter Harrison, who worked wonders at Illinois Central, Canadian National, and Canadian Pacific, in that order, wants to become chief executive officer of CSX. In this he has the support of a hedge fund called Mantle Ridge that is run by Paul Hilal, who engineered the ouster of CP management in 2012 to usher Harrison into office in Calgary. But Harrison and Mantle Ridge have gotten hung up with CSX over the numbers, which are really, really big.

The first number I want to explain is $84 million. This is the loose change that Mantle Ridge wants CSX to give it as reimbursement should Harrison come to work at CSX. You see, Mantle Ridge gave Hunter $84 million to compensate him for lost benefits because he left Canadian Pacific’s top job six months early. Hunter could have received that $84 million if he’d just sat still another six months. But he couldn’t sit still because in six months’ time it would be too late to approach CSX, which as 2017 began was far along in deciding upon a successor to CEO Michael Ward, who is now past retirement age. Mantle Ridge also wants CSX to pay the tax bill on this, which it says amounts to “a few tens of millions of dollars.” Mantle Ridge further wants to be reimbursed for the $2 million a year in consulting fees it pays Harrison.

It’s this demand by Mantle Ridge to be paid $84 million plus taxes plus consulting fees that could well derail the whole affair, for reasons I’ll explain when we return to Scarface.

But that’s just one big number. Hunter (it’s impossible to resist using his first name,. so I'll stop trying) also wants an immediate “equity award,” an option equal to 1 percent of CSX shares of stock. At least half of this would not be subject to any performance objectives that CSX would have to meet to qualify Hunter for getting the option. The option Hunter suggests has a present value of $160 million.

But Hunter’s salary needs are modest. He is suggesting a minimum $2.64 million for this year, with a bonus of almost $3 million. Then he’ll need a home in Jacksonville and incentive stock bonuses.

That’s all. CSX estimates the total cost of this at more than $300 million,So much for speculation that EHH is in this for pride, for his legacy’s sake.

What does CSX want? It wants a physician of its choosing to evaluate Hunter’s health records. That’s a no-no, says Mantle Ridge. Needless to say, CSX also resists the price being demanded for Hunter’s services.

At the conclusion of Scarface, drug lord Tony Montana (Al Pacino) finds himself surrounded by his enemies at his headquarters. Doomed, he decides to go to the Hereafter in a blaze of grenade launching and M16 gunfire and does just that. This is the course Michael Ward may be choosing—fighting back, but in an unconventional way. You see, in a normal proxy contest the shareholders vote for competing slates of directors. Only very, very indirectly do they decide $84 million questions, if you get my drift. CSX wants them to focus specifically on the $84 million question.

Therefore, CSX says it will convene a meeting of shareholders who own its stock as of March 16, at a date and place to be announced. The sole purpose of this meeting will be to ask if shareholders approve or disapprove of the financial demands of Hunter and Mantle Ridge and also the governance changes that would accompany his arrival—namely, seats on the 14-member board for Hunter, Hilal and four other people of their choosing, plus chairmanships for these new arrivals on the board’s key compensation and governance committees. Plus, Hilal’s becoming nonexecutive chairman of CSX starting in 2018. The CSX board of directors is taking no position on these matters.

Unlike Tony Montana, Ward is obviously betting he has a fair chance of surviving this fight, and I would agree.

Here’s why: CSX is largely owned by institutional investors, meaning mutual funds and pension funds and the like. They are not going to like the look and smell of this proposal. They are not going to like more than $100 million of their money going into the pocket of Mantle Ridge, which itself owns only about 5 percent of CSX. Sorry, Hunter, but it reeks of payoff money by the many (95 percent of the owners of CSX) into the pocket of the few (5% owners of CSX).

Moreover, many and possibly a majority of institutions hire corporate governance consultants to look over events like this and recommend how they should vote. And if they don’t vote according to the recommendation, they may have to explain to the beneficial owners of these institutions why they held their noses. I doubt there is a corporate governance consultant alive who could justify to clients the $84 million-plus-taxes-plus-consulting-fee pass-through.

So CSX directors are putting all this out in the open and hoping the institutions get the message. For its part, Mantle Ridge says it is pleased that shareholders are being asked their approval (what else can it say?) and is quick to point out that since it began nosing around CSX the company’s total stock market value has risen $10 billion. Unuttered is this: If we go away, the stock market value will dissipate all $10 billion of its gains. And in fact Mantle Ridge would probably be right.

What all this means is that shareholders are being asked to choose between what some would call good corporate governance and their own greed. Yes, maybe I’m making a morality tale out of this little drama. But can you suggest a better angle?—Fred W. Frailey