Going over Michael Ward's head

Posted by Fred Frailey
on Sunday, October 26, 2014

Those who read my All Hunter, All the Time blog last week noticed my puzzlement. I was trying to find a rationale — a script — that would include Canadian Pacific approaching CSX to propose a merger, letting that fact leak out, watching CSX stock rise 10 percent in a plunging market, calling off discussions abruptly, and then going live with analysts and reporters for 90 minutes to explain why nothing happened. It made no sense. What movie is this, I wondered?

A Canadian Pacific officer supplied me with the rationale behind everything that Hunter Harrison, the CEO of CP, did in this curious episode. It makes sense; I’ll buy it.

And I will also tell you the movie this mimics: "Independence Day," the 1996 sci-fi thriller directed and co-written by Roland Emmerich. A gigantic spaceship lands on Earth and proclaims, “We Come In Peace.” Of course, very quickly the invaders from outer space begin killing every living thing . But in this case it is the invaders who die.

A Wall Street hedge fund guru, Bill Ackman, approached Canadian Pacific in 2011, saying he, too, came in peace. As you know,  he ended up eating the company alive. And my friend at Canadian Pacific is convinced we are seeing the same script played out once again.

Explains my friend: “The fact CP chose to take this into a public forum is because we now aren't trying to talk to the CSX executives; we're talking publicly to the CSX shareholders.” He notes that CSX went through a nasty proxy fight in 2008 with Children’s Investment Fund, in which the stock rose more than 50 percent in a year’s time. But in the past five years CSX has been the second-worst performing stock among the Class I railroads (the worst being Norfolk Southern).

So my friend picks up his narrative: “By making the subject matter public we basically invite the CSX shareholders to question their executives’ decision-making process and potentially get them to make changes. Hunter can be quiet now because it's the shareholders who will force the changes. The other thing, though, is if you're NS you might be thinking you just dodged a bullet, as this could have set CSX up as the biggest player in the eastern U.S. Or if you are NS you might be thinking this is an opportunity and if CSX isn't interested, that you might be interested instead. If that's the case we aren't going to be talking publicly because we're talking with NS now. Either NS or CSX has significant benefits to us and to them.”    

What he is saying is that his railroad is going over the head of Michael Ward, the savvy CEO of CSX, and talking directly to the people who own the company. Goodness knows, this approach has worked before. And also fallen flat, which is why this whole cat-and-mouse game is so fascinating.

Do I buy it? Yes. It jumps through all the hoops. It makes Canadian Pacific’s behavior come together and make sense. It is classic takeover behavior: talk softly, carry a big stick, and be ready to use the stick. Otherwise, you have no credibility. And because I buy it, I can safely predict we haven’t seen the end of this. Most Wall Street analysts agree, by the way. By and large, they think the door has been opened and that we will live in interesting times in 2015. To my readers of this blog, I say this: Follow the bouncing ball. Forget what you want to have happen. Forget how you think the network should look in four years. Stifle your prejudices (as if this crowd of oversized egos ever could, God bless you all). The smartest among you will try to think like Hunter and Bill Ackman and Michael Ward. And if you can do that, let us all know what results.

If this story line I  lay out is correct, we can pretty safely predict what happens next. CSX will raise its dividend, announce even more share buybacks (the same profits divided by fewer shares equals higher earnings per share), scale back capital investments for 2015, or some mix of all of the above - anything to make itself more attractive to Wall Street and less attractive to Canadian Pacific. On the other side of the playing field, Pershing Square Capital Management, Bill Ackman's investment vehicle, will reveal it owns of significant number of CSX shares. If none of these things happen, well, I was wrong. One thing nobody ever accused me of is playing it safe.

I’ll give the last word to my source at Canadian Pacific: “Will it get past regulators, who knows? Maybe, you're selling a merger on Hunter's reputation, and the market loves him.” — Fred W. Frailey

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