The war of attrition

Posted by Fred Frailey
on Sunday, December 13, 2015

A lot of smart people who participate in this blog are busy hashing up the North American railroad network in the wake of the Canadian Pacific-Norfolk Southern imbroglio. I’m impressed by the logic you put forth for A+B and D+E and C+F, all as a result of CP+NS. Let me just suggest you are all premature. First there must be CP+NS.

It is getting late in the day for a friendly resolution of Canadian Pacific's bid to buy Norfolk Southern. A war of attrition has begun. Both railroads seem intent right now on convincing the owners of Norfolk Southern, in other words the big institutional shareholders, that theirs is the right course. Barring some breakthrough I cannot fathom, this is headed toward a vote by shareholders next spring for the NS vision of its future or that of CP. Five possible outcomes rise to the surface, and I will explain them in ascending order of likelihood.

5. Canadian Pacific is rebuffed. As I said, it appears shareholders will be asked to break the deadlock. The choice is  whether to go with Canadian Pacific or keep the faith with NS chief executive Jim Squires. Outcome number five sends CP back to Calgary. Canadian Pacific’s Hunter Harrison is dealt a stinging defeat and soon thereafter retires. Possible, yes, but I doubt it.

4. The white knight appears. In this scenario, BNSF Railway or Union Pacific races to the fore with a competing bid. Bloomberg News suggested just such an outcome after interviewing BNSF’s executive chairman, Matt Rose, late last week. There is just this little nit: I spoke to Rose just before Bloomberg did, and I am convinced Bloomberg misinterpreted Matt. BNSF will do nothing unless CP+NS goes before the Surface Transportation Board, and by then it is too late to reopen bidding. Instead, BNSF will seek conditions or look for its own merger partner (think: CSX Transportation). Union Pacific, in the meantime, is even more dead set against anyone merging with anyone, its CEO having gone so far as to proclaim this to individual STB members earlier this month. A white knight, in other words, is possible but not terribly likely.

3. NS agrees to merge. For this to happen, Canadian Pacific ally Bill Ackman, head of Pershing Square Capital Management, or another hedge fund will need to wage the sort of proxy battle among shareholders that swept former CP management out of office in 2012. The likelihood of success if high, not because I think Ackman or CP CEO Hunter Harrison is smart or NS CEO Jim Squires is dumb (all are smart people). It would succeed because everything Ackman promised CP shareholders in 2012 came to pass in terms of change at Canadian Pacific. Ackman’s creds with railroads investors are huge today. But an even bigger hurdle follows.

2. Norfolk Southern and Canadian Pacific merge. The only reason I make this the second-most-likely outcome is that it follows from the previous outcome, an agreement to merge. But there are, as Norfolk Southern warns, a lot of regulatory obstacles in the path. Let’s just say that a merger could be approved but it ain’t necessarily so. I am dubious that the regulatory challenges could be overcome.

1. Hunter Harrison runs Norfolk Southern. If Canadian Pacific allies kick the bums out at NS, so to speak, the plan is to install Harrison as chief executive at Norfolk Southern. I said two paragraphs above that it is likely CP would win a proxy contest next spring and install CP-friendly directors. While the merger case is adjudicated, Harrison would be installed as head of Norfolk Southern. He would be there whether a merger is approved by the STB or not. And that is what I think is the most likely ending.

Right now, based upon what I know, the most likely outcome is that Hunter Harrison will move to Norfolk. Less certain is that a merger will make it through the treacherous regulatory process. Even less likely is that BNSF or UP will ride in on horseback. And least likely of all is that CP will be sent packing.

That’s how I see is right now. Everything could turn on a dime, and probably will.—Fred W. Frailey

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