Mergers: Hunter on the prowl

Posted by Fred Frailey
on Thursday, October 16, 2014

Mere days after Canadian Pacific let word get out that it had its eyes on CSX, it’s apparent to railroad insiders that Hunter Harrison is not going to go away. We’re heading into extra innings.

Michael Ward, chief executive of CSX, told analysts Wednesday that that a combination of his railroad with CP could be disruptive and cause more congestion, not less. He said regulators would be “very cautious” in considering a Class I marriage. Let me translate that for you: Mr. Harrison, you need to put a lot of money on the table.

Anyone who knows anything about the wily CEO of Canadian Pacific will tell you that having opened the door to a merger with CSX, Harrison is not going to take no for an answer right off the bat and walk away happy. He will come back. And back and back again, if needs be. Everybody in the business knows this and if they say otherwise, they’re just trying to get you off the scent.  

As if on cue, we heard today from Bill Ackman, whose raid on CP ousted chief executive Fred Green in 2012 and ushered in Harrison, who had retired as president of Canadian National at the end of 2009. Ackman is Harrison’s Wall Street godfather and sits on the CP board of directors (his hedge fund still owns a stake in CP). As if he had been waiting in the wings for Ward to speak, Ackman responded: “We are not building any new railroads. The only way that we can meaningfully improve the fluidity and efficiency of rails is operational. . . . so the question is, what is the best way to achieve that?” He went on to say that some rail mergers could loosen up the congestion. And he added: “There are rail combinations that could not happen for antitrust reasons, but there are some rail combinations that are pro-competitive as opposed to anti-competitive. . . . You take the management of CP, which has done an incredible job, and you combine it with another rail where they can get the benefit of combined management teams in addressing problems.”

Blah blah blah, you say? Well, yes. But let’s look a little closer. Unlike every other CEO out there, Harrison is not afraid of new mergers. For years, he has advocated nationwide networks that shatter the iron curtain between Chicago and New Orleans. He’s not afraid of open access, either, in which captive shippers can have another railroad reach their spurs via trackage rights. He has all but said to shippers: You want open access? You can have it on a merged railroad. So to those who say shippers would rise up as one to oppose a merger in this year of poor service and massive congestion: Maybe not.

Now let’s look at finances. In the past three years, thanks to Ackman’s stirring the pot and Harrison’s producing stellar results, CP’s share price has risen 300 percent. CSX has advanced 50 percent. The result is that CP, with less than half the revenues of CSX, has a slightly higher stock market valuation. That is, its market capitalization (price times number of shares) is worth more than that of CSX—financial alchemy, you might say. And in a merger, market cap is as good as gold. To put it another way: In an all-stock transaction, CP could offer CSX shareholders a nice premium without penalizing its earnings per share should the companies merge.

Ward isn’t interested, or at least that is his public face. It may not matter. Investors smell a deal and are bidding up CSX shares; since Friday, even in the face of a stock market meltdown, CSX is up $3 a share, or about 10 percent, amid trading that is four to ten times its normal volume. Should CP keep applying the pressure, CSX shares are apt to keep climbing and the cost to CSX management of winning this war of nerves could be to see those shares plunge below where they were last week, leaving a lot of unhappy CSX shareholders holding the bag.

It has been suggested that what Harrison really wants is full ownership of Indiana Harbor Belt, the Chicago switching company that extends from CP’s Bensenville Yard, south of O’Hare Airport, to eastern and southern connections on the other side of the metro area. This would essentially give Canadian Pacific a straight shot through the heart of Chicagoland, and an underutilized hump yard in suburban Blue Island, Ill., to boot. But there’s a catch. CP owns 49 percent, and CSX and Norfolk Southern (through their jointly owned Conrail Shared Assets) 25.5 percent apiece. At the time they divided up Conrail almost two decades ago, CSX and NS agreed neither could dispose of IHB shares without the other’s permission. So scratch that idea for now.

So to sum up, we know this: CSX is almost surely the biggest connection CP has in Chicago. It is also the eastern railroad whose sometimes-dysfunctional operational management cries out most for Harrison’s brand of tender love and care. And finally, we know that as the most experienced CEO in the industry, Harrison is a proud, even vain warrior, with a Wall Street wizard (Ackman) at his side to raise money and give advice. Given all this, it is simply inconceivable that this show will not go on.

I don’t know what shoe drops next. More beating of the drums in the distance? A hostile offer? A switch to woo Norfolk Southern, leaving CSX shares to plummet back to earth? All I know is to buy my popcorn and soda and sit back to watch the rest of the entertainment.—Fred W. Frailey

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