Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

It's opposite day at CSX Corp., where an activist investor is fighting for -- rather than against -- a jumbo-sized executive pay package.

Mantle Ridge, led by former Bill Ackman lieutenant Paul Hilal, has amassed a stake in the railroad and is seeking to install former Canadian Pacific Railway Ltd. CEO and storied cost cutter Hunter Harrison in the top post at CSX. The $45 billion company seems to have been a receptive target: Current CEO Michael Ward was already nearing retirement, and after investors got wind of Mantle Ridge's plans they added $10 billion-plus to the company's market value. But negotiations broke down over Mantle Ridge's demands  for six board seats of its choosing and a compensation package for Harrison that CSX called "extraordinary in scope."

We're Listening
CSX shares spiked on the news that Harrison was teaming up with an activist investor to target the company and have remained elevated
Source: Bloomberg

The railroad has a point, but the board decided last week to let shareholders be the judge and vote on the governance and pay requests at a special meeting. A company that bends over backwards to give investors a say? It's an activist investor's dream come true! But this is where things get a little curious. While Mantle Ridge initially said it appreciated the opportunity for investors to make their voices heard, a few days later it criticized the special meeting as a distraction and a needless delay. Efforts to swing the conversation back to a two-party negotiation don't do a whole lot to thwart accusations Mantle Ridge is after effective control of the company with such a large number of designated board seats.

You have to wonder if Mantle Ridge started to worry it might not get the outcome it wanted. Investors have raised concerns about the number of requested board seats and at least one questioned the pay package and 72-year-old Harrison's refusal to be evaluated by an independent physician, the Wall Street Journal reported. Following a meeting the Journal said took place last Wednesday between Mantle Ridge and about 50 of them, the firm sent a letter saying it would actually be happy to settle for the five board seats CSX had offered if Harrison can lock down a four-year employment agreement. It also argued that its pay package proposal wasn't quite as rich as CSX thought because of the way the value of the stock options are calculated.

Whatever. Five seats on what is currently a 13-member board is still a lot considering Mantle Ridge has handpicked the CEO. The activist argues most of its nominees don't work for Mantle Ridge, which is true, but Hilal thinks this revamp is needed to empower Harrison with "substantial support." 

And about that pay package: Mantle Ridge says it amounts to about $32 million annually. While it's not a perfect comparison, that's essentially equal to what CSX's outgoing CEO Ward received in salary, stock awards and other benefits in total over the three years ended in 2015. Mantle Ridge is also seeking a one-time payout of $84 million to help cover compensation Harrison forfeited when he left Canadian Pacific ahead of schedule to participate in this plan. A potential related tax indemnity could add as much as $23 million to the tab.

Even if you strip away all the extras and focus on the base salary, the $2.2 million a year that CSX says Mantle Ridge is seeking for Harrison is almost double what Ward received in 2015. It's also more money than other CEOs of public U.S. railroads get, according to data compiled by Bloomberg:

Some Payday
Here's how Harrison's requested salary stacks up against those of other railroad CEOs
Source: Bloomberg
2015 is the most recent year for which data is available across the companies. Squires and Fritz became CEO in 2015 so it's possible their pay packages increased further in 2016. Ottensmeyer became KSU's CEO in July so his predecessor Starling's pay is also included for comparison purposes.

So essentially the argument is that CSX needs to be more aggressive about improving its profitability, but to do that it needs to balloon its CEO compensation expense. That kind of pitch may work with investors who are eyeing big returns should Harrison pull off a turnaround similar to what he orchestrated at Canadian Pacific -- although, as Bloomberg Intelligence analyst Lee Klaskow notes, CSX doesn't have as much room for margin improvement.

How Much is Left?
CSX's operating ratio, a profitability metric in which a lower number is better, has been dropping. It may struggle to match Canadian Pacific's 58.6% because of higher benefit costs and the challenges of operating in the densely populated and mountainous eastern U.S.
Source: Bloomberg, Bloomberg Intelligence

But how do you sell that to the 1,000 managers that CSX this week announced will lose their jobs or to the additional employees who may well get axed with an efficiency-focused  like Harrison in charge?

President Donald Trump has turned public complaining about job cuts into a key part of his economic agenda. Thus far he's focused on manufacturers that move positions overseas, but it's not a big stretch to imagine the commander-in-chief having some choice words for activist investors and well-compensated CEOs who make cost cuts a priority. 

Mantle Ridge may have its own activist investor to watch out for.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Ackman got seven board seats when he waged a proxy fight to install Harrison as CEO of Canadian Pacific in 2012. But that management team had resisted him, whereas CSX has been open to conversations about a shake-up, suggesting less need for such a big overhaul. 

  2. It's not uncommon for companies to make executives whole when they poach them. But CSX didn't make Harrison any job promises -- Mantle Ridge did.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net