Photographer: Luke Sharrett/Bloomberg

CSX Surges as Activists Said to Target Railroad for Overhaul

  • Departing CP Rail CEO said to team with Mantle’s Paul Hilal
  • U.S. carrier lags major North American peers in efficiency

CSX Corp. jumped the most on record after news that outgoing Canadian Pacific Railway Ltd. Chief Executive Officer Hunter Harrison is teaming up with an activist investor to shake up the least efficient U.S. railroad.

Paul Hilal, who worked for years with billionaire hedge fund manager Bill Ackman, is looking to install Harrison in a leadership position at CSX, according to people familiar with the matter. Harrison announced his retirement ahead of schedule Wednesday from Canadian Pacific, where he partnered with Ackman in an effort to combine with CSX and its eastern U.S. competitor, Norfolk Southern Corp.

Hunter Harrison

Photographer: Chris Goodney/Bloomberg

A Harrison-Hilal campaign would create another industry boardroom drama less than a year after Harrison and Ackman abandoned their attempts to take over Norfolk Southern. Harrison made Canadian Pacific into one of the industry’s best performers after taking over as CEO in 2012 and previously solidified Canadian National Railway Co.’s status as the leanest North American railroad before retiring in 2009. That followed an overhaul of Illinois Central.

“Hunter Harrison improves margins, and eastern rails CSX and NSC still have the weakest margins in the industry,” Bascome Majors, an analyst at Susquehanna Financial Group, said in a note to clients.

In a statement Thursday, CSX said it would “actively evaluate Mantle Ridge’s views” and looked forward to discussing its strategy to boost earnings growth with the firm and other shareholders. The railroad said its approach, which has the support of the board and management, has “started to deliver sustainable value.”

The shares surged a record 23 percent to $45.41 at 2:53 p.m. in New York, extending earlier gains after the company’s statement. Other carriers also rose, with Norfolk Southern advancing 4.7 percent and Canadian Pacific climbing at the same pace.

‘Unparalleled’ Record

Hilal’s Mantle Ridge fund already holds a stake in CSX, said the people, who asked not to be identified because details are private. Hilal recently started the fund after years at Ackman’s Pershing Square Capital Management. Ackman isn’t involved in the CSX planning and merging the railroad with Canadian Pacific isn’t part of the goal, the people said. Hilal served on the Canadian Pacific board for almost four years until early last year.

Paul Hilal

Photographer: Norm Betts/Bloomberg

While investors have praised the current CSX management team, they have “tremendous respect for Hunter Harrison’s unparalleled track record” at Canadian Pacific and Canadian National, as well as an earlier stint at Illinois Central. CSX’s Mike Ward committed to stay on as CEO for three more years after his heir apparent, Oscar Munoz, abruptly left the railroad in September 2015 to lead United Continental Holdings Inc.

Potentially, there’s a two-to-four-year “window for an outside CEO to run CSX while the rest of the C-Suite becomes more seasoned for the role,” Majors said.

Harrison, 72, stepped down from Canadian Pacific on Wednesday, months ahead of schedule, forfeiting C$118 million ($89 million) in awards and benefits. A separation agreement gives him a “limited waiver” of his non-competition obligations, the company said Wednesday.

“His reputation of being the most sought after manager in the North American railroad industry could make it very difficult for CSX to refute Harrison’s desire to run its franchise,” Jason Seidl, an analyst at Cowen & Co., said in a note to clients.

CSX Progress

Harrison would have his work cut out for him. Ward has already been making progress in cutting costs, said John Larkin, an analyst at Stifel Financial Corp.

“CSX management has been doing the best job of all the rails in cutting costs and re-tooling their intermodal operation for the better,” he said by e-mail. “The days of Hunter Harrison coming into a railroad with his patented slash-and-burn approach, with a focus on the cost side, are nearing an end. Someone needs, desperately almost, to figure out how to drive volume.”

In the eastern U.S., some of the curving track that cuts through densely-populated areas may make it difficult for CSX and Norfolk Southern to become as efficient as Union Pacific Corp. and Warren Buffett’s BNSF Railway Co., which operate in the vast western U.S. Canadian Pacific has long, straight stretches of track across Canada.

After Harrison took over that railroad in 2012, its operating ratio -- a measure of efficiency in which a lower number is better -- plummeted to less than 59 percent last year, a record, from 83 percent. While CSX has also been lowering its ratio, the number stood at 69 percent as of the third quarter, the highest among major North American carriers, according to data compiled by Bloomberg. Norfolk Southern’s was about 68 percent.

Sustained gains in efficiency would give a boost to earnings. Were CSX able to “close its performance gap” relative to its more efficient rivals, CSX could potentially improve its operating ratio to 60 percent, BMO Capital Markets analyst Fadi Chamoun said in a note to clients.

Cross-Country Dream

For all his operational prowess at Canadian Pacific, Harrison never succeeded in his attempts to acquire a U.S. Class 1 carrier and create a coast-to-coast network. In addition to his abandoned attempt to acquire Norfolk Southern, he also failed to advance beyond the early stages in merger talks with CSX -- first in 2014 and again last year.

The next CSX annual meeting is in May, setting the stage for a months-long effort by Harrison and Hilal to woo shareholders. That would potentially replicate his path to the top job at Canadian Pacific, where he was hired in 2012 after Ackman engineered a boardroom coup. Once in place, Harrison shrank the workforce, used fewer locomotives and closed rail yards to bolster profit and rid the company of its status as North America’s least efficient carrier.

Even before the stock surge Thursday, CSX had risen to a record on Jan. 13. The railroad was already trading at a current price-to-earnings ratio as high as 21.5 times last week. That is the highest price-to-earnings valuation since 2008.

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