Tuesday, April 10, 2012

Canadian Pacific proxy battle heats up

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The stage has been set for Canadian Pacific’s annual shareholders meeting on May 17, where hedge fund Pershing Square Capital Management will attempt a takeover of CP and replace the railroad’s president, Fred Green, and board of directors with its own candidates.

CP, in an ongoing effort to avert a takeover by the hedge fund led by William Ackman (pictured), on April 10 issued a strongly worded statement accusing Pershing Square of “misleading and inaccurate statements.” This was closely followed by a statement saying the company expects to report first-quarter 2012 diluted earnings per share in the range of 80 to 83 cents—a figure that exceeds its 2011 diluted EPS by “approximately 300%.”

Among Pershing Square’s misleading and inaccurate statements, CP said, are “claims in its proxy circular filed on April 5, 2012 in connection with CP’s annual meeting of shareholders to take place on May 17, 2012.”

“CP’s management team is aggressively and successfully executing on the company’s Multi-Year Plan to deliver a 70 to 72 operating ratio for 2014, and is targeting an operating ratio of 68.5 to 70.5 for 2016,” CP said. “The Multi-Year Plan is already yielding record operating metrics that are expected to translate into improved financial results beginning in the first quarter of 2012. Conversely, even after more than five months, Pershing Square is unable to articulate any plan or concrete suggestions to deliver results comparable to CP’s Multi-Year Plan, let alone achieve its previously stated target of a 65% operating ratio by 2015. The board believes that Pershing Square’s proposal to replace CP’s CEO, Fred Green, with [former CN chief executive] Hunter Harrison would delay and damage CP’s value-generating plan, and represents unwarranted risk to shareholder value at a critical time.”

CP’s earnings preview, released 10 days before its first quarter 2012 earnings report, said the railroad “delivered record operating performance metrics, with improvements over the prior-year period and the average of the previous three years’ first quarters. The company continues its strong operating performance into April 2012.” CP cited quarterly and three-year-average improvements in AAR train speed (27% and 13%, respectively); active cars on line (28% and 25%); terminal dwell time (27%, a “new record,” and 27%); and car-miles per car-day (51%, also a new record, and 43%).

Fred Green said, “The CP team is delivering both revenue growth and operational performance. The record operating metrics are now driving improved financial results. This is evidence that our Multi-Year Plan is the right strategy to produce value for our shareholders. CP has year-over-year growth in grain, coal, and industrial and consumer products, particularly in energy. Automotive and intermodal continue to show strength as CP builds on its customer relationships and delivers strong operating service metrics.”

In its offensive against Pershing Square, CP listed several of the hedge fund’s claims, and countered them:

“Claim: Pershing Square claims CP's growth in Freight Revenue per Revenue Ton-Mile lagged CN’s in the 2006-2011 period. Fact: CP’s Freight Revenue per Revenue Ton-Mile grew at a faster rate than CN’s during that period. In making its claim, Pershing Square intentionally obfuscated the facts by including non-rail related revenues such as revenues derived from the operation of vessels, docks, and warehousing. The fact that CP outperformed CN during this period is evidence of CP’s superior service offerings and strong customer relationships.

“Claim: Pershing Square claims that CP’s mobile assets (railcars and locomotives) were poorly utilized and has cited this as a ‘big deficiency’ on the basis of comparative operating metrics from 2010. Fact: Pershing Square ignored the significant improvements CP made coming out of 2011 and into 2012. In fact, CP’s 2012 railcar utilization is ahead of CN’s for the fourth quarter of 2011. In addition, CP's locomotive utilization during the fourth quarter of 2011 equaled CN’s when adjusted for CP’s grades and curves as determined by Oliver Wyman, highly qualified, independent railroad industry experts retained by the board.

“Claim: Pershing Square claims that poor operating margins and pension mismanagement by CP have led to negative cash flow over the past six years. Fact: CP has generated sufficient cash flow to fully fund its capital investments and distributions to shareholders and has continued to increase dividends. Residual cash from operations and proceeds from CP’s ongoing initiative to monetize non-core assets have been used to partially fund the acquisition of the DM&E, which is opening up new opportunities to grow volumes and expand CP’s North American reach. The cash and proceeds have also contributed to CP’s successful mitigation of pension contribution volatility through voluntary prefunding of its defined benefit pension plan obligations.

“Claim: Pershing Square claims that CP’s ‘biggest issue’ is CP's unit cost disadvantage relative to CN. Fact: Once again, Pershing Square’s analysis of the publicly available information is incomplete and its conclusions are flawed. CP’s operating expense per revenue ton-mile (excluding pension benefit expenses) is comparable to CN’s, and in fact, in the fourth quarter of 2011 these metrics were identical for CP and CN.

“Claim: Pershing Square claims that CP has lost market share to CN over the past six years, including 7.4 percentage points of intermodal market share, although CP completed a substantial acquisition during that same period. Fact: Under Fred Green’s leadership, CP has leveraged its core capabilities to expand its presence in emerging markets, such as energy. CP now reliably moves large volumes of crude by rail into the Gulf, the Midwest, the U.S. Northeast, eastern Canada, and the west coast of Canada. CP's market development in energy is expected provide up to $400 million in new annual revenues over the next three to four years. In addition, CP has maintained its traditional Intermodal share in the markets it serves, and regained 100% of its Intermodal shipping lines following the 2011 weather-related service disruption. CP has also regained its full Canadian grain market share, and for the 2011/2012 crop year to date, it has exceeded the five-year average volume.

Claim: Pershing Square claims CP has mishandled capital investment on excessive locomotive and car stock. Fact: CP purchased 91 new fuel efficient locomotives in late 2011 and the first quarter of 2012. These locomotives displaced 135 older, high maintenance, less reliable locomotives and improve fleet productivity. These purchases are part of a standard renewal and replacement program. Given that CP has an active road fleet of approximately 1,000 units, each with a useful life of approximately 30 years, it is necessary to replace approximately 30 units annually. It is important to note that to conserve capital during the recessionary period of 2009 and 2010, CP did not purchase any new locomotives.

“Claim: Pershing Square claims that CP’s operating ratio can be reduced to 65 by 2015. Fact: Oliver Wyman, highly qualified, independent railroad industry experts retained by the board, has independently confirmed that an operating ratio for CP of 65 for 2015 is unrealistic and unachievable. No independent industry expert has publicly endorsed Pershing Square’s targets. CP is committed to executing on the company’s Multi-Year Plan to deliver a 70 to 72 operating ratio for 2014, and is targeting an operating ratio of 68.5 to 70.5 for 2016.”

CP went on to say that its board “has attempted to foster a constructive dialogue with Pershing Square, and has an open offer to William Ackman, CEO of Pershing Square, to join the CP board. CP has included Mr. Ackman as a CP nominee on the company’s white universal proxy and recommends that shareholders vote for Mr. Ackman to join the CP board. The CP board is confident that once Mr. Ackman understands the facts and how the CP management team is executing on the Multi-Year Plan, he will endorse the Plan. The Board unanimously recommends that shareholders vote FOR the election of the director nominees proposed by CP on the white universal proxy, which will include all of the CP and Pershing Square nominees. The CP board has significant breadth and depth of expertise and experience in both the railroad industry and other complementary fields. The CP board is the right board to drive shareholder value by guiding the company through the successful execution of the Multi-Year Plan.”

CP will release its first-quarter financial and operating results at 7:30 a.m. Eastern time (5:30 a.m. Mountain time) on April 20, 2012. CP will discuss its results with analysts in a conference call beginning at 11:00 a.m. Eastern time (9:00 a.m. Mountain time) on April 20, 2012.

In early afternoon trading on April 10, CP stock was down 2.89%, while rival CN’s was down 2.46%.

Analyst weighs in

Dahlman Rose and Co. Director and Railway Age Contributing Editor Jason Seidl has this to say about CP’s pre-earnings-call announcement:

“CP’s pre-announced 1Q12 EPS is largely in line with our estimate and well ahead of consensus. This may be viewed unfavorably by investors who owned the stock on hopes the current management would be toppled.

“CP expects to report 1Q12 EPS of $0.80 to $0.83, compared to our estimate of $0.82 and well above the consensus estimate of $0.65. The beat may be perceived as a negative for Pershing Square Capital’s efforts to replace CP’s management. Investors who advocate such efforts may view the beat as rain on Pershing’s anti-management parade. The stock currently trades at around 16.4x 2012 EPS, reflecting a premium to the Class I average of 14.6x, likely due to expectations of a management change imposed by Pershing. Accordingly, the expected EPS beat may be a slight negative for the shares in the near term.

“CP’s Multi-Year Plan targets an operating ratio (OR) of 70.0-72.0% for 2014 and 68.5-70.5% for 2016. Pershing Square Capital’s OR target is 65.0%, with the activist investor’s CEO candidate Hunter Harrison admitting such a target would take years to achieve. Our OR assumptions are 77.9% and 76.3% for 2012 and 2013, respectively. Beyond that, we believe any prediction regarding the feasibility of the OR targets set by Pershing and CP would involve a good deal of speculation. The proxy fight should conclude with a shareholder vote on May 17. Until then, we believe the public feud between Pershing and the Calgary-based carrier will continue, causing volatility in the shares.

“Our 1Q12 EPS estimate of $0.82 is toward the mid-range of CP’s pre-announced narrow range of $0.80 to $0.83. As such, we do not see a reason to revisit our earnings estimates. We continue to be on the sidelines, as the shares will likely continue to trade on news of the ongoing activist investor battle, more so than business fundamentals.”

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