FINANCIAL EDGE March 2017: He sure plays a mean game of Railroad

When the Financial Edge last addressed the topic of Hunter Harrison, it was during the failed takeover of Norfolk Southern (NS) by Canadian Pacific (CP). Pursuit of NS was not Harrison’s first transcontinental endeavor.

Both before and during his public spat with NS, Harrison pursued CSX, first in October 2014, and then again in January 2016. Having been resoundingly rebuffed by NS, Harrison turned his attention back to CSX in what has clearly become one of the most interesting games of East Coast-style M&A pinball.

But there has to be a twist. In this case, Harrison has gone corporate raider and most likely prompted the May 31 retirement of current CSX CEO Michael Ward. And in one of the greatest insult-to-injury moments in recent memory, he’ll make CSX shareholders pay the money he gave up as CP CEO to take over CSX.

Check please? How does $300 million sound, plus 1% of CSX common stock? Most people would likely concede that there is a pretty big spread between the Harrison ask and a reasonable payment for his services as CEO.

Putting aside for a moment what Harrison’s boardroom end run might mean to a future merger with CP (or in lieu thereof, shared trackage rights that would amount to a merger in everything but name), two interesting issues spring to the foreground in this round of Harrison vs. CSX.

The big headline is clearly the pay requirement that Harrison is toting. Since mid-January, when Harrison announced that he was leaving CP, CSX’s stock price has leapt up an easy 30% and added roughly $10 billion in market capitalization. Harrison’s $300 million (plus an additional $440 million in stock value) is less than 10% of that increase. Additionally, investors expect an additional run-up post-inauguration of Harrison as happened at CP. (The equity market thinks so: January 2018 $50 call options are trading at roughly $4.50/share. All in, another 15% above today’s stock price.)

An equally important but less eye-popping issue is the following: Since 2007, there have been three CSX activist/takeover events. In response to those attempts, CSX made active, vocal, litigious, and successful responses to anyone who got in its way and tried to tell CSX and Ward how to run the railroad. This includes an activist shareholder dispute in late 2007, which languished in the U.S. appeals court until 2011, between CSX and Children’s Investment Fund and 3G Capital Partners.

In this case, however, CSX has pulled an about-face. Within a month, CSX has just about conceded the corner office to Harrison and made significant boardroom concessions.

For many industry watchers, CSX throwing in the towel to Harrison is veritable heresy. Harrison’s “Precision Railroading” policies rankle many rail veterans who don’t see precision as much as they see cost cutting (a.k.a. headcount and hard assets) and resource depletion, all in favor of reducing operating ratio.

It is difficult to argue with Harrison’s successful track record, but the more interesting question at CSX is, why at this time, 14 years into his tenure, no one is standing up for Ward?

CSX has weathered three big storms in the past decade. Has this current series of events just given CSX an opportunity to tell Ward that he’s not delivering on his promises to improve performance and returns, that they’ve just had enough? Is the arrival of Harrison a way of avoiding finding and possibly losing Ward’s replacement, a second time, to a more lucrative, sexier opportunity (like Oscar Munoz to United Airlines) if they wage a successful fight against Harrison and his activist partners?

Other shareholders, seemingly angry at the use of the Harrison bully pulpit, have worked with CSX to create some opposition. The opposition seems somewhat halfhearted and blatantly obvious. (We’re just not going to give them $750 million dollars in cash and stock as a payoff for replacing our CEO, are we?)

While probably not unprecedented, watching one railroad CEO hand his crown to another with only a dispute about exactly how much money and stock he should get for remaking the corner office is strikingly unusual. It is even more so when the incoming CEO is a septuagenarian. Maybe the board of CSX, its investors and executives just decided that if you can’t run a railroad your way and make money, maybe you’re just better off taking the money.