TCI, Newly Empowered, Steamrolls CN (UPDATED)

Written by William C. Vantuono, Editor-in-Chief
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There’s an 800-pound British gorilla pounding on the door of CN’s boardroom. He’s pissed, beating his chest, and licking his chops. He’s not going away until he cleans house. He’s Sir Chris Hohn, and the activist hedge fund he leads, TCI Fund Management Ltd., on Aug. 30 became a “beneficial owner” of CN, grabbing 5.2% of the railroad’s shares, putting Hohn and his business partner, Ben Walker, in a position to make CN an offer it probably can’t refuse.

TCI launched a blistering attack on CN Board Chair Robert Pace and the railroad’s management team a few short hours after the Surface Transportation Board unanimously rejected the CN-Kansas City Southern voting trust. Hohn and Walker sent a letter to the CN board full of scathing language that would make even the most experienced professional railroader cringe, accompanied by a presentation (downloadable below) painting the railroad as a dismal failure. Hohn and Walker tempered their tough talk and financial charts, which are filled with withering comparisons to CN’s peer Class I’s, by professing that CN “owns a unique asset—the best rail network in North America.”

In summary, TCI, reiterating demands it originally made in May, when its ownership in CN was 3% and it did not have the financial position and power it acquired on Aug. 30, said:

  • “CN should immediately withdraw from its agreement to buy Kansas City Southern. 
  • “CN needs a management team with more operational experience. 
  • “A railroader with a proven track record should be appointed as CEO to create a culture of operational excellence. 
  • “Jim Vena is the outstanding candidate for the job as CEO and has TCI’s full support. 
  • “The board must take responsibility for the company’s recent underperformance and failure. 
  • “The board needs more railroad experience and expertise and should therefore appoint Gil Lamphere as a director.”

Following is the full, unedited text of Hohn’s letter, co-signed by Ben Walker, and interspersed with selected graphics from its presentation. Warning: Language that could be interpreted as insulting. Read at your own risk:

“Dear Chairman Pace and members of the Board of Directors (the “Board”) of Canadian National Railway Company (“CN” or “Canadian National”);

“TCI Fund Management Limited (“TCI”), through entities it manages, has been a shareholder of Canadian National since 2018 and currently owns [more than] 36 million shares of the company, representing more than 5% of the shares outstanding, valued at $4 billion. 

“In light of the Surface Transportation Board (the “STB”) ruling today, we think it is imperative that Canadian National immediately withdraw from its agreement to buy Kansas City Southern (“KCS”). 

“The opinion of the STB is clear: It does not want Canadian National to buy KCS, so persisting in the face of explicit opposition from the STB would be hugely damaging to the reputation of CN and potentially financially disastrous because it would expose the company to the risk of forced divestment and damaging remedies. 

“The Board has a choice. It can withdraw from the merger agreement, appeal the ruling or try to proceed without a voting trust. 

“An appeal cannot be won, and it is not an appeal you would want to win, so do not embark on what would be an expensive and undignified charade. Continuing with the bid would not only be futile, but knowing it will ultimately end in failure would also be unprofessional and disrespectful to everyone involved in the process. Instead, the company should withdraw and save billions of dollars in break fees. 

“Proceeding without a voting trust would be reckless, irresponsible and massively value-destructive. The Board must understand that the rules have changed. The old rules do not apply to this transaction. There is no way you can have any confidence in how the new merger rules will be interpreted because they have never been used before. Therefore, given there is such uncertainty around the approval process , it would be negligent to make a higher offer for KCS. It would also demand billions more in advisory and break fees. 

“Not only is the STB against the deal, but the United States Department of Justice, the Federal Trade Commission and U.S. political leaders have all stated their opposition to large-scale M&A, so needlessly antagonizing these agencies would be harmful to the long-term interests of both CN and the rest of the North American railroad industry. It is time to do the right thing, accept the deal cannot be done, and withdraw from the transaction. 

“Since 2016, CN’s financial results have lagged significantly behind those of the other railroads. The company has underperformed on nearly every measure of productivity and efficiency. Revenues per RTM, expenses per RTM, return on capital, operating ratio and profits have all gone backwards compared to the rest of the industry. (See the attached presentation for an analysis of CN’s recent performance. Do not waste any time adjusting the data or making excuses. Instead, acknowledge the issues and accept that significant improvements are required for CN to achieve its full potential.)  CN has lost its way, and the business needs to be fixed as a matter of urgency. That is the top priority. There should be no other objective and no distractions. The Board should not allow another wasteful dollar to be spent on the bid nor another minute of executive time. 

“The most pressing need is not a misguided pursuit of an unattainable prize but the establishment of a culture of operational excellence that so clearly exists at other railroads such as Canadian Pacific and CSX. 

“We stated in our previous letter, dated 18 May 2021, that if the STB rejected CN’s voting trust, we would expect the immediate resignation of Chairman Pace and the CEO, Jean-Jacques Ruest. We stand by that statement. 

“From the start, it has been clear and obvious the bid would fail. That the Board sanctioned the bid, together with potential fees of C$2 billion, is an egregious failure of oversight, and there must be accountability. CN needs a change of senior management and a shake-up of the Board. That process should begin today. 

“There is one person who we think is the prime candidate for the job as Canadian National’s CEO, Jim Vena. He has a proven track record as an exceptional operator, he is available and has our full support. Mr. Vena’s time at CN and Union Pacific demonstrate that he knows how to run a railroad successfully, and make no mistake, [he] is a railroader that CN needs. 

“In addition to a change in executive leadership, more railroad experience and expertise is required on the Board, so we think Gilbert H. Lamphere should be appointed as a director. Mr. Lamphere is one of the most experienced railroad executives in North America, having previously served as Chairman of the Illinois Central Railroad and as a member of the boards of CN (1998-2005) and CSX (2008-2015). He was also one of the original proponents of PSR. Gil Lamphere is independent and would be an outstanding addition to the Board. 

“In conclusion, CN owns a unique asset—the best rail network in North America—so it does not need to acquire KCS to prosper. CN should also be the most efficient and fastest growing railroad in the industry, but change is needed to achieve this goal. History has shown that, with the right leadership, railroads can be fixed quickly. CN should be no different. 

“TCI is a long-term shareholder, and we want what is best for Canadian National. We believe the majority of other CN shareholders share our vision and would support the actions and leadership changes we are recommending.” 

I ask you to closely examine this slide from the TCI presentation. It compares the U.S. share price growth over the past two years and eight months to that of CP, Norfolk Southern, CSX and Union Pacific:

Well, I guess 36% growth since January 2018—that’s just above 12% annually—just isn’t good enough, at least not to an activist hedge fund. I suppose that’s capitalism at work?

Need more viewpoints (I sure do, as I have a tendency to get lost in my own idealism)? Here’s one from Railway Age Contributing Editor Jim Blaze:

Jim Blaze

“Mergers and similar aggressive corporate expansion tactics often can result in unintended consequences for the propagators. From my series of private conversations with many who approached me these past three months, it is clear that Wall Street types hate uncertainty. They want a simple, risk-free approach.

”The translation is that once the CN bold and richer offer was made—and then hit the STB possible voting trust pushback—that quite a few folks unfamiliar with railway M&A twists and turns became nervous, and kept asking for clarification that I could not give them, since the concept of a public M&A benefit is at best vague. “They” didn’t appreciate that response. So now, it is not just KCS managers and organizational structure that is ‘in play,’ so to speak.

“Remember when this small target of KCS was going to be relatively easy, just a difference between two bidders? It’s not so simple any more, not to mention the liability of a $700 million breakup penalty fee, possibly still owed, even if CN loses in a continuing application procedure before the STB. Ouch!

“Who saw this CN ‘control’ scenario developing back in March/April when CN’s board countered CP’s opening bid? This is a new example of the railway sector fog-of-war M&A scene under the untested STB merger rules.

“Next steps? “CN faces an internal battle. Or CP could move toward an immediate unfriendly filing of its formal application before the STB. Or CN counters with anti-competitive complaints before the STB, but possibly without a sign and sealed control application of its own. Or CN share values drop, making the future CN proposed deal price of cash and stock look less attractive. These are possibilities—not my projection of ‘the’ outcome. The most likely outcome? Unknown.

“On Sept. 3, seeking certainty, what do KCS shareholders do with their shares? To which side do they pledge? Which deal offers the highest likely long-term value to shareholders of record, given that there is a new sheriff in D.C., and the regulatory positions of the Mexican and Canadian governments are not yet articulated—sort of a wild card unknown?”

Here’s another, from Railway Age Financial Editor David Nahass:

“The emphatic rejection of the CN Voting Trust by the STB and the ‘power move’ by TCI to shake up the CN Executive Suite makes it seem, on the surface, unlikely that CN has the chops to pull off a KCS acquisition under any circumstances, whether via appeal or by offering concessions to appease the regulators. If CN’s beneficial investors (TCI Fund Management Limited) don’t have faith in the management team—clearly stating, ‘The board must take responsibility for the company’s recent underperformance and failure’— how can that management team be trusted to negotiate concessions that will satisfy the volatile mix of customers, competitors, regulators and railroads?   

“In moments of crisis, people are often directed to ‘look inward,’ evaluate key decisions and adapt to a new normal. But when the unforgiving cold of deep space sucks the air out of the room, and you’re about to be blasted out with it, it’s a better strategy to look for a safe landing spot. To CN: This is your now. Sorry.” 

POLITICAL NARCISSISM

Peter DeFazio

House Committee on Transportation and Infrastructure Peter DeFazio (D-Ore.), like most politicians, gave himself credit for STB’s ruling, saying that he “made the same point in a July 2021 letter he sent to the STB expressing his opposition to the proposed trust.”

“The decision by the Surface Transportation Board to unanimously reject the proposed Canadian National and Kansas City Southern trust sends a warning to Wall Street that further railroad industry consolidation must meet a necessarily high bar for being in the public interest,”DeFazio spouted. “I applaud the Surface Transportation Board for their work to closely scrutinize impacts in shipping markets, workers’ rights, and the impact to intercity passenger rail. I’m glad that the STB followed my call because Wall Street shouldn’t be allowed to call the shots when it comes to railroad consolidation that would hurt the U.S. economy and American workers.

Emphasis mine, that last sentence. “Followed my call”? Really, Mr. Chairman? Don’t insult the intelligence of the STB with your political narcissism, OK? For the record, your term, “workers’ rights,” does not appear in the STB ruling. Not even once (I did a search). When the history books are written, people like Keith Creel and Pat Ottensmeyer and Marty Oberman will be prominent in the narrative. You, if you’re lucky, might be a footnote in 5-point type. Now go count your PAC dollars and leave us alone.

I’ll leave you this analysis from The Wall Street Journal:

“Canadian Pacific’s decision to raise its original bid … might have been unnecessarily aggressive, since it wasn’t financially superior to the existing offer. The new offer may have convinced KCS to delay the shareholder vote on CN’s bid but, given the STB’s decision, Canadian Pacific could have eventually walked away with its prize anyway, and for billions less. Its shares fell 4.5% on Tuesday. Its rival’s stock, meanwhile, jumped 7.3%, despite being on the hook for $1 billion. If the STB had approved the trust but later rejected the merger itself, CN would have been a forced seller of KCS shares for a potential loss of billions more.”

Go figure …

Sept. 3 Update: KCS postposed its Sept. 3 shareholder meeting to vote on the CN offer until 9 a.m. (CT) on Sept. 24. It is now “evaluating its options,” which includes considering CP’s offer.

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