CP in the time of E. Hunter Harrison

As this is written, much of the railroad world awaits the Thursday, May 17, vote by Canadian Pacific share owners. Early book betting says that insurgent hedge fund Pershing Square Capital Management and its head William Ackman will take a majority if not all of the seven contested board seats.

That will lead to a reasonably prompt negotiation of the departure of Fred Green, CP’s current president and chief executive. These things are traumatic for those who suddenly find themselves out of a job they worked most of their career to attain. But the trauma is lessened by the negotiated settlement that enables the outgoing executive to maintain his style and standard of living. The one thing corporations have in large quantities is money.

The fight for control of CP originated after Canada’s second-largest railroad turned in a dreadful first quarter of 2011, with an operating ratio above 90. That drew the attention of activist investor and hedge fund operator Ackman, who saw the possibility of making a lot of money on an investment in CP if he could get the railroad to perform efficiently.

Ackman initially bought 12% of CP’s common stock, later increasing his holding to more than 14% and becoming the company’s largest investor. After the usual exchange of letters between Ackman and the CP board—all thoroughly vetted by securities lawyers, you can be sure—Ackman announced that he would seek to elect seven directors to the CP board. The fight was on.

A couple of consultancies that provide guidance to institutional investors advised large institutional investors to vote for the insurgents, and most estimates are that at least 70% of CP stock will be voted accordingly.

Ackman has said the board should elect E. Hunter Harrison to replace Green. Harrison retired in 2009 as president and chief executive of Canadian National, and since has said he signed on with Ackman because he realized he really wasn’t ready to retire at 65. At CN, once referred to derisively by CP officials as “the people’s railroad,” Harrison drove the operating ratio down into the 60s. He did this by forcing discipline on the operation.

During the time when CN was a Crown Corporation it was said that CP only had to be a little better than CN and all would be well, but CN improved so rapidly that CP was unable to keep up.

Under Harrison, CN on-time performance improved tremendously; the railroad even measured its performance in hours rather than days, as most railroads did at the time. On-time operations meant cars and locomotives were moving more than they were parked in yards and terminals. CN was able to return 800 leased locomotives to their owners, reducing operating expenses significantly.

Harrison will not win any popularity contests from many CN employees or even many CN customers. The ironic thing is that CN employees who flooded railroad blogs with horror stories usually had to admit they never had met Harrison and had formulated their opinions only from anecdotal stories.

They probably needn’t worry. Harrison is tough, but he’s not a tyrant. A significant factor that many forget is that railroads have a top-down culture. The person at the very top does not run trains. He does set the tone, the policies, the strategies.

While Fred Green may soon be gone, there is no reason to expect a wholesale cleaning out of CP management ranks. People will go about their jobs as they always have, but they will be held accountable for their performance in those jobs. Emphasis will be on meeting schedules and taking costs out of the CP system. Rank-and-file workers will see even less change. Locomotive engineers, for example, will drive their trains as they always have. As supervisors generate trip plans, more employees will find themselves completing their work assignments on time.

Once CP operations improve, shippers can expect to see rate increases. What will be different is that they will accept increases that come from operational improvement. It’s called the “value proposition” in most industries.