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CP Frowns on Ackman Plan

Zacks Equity Research

Canadian Pacific’s (NYSE:CP - News) recent face-off with imminent investor William A. Ackman, founder and CEO of Pershing Square Capital, is currently in the limelight and has sparked a lot of speculation over the company’s future.

Earlier this month, Ackman, who owns approximately a 12% stake in Canadian Pacific proposed to replace CEO Fred Green with Hunter Harrison, former CEO of rival Canadian National (NYSE:CNI - News). 

William Ackman is popular in the industry for buying stakes in companies and then incorporating strategic changes, particularly asset sales, to push the market value of shares. His past transactions include acquisition of stakes in well known companies like Wendy’s (NasdaqGS:WEN - News), McDonald (NYSE:MCD - News), Fortune Brands (NYSE:FBHS - News), J.C. Penney (NYSE:JCP - News) and Alexander & Baldwin (NYSE:ALEX - News). In exchange, his company benefits from divesting position when share prices for these companies have achieved significant growth.

However, Ackman’s measure of initiating a turnaround in Canadian Pacific beginning with the change in CEO has been voted down by the company’s board of directors. The company, through a letter in a regulatory filling, stated that Ackman’s proposal lacks credibility in light of prevailing conditions.

Management stated that the company, under the directions of present CEO Fred Green, has been working toward successful execution of its multi-year plan that promises volume growth, network expansion and costs control measures that are expected to improve the operating ratio to the low 70s percentage range in the next three years.

On the basis of these growth goals, the company has so far realized significant synergies. On continued implementation of the long-term plan, management expects further improvements in Canadian Pacific’s financial performance in this year and beyond.

The board strongly believes that any change in leadership would impact the company’s progress and Ackman’s plan is not in the best interest of the company owing to several factors.

First, Ackman did not clearly state the policies or changes to be incorporated by the proposed new CEO Harrison that could compensate for the plans executed by Fred. Second, Ackman has been advocating projection of operating ratio reduction at a rate never realized by any railroad company.

Third, Ackman has not highlighted Harrison’s non-compete contract with his former employer, which prohibits Harrison from working with a competing business until December 31, 2011 and would also make him ineligible for to any retirement benefits if he holds any new position before the end of 2014. Fourth, Ackman did not consider the structural differences between the two companies before advocating that Harrison’s policies would revive Canadian Pacific’s financial position.

Despite the conflicting opinions of the two parties, management remains open to the idea of Ackman joining the Board of Directors, expecting him to re-evaluate the changes that temper the company’s already existing plans. 

However, we believe there can be several possible implications that can immerge out of the current conflict. Given Canadian Pacific current financial position, we believe that the company’s objection on replacing its present CEO holds good given the positive changes brought in under its present leadership.

The company has bounced back on its operating performance with operating ratios improving approximately 400 bps from 2010 levels.  Despite the present economic upheaval, the company delivered strong earnings growth on the back of improved productivity, safety and services metrics. Further, improving near-term liquidity position has allowed significant investments in upgrading network capabilities along with providing higher returns to investors.

On the flip side, one can also conclude that joining of a new CEO who once headed a rival company can add to various sources of information, which remains in the interest of Canadian Pacific. Further, board may have raised questions regarding Harrison binding agreement with Canadian National but we believe that this should not pose any regulatory issue since  the agreement expired in December last year and we are already in the second week of January.

Lastly, whatever might be the implication of this ongoing debacle, it is clear that the souring relationship between Ackman and Canadian Pacific has not gone according to plan and created uncertainties over the company’s future. If further dragged, the issue can only worsen the matter for Canadian Pacific, which is already surrounded by several impediments like rising fuel prices, lackluster earnings, competitive threats and regulatory pressures.

We maintain our long-term Neutral recommendation on Canadian Pacific. Our short term (1–3 months) rating is also Hold, as indicated by Zacks Rank of #3.

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