First, let me make this perfectly clear: Two-time Railway Age Railroader of the Year E. Hunter Harrison (2002, CN/Illinois Central; 2015, Canadian Pacific) is one of our industry’s best all-time operating people. You can’t argue with what he’s been able to accomplish with his “Precision Railroading” methods.
Hunter is now 72 and is certainly entitled to a comfortable situation as an elder statesman of railroading. If I were in his position, I’d be tending to a collection of classic American muscle cars. (Hunter breeds thoroughbred horses—no pun intended with reference to his prior interest in Norfolk Southern. I’m into a different type of horsepower.)
But that’s me.
The man who doesn’t need to prove anything to anyone is contemplating his next railroad move. As I reported only a few days ago, months before his previously announced official retirement as CEO, Hunter severed all ties with CP, handing the company’s reins to President Keith Creel. CSX is reportedly in his sights.
A few relevant details: On Jan. 23, CP filed an 8-K with additional information on Hunter’s separation agreement from the company. There were no surprises, and the widely believed expectations remain that Hunter is targeting CSX, and that a merger and acquisition (M&A) is not a short- or medium-term consideration as part of his separation from CP, which previously announced it agreed to a limited waiver of Hunter’s non-compete agreement with the railroad. Per the filing, Hunter is precluded from working at CN, Union Pacific or BNSF for the next three years, leaving the possibility of CSX, Norfolk Southern, or Kansas City Southern. CP directly competes with CN in Canada and with BNSF and UP in the U.S., so the “limited” waiver only applies to railroads that have “limited direct competition” with CP, whatever that entails.
Hunter’s separation agreement also includes so-called “standstill” language that effectively limits a hostile takeover of CP by Hunter, or any railroad he’s working for, over the next three years. Bear in mind, though, that this doesn’t preclude a friendly merger during this period involving CP and whatever railroad Hunter may be working for. Hunter and Keith Creel, his successor as President and CEO at CP, have had a close, mentoring-type relationship for more than 20 years. “It’s kind of like a quarterback and a wide receiver working together,” Hunter told me two years ago. “You know, you go back to pass and you don’t have to wonder where he’s going to be. You know it, you sense it. He can do the same thing with me, and that’s pretty powerful when you can develop those types of combinations with individuals. Keith joined my team in about ’95 at Illinois Central, as an assistant trainmaster, in Memphis. Hard working, energetic, probably the brightest young man in North America, in my view, certainly on the operating side of the business. I quickly picked up and saw the talents that he brought to the business.”
So in my mind, the likelihood of a friendly transcontinental merger involving CP and (fill in the eastern Class I blank) is within the realm of possibility. Those of us who know Hunter understand that a transcontinental is his dream, his hoped-for legacy. “There needs to be, and there will be in the future, transcontinental mergers in the U.S.,” he told me. “If you look at it, particularly in the Eastern U.S., there’s no more room for infrastructure. There are people begging for more commuter rail, more [intercity] passenger rail, more freight on different routes because of sensitivity to crude or hazmat, whatever the case may be. We’ve got that situation in Chicago. So how are you going to deal with those capacity issues, with growth, with the commuter situations, t with communities that want re-routes? If you don’t sit back and take a look at the industry first and how it could be modeled and then be sure that nobody is disadvantaged competitively, then you could create a lot of capacity just with mergers and some transparency. We try to do the interchanges effectively at the Mississippi River, up and down the river. And now a high percentage of it is in Chicago—the most populated city we have from a rail standpoint, with the most interchange. We’re trying to cram everything through Chicago and it just doesn’t make sense.”
Well, CP approached CSX in 2014 and was told, “No thanks.” Then, there was the attempt at a hostile takeover of Norfolk Southern. That didn’t work, either. But some seem to believe that the climate may be better for an M&A.
The new President, who made his fortune in real estate, probably would see a cross-border merger as the ultimate example of The Art of the Deal. I can picture him “orating”: “Lots of steel. Lots of wood. Lots of rocks. Maybe a little reinforced concrete. Let me tell you, this will be a beautiful railroad. Tremendous. Love those big red engines, with those cute little beaver logos. I like beavers. They’re builders, too. Industrious. They’re so smart they build houses that are dams. But we’ll paint those engines red, white and blue. America first! I don’t care what Justin says. He’ll pay for the paint! I want to ride the first train. Maybe I can have my picture taken blowing the whistle. Tremendous.”
OK, OK, I’m getting off topic.
Others are not so sure about a merger. “We continue to field incoming calls from investors trying to understand if Hunter’s potential move to an eastern rail finally sets the table for M&A in the industry,” one commented. “We continue to believe this is very unlikely as we believe Class I rail consolidation will not happen without broader industry support, including BNSF and UP. Since we believe both western rails would strongly oppose M&A between CP and one of the eastern rails, we believe it’s very unlikely to happen.”
However, this analyst noted, “We suspect activist Mantle Ridge is trying to reach an agreement to install Hunter as CEO. If CSX resists, Mantle Ridge has until Feb. 10 to nominate a slate of directors and wage a proxy campaign. If Hunter ultimately becomes CEO at CSX, we see potential earnings power of around $4.50, including a ~60% OR, ramping buybacks and a lower tax rate. Applying a 17x P/E multiple would imply a mid-$70s share price for CSX. While there are still a lot of ‘ifs’, we think this represents the best upside case among the rails.”
(I wonder why analysts call railroads “rails.” Rails are what the trains roll on. Is “railroad” too long a word? No offense, but do you Wall Street types have a problem with words of more than one syllable?)
Said another analyst: “Should Harrison take on a leadership role at CSX, we would expect a flow of investor funds to follow, which we see as at least slightly negative for the share price performance of all of the other Class I railroads (all else being equal). In addition, we believe that investors might perceive Norfolk Southern as being at risk of market share loss given the potential for more rapid cost improvement at its direct rail competitor. While we would argue that CSX’s ability to achieve operating ratio improvement has been significantly constrained by external factors, including a rapid decline in its high-margin coal revenue, we believe Harrison has developed a unique reputation among investors for being able to drive positive change, even in the face of structural limitations. From a CP perspective, the management succession plan has been long-telegraphed, and we expect the transition to be relatively seamless.”
OK, those are a couple of Wall Street views. How about a railroader’s view? I give you our own Roy Blanchard, Contributing Editor, consultant, railroad marketing expert. He’s been over the territory more than a few times. Pay close attention:
“I think there’s less to this than meets the eye. When Hunter took over IC, it was a north-south railroad in an east-west world that had lost its focus. He scheduled everything around the grain train turns and proved his Precision Railroading concepts. Then he went to CN. We know how that worked out. CP is a lot like the Rock Island because everywhere they went, somebody else went better, and they didn’t charge enough. So stop going where you don’t need to go (Albany, Harrisburg) and start charging market rates where you can. None of those shoes fit CSX.
“CSX has taken what I’ve called five angry railroads—C&O, B&O, L&N, SAL, ACL—and made them play nice together. The OR is safely into the 60s and headed lower. There is a young, talented bench (Mike Lonegro, Cindy Sanborn, Fred Eliasson) that’s come up with the company, and a short line program that is the longest-running and best-supported in the industry.
“The route structure is an efficient Jacksonville-New York/NJ-Chicago triangle, with the Washington tunnels getting closer to a true I-95 corridor. The intermodal hub-and-spoke strategy provides more flexibility than the NS Corridor theme and fourth-quarter merchandise carloads were 65% of revenue and 43% of volume. Coal is down to 19% and 14%, respectively.
“In summary, I think CSX already practices Precision Railroading and knows there is yet more to do in taking out cost, removing redundancies, and adding value to its transportation product. Hunter Harrison may have proven he can be the right medicine for curing sick railroads, but CSX does not strike me as a candidate for the HH cure.
“Of course, it may be that CSX is worth more in pieces than as presently constituted. Is that where Hunter is headed?”
(Disclosure: Roy Blanchard owns no CSX shares nor does he have a consulting arrangement with the company.)