CP Rail rolls out new strategy

Investors have high expectations for Bill Ackman’s new regime at CP Rail. Perhaps too high.

Bill Ackman, left, shakes hands with Hunter Harrison on Feb. 6, 2012. (Photo: Fred Lum/The Globe and Mail)

After revealing last October he’d acquired a large block of shares in Canadian Pacific, U.S. activist investor Bill Ackman of Pershing Square Capital Management asked fellow shareholders to take what amounted to a leap of faith. Ackman insisted CP’s leadership had mismanaged the railway and should make way for more effective people. Though he made striking promises about what these people might achieve, he offered no discernible plan.

Shareholders took the leap by electing all seven of Pershing’s nominees to CP’s board at the annual meeting on May 17. (Accepting defeat, Ackman’s opponents, notably former chairman John Cleghorn and CEO Fred Green, fell on their swords hours before the crucial vote.) Now comes Ackman’s greater challenge: satisfying the high expectations he’s stoked.

The new board appointed former Norfolk Southern executive Stephen Tobias as interim CEO. His permanent successor will likely be 67-year-old railroading legend Hunter Harrison. Ackman has said he will consider other candidates—but he gambled tens of millions of dollars, not to mention his credibility, touting Harrison during the proxy battle. As the driving operational mind behind competitor CN Rail between 1998 and 2009, Harrison espoused a philosophy he dubbed “scheduled railroading.” Its implementation at CP would mean big changes for customers, employees and shareholders, and not everyone will like it.

Railways used to focus on filling as many train cars as possible; timing was secondary. Scheduled railroading involves sticking to a rigid schedule, guaranteeing customers delivery within a certain number of hours. This allowed CN to deploy workers more effectively; they wasted less time waiting for trains to arrive. Some customers didn’t enjoy working around CN’s schedule, but ultimately the company was rewarded with rising market share. The strategy was so successful that it was copied to varying degrees by all North American railroads. CP, though, was a poor imitator.

To do better, Harrison needs co-operation from CP’s labour force. At CN, Harrison developed a reputation for toughness. During one strike in 2004, he declared replacement workers had pinpointed inefficiencies and vowed to terminate hundreds of employees in response. “During the Harrison years, they had labour issues now and then,” says Kam Hon, managing director at bond rating agency DBRS, “but the disrupt ions were never extensive, so it never really hurt CN’s performance.” Harrison must walk the same tightrope at CP. “The union is already rattling sabres,” Hon observes. “That will be the No. 1 challenge.”

Success will be measured by CP’s operating ratio, an expression of a railway’s operating costs relative to its revenues. It’s the industry’s most important measure of efficiency. Last year, CP’s was above 81%, making it North America’s least efficient railroad. (A lower number is better.) Foremost among Ackman’s assurances was that CP would reach a ratio of 65% by 2015. Expectations have been set high, with two of 11 analysts raising their ratings on the stock on May 17 itself. Failure to deliver could be punished severely.