Pershing Square Capital has orchestrated one of the biggest turnarounds in railroad (and, arguably, corporate) history. Now, as the question of rail mergers looms large, here’s a look back at how the hedge fund pulled it off and raked in billions.
Todd Korol / Reuters
In the summer of 2011, after three months of 100-hour work weeks, a hedge fund executive in New York thought he had the Canadian train business all figured out. But his boss, Bill Ackman, to whom he'd soon present an activist investment idea for Canadian Pacific Railway, would have the final say.
Followers of Ackman's Pershing Square will know how that presentation went, and how the idea ultimately unfolded into what is widely considered one of the greatest activist investing campaigns in history, adding more than $25 billion in value in just over two years. But what few may know is how that executive, Paul Hilal, found and carried the Canadian Pacific thesis to its multi-billion-dollar payday.
And now, with talk of a possible merger of the Canadian rail giant and CSX, another North American railroad, Pershing Square and Canadian Pacific stand to rake in even more money if they can create a bigger, more efficient railroad.
"They've had everything go right," said Keith Schoonmaker, an analyst covering Canadian Pacific at Morningstar. In the 28 months the hedge fund has been advocating for change at Canadian Pacific, it has transformed what was a $7.1 billion company into one now valued at around $34 billion.
Not everything went Pershing Square's way, and particularly not the factors left to the gods. A grueling 100-year flood in Calgary and one of the worst winters on record both hit transport businesses hard in the last year. But Canadian Pacific still thrived, under the guidance of Pershing Square-appointed CEO Hunter Harrison. And even though the eventual completion of the KeystoneXL oil pipeline, long stalled by environmental concerns, could reduce some of Canadian Pacific's oil transport business, Schoonmaker says oil is not a make-or-break factor, given the company's other strengths.
"There's plenty of value in this railroad without the crude franchise," Schoonmaker said. "If it's diverted into pipeline, that's not a fatal problem for them. The oil development out of heavy crude in Alberta is much more difficult to move on the pipeline, it's somewhere between peanut butter and a hockey puck in consistency, so you'll need CP. There are also drilling materials, pipe, and frac sand to be shipped by rail to the most advantageous locations."
So just how did Pershing Square transform Canadian Pacific from the worst performing railroad in North America into one of the most efficient railways today, adding almost $1 billion in market value per month along the way? It all started with Paul Hilal's brother and a dinner party.
angelo_narciso/angelo_narciso
Hedge funders often throw "ideas" dinners to discuss investments that are going well and those that are falling short. It was at one such dinner in the summer of 2011 that Hilal's younger brother Phillip overheard a couple of guys bemoaning investments in a Canadian railroad that they were "just getting crushed" on. The younger Hilal called his brother the next morning, who decided to spend his August learning all about the world of Canadian trains.
"By early August, I took a look at the Canadian railroads, based on a lead, that some shareholders were frustrated with one of them," Hilal told BuzzFeed News. "There are seven class one rail roads in North America. Five of them are in the U.S. and their margins were roughly 30%. Canadian National was at about 40% and Canadian Pacific was at about 18%."
The problem, as he saw it, with Canadian Pacific? "They had convinced themselves and the investment community that unique structural -- i.e. prohibitively expensive or impossible to overcome -- challenges prevented them from performing as efficiently as the other railroads. So I spent August of 2011 trying to figure out whether these explanations were really excuses. In my opinion, they were. Cultural due diligence established that CN's team comprised hungry, motivated, results-oriented, go-getters. CP's alumni, by contrast, described it as crippled by a culture of slackers".
According to Hilal, Canadian Pacific claimed that their path through the Rocky Mountains was steeper and their tracks were curvier, and said that they had to deal with worse weather. Hilal decided that this wasn't exactly the case, at least not to the extent that it would cause such a serious disadvantage in efficiency. So he decided to take action.
"They had some relative disadvantages, but no more so than every other railroad," Hilal said. "All they needed was leadership and culture change, and some fresh perspectives on the board."
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