Activist hedge fund investor takes 12.2-percent stake in Canadian Pacific

Pershing Square Capital Management, a $10 billion hedge fund run by the prominent activist investor Bill Ackman, disclosed Friday, Oct. 28, that it had acquired a 12.2-percent stake in Canadian Pacific Railway Ltd. (CP), triggering discussion about what the investment means for the railroad's future.

In a 13-D statement with the Securities and Exchange Commission, Ackman called CP's shares "undervalued" and an "attractive investment." A 13-D filing usually indicates an acquirer of shares is planning to take an active role in pushing for change at the company targeted for investment. A CP spokeswoman was unavailable for comment at press time.

Since October 2010, CP's share price has lagged those of U.S. railroads and of its main Canadian competitor, Canadian National Railway Ltd. CP's share price has barely budged in the past 12 months, while the prices for shares of the three publicly traded U.S. Class I railroads, Norfolk Southern Corp., CSX Corp., and Union Pacific Corp., as well as those of Canadian National, have risen by double-digit percentages.

William D. Greene, lead transportation analyst for Morgan Stanley & Co., said Ackman's presence potentially could have a "game-changing impact" on CP's shares, even if Ackman's role is relatively muted. Greene said CP's stock, which closed Friday at $64.57 per share, could trade at a price near $100 a share by the end of next year if investors believe in management's ability to achieve its operating targets over the next three to four years.

After an initial upward bump on news of Ackman's investment, CP stock was trading down almost $1.00 a share at midday Monday amid general weakness in U.S. and international equity markets.

Greene said investors have been unwilling to credit CP's management with achieving operational progress, choosing instead to draw comparisons with Canadian National and punishing CP for execution problems that were due primarily to bad winter weather followed by springtime flooding.

Greene also said Ackman's investment could persuade potential investors who are skeptical of CP's progress that the company is on track to meet its operational targets, the most important of which is achieving an operating ratio (operating expenses divided by revenues) of 70 within the next three to four years. CP is expected to attain an 80.9 percent operating ratio in 2011. A lower percentage normally indicates that a carrier is operating more efficiently.

In a research note issued the day before Ackman's disclosure, the New York investment firm Wolfe Trahan & Co. repeated its "underperform" rating on CP stock. The firm said that although CP's network has recovered from the effects of severe weather in the first half of the year, its pricing power remains weak compared to other railroads. CP also faces challenging cash-flow prospects as it deals with rising capital expenditures while gearing up for the winter by bringing on more employees and equipment.

CP last week reported an increase in third-quarter revenue to $1.34 billion from $1.286 billion in the same quarter a year earlier. However, operating income over the same period fell 3.9 percent to $324.6 million, due partly to the weather-related service disruptions.

The railroad expects strong gains in Canadian coal and grain volumes, offset by weakness in similar commodities in the United States.

Ackman generally takes large positions in established companies whose share prices he believes have been unduly depressed due to investors' concerns over performance issues, competitive position, or general business conditions.

Ackman made his name early last decade by taking a big stake in fast-food giant McDonald's Corp. McDonald's, which was struggling at the time, subsequently turned around its operations, resulting in a nearly six-fold gain in its share price over the past 10 years and creating a huge windfall for Ackman.

Lawrence H. Kaufman, a long-time rail executive, journalist, and consultant, said he was puzzled by the investment. Kaufman noted that CP is not the kind of poorly managed, underinvested company that hedge fund investors normally target for a turnaround.

CP, Kaufman said, is "not known to be underinvested, and I think it is reasonably well run. It's had some real problems with weather, but that doesn't account for hedge fund interest."