(The following story by Claudia Montoto appeared on the Financial Times website on October 30.)
NEW YORK — Although the fad of potential rail LBO’s seems to have subsided, CSX activist shareholder TCI continues to push for internal changes. According to industry sources, it is likely that CSX management will attempt to deflect TCI’s demands, though it remains more likely that the company’s number three shareholder will be successful in realizing some internal change.
Any investor hopes of a quick jolt to CSX’s weakening share price could prove futile, as the company and its shareholder activist are strapping in for a long and bumpy ride. “If I were investing in this company, I wouldn’t do it on some sort of change event I’d do it based on the fact that railroads are good businesses long term,” an industry source said.
Earlier this month, TCI – officially recognized as The Children’s Investment Master Fund – submitted a letter to CSX’s board of directors urging the company “to act immediately and act voluntarily to strengthen CSX’s corporate governance, management, business performance, and the Board itself.” Among a number of requests, TCI asked urged the company to separate the chairman and CEO roles from Michael Ward, indicating that his interests are not aligned with those of the CSX shareholders.
CSX management has proven resilient to TCI’s prior overtures, and according to the source, Ward is likely to again try and fend off the efforts of the UK-based hedge fund unless there is pressure brought on the board that he can’t realistically resist. Frankly, said the source, Ward is not a deal kind of guy, but rather a conservative and operationally focused rail executive.
The only potential outcome of the activism is the replacement of Ward if people lose confidence in him, the source said. However, he added that he does not believe there is a strong enough case against Ward that would prompt such a belief.
Meanwhile, an industry analyst said he believed CSX may crack by acquiescing to the creation of an independent board. TCI, said the analyst, wants to have members of that board that will listen to TCI and take them more seriously. The fund, he and a person familiar with the situation said, has no intention of “going away.”
TCI has been known to aggressively pursue its targets using similar strategies. Earlier this year the fund took on ABN Amro and demanded for a break-up of the company with merely a 1% stake; the Dutch bank sold itself in October for USD 101bn. TCI had also been recognized – with help from Atticus and other US hedge funds – for having ruptured the potential marriage between the London Stock Exchange and Deutsche Boerse in 2005.
Atticus, also a CSX shareholder, has been silent subsequent to TCI’s letter last week.
In May, during a keynote address at a trade event in New York, TCI Partner Snehal Amin said the mega-fund’s plan to improve CSX’s margins would involve price increases by 7% a year, increased operating ratio by 1% per year, and a 20% buyback of stock per year. But in TCI’s recent letter, there was no mention of rate/price increases. Among its requests, TCI urged CSX to refresh the board with new independent directors, allow shareholders to call special meetings, align management compensation with shareholder interests, present shareholders with a plan to improve CSX’s operations, justify the company’s 2007-2010 capital spending plan, and improve relations with labor, shipper and shareholders.
Asked how likely it is that TCI will succeed in its efforts this time around, the person familiar with the situation said he believed it will depend on CSX management, and whether they will change their tone. “It’s probably easier to work with [TCI] than to work against them,” he said.
CSX is the toughest rail to operate on structural grounds due to the existence of bottlenecks in its system, the first source said. Rail bottlenecks are defined as segments of track that either originate or receive rail traffic via a single rail line, although another railroad is able to carry that traffic for part of its through movement. Extreme congestion occurs in conjunction with the minimal infrastructure of the bottlenecks and ultimately delays the flow of increased cargo or passenger levels, affecting the so-called efficiency of a railroad.
In May, CSX announced that it had submitted an application to the US Department of Transportation (DOT) seeking Corridor of the Future designation for the 1,200 mile I-95 rail corridor between Washington, DC and Miami which would relieve freight congestion. According to the same release, the company expects to make core capital investments of roughly USD 1.5bn in 2007, USD 1.6bn in both 2008 and 2009, and USD 1.7bn in 2010 to help tend to increasing transportation demands.
And yet despite CSX’s challenges, the source said the company has held the line on pricing, adding that he thought the pricing story was still a good one. However, he cautioned that the company is likely maxed out on volume growth, so operating more efficiently – as requested by TCI – is not an easy task to undertake, particularly if the US market goes into a softer economic environment.
”I don’t see lightened value just sitting there,” said the source, while the second source said it was questionable whether TCI could take the class 1 rail to a more proficient level operationally.
According to CSX’s most recent annual report, the company’s 2006 revenue increased 11% from the previous year, while EBITDA and net income from continuing operations increased 21% and 82%, respectively. In relation to rail volume, 3Q07 showed signs of continued decreasing volumes, with the overall volume having declined by 4% compared with the previous year’s Q3. On the other hand, revenue grew 3% which suggested that CSX was able to achieve pricing gains to offset the decrease in volume.
Asked whether market rumblings that CSX could consider a break-up between its rail and intermodal operations were sensible, the first source said it is unlikely Ward would consider the radical idea and run the risk of long-term fragmentation of operations for a small boost in the share price.
However, the second source noted that there is some value to CSX’s intermodal that could potentially – if it did not have many assets – receive a high multiple if split from the rail. And still, the synergies of having the operations under one roof are substantial as the intermodal feeds the rail business, the second source said.
CSX’s share value has increased roughly 28% year-to-date.