(The following story by Robert Wright appeared on The Financial Times website on June 23.)
LONDON — The two rail systems that wind through the grim industrial landscape of northern New Jersey are outwardly hard to distinguish – except by the different liveries of the trains that run on them.
The black and white locomotives of Norfolk Southern and the blue and yellow of CSX run similar operations serving the factories, ports and distribution centres that make the area one of the US’s most important sources of railroad cargo.
Yet, for almost the whole history of the pair – CSX was formed through a merger in 1978 while Norfolk Southern was formed in 1982 – Norfolk Southern has performed better financially and operationally than its rival.
Indeed, CSX has long been a laggard of the seven large North American railroad groups, also known as the Class Is. Since the pair split rival Conrail between them in 1997,
NS and CSX have dominated the industry east of the Mississippi river.
The reasons for CSX’s underperformance and how best to close the performance gap with its peers are key issues in the battle over board seats that will dominate CSX’s annual meeting, which takes place on Wednesday in a rail yard near New Orleans.
The outcome of the meeting – at which The Children’s Investment Fund (TCI) and 3G Capital, another hedge fund, will be trying to win five of CSX’s 12 board seats – could shape the future of shareholder involvement in the reviving US railroad industry.
However, observers warn that whatever happens on Wednesday improvements in CSX’s performance will be steady rather than dramatic.
Referring to TCI’s demands for radical changes in CSX’s pricing policy and investment spending, one railroad investor likens the hedge fund to a baseball batter trying to win a game with a few spectacular shots.
“It seems to us as if some people are looking for triples and home runs,” he says. “Our view is there are a lot of singles and doubles.”
At the heart of CSX’s problems, according to Anthony Hatch, a respected railroad analyst, is its history of diverting investment away from the railroad. In the 1980s, when rail price rates were too low to make significant capital spending worthwhile, CSX became a conglomerate. It invested its revenue in more apparently lucrative, since-sold businesses.
Most observers believe infrastructure suffered underinvestment until John Snow, who became chief executive in 1988, left to become US Treasury secretary in 2002. “CSX was making reasonable, rational decisions on the information it had at the time,” Mr Hatch says. “Rail returns were poor.”
Norfolk Southern invested more steadily, gaining a reputation for targeting its spending well. Although it, like CSX, suffered operational problems integrating its portion of Conrail, it has generally handled the past few years’ boom in demand for rail service more cheaply and efficiently than CSX.
“Most people agree that Norfolk Southern is still the gold standard, certainly in terms of operations,” Mr Hatch says.
However, TCI argues that CSX now invests more heavily than is necessary to maximise returns for shareholders. Early in its campaign against the management last year, it called for significant cuts in infrastructure spending following the US economic slowdown.
The calls, which TCI has toned down recently, have formed a key part of the media and political campaign CSX has orchestrated against TCI.
In a private media briefing in May, a senior CSX executive claimed the London-based fund represented an unacceptable foreign threat to a key piece of US infrastructure.
Michael Ward, CSX’s chief executive, insists investment is towards the bottom end of the range among Class Is, which typically use 16-20 per cent of revenues for capital expenditure. CSX’s ratio is about 17 per cent.
“We’re good business people and any incremental capital spend that we make goes through a very rigorous review process and there’s a hurdle rate for any capital investments,” Mr Ward says.
Yet the shock of facing the railroad industry’s first activist shareholder revolt seems not to be doing CSX significant harm. The company’s first-quarter results saw it pull almost level on some performance measures with NS, even though performance is likely to level off later in the year.
The most significant feature of the battle, meanwhile, may be that it is taking place at all. For years, the railroad investor points out, shareholders’ main concern was whether railroads could earn enough to avoid bankruptcy.
That shareholders now debate the appropriate levels of investment and profitability shows how remarkable a turnround the industry is enjoying.