(The following appeared at SeekingAlpha.com on August 5.)
CSX Corporation (CSX) is still refusing to seat two of four dissident director nominees as it hopes an appeals court decision will disqualify a block of shares voted by activist hedge fund Children’s Investment Fund. The independent inspector of elections has found that four of five TCI nominees won election during the June 25th annual meeting, but if the appeals court upholds the fact that TCI violated securities laws, it could mean a complete loss for the activist hedge fund.
So, why should investors be watching this situation closely? Activist hedge funds are well known for unlocking value in their target companies. In the case of CSX, TCI believed that it could profit from a potential leveraged buyout of the firm back in December 2006. By January of 2007, TCI had acquired more than 10% of the company and was discussing the plan with investment bankers. By April, TCI knew it was not going to get what it wanted passively and began a proxy contest.
A victory in the proxy contest would be great news for shareholders as the hedge fund may seek a leveraged buyout at a substantial premium. However, even if a buyout does not occur, it is likely that the activist fund will take some actions to unlock shareholder value. After all, investors are all concerned about the same thing – making money off of their investments. Unfortunately, investors won’t know the outcome of this proxy fight until September when the courts are expected to make a decision.
Railroads also represent a growing industry. A recent Barron’s article noted that Americans may finally see rail travel as attractive, as sky-high fuel prices continue to push up driving and flying costs. More, railways are carrying more freight with trucks being bogged down with high diesel prices, traffic delays, and other negative influences. The U.S. Chamber of Commerce itself sees an 88% increase in demand over the next quarter of a century.
Warren Buffett has also beefed up his stake in the railroad industry. His Berkshire Hathaway has amassed an 18% equity stake in the Burlington Northern Santa Fe (BNI), which is the second largest publicly traded U.S. railroad company. The billionaire investor also counts many other smaller lines among his holdings. Since Buffett is known for buying on the cheap, many investors see this as a great opportunity to get in at the industry’s bottom.
Investors in any case should be looking for two things: value and a catalyst. Warren Buffett’s interest in the industry is a clear indication to many that there is value in the industry. There is also a lot of fundamental data arising in support of an industry turnaround. Meanwhile, there is no better catalyst for investors than an activist hedge fund when you know they’re on your side. TCI’s involvement in CSX is just the catalyst needed to unlock value – now investors just have to see who wins in court.
Investors should also consider how to best profit from the situation. Since railroads may take a while to turn around, something long-term is preferable. However, short-term volatility in the near future could push prices sharply higher or lower. As a result, LEAPS options may be the best choice for many. These long-term options allow investors to commit less capital to the position but retain the same upside as owning 100 shares (per contract). If things go bad, your losses are limited to the premium paid.
Disclosure: No position in CSX.