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CP Rail open to talks with activist investor

Rail cars loaded with canadian wheat travel through the Rocky Mountains on the Canadian Pacific railway line near Banff, Alberta, October 6, 2011.


Canadian Pacific Railway Ltd. is opening the door to talks with an activist hedge fund, saying it had already embarked on an efficiency drive before being approached by the U.S. financial manager.

New York-based Pershing Square Capital Management LP, headed by William Ackman, disclosed its $1-billion (U.S.) investment late Friday, revealing that it had become CP's largest shareholder. Pershing wants to discuss a strategic review of the Calgary-based railway's operations with CP executives and directors.

While CP didn't provide details Monday of its productivity campaign, the freight carrier said recently that it's on a spree to hire hundreds of new workers and buy extra locomotives as it seeks to assure customers that it will avoid a repeat of last winter's frequent delivery delays due to severe weather. CP has budgeted more than $1-billion (Canadian) in capital spending this year, including improvements to its track system on the Canadian Prairies and into North Dakota.

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"As with others, CP is open to the views of its shareholders. We will speak with Pershing Square to hear their input into our plan, already targeted at realizing greater efficiency and improved service reliability," CP said in a memo to its employees.

As part of its spending plans, Canada's second-largest railway will also extend its sidings – sections of track located to the side of main rail lines – in a bid to give workers more flexibility in repositioning trains quickly.

"As we've been discussing for the past few quarters, especially heading into winter, it is important that each of you continue focusing on strong performance on the IOP [integrated operating plan] meeting our customer needs and ensuring the safe operation of the railway," said CP, adding that "while we have an active dialogue with many of our investors, our practice is not to comment on those discussions."

CP stock fell 3 per cent on Monday, but it has still surged about 34 per cent since hitting a two-year low on the TSX on Sept. 23 – the day that Pershing began accumulating shares in the railway. Pershing now owns 12.2 per cent of CP.

BMO Nesbitt Burns Inc. analyst Fadi Chamoun said it could take at least three years before the full benefits are realized for CP's current efficiency drive.

One of the topics expected to be raised in discussions between CP and Pershing will be ways to speed up the trains and put the productivity campaign on the fast track.

RBC Dominion Securities Inc. analyst Walter Spracklin said CP shares still have room to run, even after surging over the past five weeks. On Monday, Mr. Spracklin raised his 52-week price target on CP shares to $80 each from $66.

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"Our price target of $80 is based on the rough midpoint between our fundamental target of $72 and our take-out valuation of $90," he said in a research note. Mr. Spracklin played down the scenario of an outright sale of CP to a pension fund, though he said asset sales are possible.

Montreal-based Canadian National Railway Co. has become a trend setter by setting detailed schedules for trains. By contrast, CP is a laggard, say analysts, who watch a key indicator called the operating ratio – operating costs as a percentage of revenue. Like a player's golf score, a lower operating ratio is better. While CP's nine-month performance worsened, CN's ratio improved.

UBS Securities Canada Inc. analyst Tasneem Azim noted that Pershing intends to engage CP executives and directors in talks on ways to improve train operations, given CP's lagging operating ratio.

With Pershing's CP investment, both of Canada's major railways now have a U.S.-based investor as their largest shareholder. Microsoft co-founder Bill Gates controls more than 10 per cent of CN.



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In total, Pershing Square Capital Management acquired 18 million CP Rail common shares at an average price of $54.46 (U.S.) and also picked up 2.65 million call options at $31.81 a share for the right to acquire the stock at a strike price of $30.55. With its 12.2-per-cent stake, Pershing is now CP's largest shareholder.

On Sept. 23, Pershing began acquiring CP shares as its stock price slumped to two-year lows. From Sept. 23 to Oct. 17, Pershing paid an average of $49.53 a share, and from Oct. 18 to Oct. 28, it paid an average of $58.68.

Pershing's further purchase of CP stock on Oct. 18 pushed the hedge fund's holdings in the railway above 5 per cent. Under disclosure rules with the U.S. Securities and Exchange Commission, any initial accumulation of 5 per cent or more of a company's stock must be publicly revealed within 10 days.

Pershing filed its Schedule 13D form to the SEC after markets closed Friday.

Brent Jang

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About the Author

Brent Jang is a business reporter in The Globe and Mail’s Vancouver bureau. He joined the Globe in 1995. His former positions include transportation reporter in Toronto, energy correspondent in Calgary and Western columnist for Report on Business. He holds a Bachelor of Commerce degree from the University of Alberta, where he served as Editor-in-Chief of The Gateway student newspaper. Mr. More

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