The fight for control of Canadian Pacific Railway

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When he flew to Montreal three weeks ago to meet with senior officials of Canadian Pacific Railway Ltd., Bill Ackman came bearing a thick, limited-edition book.

The weighty volume is Mr. Ackman's signature opening move. Ever since the New York-based shareholder activist founded Pershing Square Capital Management LP in 2003, nearly two dozen undervalued companies, including Wendy's International Inc., Target Corp. and J.C. Penney Co. Inc. have received an Ackman book. The confidential studies, often the product of months of work by Pershing Square's analysts and consultants, are detailed blueprints for boosting long-term profits at companies in his crosshairs.

CP shareholders can expect to learn within the next several weeks whether Mr. Ackman's book will be embraced by the company as a road map to recovery or a declaration of war.

Mr. Ackman's funds have spent $1.2-billion (U.S.) to acquire a 12.4-per-cent stake in CP, becoming the railway's largest shareholder. If the 130-year-old railway's board of directors agrees to yield to the brash 45-year-old, shareholders can expect a range of moves that could include management changes, extensive cost cutting and asset sales, sources say.

Should the freight carrier instead seek to rebuff Mr. Ackman's proposals for change, the company and its blue-chip directors, including Suncor Energy Inc. chief executive officer Rick George and former Royal Bank of Canada chief John Cleghorn, face the prospect of a very public and noisy power struggle that could redefine the boundaries of shareholder influence in Canada's historically passive investor community.

In this match, Mr. Ackman is challenging a century-old institution that helped knit together a country, nurtured regional economies and now transports an ever-increasing share of Canadian resources bound for booming Asian markets.

If CP's well-connected directors opt to challenge Mr. Ackman, the investor would be facing his biggest fight yet with the business establishment. Spokespersons for CP and Pershing Square declined to comment about their discussions.

Most of the 23 companies Pershing Square has targeted in the past eight years have bowed to Mr. Ackman's pressure for change. Two were dragged into proxy battles after they balked. He won the fight for board representation on Ceridian Corp., a U.S. payroll company, but lost the contest with the Target retail chain. Both involved bruising public campaigns against directors, but his thwarted two-year quest to shake up Target took shareholder activism to a new level of high drama.

During a speech to Target shareholders at a 2009 annual meeting in Wisconsin, the grey-haired activist, whom company insiders dubbed "the silver fox," likened his shareholder rebellion to John F. Kennedy's famous call to fight foreign tyranny. Invoking the late president's 1961 inauguration speech, Mr. Ackman choked up and wiped away tears when he said: "We will pay any price, bear any burden, meet any hardship."

The theatrical moment failed to persuade enough shareholders to vote for Mr. Ackman's dissident slate of directors at the meeting, but his activism had an impact. In the wake of Pershing Square's proposals, Target has sold or put up for sale most of its credit card assets. Since then, the retailer's widely admired chief marketing officer defected to work for one of Mr. Ackman's more obliging turnaround targets, J.C. Penney.

The activist has privately vowed he will never again wait more than a few months for a company to heed his demands for change, according to people familiar with Mr. Ackman's failed Target campaign. The investor has since sold most of his holdings in the retailer.

Slow to innovate

The arrival of such a restless and powerful investor could not have come at a worse time for CP chief executive officer Fred Green. Since he was named CEO in 2006, Mr. Green, 54, has been fighting an uphill battle to keep up with more profitable competitors such as Canadian National Railway Co., which began investing heavily in the late 1990s to upgrade its tracks, and improve its train speeds and service. CN now ranks as the industry's most efficient railway.

"Some of things that CP is doing now are, in some respects, catching up to what CN has been doing for a while," said National Bank Financial Inc. analyst Cameron Doerksen.

Using the industry's standard measure of performance, the operating ratio, CP has been unable to keep up with its competitors. The railway ranks as the least efficient of North America's Big Six railways with operating costs equalling 82.4 per cent of its revenue in the first nine months of 2011. At industry-leading CN, operating costs were 63.1 per cent of revenue.

Like many of his predecessors, Mr. Green is a CP lifer; he joined the company in 1978. Carrying a commerce degree from Concordia University, he distinguished himself as a methodical executive with an affinity for managing complex projects. He was promoted to the management fast track at CP in 1996 after he impressed the railway's top executives with his steady management of the company's colossal migration from its historic head office in Montreal to a new home in Calgary.

"He is good with details," said Anne Golden, CEO of the Conference Board of Canada, where Mr. Green is a director. "He reads all our reports, is totally engaged and has detailed questions and constructive suggestions about our work."

On the public stage, however, Mr. Green is sometimes challenged when communicating his message. His preference for buzzwords such as "asset velocity" and railway "fluidity" has been known to mystify listeners on CP's quarterly conference calls. When he met with an angry group of CP staff amid the global financial crisis of early 2009 to explain hundreds of job cuts, workers were infuriated when he retorted "suck it up, buttercup" to an employee complaining about extra weekend shifts.

"Fred Green isn't personable," said Tom Murphy, a local union president with the Canadian Auto Workers, who attributed the CEO's harsh response at the session to frustration with unruly employees. "He won't come over and greet you and say, 'Hi, how's it going?'"

Unlike its competitors, CP has been slow to innovate. The delay is partly explained by its former life as a subsidiary of Canadian Pacific Ltd., a massive hotel, shipping, rail, mining and energy conglomerate that was broken up in 2001. The railway was seldom blessed with large increases in capital budgets, and the complex process of being spun off from its parent preoccupied management for years.

Now that CP is finally modernizing its train network, it is shouldering billions of dollars in capital expenses at a time when the global economy is faltering. Complicating matters, the company has had to borrow $1.3-billion to replenish a shortfall in its pension plan. The heavy costs have suppressed CP's profit and stock price, leaving it vulnerable to activists such as Mr. Ackman. When his Pershing Square funds began acquiring CP stock in September, its share price had fallen to a two-year low of $44.74 on the New York Stock Exchange.

Making converts of critics

Although some analysts have publicly questioned the scale of CP's investment in more than 90 new locomotives and 1,100 additional staff in an uncertain economic climate, Mr. Green has placed a priority on improving service at a railway notorious for train delays and broken promises.

Mr. Green believes improved service, train speeds and capacity are essential to securing lucrative long-term contracts with potash, grain, mining and pulp companies transporting an increasing share of their output to booming economies in China and Southeast Asia, according to company insiders.

"It is very hard to create value for shareholders if you don't create value for customers. He is really, really focused on delivering to clients," said one person close to Mr. Green who declined to be identified.

Improving service at CP is no easy task. The railway is more vulnerable than competitors to adverse weather and slower train speeds because its tracks climb through steep Rocky Mountain grades and flood-prone Prairies. The company's first-quarter profit slid 67 per cent after winter avalanches slammed its operations. Things went from bad to worse in the spring when unusually harsh flooding submerged some of its tracks from the Prairies to Chicago for 23 days.

Despite these setbacks, CP has been able to make converts out of some of its harshest critics. A few years ago, relations between CP and its largest client, Teck Resources Ltd., were so badly frayed that CP executives were taking pot shots during a quarterly conference call at the mining giant's production problems at its B.C. coal mines. From Teck's point of view, according to company insiders, the railway was costing it time and money with major Asian customers because train shipments of metallurgical coal to Asia-bound ships in Vancouver harbour were frequently delayed because of late or undersized CP trains.

Teck CEO Don Lindsay credits Mr. Green for repairing the relationship by committing last year to invest in increased train and track capacity and loading innovations that have enabled the mining company to speed up and increase the size of its coals shipments. In return, Teck signed a 10-year contract with CP to transport its booming metallurgical coal output bound for China and other ports.

"We've been pleased with their dedication to ensuring that we get the rail service we need. Fred Green understands that to grow the economy, especially in Western Canada, we need to work together to get the most out of the rail network," Mr. Lindsay said.

For many of CP's smaller clients, the railway still has long way to go to repair its reputation as an unreliable and indifferent transportation company.

"Surely to goodness, if a courier company can tell you where a parcel is, CP should be able to tell you where its train is," said Richard Phillips, a canola famer near Tisdale, Sask., who, along with the local grain elevator operator, was forced to keep extra workers on hand for several days in February when CP failed to show up at the promised time with 50 railcars.

The railway never called to explain or apologize for the delay, Mr. Phillips said.

Although it is too early to predict how Mr. Ackman will play his hand at CP, recent meetings with railway executives and public communications from the investor suggest that a management overhaul is a top priority.

When Mr. Ackman first met with a handful of senior CP officials earlier this month, people familiar with the session said Mr. Green barely spoke. Leading the discussion was the railway's chairman, Mr. Cleghorn.

Given Mr. Ackman's track record with managers of underperforming companies, it's easy to understand why Mr. Green had little to say.

In a quarterly letter to Pershing Square investors released this week, Mr. Ackman identified new management as one of his core strategies for "increasing long-term intrinsic value" at target companies. In his effusive account of the turnaround at J.C. Penney, Pershing Square's largest investment, he trumpeted his recent recruitment of Ron Johnson, former retail chief of Apple Inc., to lead J.C. Penney's recovery.

"I expect to look back on the decision by the company to hire Ron, and our role in identifying and recruiting him, as one of the most significant contributions that we have ever made to any company," Mr. Ackman wrote.

He did not directly discuss management in the letter's short four-sentence summary of the CP investment. But he left little doubt that the railway's executive suite is a concern when he wrote that the railway's poor performance "is generally not attributable to structural factors."