It’s time for siege on CN to cash in and move on

Here’s a message for Christopher Hohn, the U.K. hedge fund manager who has laid siege to Canadian National Railway Co. (CN) since mid-September. Enough, already.

Even before the culmination of Hohn’s months-long attack on CN in a proxy fight launched Sept. 13, most of the wrenching changes Hohn’s TCI Fund Management Ltd. sought at CN had been achieved or were underway.

Hohn’s persistence in trying to impose his own CEO and slate of directors on CN awaits a vote of CN shareholders in March. That just extends a period of uncertainty likely to harm all parties, including CN’s workforce and the railway’s customers.

CN has, of course, ended its pursuit of the Kansas City Southern railroad (KCS). Hohn excoriated the CN board for that folly, as he saw it, claiming it might cost CN as much as $2 billion in liabilities if the deal failed.

Hohn was wrong.

CN instead pocketed a windfall of about $700 million (U.S.) in deal termination fees when KCS broke its agreement to merge with CN and returned to its original merger partner, Canadian Pacific Railway Ltd. (CP).

With the KCS issue buried, Hohn then succeeded in pressuring CN’s chief executive to quit the post just three years into his tenure. J.J. Ruest said last week he will step down as CEO early next year.

CN’s chairman, whom Hohn also sought to oust, is retiring next year.

On Sept. 17, CN unveiled an ambitious turnaround plan that addresses Hohn’s stated concerns.

CN vows to boost operating profit by about $700 million (Canadian) by cutting expenses. That strategy includes laying off about 1,050 employees.

CN is also committed to asset sales. It might sell all or part of its freight-forwarding trucking service and a fleet of Great Lakes ships, among other streamlining efforts.

And after recent years of heavy investment in an upgraded rail network, CN will cut spending to 17 per cent of revenue from more than 20 per cent.

CN’s financial performance has already seen a marked improvement. On Oct. 19, CN reported that in its latest quarter its revenues increased by 5 per cent, and profits improved by 10 per cent.

CN managed to post those impressive numbers amid pandemic-related supplychain disruptions and continued weakness in cargo volumes.

And CN’s stock price has sprung to life.

Goosing the share price is the prime objective of so-called activist investors, who buy a small fraction of a company’s stock — in this case 5.2 per cent of CN stock accumulated by TCI this year — and use it to pressure management to rapidly increase the value of their newly acquired shares.

Hohn has already done well on that score, too.

In just five months, CN shares have soared in value by almost one-third from their low point this year. They reached a record-high price of $167.50 before slipping a bit this week to $164.

But Hohn, who has a flair for inflammatory rhetoric, still isn’t satisfied.

Hohn dismisses the turnaround strategy he pressured CN to develop. A new plan without a new CEO is, Hohn says, a “massive corporate governance failure” that “puts the future of the company at risk.”

That is way over the top. The future of the 102-year-old CN, one of North America’s biggest transportation companies, and by several measures the best-run railroad on the continent as recently as 2017, is in no way at risk.

And it’s unlikely that CN will wait until March to appoint a new CEO. Indeed, there’s a strong possibility CN’s existing board will tap as its new CEO Jim Vena, Hohn’s own choice to run CN.

Vena, a 40-year veteran of CN with turnaround experience at Union Pacific Corp., is not on Hohn’s proposed slate of directors, but would become CEO in Hohn’s plan.

But Hohn doesn’t stop with Vena’s installation. He is also determined to load the CN board with a slate of directors who owe their posts to him.

That’s how the activist-investor game works. But it’s not ideal that CN has become part of a game for Hohn’s personal wealth extraction. As noted, Hohn has already been handsomely rewarded for his disruptive efforts at CN.

It doesn’t help that the Street isn’t overly impressed with TCI’s own plan for CN, unveiled last week.

Among the analysts with doubts about TCI’s proposed changes at CN, is Christian Wetherbee of Citigroup Inc.

The TCI plan stops “short of providing detailed financial projections of what CN would look like under new board oversight and Jim Vena’s leadership,” Wetherbee wrote in a client note last week.

“We view this as a crucial step in the process to win shareholder support (in March) for change at the board and of the CEO.”

It’s fair to say that CN invited Hohn’s meddling.

As this space pointed out in April, over the past several years CN has fallen behind CP and some of its other North American peers on several key performance measures.

At 15.8 per cent, CN’s fouryear pre-pandemic profit growth lagged that of CP (53 per cent). And last year, CN’s profits fell by 14.3 per cent while CP’s profits were unchanged.

CN’s stock performance over the past five years was the worst of its Class I railroad peers in North America. CN shares gained 95 per cent in that period, to industry-leading CSX Corp.’s 253 per cent.

And by 2020, CN’s operating ratio — its costs as a percentage of revenue — had increased to 64.4 per cent to CP’s exemplary 57.1 per cent.

There is a growing concern in the industry, though, that operating ratios have become fetishized.

There comes a point when improving that key measure requires cost cutting that reduces capacity and the ability to attract new customers.

Which puts Hohn’s demand for a sharp reduction in the operating ratio — which CN has already managed to improve to 62.7 per cent in its third quarter — in conflict with his insistence that CN create more capacity to generate more revenue.

Hohn’s work at CN is effectively done. It’s time for him to cash in and move on. Hohn’s continued pressure on CN, according to Railway Age, an industry Bible, means “the rhetoric- and allegation-filled press releases from both sides will continue like hand grenades, to be lobbed.”

Hohn himself represents the only risk to CN, albeit a shortterm one. CN needs to get on with its avowed mission to run its business more efficiently. And it must prepare to take on a strengthened CP should U.S. regulators approve CP’s acquisition of KCS next year.

We’ve had high drama at both of our transcontinental railways this year.

The contest over KCS ended peacefully. For the sake of CN’s employees and customers, let’s hope CN’s ordeal ends sooner than later.

Be well. Stay safe.

CN’s stock performance over the past five years was the worst of its Class I railroad peers in North America