Why A Hunter Harrison Bid For CSX Isn't As Simple As It Seems

Following reports of Hunter Harrison attempting a management shakeup at CSX Corporation (NASDAQ: CSX) along with hedge fund manager and activist investor Paul Hilal, Loop Capital's Rick Paterson told Benzinga that it isn't as simple as it seems.

Harrison + Hilal = Lethal Combo

According to a Wall Street Journal report Harrison, who announced an early departure from Canadian Pacific Railway Limited (USA) (NYSE: CP), is in the process of finalizing an agreement with Hilal to secure a senior management position at CSX. Incidentally, Canadian Pacific had made overtures towards CSX twice, once in 2016 and another time in 2014. However, the advances were rebuffed.

Hilal, who left William "Bill" Ackman's Pershing Square in 2016, started his own hedge fund, which goes by the name Mantle Ridge LP. Harrison and Hilal had previously associated to bring about consolidation in the industry, seeking unions with CSX and Norfolk Southern Corp. (NYSE: NSC). Harrison relinquished office at Canadian Pacific ahead of the June 2017 timeframe, when his contract was set to expire.

Harrison's Cost Discipline

Harrison was very effective in bringing cost disciple at Canadian Pacific, with the decline in operating ratio to 58.6 percent at the end of 2016 from 81.3 percent at the end of 2011 standing testimony to that. In comparison, CSX's ratio stands at 69.4 percent. The company is targeting a ratio in the mid-60s in the longer term.

Loop Capital's Paterson Sees 2 Sticking Points

Paterson said, on paper, the deal looks a no brainer, as CSX has the strongest pricing in the industry and Harrison is the king of costs. The analyst sees two sticking points, the first is on control. According to Paterson, Harrison has to be none other than the CEO if his low-cost operating model is to work, given that it has to be adopted at all levels of the organization.

"CSX's current CEO may not, quite, be ready to ride off into the sunset and below him are three strong successor candidates that may not like their chances of surviving a Hunter Harrison regime change," Paterson said.

Loop Capital sees operating philosophy as the next sticking point. The low cost and high customer service philosophy that worked with Canadian Pacific may not work with U.S. eastern railroads, Paterson said.

Paterson also referred to Norfolk Southern's argument against a potential combination with Canadian Pacific in 2016, which said Harrison's low cost approach would erode service, inhibit growth and cede market share in its most service sensitive businesses, like intermodal and automotive.

"Given the stark contrast in operating styles, Mr. Harrison would need to rebuild CSX's operating plan almost from scratch, rather than merely tweak it, and hence institutional resistance," the analyst stated.

Concluding, Paterson said at the end of the day, shareholders will likely have the final say.

At the time of writing, CSX shares were slumping 4.50 percent at $43.46.

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