While everyone watches the ticker tape and scratches their heads about Greece's latest round of chest-thumping, savvy investors are ignoring the noise and making moves. One of the savviest, activist and hedge-fund manager Bill Ackman of Pershing Square Capital Management, has revealed his new target: Canadian Pacific Railway (CP).
Canadian Pacific is a $10 billion railroad that operates nearly 15,000 rail miles across six Canadian provinces and 13 western U.S. states. Earlier this week, Pershing Square announced that it had acquired 20.6 million shares, 12.2% of the company, consisting of stock and 2.6 million call options. Ackman began accumulating shares in September, when the price ranged between $46 and $54 per share. Thanks to the October rally, CP shares now sit around $60 -- a tidy little profit, but the real upside may still be unrealized.
Ackman's interest puts CP and the rail industry back in the spotlight. He hasn't disclosed any plans for CP so far, but has said he intends to engage in discussions with management. Canadian Pacific currently fetches 19x trailing earnings and 10x enterprise value/EBITDA. Canada's largest railroad, Canadian National Railway (CNI) currently trades for 15x trailing earnings and 10x EV/EBITDA, yet Canadian National's operating margins of 36% are nearly double Canadian Pacific's 19% margins.
Industry analysts cite several possible scenarios for CP, none of which have been confirmed or denied by anyone involved. Ackman's penchant for separating businesses to streamline operations suggests that he would separate the track infrastructure business from rail operations. In the past couple of years, Ackman has had varying degrees of success with this approach, including a home run with General Growth Properties (GGP), a very tidy profit with the spin-off of Fortune Brands (FBHS), and moderate success with retailer Target (TGT), where Ackman spent millions on a failed attempt to get a board seat. (He did succeed in getting Target to sell credit-card receivables, though.)
Some speculate that Warren Buffett, whose Berkshire Hathaway (BRK.A, BRK.B) acquired BNSF Railway several years ago, would be interested in buying Canadian Pacific. That would give Burlington access to the entire Western U.S. and Canada. Government regulations, however, will likely hinder a sale to another railroad.
Railroads are the lifeline of any economy, and they've come a long way since their heyday. Capital investments and greater efficiencies have made rails much more profitable over the years. Good economy or bad, basics like coal and grains will always need to move by rail. The economic resilience of railroads in the current environment is proven by a quick share price rebound, with many rail stocks trading near 52-week highs.
Canadian Pacific's strategic terminals and long trains make the business a valuable asset. Longer trains reduce fuel consumption and lower track maintenance costs. The fact that its operating margins are below peers suggests that there is a lot of opportunity to improve operational efficiency. Even the smaller Kansas City Southern (KSU), which would combine nicely with CP, runs at near 30% operating margins.
Ackman got into CP at a good price level. The shares spiked when news of his stake emerged last week but have retreated since. Many analysts believe that CP shares could be worth close to $80 based on improved profits due to continued operational efficiencies. If the market cooperates and sends shares back down to Ackman's purchase levels, it may be a smart to jump on board Ackman's train.