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John Cleghorn is the chairman of Canadian Pacific Railway and a former chief executive officer of Royal Bank of Canada. (Will Lew for The Globe and Mail)
John Cleghorn is the chairman of Canadian Pacific Railway and a former chief executive officer of Royal Bank of Canada. (Will Lew for The Globe and Mail)

The story behind the all-out war to control CP Add to ...

There comes a moment in every corporate battle when the first cannon is fired.

In the unfolding power struggle at Canadian Pacific Railway Ltd. , that moment came at 7:22 a.m. on Jan. 4, when the send button was clicked on an e-mail, lighting a fuse from New York to Toronto.

The general holding the match was Bill Ackman, a brash 45-year-old activist investor who has made a $1.4-billion bet on the railway, buying a 14.2 per cent stake in the belief that it will give him enough clout to push for a management overhaul and raise its stock price.

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The target in Mr. Ackman’s crosshairs was John Cleghorn, the 70-year-old chairman of CP and a former chief executive officer of Royal Bank of Canada. A sombre and courtly business veteran, Mr. Cleghorn, personifies the buttoned-down reserve of the Canadian establishment.

It is doubtful Mr. Cleghorn, a military history buff, had ever received a message like the one that was fired into his inbox that morning. Under the subject line “War and Peace,” Mr. Ackman had typed out a lengthy e-mail, obtained by The Globe and Mail, that warned his “border skirmish” with the company would turn into “a nuclear winter” if his demands for a new CEO and two seats on the board were not met.

His atom bomb, he explained, would be a proxy battle for new directors that “would not go well” for the board and CEO Fred Green because of their “very poor” track record.

“We will take the largest public hall available in Toronto and we will make a presentation to the shareholders and the public ... about management and board failures of the last ten years at CP. We will examine management and the board’s track record and history.”

Mr. Ackman, a sharp-elbowed investor who describes himself as a “direct” communicator, hoped his e-mail would prod into action a board that he believed was moving “too slowly” in response to his demands.

To Mr. Cleghorn and the startled CP directors with whom he shared the e-mail, however, the message was an act of hostility that challenged the authority of a board stacked with leading business figures such as Suncor Energy Inc’s Rick George, former deputy prime minister John Manley and grain merchant Hartley Richardson, a fifth generation descendent of one of Canada’s oldest business families.

According to people familiar with the company, the directors were outraged by the e-mail’s tone and demands. Mr. Cleghorn and his directors believed they had bent over backwards to meet and discuss Mr. Ackman’s proposals. They saw the e-mail as an attempt by Mr. Ackman, a minority shareholder, to usurp the board’s authority to hire and fire a CEO. They quickly decided to break off discussions with their largest shareholder; peace would not be accepted on Mr. Ackman’s terms.

On Monday, five days after Mr. Ackman’s e-mail, the board steered CP towards a head-on collision with the investor. They publicly dismissed his proposed hiring of former Canadian National Railway Co. boss Hunter Harrison as “detrimental” to the company’s strategy. Hours later, Mr. Ackman declared war, announcing a proxy contest to elect new directors who backed his plan to replace Mr. Green.

Mr. Ackman said in an interview that that he is “sorry” his e-mail “offended” CP’s directors, but his intention was to alert them in clear terms that their inaction was moving the two sides toward a confrontation.

“I was laying out clearly and directly what was going to happen.” (Mr. Ackman also said he was “disappointed that excerpts of a private communication with Mr. Cleghorn has been released to the press.”)

What happens next will likely be an epic tug of war over who gets to drive what has become a runaway train. The contest at CP has the potential to reshape a historic national railway, under the hard-charging leadership of Mr. Harrison, who Mr. Ackman wants to air drop into CP. It could also further shift the balance of boardroom power away from directors who are seeing their authority increasingly challenged by powerful pension and hedge funds.

“We are walking down a path where power is slipping from boards to shareholders and we should ask ourselves, ‘What are the implications?’ ” said Ed Waitzer, a corporate lawyer with Stikeman Elliott LLP and former board adviser to BCE Inc., which saw its management overhauled after lengthy brawl with the Ontario Teachers’ Pension Plan.

But for corporate directors, the muscular tactics of investors like Mr. Ackman are making it harder to say no to shareholder demands.

Jon Grant, lead director of CCL Industries Inc. and a veteran of 15 boards, said the “polite” world of Canadian boards is being rapidly altered by global influences, and as a result boards are at times “intimidated” by investor pressure.

“One of the things we forget as directors is that directors are responsible to the corporation first and to shareholders second,” he said.

For CP’s directors, Mr. Ackman’s challenge to their authority is a huge preoccupation at a time when the company is under enormous pressure to revitalize its sluggish operations, which are the least efficient of North America’s Big Six railways. The activist can be expected to escalate his criticisms of the company’s leadership as the proxy vote approaches in the spring and a debate is emerging over how the board should respond.

Len Racioppo, president of Montreal-based Jarislowsky Fraser Ltd., which does not currently own CP shares, said the railway is being challenged because shareholders are “extremely frustrated” with a company that is underperforming.

“Everyone has to squeeze more to generate returns. Why should companies be treated any differently, and why should boards be any different? You’re seeing it everywhere,” he said.

Alan Radlo, a Boston-based portfolio manager with CI Financial, which has a small stake in CP, counters that it is a “disgrace” that the board has extended special privileges to Mr. Ackman by meeting with him privately and discussing his proposals for management and board changes.

“There shouldn’t be favouritism with one shareholder. I definitely have a problem with the company showing privilege to this activist,” Mr. Radlo said. “What about other shareholders?”

The activist investor

Few would have guessed 10 weeks ago that war would break out so quickly between CP and its largest shareholder. From the beginning, CP’s board had raced to put out the welcome mat to an investor whose lucrative bets against subprime mortgage insurers in the United States had seen him lionized in the Academy-award winning film Inside Job.

The combined impact of Mr. Ackman’s big stake, influence and an exuberant market reaction that sparked a 7 per cent increase in CP’s stock since Oct. 28 put enormous pressure on the board to respond to him after his hedge fund, Pershing Square Capital Management, announced its stake on Oct. 28. Mr. Ackman had requested a meeting with CP’s directors, but typically boards don’t meet with minority shareholders, and certainly not so soon after their investment.

There is nothing typical, however, about Mr. Ackman. Since he founded Pershing Square in 2003, he has profited from most of his 23 turnaround targets by agitating, embarrassing and, on two occasions, mustering enough shareholder support to vote out intransigent directors and executives.

By opening the door to him, the directors hoped they could forge a constructive relationship with the investor and avoid public confrontations, people familiar with the company said.

At first it looked like the peace process would work. On Nov. 2, five days after Pershing Square’s announcement, Mr. Cleghorn, Mr. Green and a handful of their advisers welcomed the activist and one of his partners, Paul Hilal, at a small airport terminal in Montreal where Mr. Ackman’s private jet had just arrived from New York.

The meeting began with Mr. Ackman presenting a book to Mr. Cleghorn that outlined his proposals for change at CP. The book was thick with data, but the only passage that really mattered was the blockbuster proposal to hire rail legend Hunter Harrison as the next CEO. Mr. Harrison, the retired former chief of CP’s archrival CN, was presented as the solution to the company’s problems. He could transform CP the same way he had transformed CN into North America’s most efficient railway.

Sitting next to Mr. Cleghorn while Mr. Ackman sang Mr. Harrison’s praises was Mr. Green, who was facing for the first time the prospect of losing his job to a man he had been locked in competition with for much of the past decade. According to people familiar with the session, Mr. Green, a CP lifer, said almost nothing.

When the meeting ended, Mr. Cleghorn promised to take Mr. Ackman’s book of ideas back to the board. In exchange, the student of military history gave Mr. Ackman something to read on his flight home: a history of the American Civil War.

What happened in the two months following the Montreal meeting is a subject of debate. Sources close to CP say the company moved at lightning speed to accommodate Mr. Ackman. In early December, CP’s governance committee invited Mr. Ackman to meet with them in Calgary so they could review him as a candidate for the board.

The board, Mr. Cleghorn said in an interview this week, agreed to offer Mr. Ackman a director’s seat to engage him in “a constructive dialogue” at the board level. The only proviso was he had to sign “fairly normal” legal agreements.

Fairly normal agreements, Mr. Ackman discovered, included a document known as a standstill agreement. By signing it, he would be effectively prohibited from launching a proxy battle. It was a non-starter. His other aggravation was that the board had rejected his second candidate for the board, his partner Mr. Hilal, who had flown with him to Calgary but was not included in the boardroom session.

Talks between Mr. Ackman and Mr. Cleghorn cooled after the December setbacks. According to people familiar with the discussions, telephone calls and e-mails between Mr. Ackman and Mr. Cleghorn tapered off. The lack of communication was interpreted by the Pershing Square camp as a sign that the board did not want to hire Mr. Harrison.

By Jan. 4, Mr. Ackman was tired of waiting, and he fired of his War and Peace e-mail.

Deal experts said it is likely he has been so forceful with the company because he has a high degree of comfort that CP shareholders will support his bid to replace Mr. Green and a minority of the company’s directors.

While shareholders may disagree about his tactics, many agree Mr. Ackman’s trump card is Hunter Harrison. The Memphis-born railroader, who began his career squirting oil at train wheels, earned his legendary status in the industry by transforming Illinois Central Railroad and Canadian National into two of the industry’s most profitable and admired companies.

Although he is 67 and has been sitting on the retirement bench for two years, media reports about his potential candidacy earlier in December sent CP’s stock higher.



Mr. Harrison’s chief selling point is his 11-year record as CN’s chief operating officer and then CEO, ending in 2009. Under his leadership, the railway improved productivity by streamlining staff, setting detailed schedules and closely monitoring the amount of time trains spend in rail yards.

He squeezed profits from every corner of the railways operations, including a controversial introduction of penalties slapped on customers that were late loading or unloading freight.





Translating his success at CN won’t be easy at CP. CP’s tracks travel through more rugged terrain. For example, CP trains travel more slowly through Western Canada because they must pass through spiral tunnels in the Kicking Horse Pass in the Rockies. By contrast CN trains climb lower grades through the Yellowhead Pass.

CP has the additional burden of heavier labour costs. Seeking greater flexibility from the Teamsters union in operating trains, the company is in contract talks and wants the ability to unilaterally establish workdays of up to 12 hours and set new rules on vacation. The Teamsters represents 4,800 CP conductors, engineers and rail traffic controllers.

Battle preparations

If CP’s board and Mr. Ackman are unable to overcome their differences and strike a settlement, shareholders can expect months of furious campaigning from both sides ahead of a vote that is expected to take place at CP’s annual meeting in May.

According to market sources, the campaigns are already starting to take shape. CP is casting Mr. Ackman as a fast-buck artist whose primary interest is a quick return on his investment. As for his candidate Mr. Harrison, he is past retirement age, is anchored in his Florida home and his reign at CN was controversial.



Pershing Square is seeking to cultivate shareholder support by dismissing CP’s campaign as an outdated script. Unlike corporate raiders of the past who made quick money pushing targets into takeover play, the hedge fund positions itself as a medium-term investor whose people works inside the tent with new management to increase long-term value at underperforming companies.

The stakes are high if the dispute between the company and the activist goes to the brink with a proxy vote. If Mr. Ackman follows through on his e-mail threat to challenge the performance of CP’s board of distinguished directors, he could find himself in a messy feud with powerful business leaders who have many allies in Canada’s leading business and political institutions.

If he wins shareholder support for an alternative slate of directors, the embarrassing upset will make it harder for directors of other companies to assert their authority over rebellious investors who hold minority stakes. Unlike directors, who are bound by a legal obligation to act in the best interest of the company, minority investors are free to act in their own self-interest.

A loss for Mr. Ackman would hand him his second humiliation in less than three years. In 2009, Mr. Ackman lost a bruising proxy battle to replace directors at Target, the Wisconsin-based retailer. The defeat cost Pershing heavily. The fund that bought the Target shares lost so much of its value shortly after the showdown that Mr. Ackman cut fees and apologized for one of “the greatest disappointments of my career to date.”

So far, Mr. Ackman has reaped a huge return from his CP investment, as market enthusiasm for him and the prospect of Mr. Harrison has sent the company’s stock on tear, increasing the value of his holding by more than $300-million to date. That gain could evaporate quickly if his quest to put CP on a new track fails, an outcome that Mr. Ackman does not appear willing to consider.

“We will win the election by a landslide vote,” he boasted in his e-mail to Mr. Cleghorn. “Let’s avoid having a border skirmish turn into a nuclear winter, life is too short.”

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