An activist hedge fund that's been waging war against the board of
may be forced into retreat by the demands of its own investors.
After acquiring enough CSX shares to earn voting rights in a proxy dispute last year, The Children's Investment Fund Management, or TCI, could find itself in the awkward position of having to dump the railroad company's stock because of its own need for capital.
The result could be a blow to CSX's market value that is driven by insider shareholders rather than the company's fundamental performance -- exactly the opposite of what TCI set out to do.
London-based TCI partnered in 2007 with New York's 3G Capital Partners to wage war on CSX, arguing that the Jacksonville, Fla., railroad operator's board was too entrenched and had not served shareholders well. Between the two, TCI and 3G Capital have amassed more than 35 million shares of CSX, nearly 9% of the outstanding shares -- enough to secure four of the company's 12 board seats.
Now massive hedge fund redemptions and selling may derail TCI's plans. As pressure to maintain adequate capital grows, the fund could be forced to pare or abandon its position in CSX.
CSX is TCI's third-largest equity position and one of the best performers in its portfolio, making the stock a good candidate for liquidation if the fund needs to raise capital.
TCI purchased its entire stake in CSX -- nearly 18 million CSX shares worth about $558 million -- in the first quarter of 2007, according to regulatory filings. In the worst case scenario, TCI is down somewhere near 10% on its investment, though depending on the exact date it bought shares, the investment could be up slightly. The fund did not report its exact purchase date.
Some of TCI's other big equity positions have performed worse. The fund's biggest investment is in
, with a total of 24 million shares for a value of $1 billion. TCI first bought Union Pacific stock in the first quarter of 2007 and has added to its stake nearly every quarter since. According to regulatory filings from the second quarter, TCI doubled its position in the railroad company at a time when shares traded above $60. Shares have fallen 23% since that time to roughly $48 a share.
TCI's second-largest holding is 6 million shares of
, which carries an equity value of $828 million. TCI initially invested in MasterCard in the first quarter of this year and has added to its position in the second and third quarters. That stock is down 31% so far this year and nearly 50% over the last six months.
From a fundamental point of view, CSX looks solid. The company exceeded third-quarter estimates in October; BB&T Capital Markets analyst John Barnes said his "bullish thesis remains very much intact"; and Deutsche Bank analyst Marcelo Choi noted that "rails have proven in the past that they can generate firm pricing despite soft volume."
Nonetheless, other hedge funds have begun dumping entire stakes in the company.
More than 18 funds sold their entire positions in CSX some time in the third quarter, including Seneca Capital Advisors, Matrix Capital Management, JGD Management and TPG-Axon Capital, according to regulatory filings. And while
is the fifth-largest holder of CSX shares, it halved its stake in the previous quarter, selling more than 15.6 million shares. Taconic Capital Advisors, which held positions in both CSX and Union Pacific, has since sold off both completely.
Could these other hedge funds, smelling blood in the water, be exiting their positions in CSX and Union Pacific, exacerbating TCI's troubles?
"Hedge funds are very opportunistic," said Joel Schwab, managing director at HedgeFund.net. "There is a wide swath of hedge funds looking for any signs of weakness with public equities. The fact that one hedge fund is involved would really mean nothing to them about putting on a long or a short position to the other fund's detriment."
Schwab says that a wide group of hedge funds generally play follow the leader. Because many are experiencing redemptions right now, it may be forcing them to liquidate positions, he says.
"TCI is a very prominent fund, so it's possible that some hedge funds may have followed them into CSX," said Schwab. "But with the wave of hedge fund redemptions, it would certainly be within the way hedge funds operate for them to move on, regardless of TCI's interest. They'll look down their portfolio and they'll determine what's the best investment to jettison."
Even CSX's CEO Michael Ward sold nearly his entire holding in early November, at roughly $46 a share. In the regulatory filing for the transaction, Ward cited his wife as the reason for the sale, presumably due to a divorce settlement. Since that time, the stock has fallen 25% to its lowest level in two years. CSX did not return a request for comment.
So far, there are no regulatory filings showing any sales of CSX stock by TCI or 3G Capital. Should that change, it will have to be reported right away because of disclosure rules for the fund's representatives on the CSX board. That's little consolation, though, for those shareholders who have seen shares fall from their 52-week high of $70.70 in May to $35.74.
Neither TCI nor 3G Capital were available for comment.
Of course, not every fund is selling. In the third quarter,
, Barclays Global, Tiger Global Management and
Janus Capital Management
were among those that increased their stake in CSX. Citigroup is currently the largest holder of CSX shares with a total of 21.1 million, Barclays ranks second with 18.6 million shares, and both Tiger Global and Janus are in the top 15 holders by amount held.
But if hedge funds are indeed trying to break TCI, they picked an easy mark. TCI was launched in January 2004 by Christopher Hohn, who donates a significant portion of all fees earned to a charitable trust and is known to have an activist bent. For example, TCI amassed a large share of German stock exchange Deutsche Boerse and forced the resignation of its CEO after he refused to abandon his plan to takeover the London Stock Exchange.
One criticism of the fund is that it is particularly vulnerable to market declines because Hohn focuses on very concentrated bets in a handful of companies, abandoning the traditional hedging technique. Those bets certainly paid off in the past, with TCI returning 42% on an annualized basis from its launch in 2004 through last year.
However, the implosion of other hedge funds is spreading fear, likely affecting TCI and its own returns. The fund faced a significant setback after it sold its entire stake in the Japanese company
Electric Power Development
, known as J-Power, after the Japanese government intervened, citing national security. TCI had been attempting since 2005 to force the company to increase its dividend before selling its 9.9% stake back to the company at a loss of $130 million.
The public battle with CSX has only made matters worse for Hohn, who is reported to be publicity-shy and prefers to maintain a low profile. In May, TCI's founder was grilled in a New York court regarding his fund's investment in CSX. In September, after seeing four of his five picks finally seated on CSX's board, Hohn told
that he was rethinking his aggressive activist strategy.
"It has been very profitable for us, but it is unpredictable and expensive," Hohn said in the interview. "Just look at CSX. We've already spent over a year trying to effect change and paid out more than $10 million in legal fees on the proxy fight."
As part of the discovery process related to the court case, emails between Hohn and TCI co-founder Patrick Degorce showed that Hohn was contemplating the need for more capital, but ultimately decided that the move "may damage
TCI's long-term franchise."
The CSX saga became more expensive for TCI on Wednesday, after CSX announced that it joined a settlement with all parties to a civil action brought by Deborah Donoghue, a shareholder of CSX. Donoghue had sought to recover so-called "short-swing" profits alleged to have been realized by TCI and 3G Capital in connection with their alleged purchases and sales of CSX securities. The settlement, subject to approval by the court, will cost TCI another $10 million.