If nothing else, the Canadian Pacific Railway (CP - Get Report) and activist investor Bill Ackman have put a massive spotlight on the operations of Norfolk Southern (NSC - Get Report) . Expect the railroad's shareholders to benefit even if it successfully fends off CP's hostile $28 billion offer.
The Calgary-based CP and Ackman's Pershing Square Capital Management spent more than two hours on a call with investors earlier this week outlining their case for consolidation and trying to win over skeptics. It has been more than a decade since a large North American rail deal was announced, and Canadian Pacific faces an uphill climb trying to convince regulators and shipping customers that further consolidation is to be encouraged.
But even if Canadian Pacific fails to win its takeover battle, it seems likely to pressure Norfolk Southern into taking some shareholder-friendly measures. Barclays analyst Brandon R. Oglenski notes that in rejecting the CP offer Norfolk Southern broke from tradition and provided financial guidance, promising to bring down expenses and achieve double-digit earnings growth through 2020.
"While clearly an indication of positive change inside Norfolk's boardroom, we suspect guidance was not likely prior to the CP offer," Oglenski wrote. "We are encouraged to see Norfolk enter a new era of accountability."
As Canadian Pacific is quick to highlight, there is indeed room for improvement at Norfolk Southern.
CP Chief Executive Hunter Harrison, in just a few years on the job, has taken that railroad's operating ratio -- a measure of operating expenses to net sales -- from about 80% in 2011 to just below 60% in the most recent quarter, boosting profits in the process. Harrison on the investor call noted that Norfolk Southern, which reported a ratio of about 70% in the last quarter, has been talking for more than a decade about how to become more efficient without noticeable results.
Norfolk Southern ranks by many measures as the least efficient among North America's seven Class 1 railroads. The company's argument that much of that expense is to provide superior service might appeal to the shippers it needs to lobby on its behalf before the Surface Transportation Board to try to block CP's overtures, but it is far from clear that same message will play as well with investors.
The offer comes at a difficult time for railroads in general, and Eastern-focused operators like Norfolk Southern in particular. Weak industrial demand, high inventories and soft commodity prices, joined with a strong U.S. dollar that should hurt exports, have caused expectations for pricing to be lowered going into 2016. Norfolk Southern's business hauling coal has come under particular pressure as demand for that form of energy has ebbed.
Even if Canadian Pacific's offer is derailed, Norfolk Southern could face pressure from other sources.
Bill Ackman, whose Pershing Square led a proxy campaign that resulted in Harrison taking the job at Canadian Pacific and remains among the railroad's largest shareholders, on the call with investors spared no words in criticizing Norfolk Southern CEO James Squires, a lawyer by training who has been with the company since 1992 in various legal, financial and operational roles and who became CEO in June.
Ackman called Norfolk Southern "an ideal activist situation," saying Squires "is fighting to keep his job" and that the CEO "does not have a proven track record" for turning around railroads.
"What happens in situations like this is that pride gets in the way," Ackman said, claiming that Canadian Pacific has heard from a number of Norfolk Southern shareholders who he says support the takeover effort.
It seems reasonable other activists are watching the situation with great interest, perhaps pondering trying to replicate the Pershing Square/CP success at Norfolk Southern should the target fight off the merger overture or regulatory hurdles prove too much to overcome. Ackman noted that Norfolk Southern's initial defense "seems familiar to me," referencing the similarity to the tactics Canadian Pacific employed before giving into the investor in 2012.
It is far too early to predict whether Canadian Pacific will succeed in buying Norfolk Southern. But even without a deal, there's reason for investors in the railroad to hope for better times ahead.