The investors behind startup activist fund Mantle Ridge have agreed to commit $1.2 billion for five years, an unusual structure but one that governance experts contend helped drive a blockbuster settlement - the biggest so far in 2017 -- reached earlier this week between the insurgent manager and railroad operator, CSX (CSX) .
At issue is a deal struck late Monday with Mantle Ridge's founder Paul Hilal that installed railroad veteran Hunter Harrison as the CEO of CSX, with a four-year contract. Also, as part of the settlement, CSX is bringing on five new directors, including Harrison and Hilal, while three incumbent board members will be required to step down shortly.
To be sure, Hilal would not have been able to reach a deal with CSX had he not been able to bring Harrison to the table. The railroad veteran was famously installed as CEO of Canadian Pacific Railway (CP) in 2012 in the wake of a boardroom battle launched with Hilal's help by activist fund Pershing Square Capital Management. At CP, Harrison engineered a turnaround that helped CP's Toronto-listed shares climb nearly 190% during his tenure.
However, behind-the-scenes, an unusual ownership structure at Mantle Ridge is being lauded by governance academics as a key reason why long-term institutional investors, mainly passive index funds and public pension plans, supported Hilal and Harrison's campaign, all of which helped the fund achieve its success at CSX.
For activists to succeed at driving changes at targeted companies, they need to convince long-term investors to back their plans. Corporations and corporate boards will often give in to the insurgent's demands if they know that long-term institutional investors would support the dissident's boardroom candidates in a possible proxy fight. However, in many cases, long-term index funds and pension plans oppose insurgent managers, arguing that they are only interested in producing a short-term share price spike that will ultimately leave the company they must continue to invest with hobbled.
But institutional investors at CSX were likely impressed by Mantle Ridge's move to require its limited partners to commit $1.2 billion for five years - the fund accumulated a 4.9% CSX stake with that capital. The five-year lockup is unusual, with many activists and traditional hedge funds allowing investors to redeem their investments quarterly, or at least annually. Instead, the structure is closer to that of a private equity firm, where investors typically have their capital locked up for seven or more years.
Charles Elson, chief of the University of Delaware's Center for Corporate Governance, argued that the five-year lock up with incentives at the end took away any grievances from institutions that Mantle Ridge would have a too short-term focus. "That [structure] removes any complaint about short-term profit," Elson said. "That was really smart. They are going to be here for a long time, not going after a quick sale of assets. They're here to develop long-term shareholder value."
Columbia Law School Professor Jeffrey Gordon agreed that the fund's organization eliminates a concern often raised about activists -- that they are typically under a lot of pressure to return investor money in a relatively short period. "Activists usually want to show winning investments early on so they can raise the next fund," Gordon said. "But Hilal can say to other institutions, 'I'm like you, and I'm measuring my success over the long-term horizon.'"
Hilal explained the motivation behind the structure recently at a Reuters event before the settlement, arguing at the time that the long duration more closely aligns his limited partner investors with the other CSX shareholders he was engaging. "These shareholders aren't looking for a near-term pop in the fund," Hilal said. "They want to see the company's value go up in an intrinsic way."
Also, Hilal and Mantle Ridge's long-term investment strategy also likely helped convince CSX to grant Harrison a four-year contract as CEO, a big victory for Harrison as the railroad giant had preferred to give him a two-year contract instead. It also likely helped Hilal get himself a seat on the board and its critical executive, compensation, finance and governance subcommittees.
The longer contract and Hilal's oversight from the board also give Harrison the political capital to implement an operating approach he pioneered - and is famous for -- known as precision scheduled railroading, a strategy that allows the railroad company to schedule shipments in a precise way by knowing how trains move between customers and interchanges. Analysts expect Harrison will take the first 18 months of the job to improve CSX's record when it comes to picking up and delivering cargo on time.