CP Railway Proxy Contest - Outlier or Trend

7/21/2019 CP Railway Proxy Contest - Outlier or Trend

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Shareholder Activism:

Trends in Canadian Proxy Contests and

Canadian Pacific Railway Case Study

William K. Orr and Aaron J. Atkinson

February 7, 2013



The Current Landscape in Canada

• Short of an outright take-over, a public campaign for change inthe boardroom and a company’s future strategic direction isthe ultimate weapon available to a shareholder seekingcorporate reform.

• Fasken Martineau undertook an empirical study that reviewedall 101 formal proxy contests in Canada between Jan 1, 2008and Dec 31, 2012.

• Over the study period, there were 87 “board-related” contestsand 14 “transaction-related” contests.

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Key Findings

from our Proxy Contest Study• It ’s true: proxy contests are on the rise.

• A total of 101 contests were completed during the 2008-2012 studyperiod, representing an 84% increase over the preceding five-year period. The last five years also witnessed a 98% increase in thenumber of contests focused on change in the boardroom.

• Dissidents achieved success well over half of the time.

• In 54% of all board-related Contests, dissidents were successful in their public campaign for board change.

• No one is immune.

• Issuers of all sizes and in all industries were the targets of board-

related contests. Indeed, the composition of companies targeted inboard-related contests almost mirrored the composition of Canadian-listed issuers by size and industry sector.

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Key Findings

from our Proxy Contest Study• Dissidents often benefit from a high-stakes game. Higher

success rates were associated with:

• having more “skin in the game” with a significant equity stake;

• employing “winner takes all” tactics, including by seeking a

clean sweep of the boardroom;• waging a lengthier public campaign despite the added costs.

• True settlement is elusive.

• Once a board-related contest was publicly initiated, it almostalways went the distance.

• Fewer than one in five board-related contests during the studyperiod ended with an announced settlement. Moreover, aquarter of these settlements may have been less motivated bycompromise than by a desire to ensure an orderly outcome to aforegone conclusion.

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Some Key Considerations for both the

Dissident and the Issuer Target• For issuers, the best defence is to avoid being a target,

including by undertaking regular self-assessments and takingremedial action promptly

• there are few structural defences

• a proxy contest may be lost before a target has a meaningfulopportunity to respond

• Potential “dissident” shareholder must identify target, issues of concern and strategic approach, including size of equity stakeand when to make intentions public

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Some Key Considerations for both the

Dissident and the Issuer Target• Once a contest becomes public, frame the argument and

secure public opinion -- a proxy contest is, at root, a politicalcampaign

• Engage early with key shareholders and other parties of

potential influence, including proxy advisory firms

• Consider post-proxy contest dynamics

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Some Background to the CP Contest

• CP’s 13 member board had deep experience at executivelevels and solid business and regulatory credentials.

• The Chairman of the Board was John Cleghorn, former Chairman of the Royal Bank of Canada. CP’s Chief ExecutiveOfficer, Fred Green, had held that position for five years andhad been with CP for over 33 years.

• CP consistently adopted corporate governance “bestpractices”, including majority voting and say-on-pay, and wasrecognized as governance a leader.

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• Between April and September 2011, the trading price of CP’scommon shares declined from around $63 to a low in lateSeptember just below $49 per share. CP had experienced a verydifficult winter and spring with many service disruptions for avariety of reasons, including avalanches, flooding and other

weather-related events.

• A key metric against which railway performance is judged is“operating ratio” or “OR”, which is a measure of a railway’sefficiency. A lower OR is better. CP’s OR has lagged itscompetitors substantially for many years and in 2011 was inexcess of 80%. In contrast, CN’s OR was below 70%.

• CN’s former CEO, Hunter Harrison, is credited with driving CN’sindustry-leading OR and is widely viewed as a legend in theindustry. The 67 year-old Mr. Harrison had retired from CN onDecember 31, 2009.

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• CP’s rail competitor in Canada is Canadian National, a muchlarger railway with routes primarily in Eastern Canada and theUS. CP’s routes are primarily in Western Canada and the US.CP is one of the smallest of the Class I Railways in North America.

• CP’s position was that much of the difference in OR was dueto external factors such as legacy pension costs, tighter curves and steeper grades, and greater competition along itsroutes. CP was in the midst of executing its “Multi-Year Plan”to reduce its OR.

• Pershing Square had some recent success placing twoindividuals on the board of J.C. Penney, but had also recentlylost a proxy contest involving Target. Pershing Square has notpreviously focussed, at least publicly, on the rail industry.

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Pershing Square Arrives on the Scene

• In September, 2011, Pershing Square begins acquiring its stake,crossing the 5% ownership threshold for 13D reporting purposesin the United States in October.

• On Friday, October 28, Pershing Square files a 13D disclosing

that it had acquired beneficial ownership of approximately 12.2%of the common shares. The filing included disclosure that it:

expect[s] to engage in discussions with management,the board, other stockholders of [CP] and other relevantparties concerning the business, management,operations, assets, capitalization, financial condition,governance, strategy and future plans of [CP], whichdiscussions may include proposing or considering one or more of the actions described in subsections (a) through(j) of Item 4 of Schedule 13D

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Pershing Square Arrives on the Scene

• Shares of CP rose to $63.80 per share, a price last reached inMarch 2011.

• Pershing Square is cited in the press as having a track recordof working “inside the tent” to make changes at the companiesin which it invests.

• William Ackman provides press interviews almost from theoutset and frequently throughout the contest.

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CP Engages with Pershing Square

• Initial discussions take place and a meeting is held in Montrealthe following Wednesday, November 2, 2011. The two sidesleave the meeting with differing recollections of what wasagreed.

• Pershing Square's principal proposal ultimately amounts to thefollowing:

• a request for two board seats for Pershing Square;

• a proposal that CP hire Hunter Harrison as CEO; and

• a proposal that CP hire another CN executive prior to Mr.Harrison joining CP.

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• CP engages advisors in Canada and the US., including Oliver Wyman, a consulting firm with substantial experience in therail industry, to evaluate Pershing Square’s assertionsregarding CP’s operations.

• Quite apart from any of the substantive merits of PershingSquare’s proposals, the proposals raise some initial significantlegal issues for the board concerning Mr. Harrison’s post-retirement obligations to CN.

• In mid-December, CP invites Mr. Ackman to join the board

and, at the same time, adds two directors with substantialrailroad industry expertise (Ed Harris and Tony Ingram).

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• Pershing Square keeps up the pressure during this period, byincreasing its stake to 14.2% and disclosing in a further 13Dfiling the general nature of its proposal, which is to seekchanges to CP’s business and operations, executive

management and board composition.• Just before Christmas, talks break down between the parties.

No communications take place for the remainder of the month.

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The “ Border Skirmish”

• On Friday, December 30, the Globe and Mail publishes anarticle titled “CP’s activist investor eyes former CN CEO Mr.Hunter Harrison”. The article, citing sources “familiar with thestrategy of [Pershing Square],” discloses publicly for the first

time Mr. Ackman’s proposal to replace Mr. Green with Mr.Harrison. The article also suggests that CP had been initiallyreceptive to the proposal to hire Mr. Harrison.

• Letters are exchanged in early January in which the partiesmake various accusations about the press reports and related

matters. The correspondence is highlighted by Mr. Ackman’s“nuclear winter” email.

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The Proxy Contest Begins

• On January 9, CP publishes a lengthy open letter toshareholders in which the board unanimously endorses CP’smanagement and its plan. Later that day in an interview withBloomberg, Mr. Ackman states that Pershing Square intends

to initiate a proxy contest.• Over the next several weeks, CP’s senior management team

and board members meet with CP shareholders.

• During this time, CN also commences litigation in Illinois withrespect to Mr. Harrison’s post-employment covenants. Mr.

Ackman publicly states that Pershing Square is prepared toguarantee Mr. Harrison's retirement benefits.

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• On January 24, Pershing Square announces five nominees tobe elected to the board and does so using the publicbroadcast solicitation exemption. A sixth nominee withsignificant railway experience is later announced on February

22 and a seventh nominee is added after CP mails its proxycircular setting the board at sixteen.

• In all cases, Pershing Square keeps its board seats to aminority.

• On January 26, CP issues its fourth quarter results which

showed “record-breaking” operational improvements. Later news releases by CP also point to operating improvements.

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• On February 6, Pershing Square holds a “Town Hall” meetingin Toronto which includes presentations from Mr. Ackman,Paul Hilal (another Pershing Square principal), and aninterview with Hunter Harrison and the Pershing Square

nominees. Shares of CP continue to rise, reaching nearly$75.00 per share at the close of trading.

• On March 22, CP issues its proxy circular which includessixteen nominees to the board, including Mr. Ackman. CPalso pioneers the use of a "universal" proxy in Canada whichsets out all known nominees to the board, including thosenominated by Pershing Square. CP decides not to set a proxycut-off time.

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• On March 27, CP holds an investor day in Toronto at whichmanagement reports on the operational improvements at CP.

• On April 5, Pershing Square issues its formal proxy circular which includes seven Pershing Square nominees in total.

• On April 20, CP announces its first quarter results which showed“record” operating metrics. Its operating ratio was 80.1%, animprovement of 1050 basis points.

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Proxy Advisors Issue their

Recommendations• In early May, the key proxy advisory firms announce their

recommendations:

• ISS recommends a vote for all of the Pershing Squarenominees and nine identified CP incumbents.

• Glass Lewis recommends a vote for all of the Pershing Squarenominees and a withhold vote on eight CP incumbents.

• Egan Jones recommends a vote for all of the Pershing Squarenominees and a withhold vote on all CP incumbents.

• Certain shareholders, including Canada Pension Plan andOntario Teachers Pension Plan, make public announcementsthat they will vote for the Pershing Square nominees andwithhold their votes for all CP incumbents.

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Meeting Day Approaches

• In the days leading up to the meeting, there are variousdiscussions between advisors to Pershing Square and CPconcerning a potential meeting protocol and related matters.

• The proxy deposit reports delivered show an overwhelming

majority in favour of the Pershing Square nominees. The votingfor the CP nominees largely tracks the ISS recommendation.

• In the early morning of May 17, CP issues a press releaseannouncing the departure of Fred Green after 34 years of service. In addition, Mr. Green and five other nominees,

including Mr. Cleghorn, withdraw their candidacy for the board. At the close of trading, CP shares close past $75.00.

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The Aftermath

• Following the contest, Mr. Harrison was hired as CEO followinga search process.

• Three of the incumbent directors have since resigned andthere have been other changes in the executive suite.

• Most recently, CP hired Keith Creel as its President and COO.

• CP shares have traded above $110 per share.

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Concluding Remarks

• Shareholders engaging in proxy campaigns are increasinglysophisticated and experienced and are prepared to riskreputations and significant capital in a public contest.

• While a substantial portion of Canadian issuers targeted in the

last five years have been “small cap” issuers, it is clear fromrecent experience that even the largest “blue chip” companiesare not immune.

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Concluding Remarks

• Magna, Maple Leaf, Viterra, Telus, Rona and Agrium have allbeen targeted by shareholders in very public fights recently.

• There are few structural defences to a contest in Canada andshareholders have many tools at their disposal.

• Boards are well-advised to engage with their shareholders, notmerely to avoid a proxy contest, but to understand their viewsand to enhance shareholder value.

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William K. Orr

Partner 416 865 [email protected]

Aaron J. Atkinson

Partner 416 865 [email protected]

Documents

CP Railway Proxy Contest - Outlier or Trend