CSX Bets More Than $200 Million Harrison Can Spur Turnaround

(Bloomberg) -- Railroad turnaround veteran Hunter Harrison is back in a familiar place -- at the bottom.

This time he's joining CSX Corp., the least efficient major North American railroad, which named him chief executive officer late Monday. In 2012 he took over at Canadian Pacific Railway Ltd. and during the next four years transformed the perennial laggard into a top performer by cutting costs and speeding up service.

Overhauling CSX may prove more challenging because of geography. With a 21,000-mile network in the eastern U.S., the carrier has stretches of curving track that cut through densely populated areas and the Appalachians. The other eastern carrier, Norfolk Southern Corp., faces similar challenges and also trails carriers in Canada and the western U.S. in efficiency measures.

At stake as Harrison, 72, tries to whip CSX into shape: compensation of more than $200 million and perhaps -- according to an estimate last month by the railroad -- as much as $300 million.

That includes $84 million in forfeited pay from his old job as head of Canadian Pacific. Without that and a related tax indemnity, he'll resign after the 2017 annual meeting, CSX said. Shareholders should decide whether to award it, the Jacksonville, Florida-based company said. 

Harrison's package includes nine million stock options that were valued at about $103 million on the day they were granted, according to a Bloomberg calculation using assumptions disclosed in CSX's most recent annual report. He also will receive a $2.2 million annual salary and a yearly bonus with a $2.8 million target payout. Combined with the $84 million make-whole payment and as much as $23 million to cover taxes, the package comes out to about $230 million. 

Options Assumption

A CSX spokesman declined to comment on Bloomberg's estimate. The company's earlier valuation of Harrison's pay package included a higher estimate of the options he would receive and other long-term incentive compensation that wasn't mentioned in CSX's latest filing.

Read more: Shareholders think Harrison is worth nine figures

Harrison teamed up with Paul Hilal, founder of activist fund Mantle Ridge, to target CSX for a management shakeup in January, and Hilal will become the railroad's vice chairman. Here's what to watch as Harrison takes over as head of his fourth railroad, after Canadian Pacific, Canadian National Railway Co. and Illinois Central.

CSX was the worst performer last year among major North American railroads by operating ratio, the industry's gold standard of efficiency, according to data compiled by Bloomberg. The benchmark measure, in which a lower number is better, was more than 69 percent for CSX. The previous management set a long-term goal of 65 percent and announced a plan to cut about 1,000 management positions last month.

By the end of Harrison's tenure, the ratio is likely to fall to less than 60 percent, said Fadi Chamoun, an analyst at BMO Capital Markets, and Walter Spracklin at RBC Capital Markets.

“We expect emphasis now to be placed on cost cutting, with pace and timing of CSX's operating ratio improvement the key variable,” Ben Hartford, an analyst at Robert W. Baird & Co., said in a note to clients Tuesday.

There's also a way to measure his gains relative to a similar carrier: Norfolk Southern Corp., the other eastern U.S. railroad. Its operating ratio last year was just under 69 percent.

While at Canadian Pacific, Harrison twice tried -- and failed -- to buy CSX, first in 2014 and again last year. He also tried to combine the Canadian railroad with Norfolk Southern.

Labor Cuts

Harrison's methods have cost jobs. Canadian Pacific ended last year with 11,653 full-time employees, a 34 percent reduction from June 2012, the month before he took over.

Labor costs will be Harrison's biggest opportunity for reducing expenses, with Canadian Pacific and Canadian National about twice as productive as CSX, Christian Wetherbee, an analyst at Citigroup Inc., said. Closing the gap with the Canadian peers, even partially, could generate as much as $900 million in annual savings for CSX, he said.

At CSX, Harrison will “cut into the rank and file headcount” by reducing yards and repair shops, said Jason Seidl, an analyst at Cowen & Co. The railroad reported about 27,000 employees as of the end of last year.

Harrison also put non-labor costs under a microscope. On his watch, Canadian Pacific moved out of a downtown Calgary office tower to a new building adjacent to a rail yard. Mark Wallace, who was Harrison's chief of staff at the time and now looks poised to join him at CSX, estimated in 2014 that the move saved about C$20 million ($15 million) a year in rent.

Longer, Faster

At Illinois Central, Harrison developed the concept of so-called precision railroading, breaking with the standard industry practice of holding trains until they were full. The approach involves running shipments and carloads on fixed timetables to ensure reliable deliveries.

At Canadian Pacific, he also stored hundreds of locomotives. He closed several hump yards -- used to separate and sort rail cars -- and intermodal terminals in cities including Chicago and Milwaukee to trim costs and set the stage for potential land sales.

And he pushed for longer, faster trains. The average length of Canadian Pacific's trains increased 25 percent during Harrison's tenure.

In 2012, the carrier introduced a new “premium” intermodal service, removing a day from the 2,600-mile (4,200-kilometer) transcontinental route from Toronto to Vancouver -- and two days from the 2,200-mile service between Vancouver and Chicago.

“The bear case is that congestion east of the Mississippi is that much greater than it is in western Canada,” said Lee Klaskow, an analyst at Bloomberg Intelligence. “But even if topography matters, there will be a better operating performance under Hunter Harrison.”

--With assistance from Anders Melin

To contact the reporter on this story: Frederic Tomesco in Montreal at tomesco@bloomberg.net.

To contact the editors responsible for this story: Brendan Case at bcase4@bloomberg.net, Tony Robinson, Bruce Rule