Why Bill Ackman is Going To Be a Train Conductor For Halloween

Towards the close of trading on Friday, shares of Canadian Pacific (NYSE: CP) started spiking on no news. Benzinga contacted the company, and the company did not have any reason why the stock spiked.

After the close of trading, Pershing Square reported a 12.2% stake in the Canadian railroad, which obviously got leaked early. While the SEC should investigate this matter, that is another topic for another day.

Pershing Square's Bill Ackman has been thought of as one of the smartest value investors in the world, this side of Warren Buffett. Yet, he does not own a company like Berkshire Hathaway (NYSE: BRK-A), he runs a hedge fund. So why would he go after a railroad company like when Buffett purchased Burlington Northern Santa Fe?

When Ackman and Pershing Square filed the 13D late Friday night, it was clear why Ackman filed. He thought shares were undervalued. In the 13D, it says, "The Reporting Persons believe that the Common Shares are undervalued and are an attractive investment."

It goes on to say, "The Reporting Persons expect to engage in discussions with management, the board, other stockholders of the Issuer and other relevant parties concerning the business, management, operations, assets, capitalization, financial condition, governance, strategy and future plans of the Issuer, which discussions may include proposing or considering one or more of the actions described in subsections (a) through (j) of Item 4 of Schedule 13D."

Pershing's average acquisition price is $54.46, and has an exercise price on the warrants far below where shares are trading.

Pershing Square owns 20,659,504 common shares, including 2,650,000 underlying common shares through an over-the-counter American-style call option. Ackman's involvement in CP caused Citigroup to raise the price target to $70.

For Ackman to discuss a potential merger with Canadian Pacific, there are only a few other railroads out there. Canadian National Railway (NYSE: CNI) is one name that will get mentioned immediately, as Canadian Pacific shares have underperformed rivals, including CNI and Norfolk Southern (NYSE: NSC). Canadian Pacific would not be able to consolidate rail lines with Canadian National, as many of the lines are different, and run through much more treacherous terrain, including the British Columbia, Alberta mountain terrain.

One thing Ackman could look to do is try to improve efficiency. Canadian Pacific's operating ratio is 82.4%, while Canadian National's operating ratio is 63.1. In this case, lower is better. Operating ratio measures operating costs as a percentage of revenue.

Railroads have been booming in recent years. Just look at recent earnings from Norfolk Southern and Union Pacific (NYSE: UNP). As trade with Asia becomes even more important, exports of potash, coal and grain have surged as China grows ever faster. Ackman clearly sees a railroad that should be operating at much higher efficiency levels, given with how hot the rail sector has been in recent year.

Mr. Ackman may not take over the North American railroad as Buffett did with Burlington Northern Santa Fe, but he definitely sees value in this name, and is willing to put on his conductor hat to get value for shareholders.

ACTION ITEMS:

Bullish:
Traders who believe that Ackman's experience with getting something done as an activist investor will lead to improved efficiency for Canadian Pacific might want to consider the following trades:

• Canadian Pacific will be the biggest beneficiary of anything from Ackman. The sector as a whole could get a boost, as Ackman brings light to the rails. Traders could look at CSX (NYSE: CSX), Union Pacific (NYSE: UNP) and Kansas City Southern (NYSE: KSU) for a small boost.

Bearish:
Traders who believe that Ackman will not be able to get anything done may consider alternate positions:

• Shares are weaker this morning, having given up all of their pre-market gains from the news. Shares have also lost 1% since the beginning of the year, compared to a 19.2% gain for CNI. If Ackman is unable to get something done, shares could drop further.
  
  

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