Wednesday, February 15, 2017

Concerns amid discussions with Mantle Ridge, Hunter Harrison prompts CSX to call special meeting

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CSX has called a special meeting of shareholders for March 16, 2017, "to seek shareholder guidance on certain extraordinary requests of Mantle Ridge and Hunter Harrison."


CSX said it had engaged in discussions with Mantle Ridge, which owns 4.9 percent of CSX stock, and Hunter Harrison as it had been seeking options on CEO succession and cited Harrison's experience and accomplishments.

At the center of the discussion is CSX's concerns over Harrison's requested compensation package, which CSX estimates to exceed $300 million and that effective control of the Class 1 would be granted to a 4.9 percent shareholder, that could benefit in excess of $100 million.

In response to the call for a special meeting, Mantle Ridge issued a statement from CEO Paul Hilal that said, "We are pleased that CSX agrees that change is needed, and note that CSX enjoyed a $10.4 billion increase in market value since January 18, 2017 reflecting optimism that Mr. Harrison may join as Chief Executive Officer, and effect a transformation of CSX to a Precision Scheduled Railroading model. We have been engaged in constructive dialogue with CSX's Board for several weeks. While we had hoped to reach a negotiated agreement, we appreciate that CSX shareholders will have the opportunity to make their voices heard on the optimal governance and compensation structure that will create the conditions for a successful transformation. We remain fully confident in a favorable outcome for CSX and its shareholders and are excited for the future."

Hunter Harrison added, "If we create the right conditions for success, we have the best chances for success."

CSX posted the below summary of discussions, as well as the letters on its website Feb. 14:

CSX proposals to Mantle Ridge and Hunter Harrison:

  • Mr. Harrison would be appointed as CEO of CSX with compensation that fully reflects Mr. Harrison's experience and accomplishments, replacing Michael Ward, who would retire as Chairman and CEO;
  • Mr. Harrison, Paul Hilal (the CEO of Mantle Ridge) and three other individuals (to be mutually agreed) would be appointed to the CSX Board;
  • Four incumbent CSX directors would retire over the next three years;
  • Chairman of the Board and composition of committees would be determined by the newly constituted CSX Board; and
  • There would be no standstill agreement between CSX and Mantle Ridge.

CSX believes that the following represent Mantle Ridge's and Mr. Harrison's current demands:

With respect to matters relating to Mr. Harrison's employment:

  • CSX estimates that the aggregate value of the compensation package requested by Mr. Harrison and Mantle Ridge, including the requested reimbursement and tax indemnity, exceeds $300 million. The details are summarized below.
  • CSX would pay $84 million to fund Mr. Harrison's obligation to reimburse Mantle Ridge for compensation and benefits he chose to forego at Canadian Pacific, which Mantle Ridge had previously agreed to cover, and would assume a related tax indemnity provided by Mantle Ridge to Mr. Harrison. Mantle Ridge has described the cost of the tax indemnity to be "as much as a few tens of millions" of dollars. CSX would also reimburse Mantle Ridge for a $2 million annual consulting agreement with Mr. Harrison.
  • CSX would enter into a four-year employment agreement with Mr. Harrison providing, among other things, an immediate equity award, such as an option, covering 1% of CSX's outstanding common stock, at least half of which would not be subject to performance measures of any kind and would vest upon Mr. Harrison's death or disability, his resignation for "good reason" or his termination for poor performance, subject to performance metrics on the performance portion of the award. The proposed employment agreement provided by Mr. Harrison includes as an illustrative example a stock option with a present value, as stated in the proposed agreement, of $159.5 million.
  • Mr. Harrison would also receive an annual base salary of $2.2 million, a target bonus of 120% of base salary, with a minimum bonus of $2.64 million for 2017, extensive benefits and severance protections as well as housing in Jacksonville, Fl., and be eligible to participate in CSX's incentive programs, including long-term incentive programs. The average nominal value of the long-term incentive awards granted to CSX's CEO during the last three years was approximately $7.67 million per year.
  • The proposed employment agreement omits customary non-compete and employee non-solicit covenants. The proposed employment agreement also would require CSX to assume responsibility for non-compete and employee non-solicit obligations owed by Mr. Harrison to Canadian Pacific, which could restrict CSX's conduct, including the entry into potential mergers.
  • Mr. Harrison has declined CSX's request that an independent physician designated by the CSX Board conduct a pre-hire review of Mr. Harrison's medical records.

With respect to governance matters, Mantle Ridge has insisted that:

  • Mr. Ward would retire as CEO and Chairman immediately.
  • Mantle Ridge would designate six of fourteen directors on the reconstituted CSX Board, including Mr. Hilal and Mr. Harrison.
  • Three incumbent CSX directors, in addition to Mr. Ward, would retire from the CSX Board effective as of CSX's 2017 annual meeting, and Edward J. Kelly, III, CSX's Presiding Director, would retire from the CSX Board in 2018, leaving at that point seven incumbent CSX directors. Director John Breaux would be ineligible to stand for reelection, under CSX's current director age limitations, after CSX's 2018 annual meeting. At that time, the number of incumbent CSX directors would drop from seven to six.
  • Mr. Kelly would serve as Chairman of CSX for one year, with Mr. Hilal as Vice Chairman. Mr. Hilal would succeed Mr. Kelly as Chairman.
  • Mantle Ridge would select the Chairs of CSX's Compensation Committee and Governance Committee, and would have "heavy" representation on these committees and representation on all other CSX committees.
  • To account for Mr. Harrison's age, CSX would amend its bylaws to permit any director who is younger than the current director age limitation (i.e., 75 years of age) when first elected to continue to serve as a director for up to five consecutive one-year terms.

CSX's Board has concerns with Mr. Harrison's and Mantle Ridge's proposals.

  • First, the CSX Board believes that the governance requests would grant effective control of CSX to a less than 5% shareholder, which would be receiving additional benefits from CSX that may substantially exceed $100 million.
  • Second, the economic costs of Mr. Harrison's and Mantle Ridge's employment-related proposals (which CSX estimates, with the requested reimbursement and tax indemnity, to exceed $300 million), are extraordinary in scope and structured largely as an upfront payment and as equity grants that would be payable to Mr. Harrison upon his death or disability with only a portion of the equity grant including any performance metrics. The CSX Board believes such an employment arrangement for an incoming CEO is exceptionally unusual if not unprecedented.

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