Norfolk Southern may face a potential increase in value with activist Ancora's potential use of a proven strategy.

Company: Norfolk Southern (NSC)

A railway company, it transports various raw materials, intermediate products, and finished goods across the United States.

Stock Market Value: $57.56B ($254.83 per share)

Activist: Ancora Advisors

Percentage Ownership:  ~1.75%

Average Cost: n/a

Ancora is a family wealth investment advisory firm and fund manager with $9 billion in assets under management, and an alternative asset management division that manages approximately $1.3 billion. The firm was founded in 2003 and hired James Chadwick in 2014 to pursue activist efforts in niche areas like banks, thrifts and closed-end funds. Ancora's website lists "small cap activist" as part of its products and strategies, and its strategy has evolved in recent years. From 2010 to 2020, the majority of Ancora's activism was 13D filings on micro-cap companies. In the past few years, the firm has taken a greater number of sub-5% stakes in larger companies. The alternatives team has a track record of using private and when necessary, public engagement with portfolio companies to catalyze corporate governance improvements and long-term value creation.

What's happening

An investor group led by Ancora has announced plans to launch a proxy fight against Norfolk Southern, with the goal of replacing a majority of the company's board and CEO, Alan Shaw, according to a report in the Wall Street Journal on Feb. 1.

Behind the scenes

Ancora, a $9 billion wealth advisory firm, has become known for its activism and is now respected and feared as an activist. The firm's $1 billion position in NSC likely means it has a partner who has invested in the activist effort and is relying on Ancora to lead it.

Activist investors have frequently targeted railroads such as Norfolk Southern (NSC) for many years, including TCI at CSX, Pershing Square at Canadian Pacific, Mantle Ridge at CSX, TCI at Canadian National, and now Ancora at Norfolk Southern. The reason for this is that railroads are relatively simple businesses, and when they underperform their peers, it is easy to understand why and generally simple to fix.

Over the past one, three, and five years, Norfolk Southern has underperformed the markets and its peers. The key metric to look at in a railroad company is the operating ratio, which drives railroad profitability and shareholder return. The operating ratio is the company's operating expenses as a percentage of revenue. When Pershing Square and Hunter Harrison went to Canadian Pacific, CP had an operating ratio of 81%, and Harrison was able to get it down to 64.7%. When Mantle Ridge and Hunter Harrison came into CSX, the company had an operating ratio of 70%, which Harrison was able to get down to 58.4%. NSC's operating ratio is almost 69%, and the right management team with the right strategy should easily be able to get the operating ratio down close to 60%.

Hunter Harrison and his team have successfully implemented precision scheduled railroading (PSR), which prioritizes consistent, reliable, and predictable service through scheduling and running fewer trains. This strategy reduces switching costs and safety risks, and has been successful every time it has been implemented. However, NSC does not utilize PSR, instead opting for a resilience model that prioritizes cost reductions. This model enables more short-haul and lower margin intermodal transportation, which uses two modes of transportation like rail and truck or rail and water. Under a PSR strategy, NSC could improve its transportation mix to more higher margin routes and merchandise categories.

Ancora is likely to adopt a similar strategy as Canadian Pacific and CSX to gain control of the board. The company will nominate a majority slate of directors, including former Ohio governor John Kasich and former Kansas City Southern executive Sameh Fahmy, and is expected to include at least one Ancora representative on the slate. While a majority slate does not guarantee success, Ancora does not need a majority of the board to be successful. The key element in both Canadian Pacific and CSX situations was the replacement of the CEO, which Ancora will likely have to do for success.

Ancora is confident that it will win a proxy fight if a settlement cannot be reached in discussions with the company. This strategy is widely accepted in the activist world and among investors who were shareholders of Canadian Pacific and CSX. Three of NSC's top shareholders are also former investors of CSX, and several other hedge funds that own NSC are expected to support Ancora's director slate.

Ken Squire is both the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.