Student: Madina Akhtanova

Conrail case

Student: Madina Akhtanova

Group: Finance 4A

1.Why does CSX want to buy Conrail? Why can CSX justify paying a premium to acquire Conrail?

The acquisition of the rail network of Conrail would provide CSX with the

highly lucrative long haul, contiguous and therefore low cost service between

the southern ports, the northeast and the Midwest and this would deny Norfolk

access to the northeast market

a) The Stagger’s Rail Act of 1980 has created a deregulated environment in which acquisitions are used to improve the competitive positioning of existing companies in railroad industry.

b) The acquisition of the rail network of Conrail would provide CSX with the highly profitable long haul and provide low cost service between the southern ports, the northeast and the Midwest. The combined company will come up to more that $8,5 billion in revenues and about 70% of the Eastern railroad market;

c) This big control over market and becoming more efficient and competitive will close Norfolk access to the Eastern railroad market;

d) The main thing is reduction of costs and offering new services to customers (economies of scale) through: faster load and unload of goods; exchange of market knowledge and customer base; more line tracks;

e) The cost reduction would yield an additional $370 million in annual operating income by the year 2000; also projected that revenue increases would yield an additional $180 million in annual operating income.

f) The Railroad is in comparison with others is very old and relatively fully developed industry, therefore the only way to grow in some way is to make acquisitions;

g) Main additional revenues, described above will come from taking business over from Norfolk Southern.

CSX officials insist that new business, merger efficiencies and other cost cutting (mainly described above) will justify the Conrail acquisition premium.

2. Why would the Surface Transportation Board (STB) likely approve the merger (i.e., why might the STB not be too concerned about the impact the merger will have on competition in the northeast)?

The Surface Transportation Board is more likely to approve the merger than to forbid it. From the given information we know that STB earlier approved to big mergers, such as Burlington Northern acquired Santa Fe Pacific and Union Pacific acquired Southern Pacific. Both of these companies operates in western market and after that they become two very powerful railroad companies in the US. Thus, for STB it would be silly to forbid merger of CSX and Conrail, by preventing them to have the ability to compete with two big western companies. Also they should not forget the Stagger’s Act that supports railroad market to make mergers to lower cost and improve profitability.

3. What is the per share value of Conrail to Norfolk Southern? To CSX? What factors account for the difference? How much should CSX be willing to pay for Conrail? Value Conrail using the multiples of competitors as well comparable transactions methods. For calculations, show your work (don’t just write the final number).

Multiples valuation

Target-Acquirer	EPS	Book value	Sales	EBITDA
Santa Fe Pacific- Burlington Northern	21,4x	4,5x	2,6x	13,1x
Chicago and North Western-Union Pacific	18,3	5,5x	2,4	8,5
Southern Pacific-Union Pacific	18,4	3,7x	1,7	12,2

From Exhibit 6.

Averages of multiples: (by summing and dividing to 3)

EPS	Book value	Sales	EBITDA
19,4x	4,6x	2,2x	11,3x

Potential value of Conrail’s stock:

Number of shares: 90,5 million

Amounts in $ million

	Maximum multiple(A)	Number from Exhibit 6(B)	Firm value(C)	Debt value(D)	Equity value(E)	Stock value(F)
EPS	21,4x	4,91				105,1(A*B)
BV	5,5	32,46				178,53(A*B)
Sales	2,6		9677,2(A*B)		7583,2(C-D)	83,79(E/90,5)
EBITDA	13,1		13322,7(A*B)		11228,7(C-D)	124,07(E/90,5)

	Minimum multiple(A)	Number from Exhibit 6(B)	Firm value(C)	Debt value(D)	Equity value(E)	Stock value(F)
EPS	18,3x	4,91				89,87(A*B)
BV	3,7	32,46				120,1(A*B)
Sales	1,7		6327,4(A*B)		4233,4(C-D)	46,78(E/90,5)
EBITDA	8,5		8644,5(A*B)		6550,5(C-D)	72,38(E/90,5)

	Average multiple(A)	Number from Exhibit 6(B)	Firm value(C)	Debt value(D)	Equity value(E)	Stock value(F)
EPS	19,4x	4,91				95,27(A*B)
BV	4,6	32,46				149,32(A*B)
Sales	2,2		8188,4(A*B)		6094,4(C-D)	67,34(E/90,5)
EBITDA	11,3		11492,1(A*B)		9398,1(C-D)	103,85(E/90,5)

FCFE valuation method (information about gain in operating income from Exhibit 7)

Value of Conrail to CSX

K=6,83%+1,3*7,4%=16,45%.Terminal value was found using g=3%(inflation rate in that period)

Amounts in $ million

						Terminal value
Gain in operating income
Tax(35%)		65,8	138,6	192,5	198,45	1519,7
FCFE		122,2	257,4	357,5	368,55	2822,3
K		16,45%	16,45%	16,45%	16,45%	16,45%
PV of FCFE		90,1	163,0	194,4	172,1	1318,0
Sum of PVs	1937,6(A)
# of shares	90,5(B)
Per share amount	21,4(A/B=C)
Pre-bid price	71(D)
Total stock price	92,4(C+D)

Value of Conrail to Norfolk

K=6,83%+1,15*7,4%=15,34%

Amounts in $ million

						Terminal value
Gain in operating income
Tax(35%)		65,8	138,6	192,5	198,45	1519,7
FCFE		122,2	257,4	357,5	368,55	2822,3
K		15,34%	15,34%	15,34%	15,34%	15,34%
PV of FCFE		91,9	167,8	202,0	180,5	1382,6
Sum of PVs	2024,8(A)
# of shares	90,5(B)
Per share amount	22,4(A/B=C)
Pre-bid price	71(D)
Total stock price	93,4(C+D)

4. Analyze the structure of CSX’s offer for Conrail (a) Why did CSX make a two-tiered offer?
(b) Discuss the various anti-takeover measures included in the CSX-Conrail merger agreement (i.e., no-talk clause, poison pill, break-up fee, lock-up options). What implications do these provisions have for the cost of acquiring Conrail for other bidders (other than CSX)?

A two-tired deal was made because of the heavy regulation Pennsylvania’s Business Corporation Law. The Law required that if 20% shares of the company are acquired then all shareholders must be offered the same price so converting it into vote. The CSX would purchase 90,5 million Conrail shares to complete acquisition. The first 40% of the shares to be paid in all cash at $92,5 offer and rest at share exchange at 1,85619:1 for 60% shares (blended value-$89,07).

The first stage, a cash tender offer for 17.86 million shares at $92.50 per share, began the day after the merger announcement. These shares represented 19.7% of Conrail’s acquisition shares. The second stage, another cash tender offer for an additional 20.3% of Conrail’s acquisition shares at the same price, could proceed only after Conrail shareholders approved the deal as required under Pennsylvania law. By structuring it in this way CSX could ensure a lower price paid for the remaining 60% of shares. At around the opt out vote as required by the fair value statute, CSX and their supporters would own approximately 35,5 of acquisition shares and they would only need 14,6%of the acquisition shares to vote in favor of opting-out for it to pass.

No talk clause

It prevents Conrail from considering any other takeover offer for 6 months. Yet if another offer did emerge, the Conrail board could consider the bid and possibly terminate its merger agreement with CSX under a number of conditions.

Poison pill

Poison pill would give each shareholder the right to purchase an additional share of stock at a 50% discount if another party purchases 10% or more of Conrail shares. If another bidders make offer, they will have to buy these additional shares, increasing the acquisition costs. It wards off potential bidders and if there is no poison pill, it is possible that new offers will appear.

Break up fee

Conrail obligated to pay CSX $300 million if the transaction did not take place. By looking at break up fees, we see that another bidder would have to pay more than $300 million for Conrail. Again it is one of barriers to new offers.

Lock up options

CSX is given lock up options which will allow them to buy 15,6 newly issued shares at a price $92,5 per share. This will let CSX maintain its ownership control and prevents other interested bidders into getting similar deal, else CSX would have to increase its offering

5. As a shareholder of Conrail, would you tender your shares to CSX at $92.50 in the first-stage offer? Why?

As a shareholder I would not tender my shares to CSX. Because it is known that if merger occurs, Norfolk Corporation will loose its power. Actually, I think that Norfolk Corporation as the third major Eastern railroad and most efficient and best- managed railroad in the US will appear in this game of railroads. Conrail needs acquisition anyway, so it is better for them to wait for the moment when Norfolk will consider all issues and come in with their offers and prices. Undoubtedly, the price will be higher than CSX’s offer, if they want to win this competition. For both companies Conrail is very good opportunity to become more efficient and powerful and get the bigger piece in the railroad pie industry in the US. Also multiples valuation shows that potential stock price can be bigger that offered price of CSX.

The acquisition of the rail network of Conrail would provide CSX with the

highly lucrative long haul, contiguous and therefore low cost service between

the southern ports, the northeast and the Midwest and this would deny Norfolk

access to the northea

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