Conrail Case

Con running G455 Corporate Restructuring Team 7 1) why does CSX want to buy Con quetch? In an industry beset by limited options to consolidate domestic rail traffic, CSX looked at Conrail as an street to increase commercialise sh be and pass water entry to the North eastern United States rail ne cardinalrk. With air travel, road travel and trucking taking an increase consider, significant tax income growth became difficult. As Conrail became profitable, Congress explored ways of privatizing it, fine-looking CSX an opportunity to acquire Conrail.Though Conrail suffered from performance inefficiencies it had certain strengths relative to CSX and Norfolk with respect to eminentest revenue per mile of track operated, per carload originated etc. Conrail with in operation(p) revenue of $3,686 nonpareil thousand million and 29. 4% of Eastern rail freight traffic was attractive abounding for CSX to consider the conjugation. The joint entity would ingest $8. 5b in rail revenu e and would confine the Eastern market with a market portion of 70%.CSX estimated the scholarship to also create synergies resulting in consolidation of overlapping operations and non only increase the joint entitys revenue through championing improvements, but also the operating(a) incomes through economies of scale. Cost synergies was judge to help in increasing the annual operating income by $370m and revenue increases was expect to help increase annual operating income by $180m. (establish on military rank of synergies, taking PV of marchesinal lever, we estimate the gains in Operating Income to be affect to $3,047. 13. CSX expected the acquisition to improve the joint entitys competitive direct vis-a-vis Norfolk southernern as the joint entitys rail networks would expedite long-haul, contiguous and therefore low comprise service. As Norfolk grey lacked access to Northeast market it would be less able to provide long-haul routes from South or Mideast. The purcha se of Conrail would thus provide CSX with control of the Eastern rail network. From a financial perspective, the projected revenue gains and cost savings was expected to make the joint entity become more efficient than Norfolk Southern.Likelihood of a pit (Norfolk Southern) acquiring Conrail, resulting in competitive disadvantage for Conrail was also a factor. 2) ground on doubles and a premiums paid approach, how much should CSX be testamenting to accept for Conrail? We took sales, EBITDA, Book nurse Multiples and Four week acquisition Premiums from Exhibit 6. We recitation number of Conrails sh ars bully as 90. 5 million at the share scathe of $32. 46 from the similar Exhibit 6. Conrails regard as Sales EBITDA Book Value Premium % $3,722 $1,017 $32 $6,516 Multiples High Low 3. 6 1. 7 13. 1 8. 5. 5 1. 7 73. 0% 34. 0% Conrail merchandise Price Low Average $ 1,032 $ 3,712 $ 3,350 $ 5,465 $ (301) $ 5,398 $ 8,731 $ 9,986 High $ $ $ $ 8,104 8,028 10,862 11,273 See Calculati ons spreadsheet for details. As the Conrail is passably attractive resource for CSX it should be willing to pay on the high side of the Conrail Market Price. We have highlighted the High Price in the preceding(prenominal) table. We 2 have also calculated the legal injury by heterogeneous methods (sales ratio, EBITA, etc). The price calculated by these methods is reasonably c unload to the press price of CSX.Within the high price too, there seems to quite a difference in valuations. The multiple analysis methodology assumes that solely companies within an industry have similar characteristics. As expected there is wide random variable is surrounded by low, high and mediocre. Within the rail industry there is wide variance in capital structures, profitability etc, which is reflected in Conrail Market Price. Other than multiple and premium methods, CSX should be detailed financial analysis based on synergies etc. to come up with the price. The synergies given in the case are st ated as benefits in Operating Income. This is not an unambiguous term. For purposes of this and concomitant questions, assume that these synergies are net of costs (COGS and Capital Expenditures) and the subsequently-tax payment to bondholders. The term operating income is likened to net income or the taxable income to bourgeonholders. Further assume that no(prenominal) of these acquisitions will affect the acquirers equity cost of capital. 3) Based on the data in Exhibit 7 and the rendering of operating income gains given above, how much should CSX be willing to pay for Conrail? Support your resolution with appropriate analysis.According to operating income gains we can rank a firms market price as its pre- nuclear fusion hold dear and the present value of gains in operating income. Lets assume that value of Conrail before the nuclear fusion reaction is tolerable to its market cap. Then taking Conrail share price as $71. 94 ( median(a) of year end and high stock price) and number of shares outstanding as 90. 5 million shares (Exhibit 6) we get Conrail market value equal to $6,510. 57 million ($71. 94 x 90. 5 million). We assume G =3%, MRP = 7%. We take risk free as 30-year maturity US Bonds rate, which is 6. 3% (Exhibit 8) merged CSX-Conrail equity beta as average of CSX and Conrail equity betas, which is 1. 33. rE = rf + MRP ? E = 6. 83% + 7% x 1. 33 = 16. 11% Now we can find Conrails synergism value as present value of gains in operating income. 1997 constitutional wear in Operating Income Total Gain in OI after 40% evaluate Gain in OI (discounted rE) $ $ $ 1998 $ 88 $ 12. 80 $ 7. 15 $ $ $ 1999 396 237. 60 176. 26 $ $ $ 2000 550 330. 00 210. 84 2001 $ 567 $ 340. 20 $ 187. 21 Value of estimated gains = $671. 46 Terminal value = $2,673. 83 Present value of Terminal Value = $2,365. 67 Conrails Synergy Value is equal to $3,047. 13.See Calculations spreadsheet for details. The maximum price, which CSX should be willing to pay for Conrail is $6, 510. 57 + $3,047. 13 = $9,557. 70 3 The best price of the merger is somewhere in between of $6. 5 and $9. 5 billion. Wed advise a price closer to Conrails market value rather than the average of these two figures. In this case two Conrail and CSX shareholders win from the merger. If they take price closer to the high CSX shareholders can lose due to over estimated synergy gains. 4) Analyze the structure of CSXs stretch forth for Conrail. CSX spined a two-phased grapple for Conrail worth $8. 3 billion at the nnouncement. CSX would purchase 90. 5 million (100%) of Conrail shares to complete the deal. In the first phase, CSX before rendered $92. 50/share for 40% of Conrails shares. This front-end offer would be completed in two stages for regulatory reasons, purchasing 19. 7% in stage star and the other 20. 3% once approved by the shareholders. Once all of phase one was completed, CSX would purchase the remaining 60% of Conrails shares by exchanging shares in a ration of 1. 856 191. 0 (CSX Conrail), yielding shareholders roughly $89. 07/share (blended value) based on recent Conrail and CSX stock performance.In addition, the merger agreement contained nutriment related to break-up fees, lock-up options, poison pills, and no talk clauses. These purveys provided some aim of protection against advances from NorfolkSouthern or other competitors looking to purchase Conrail. Notably, the no-talk clause mandatory Conrail to abstain from any conversations related to buy-out with other firms though this could be repugn where the boards fiduciary duty to protect investors superseded said restrictions. 5) Why did CSX make a two-tiered offer? What effect does this structure have on the transaction?Pennsylvanias fair value ordinance undeniable all bidders holding 20% or more of stock to offer the same price to all shareholders unless target shareholders agreed to explicitly repeal this position. Also the same codified limited any shareholders (with a 20% or lar ger stake) voting rights unless management approved it. Finally, the law undeniable management to consider and protect the interests of employees and the biotic community. This two-tiered structure affected the timing and the cost of the deal. As a result of the deals structure, Norfolk Southern had two opportunities to block with a hostile takeover driving up the price of the acquisition.By close of business prior to the shareholder votings to opt-out of the fair value statute, CSXs bid was up to $110/share, resulting in an offer that was $321,500,000 more than originally planned for the remaining 20. 3% in phase I. The structure of the deal also leaded CSX to pay for 40% of Conrail in cash (in two phases) opus paying for the remaining 60% of the target with CSX stock. This meant that changes to CSX or Conrails stock price prior to the transaction completing could impact the cost of the replete(p) deal 6) Why did Norfolk Southern make a hostile bid for Conrail? Conrail is con sidered a scarce jewel.Conrail was the sole class I railway system serving the Northeast market of the United States with control of 29. 2% of the rail freight market east of the Mississippi river. Although Conrail was inefficient and not precise profitable, its revenue per mile of track operated, per carload originated, and per ton originated were the highest in the industry. If the merger between CXS and Conrail succeeded, Norfolk Southern would be negatively impacted with estimates of up to $320 million by 2001. This is clearly a battle Norfolk can not expend to lose as it may impact its very existence in the long run. 7) How much is Conrail worth? In a bidding war, who should be willing to pay more, Norfolk Southern or CSX? Again, note the previous definition of operating income when interpreting the data in Exhibits 6a and 6b. We use the same system of logic of gains valuation as we did it in question 3. Assumptions for CSX-Conrail amalgamation We assume the same G =3%, MRP = 7%. We take risk free as 30-year maturity US Bonds rate, which is 6. 83% (Exhibit 8) merged CSX-Conrail equity beta as average of CSX and Conrail equity betas, which is 1. 33. rE = rf + MRP ? E = 6. 83% + 7% x 1. 33 = 16. 1% Now we can find CSX-Conrail synergy value as present value of gains in operating income. 1998 240 144. 00 (66) 210. 00 1999 521 312. 60 (123) 435. 60 323. 14 $1,260. 76 $5,086. 73 $4,655. 08 $5,915. 84 $12,426. 41 2000 $ 1,811 $ 1,086. 60 $ (189) $ 1,275. 60 $ 400. 60 2001 $ 752 $ 451. 20 $ (196) $ 647. 20 $ 356. 15 Total Gain in Operating Income Total Gain in OI after tax revenue (40%) CSX Total Loss in OI CSX Total gain in OI from merger Total Gain in OI (discounted rE) Value of estimated gains in OI Terminal Value of estimated gains in OI PV of TV Total value of gains in OI for CSX Value of Merger for CSX $ $ $ $ $ $ $ $ $ 180. 87 Assumptions for Norfolk SouthernConrail Merger We assume the same G =3%, MRP = 7%. We take risk free as 30-year maturity US B onds rate, which is 6. 83% (Exhibit 8) merged Norfolk SouthernConrail equity beta as average of Norfolk Southern and Conrail equity betas, which is 1. 23. rE = rf + MRP ? E = 6. 83% + 7% x 1. 23 = 15. 41% Now we can find Norfolk SouthernConrail synergy value as present value of gains in operating income. 1998 $ 231 $ 139 $ (130) $ 269 $ 233 1999 $ 429 $ 257 $ (232) $ 489 $ 367 $1,468. 67 $6,044. 6 $5,531. 72 $7,000. 39 $13,510. 96 2000 $ 660 $ 396 $ (308) $ 704 $ 458 2001 $ 680 $ 408 $ (320) $ 728 $ 410 Total Gain in Operating Income Total Gain in OI after Tax (40%) Norfolk Southern Total Loss in OI Norfolk Southern Total gain in OI from merger Total Gain in OI (discounted rE) Value of estimated gains in OI Terminal Value of estimated gains in OI PV of TV Total value of gains in OI for CSX = Value of Merger for CSX 5 From the calculation above we see that value of Conrail acquisition is much, over 1 billion higher for Norfolk Southern than for CSX.Moreover, the expiry in acquiring Conrail leads to significant loss in revenues and market share for both of bidders but more for Norfolk Southern. Not surprisingly that they have unplayful intention to wage a bidding war. 8) As a shareholder, would you vote to opt-out of the Pennsylvania anti-takeover statute? In the case of conrail as a shareholder, we would not vote to opt-out of the Pennsylvania antitakeover statute. The PA statute provides Conrail shareholders with a fair value statute provision on their stock ownership.Specifically, bidders holding 20 percent or more of a companys stock are required to offer all shareholders the same price unless the target shareholders opt-out of the statute. The CSX two-staged offer had a blended value which clearly demonstrates that Conrail shareholders would have been given divers(prenominal) pricing for each stage in the offer. The poison pill provision under the CSX and Conrail merger agreement does not give Conrail shareholders the rights to buy discounted shares sin ce the merger agreement required Conrail to suspend its poison pill.Therefore, the poison pill favors the acquirer and not the Conrail shareholders. Finally, as a shareholder, the best strategic position is to allow the bidding war to commence and observe how CSX and Norfolk Southern compete against one another for the Conrail business. It is patent that there will be an acquisition and it is obvious based on both acquisition proposals, that each company will issue multiple offers in an effort to acquire Conrail due to its strategic location in the Northeast United States. In general, however this statute could be disadvantageous to shareholders in certain cases.The statute tries to protect the interests of employees and community where the target company was located in addition to meeting their fiduciary duty to the shareholders. The statute frees companies from any obligation to sell itself to the highest bidder. Conrail used the statute to blunt Norfolks offer though it was bett er for shareholders. The fair value statute aspect helped the shareholders of Conrail (as parties in support of merger still postulate 14. 6% of acquisition shares to vote in favor of opting out. ) 6