Conrail Analysis B

Case Analysis Consolidated Rail Company (B)
Submitted by:
Rakesh Salecha Ranjeetha V Ramanuj Ramnath Shenoy Nirmit Jain
1. Why did Norfolk Southern make a hostile bid for Conrail?

Conrail was the sole Class I railroad serving the lucrative Northeast market which was considered by many as the industrys prized possession. It had the highest revenue per mile of track operated, highest revenue per carload originated and per ton originated. It also had a very high operating margin and a high employee/ mile of track hence the there was considerable room for improvement in terms of increasing profit margin and lowering employees. Hence the company which would acquire conrail can make considerable profit in synergies ($565 Mn/ year for CSX and $ 515 Mn / year for Norfolk). This coupled with the fact that if CSX acquired conrail they would hold a consolidated market share of 68 % inviked the hostile bid from Norfolks end as elsewise it would be completely out of the Northeast market. This a industry where economies of scale can cut the costs and increase profit margins. Conrail is having very low operating efficiency compared to others in the industry. Norfolk realized if deal between Conrail and CSX was consummated it would have significant effects on nations transportation and for the shipping public. Norfolk predicted that there exists a lot of synergy in this merger and synergy is not only through the deal but also by taking the other competitors market share and also the competition for the Norfolk after the deal is tough and even to sustain in the industry is difficult. Norfolk Sotherns hostile offer comes as no surprise.
2. How much is Conrail worth? In a bidding war, who should be willing to pay more, Norfolk or CSX?
Ans: The valuation of Conrail is as follows:
Conrail Valuation
Valuation in a competitive bidding situation
CSX1 CSX2 NS
CSX -- value of synergies CSX -- value of synergies plus loss if rival gets it Norfolk Southern -- value of synergies plus loss if rival gets it
CSX Buying Conrail: 1. Without Considering Opportunity Cost:

Conrail Valuation CSX Valuation 1 Required return Re 15.93% = = Rf 6.83% + + Beta 1.3 Mkt Risk Prem 7.00%
1997
Gain in Operating Income TV w. const growth model at After tax PV NPV Shares NPV per share Pre-merger Total 0 4% 35% 2164.35 90.5 23.92 $71.00
1998
188
1999
396
2000
550
2001
567 4943 3581 1710
0 0
122 91
257 165
358 198
$ 94.92
2. Considering Opportunity Cost:
Conrail Valuation CSX Valuation 2
Required return
Re 15.93%
= =
Rf 6.83%
+ +
Beta 1.3
Mkt Risk Prem 7.00%
Gain Gain in Operating Income TV w. const growth model at After tax PV NPV Shares NPV per share Opportunity Cost Loss if rival gets target TV w. const growth model at After tax PV NPV Shares NPV per share Pre-merger Gain Opp cost Total
1997 0 4% 35% 2864.45 7 90.5 $ 31.65 1997 0 4% 35% -742.462 90.5 $ (8.20) $71.00 $ 31.65 $ 8.20 $110.86
1998 240
1999 521
2000 730
2001 752 6556 4750 2268
0 0
156 116
339 217
475 263
1998 -66
1999 -123
2000 -189
2001 -196 -1709 -1238 -591
0 0
-43 -32
-80 -51
-123 -68
Norfolk Southern Buying Conrail:

Conrail Valuation NS Valuation 2 Required return Re 15.93% = = Rf 6.83% + + Beta 1.3 Mkt Risk Prem 7.00%
Gain Gain in Operating Income TV w. const growth model at After tax PV NPV Shares NPV per share Opportunity Cost Loss if rival gets target TV w. const growth model at After tax PV NPV Shares NPV per share Pre-merger Gain Opp cost Total
1997 0 4% 35% 2579.35 90.5 $ 28.50 1997 0 4% 35% 1235.74 90.5 $(13.65) $71.00 $ 28.50 $ 13.65 $113.16
1998 231
1999 429
2000 660
2001 680 5928 4295 2051
0 0
150 112
279 179
429 238
1998 -130
1999 -232
2000 -308
2001 -320 -2790 -2021 -965
0 0
-85 -63
-151 -97
-200 -111
Norfolk can pay 113.16 CSX can pay 110.86 In a bidding war, who should be willing to pay more, Norfolk or CSX? Our analysis shows that Norfolk should pay more.
3. Why did CSX refer Norfolk bid as non bid? What should Norfolk do as mid of January 1997?
CSX gave no talk clause poison pill to Conrail in the terms and conditions of merger agreement it tried to acquire the company in two tire 3 stage process. Both CSX and Norfolk began a media blitz in January 1997, each hoping to persuade the public that they were more responsive to Conrail's other constituencies. It is noteworthy that all of the advertisements were either addressed directly to shareholders, or implicitly aimed toward them. On January 21, 1997, after Conrail shareholders refused to opt out of the fair price provision, Norfolk printed a large "thank you" to Conrail shareholders in a national advertisement. Norfolk continued to plead to shareholders short -term interests.
4.
As share holder would you opt out of Pennsylvania anti takeover statute? What do capital markets react?
Pennsylvania's fair price provision guarantees shareholders the right to obtain, from a bidder acquiring more than 20% , the highest price the bidder paid for the shares within the 90-day period ending on and including the date the bidder acquired 20% ownership. If the shareholders do not receive the highest price paid, then the transaction will require approval from the shareholders, not including the bidder. As share holder this is good to a share holder it protects against hostile takeovers So as a share holder one should not opt out of the Pennsylvanias law of anti takeover at this point of time. The stock price of Conrail went up from 71$ on seeing the competition between two big players in acquiring Conrail. They assumed that Conrail has intrinsic value and anticipated that they could liquidate their shares at higher prices. As a shareholder I would vote to opt out of the statute since NS is a better merger option for Conrail since it would be able to extract more value from the deal in the form of Synergy. Secondly CSX is offering a blended value / share of Rs 102.16 per share as on 16th Jan. Although this offer is lower than Norfolks but in the long run the operating margin of the merged entity would be greater than Norfolk which would allow them to further leverage the market share that they would hold.
5. What are the costs and benefits of regulating the market for corporate control through statutes like Pennsylvania anti take over law?
Anti takeover laws raise both the costs and benefits of mounting a hostile takeover. By raising the cost of takeover they allow managers to pursue goals other than maximizing shareholder wealth, and the resulting slack increases the payoff from a successful takeover. With out the Pennsylvania anti takeover law share holder can opt for CSX or Norfolk and the process would have been completed faster and more easily. But at the same time the benefits are it helps to give more importance to shareholders goals and helps to give fair price and protects from hostile bids.

Conrail Analysis B

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Case Analysis Consolidated Rail Company (B)

1. Why did Norfolk Southern make a hostile bid for Conrail?

CSX Buying Conrail: 1. Without Considering Opportunity Cost:

2. Considering Opportunity Cost:

Conrail Valuation CSX Valuation 2

Mkt Risk Prem 7.00%

2001 752 6556 4750 2268

2001 -196 -1709 -1238 -591

Norfolk Southern Buying Conrail:

2001 680 5928 4295 2051

2001 -320 -2790 -2021 -965

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