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Con Rail

Equity Valuation: Application to Conrail Prof. Ian Giddy New York University case study. L What's Conrail worth? l How was the CSX offer structured? l What would Conrail shareholders react to the offer?

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727 views9 pages

Con Rail

Equity Valuation: Application to Conrail Prof. Ian Giddy New York University case study. L What's Conrail worth? l How was the CSX offer structured? l What would Conrail shareholders react to the offer?

Uploaded by

Mario A. Betancur
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© Attribution Non-Commercial (BY-NC)
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Download as pdf or txt
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Ian H.

Giddy

Valuation: Conrail-1

Equity Valuation: Application to Conrail Prof. Ian Giddy


New York University

Case Study: The Acquisition of Conrail Why merge Conrail and CSX? l Whats Conrail worth? l How was the CSX offer structured? l How would Conrail shareholders react to the offer?
l

Copyright 2000 Ian H. Giddy

Valuation: Conrail 2

Ian H. Giddy

Valuation: Conrail-2

Gains from Conrail Acquisition? Rationale: Firm A should merge with Firm B if [Value of AB > Value of A + Value of B + Cost of transaction] l Synergy l Gain market power l Discipline l Taxes l Financing
Copyright 2000 Ian H. Giddy

Valuation: Conrail 3

What is Conrail Worth?


l

Stand-alone value
uMarket

value uComparables uDiscounted present value

Value to acquirer l Value in bidding-war context


l

Copyright 2000 Ian H. Giddy

Valuation: Conrail 4

Ian H. Giddy

Valuation: Conrail-3

What is Conrail Worth?


l

Stand-alone value
uMarket

value: $71.00 uComparables uDiscounted present value

Value to acquirer l Value in bidding-war context


l

Copyright 2000 Ian H. Giddy

Valuation: Conrail 5

What Is The Deal Worth?


l

Two-tier offer (why?)


uFront-end

cash offer 40%*$92.50 uBack-end stock swap 60%*(1.85619*$46.75)

Combined offer 40%*$92.50+60%*(1.85619*$46.75) =$89.07


l
Copyright 2000 Ian H. Giddy

Valuation: Conrail 6

Ian H. Giddy

Valuation: Conrail-4

What is Conrail Worth?


l

Stand-alone value
uMarket

value: $71.00 uComparables uDiscounted present value

Value to acquirer l Value in bidding-war context


l

Copyright 2000 Ian H. Giddy

Valuation: Conrail 7

How Much Can a Buyer Pay?


Applying the discounted cash flow approach, we need to know: 1. The incremental cash flows to be generated from the acquisition, adjusted for debt servicing and taxes 2. The rate at which to discount the cash flows (required rate of return on equity) 3. The deadweight costs of making the acquisition (investment banks' fees, etc) 4. Cost of losing out!
Copyright 2000 Ian H. Giddy

Valuation: Conrail 8

Ian H. Giddy

Valuation: Conrail-5

What Gains from the Merger?


Current Market Value

Current market overpricing or underpricng

Maximum restructuring opportunity

Companys DCF value 2

5 Restructuring Framework 4
Disposal/ Acquisition opportunities

Total restructured value


Financial structure improvements
(Eg Increase D/E)

Operating improvements

3
Potential value with internal improvements

Potential value with internal + external improvements

Copyright 2000 Ian H. Giddy

Valuation: Conrail 9

What's It Worth? Valuation Methods l Book value approach l Market value approach l Ratios (like P/E ratio) l Break-up value l Cash flow value

Copyright 2000 Ian H. Giddy

Valuation: Conrail 10

Ian H. Giddy

Valuation: Conrail-6

Estimating Future Cash Flows

n n

Dividends? Free cash flows to equity? Free cash flows to firm?

Copyright 2000 Ian H. Giddy

Valuation: Conrail 11

Conrail: Required return

kj = RF + j (km - RF)
where: kj = RF = 16.15% (required return on company) 6.83% (US Treasury bond) 1.30 (estimated Beta for company) 14% (average S&P return)

j
km

= =

We can use this required return to evaluate whether a companys stock is worth buying.

Copyright 2000 Ian H. Giddy

Valuation: Conrail 12

Ian H. Giddy

Valuation: Conrail-7

Conrail: Value of Synergies?


If CSX can produce the following dollar profits for the next four years and beyond, at a discount rate of 16.15%, what is the present value of the cash flow stream? $0 $111 $259 $381.

$1.xxxb = Present Value of cash flow stream $1.xxxb/90.2m shares =$? Per share .add to $70 to get price could afford
Copyright 2000 Ian H. Giddy

Valuation: Conrail 13

What is Conrail Worth?


l

Stand-alone value
uMarket

value: $71.00 uComparables uDiscounted present value

Value to acquirer l Value in bidding-war context


l

Copyright 2000 Ian H. Giddy

Valuation: Conrail 14

Ian H. Giddy

Valuation: Conrail-8

Case Study: The Acquisition of Conrail Could Norfolk Southern make a bid? l How? How much? l Does this change what CSX has to pay? l Answer: Yes!
l l

Result: Conrail shareholders opposed the CSX move and Conrail was split

Copyright 2000 Ian H. Giddy

Valuation: Conrail 15

Equity Valuation : Results Estimating discount rate l Estimating cash flows l Application to CSX 1 & 2 l Application to NS l Decision?
l l

See spreadsheet: conrail.xls

Copyright 2000 Ian H. Giddy

Valuation: Conrail 16

Ian H. Giddy

Valuation: Conrail-9

What's It Worth? Valuation Methods l Book value approach l Market value approach l Ratios (like P/E ratio)
uConrail:

$89/4.91=18x uAOL: 150x

Break-up value l Cash flow value


l
Copyright 2000 Ian H. Giddy

Valuation: Conrail 17

www.giddy.org
Ian Giddy NYU Stern School of Business Tel 212-998-0332; Fax 212-995-4233 [email protected] http://www.giddy.org

Copyright 2000 Ian H. Giddy

Valuation: Conrail 21

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