conrail case solution_group 8

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Case Study: Acquisition of Conrail Corp. by CSX GroupCourse: M&ASubmitted By: Group 8Arun Maithani 11ADeepika 15ANavneet Sharma 26ANitesh Singh 29ASahil Taneja 39AShobit Mahajan 48ABakul 62K

The acquisition of Conrail: case summaryPlayers:

Richmond-based CSX (CEO: John W. Snow)Virginia-based Norfolk Southern (CEO: David R. Goode)Philadelphia-based Conrail (CEO David M. LeVan)

The US railroad industry is a mature market. Therefore growth through acquisitions is a lucrative strategy.

The Game:

CSX has put forward a two tier offer to acquire ConrailThe front end offer for 40% of the shares at $92.50The second phase offer to acquire remaining 60% shares through stock swap with an exchange ratio of 1.85619Conrail is also a potential target for Norolk Southern (which later offered 14.1% premium over CSXs offer)Pennsylvania laws makes a takeover difficultConrail has a provision of poison pill to thwart off any hostile takeover attempt

Company profile: Conrail and CSX

ConrailFormed from the remains of six bankrupt Northeastern railroads in 1973Earned its profit in 1981- $39.2 million on revenues of $4.2 billion. Privatized through an IPO in 1987Major player in the Northeastern cities and their connection with major mid-western hubsMajor financial indicators (as of 1995) Operating revenues - $ 3.686 billion Operating ratio 79.9% Revenue per share - $ 156,784 P/E ratio 12.9 CSXA Virginia-based diversified transport company (intermodal services, ocean-container shipping, contract services and railroad servicesMajor player in the Southeastern and Midwestern states and the Canadian Province of OntarioIn 1995 it operated 18,645 miles of track and controlled 38.5% of the Eastern rail freight marketMajor financial indicators (as of 1995) Operating revenues - $ 4.819 billion Operating ratio 76.7% Revenue per share - $ 163,151 P/E ratio 11.6 Gains from Conrail acquisitionConrail A lucrative target in otherwise mature US railroad market:Conrail is provider of Freight transportation in the Midwest region of the U.SConrail is the ideal extension for both CSX & Norfolk Southern into the NortheastNortheast Corridor is a must for a transcontinental railroad

Rationale for CSX to acquire Conrail:Strategic- To pre-empt any such move from Norfolk and thus ensure a better competitive positioning in the industry, in view of the following strategic rationaleThe acquisition of the rail network of Conrail would provide CSX with the highly lucrative long haul, continuous and therefore low cost service between the southern ports, the northeast and the Midwest and this would deny Norfolk access to the northeast market.(Refer to exhibits 9)In short haul routes between the Midwest and the south, the merger would be more competitive than Norfolk through cost reductions.The acquisition can potentially help form a strong East-West rail network as well as ties across Canada especially post the NAFTA agreement in 1994

Financial rationaleThe acquisition will help add 8.5 Billion in rail revenue.Help consolidate operations and increase service improvements.Cost Reduction would yield additional 370 Million in annual operating income by the year 2000, net of merger costs

Understanding CSXs offer

Two-tier offer worth an estimated total value of $8.3 billionWill offer front-end shareholders $92.50 in cash for their shares. This offer is extended to 40% of the shareholdersRemaining shareholders will have the opportunity to convert one share of Conrail for 1.8569 shares of CSX. Based on CSXs stock price of $46.75 that Is equal to $86.78. Accounting for TVM, back-end shareholders will get around $9 per share less than the front-end shareholders making it an unequal offerDue to obligation to bid for all shares at the same price once 20% ownership is reached, front-end offer is divided in two stages. First CSX will put forth a tender offer for 19.7% of Conrails share and once the shareholders have voted for nullification of the fair value status , CSX will proceed to tender the remaining 20.3% of the shares

36.2 million shares * $92.5 = $3.348 billion100.8 million shares * $46.75 = $4.712 billion

Thus, summing both figures, the proceeds from the cash tender offer and the expected value of shares once they are converted, we get a total value of $8.06 billion

($8.06 billion)/(90.5 million shares) = $89.06 per shareHence blended price = $89.07Non taxable institutions 48%Tax paying institutions 34%Individuals 17%Insiders 1%Non taxable institutions 28.8%Tax paying institutions 20.4%Individuals 10.2%Insiders 0.6%CSX -40%Clauses and implications of CSXs offerConrail A lucrative target in otherwise mature US railroad market:No Talk Clause-Conrail not to engage in merger talks for a period of 6 months unless certain conditions are met: The clause will limit the chance of other hostile bids while the deal with CSX is onShare purchase- CSX can buy 15.96 million new shares of Conrail at 92.5$. This clause will let CSX maintain its ownership control and prevents other interested parties into getting into similar deal, otherwise CSX would have to increase its offeringBreakup fees- 300 million USD- The clause ensures that CSX gets the money in case deal doesnt come through and hence its fees associated with the deal gets covered. Also looking at the value of the breakup fees, it becomes evident that another bid would have to be greater by at least 300 million USD for ConrailPoison Pill-Conrail suspended its poison pill clause which allowed current shareholders to buy shares discounted at 50% to maintain their ownership interest- if an outsider attempted to buy more than 10% of the overall shares. By removing the poison pill, the shareholders made sure that CSXs ownership rights would go unchallenged since no dilution of stake would occurWhy not an all cash offer?The two tier offer is designed to pay less to the non tendering shareholdersAs the current stock prices of CSX were already at nearly the 1 year high, probability of an upward revision on deal announcement was lowWith low cash reserves in its balance sheet, an all cash offer was not an option raising debt would have increased cost of capital in a capital intensive industry

Blended offer: Calculating the net price per share

Blended Offer PriceTotal No of Shares ('000)90,500Price for 40% share$92.540% Consideration (amount in $ '000)3348500Exchange Ratio1.85619:1New Share to be issued ('000)100791Price per share$46.75Value of exchange consideration (amount in $ '000)4711985Total Value of Consideration$8060485Value per share ($)89.07Poison pill and its costPoison pill:Security against hostile takeoverGives holders the right to purchase stock at a discountCan be adopted without shareholder approvalIn the Conrail case the trigger level was 10% and the discount factor was 50% of the current market price

ParticularsValueNOSH 90,500,000 No. of shares offered 81,450,000 CMP $71.00 Offer price $35.50 Current market cap $ 6,425,500,000 Inc in marekt cap $ 2,891,475,000 New market cap $ 9,316,975,000 Total no. of new shares 171,950,000 New share price $ 54.18 Loss per share $ 16.82 Cost of poison pill $ 156,672,290,131.58

Standalone valuation of Conrail: DCF approachke= RF + bj (km - RF)ke= 16.15%RF= 6.80% (US Treasury bond for stedy state)bj= 1.30 (estimated Beta for company, 1 for steady state)km= 14% (average S&P return)kd= 7.42% (pre tax bond yield)WACC= 11.85%

Line item (In $ million or %)19941995199619971998199920002000Revenue373336863,7143,8393,9684,1024,2404,382Total cost of sales312732303,1133,2183,3263,4383,5543,673EBIT532392531549567586606627% Tax rate35%35%35%35%35%35%35%35%EBIT(1-t)345.8254.8345.15356.76368.77381.17394.00407.25Less: Capex3112167.0 69.3 71.6 74.0 76.5 79.1 Capex as % of sales8.33%0.57%1.80%Less: Changes in WC-732631.0 32.0 33.1 34.2 35.4 36.6 FCFF107.8207.8247.15255.47264.06272.94282.13291.62FCF Growth Rate92.76%18.94%Terminal Value (TV) at the end of five year4350.20PV (Yr-1996)2282111951801672,485EV(FCFF)3,466Thank You!