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 industry’s 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 Norfolk’s 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 nation’s 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 competitor’s market share and also the competition for the Norfolk after the deal is tough and even to sustain in the industry is difficult. Norfolk Sothern’s 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

CSX -- value of synergies

CSX2

CSX -- value of synergies plus loss if rival gets it

NS

Norfolk Southern -- value of synergies plus loss if rival gets it

CSX Buying Conrail: 1. Without Considering Opportunity Cost: Conrail Valuation CSX Valuation 1

Gain in Operating Income TV w. const growth model at After tax PV NPV Shares NPV per share Pre-merger Total

Re 15.93%

Required return

4% 35%

$

2164.35 90.5 23.92 $71.00

$ 94.92

= =

Rf 6.83%

+ +

Beta 1.3

Mkt Risk Prem 7.00%

1997

1998

1999

2000

2001

0

188

396

550

567

358 198

4943 3581 1710

0 0

122 91

257 165

2. Considering Opportunity Cost:

Conrail Valuation CSX Valuation 2

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

Required return

Re 15.93%

4% 35%

= =

Rf 6.83%

+ +

Beta 1.3

Mkt Risk Prem 7.00%

1997 0

1998 240

1999 521

2000 730

2001 752

0 0

156 116

339 217

475 263

6556 4750 2268

1997 0

1998 -66

1999 -123

2000 -189

2001 -196

0 0

-43 -32

-80 -51

-123 -68

-1709 -1238 -591

2864.45 7 90.5 $ 31.65

4% 35%

NPV per share

-742.462 90.5 $ (8.20)

Pre-merger Gain Opp cost Total

$71.00 $ 31.65 $ 8.20 $110.86

Norfolk Southern Buying Conrail: Conrail Valuation NS Valuation 2

Required return

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

4% 35%

Re 15.93%

= =

Rf 6.83%

+ +

Beta 1.3

1997 0

1998 231

1999 429

2000 660

2001 680

0 0

150 112

279 179

429 238

5928 4295 2051

1997 0

1998 -130

1999 -232

2000 -308

2001 -320

0 0

-85 -63

-151 -97

-200 -111

-2790 -2021 -965

2579.35 90.5 $ 28.50

4% 35%

NPV Shares

1235.74 90.5

NPV per share

$(13.65)

Pre-merger Gain Opp cost Total

$71.00 $ 28.50 $ 13.65 $113.16

 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.

Mkt Risk Prem 7.00%

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 Pennsylvania’s 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 Norfolk’s 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 shareholder’s goals and helps to give fair price and protects from hostile bids.