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Executive Summary Conrail has received two acquisition bids from CSX and Norfolk Southern.
Introduction Conrail and CSX, the nation’s first and third largest railroads, have decided to participate in a merger of equals. CSX has offered to acquire Conrail in a two tiered deal. The first 40% of tendered Conrail shares will be bought at a price of $92.50 while the remaining 60% will be acquired through a stock swap at a ratio of 1.8561921 (CSX:Conrail). In the midst of this offer, a hostile Bid comes in from Norfolk Southern, a competitor in the Industry. Norfolk Southern offers ____ Analysis Case A, Question 1: Why is CSX interested in Conrail? How much should CSX pay for Conrail? The Stagger’s Rail Act of 1980 has created a deregulated environment in which acquisitions are used to improve the competitive positioning of existing companies within the railroad industry. CSX is interested in Conrail for a couple of reasons. Primarily, CSX would like to acquire Conrail because its routes are complementary to their own, allowing the combined company to provide “long-haul, contiguous, and therefore low-cost service between the Southern, Eastern, and Mid-Western parts of the United States.” Additionally, CSX’s acquisition of Conrail would prevent the company’s main competitor Norfolk Southern from gaining access to routes in the Northeastern United States. This would leave Norfolk Southern at a large strategic disadvantage. Lastly, the combination would provide cost synergies and reductions, even on the shorter haul trips, that would far exceed those of Norfolk Southern in aggregate measures. Contrarily, it was also suggested by an analyst that the merger was a result of fear. Essentially, it was said that CSX was concerned that Norfolk Southern would make a bid first, thus achieving a first mover advantages and getting the same benefits that CSX itself would from the merger, effectively degrading CSX’s competitive positioning within the industry. Whether the deal was motivated by fear or strategic positioning, the merger will improve the competitive positioning of CSX, ultimately making the combined CSXConrail company extremely powerful in the industry. CSX should pay somewhere between $93.73 and $110.55 for Conrail. This range is based on transaction multiples analysis (EPS, Sales, EBITDA) used in previous railroad deals (calculated using only completed deals) and a Discounted Cash Flow approach of incremental cash flow including the revenue gained from rival Norfolk Southern (See exhibits A and B for details).
Case A, Question 2a: Analyze the structure of the CSX-Conrail deal. Why did CSX make a two tiered offer? What effect does this structure have on the transaction? CSX likely made a two tiered deal due to financial and regulatory considerations. They use the first tier cash offer of $92.50 to gain control of the stock, and will then force the remaining shareholders to accept a lower value of $86.78 (derived from the exchange ratio of 1.85619 and the initial CSX stock price of $46.75) in the form of a stock swap, thus saving cash. Additionally, because the merger was taking place in Pennsylvania there were many specific regulatory requirements which explain why the first tier section of the deal was further split into two stages. -first offer taking only 19.3% to avoid Pennsylvania one price deal and turn it into a vote -after first offer have 35.6% including mgmt, and need 14% to get opt out approval for a two tiered offer -use second offer of 92.50 to entice shareholders to vote for opt out provision -give remaining 60% of shareholder a lower value to reduce value paid.
Case A, Question 2b: What are the economics rationales and takeover implications of the various provisions in the merger agreement (no talk clause, lock up options, break up fee, poison pill) Provision No talk clause-Conrail is unable to engage in merger talks for a period of 6 months unless certain conditions are met: 1)Considering another offer is necessary to meet fidicuary responsibilities to shareholders. 2)Another offer emerges that makes it unlikely that CSX can complete the merger or win the necessary opt out vote Lock Up Options-CSX has option to buy 15.96 Million newly issued common stock shares of Conrail at $92.50. This is 18% of total shares in the company, which is
Economic Rationale and Takeover Implications This ensures that CSX’s investment of time and money is worthwhile, as it lessens the chances of another bidder entering the picture, and either blocking the deal or significantly raising its cost. Pennsylvania law does give the Board of Directors more leeway than is present in other states in regards to fidicuary responsibility, thus increasing the probability that Conrail could consider other offers. This is a positive attribute for Conrail as it allows them more opportunity to achieve a better value for their shareholders, but negative for CSX as it doesn’t provide as strong of a barrier to new bidders. This ensures that CSX is able to maintain their ownership control over Conrail. It prevents Conrail from selling these shares to another buyer, thus reducing the risk of the occurrence of a bidding war in which CSX would have to increase their offering dramatically or be unable to complete the deal.
relatively high for this type of agreement Break Up Fee-$300 Million, 4% of deal which is higher than a normal circumstance.
Poison 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.
This ensures that CSX does not lose the money it invests in the fees associated with the deal, and also that it is compensated for potential reputation damage and time investment. This also acts as an disincentive for Conrail to look into other bids, and/or decide not to move forward with the deal in general. It ensures that another profitable bid would have to be at least $300 million more to compensate for the loss associated with the break up. This suspension allowed CSX to gain ownership control of the company, by reducing the possibility that current shareholders could challenge their stake and dilute the power of their shares. This makes it easier for the company to move forward with the takeover deal leading to less of a required value outlay , while navigating the regulatory issues within Pennsylvania.
Case A, Question 3: As a Conrail Shareholder would you tender your shares to CSX at a price of 92.50 in the first offer? A prisoner’s dilemma analysis shows that in the complete absence of another bidder and a foreseeable market for the acquisition of the company, it is in a shareholder’s best interest to tender their shares during the first round offer whether or not the deal succeeds ultimately. This is because the absolute value in this circumstance is higher. Therefore, we would tender our share in the initial round. Tender Deal Succeeds
$92.50-price paid to shareholder if they sell
$88.20- weighted average of future outcomes in continuation of first tier offer and second tier offer * associated with remaining 80% of shareholders after first offer (.25*92.50+.75*$86.78) $92.50-price paid to $71.00-share price of shareholder if share is sold Conrail before merger speculation
Case B, Question 1: Why did Norfolk Southern make a hostile bid for Conrail?
Norfolk Southern made a hostile bid for Conrail because not doing so was going to cause them to lose revenue. The CSX-Conrail merger would effectively shut Norfolk Southern out of the Northeastern routes in the United States, and prevent them from achieving a competitive cost structure, specifically savings associated with overlapping operations and cheaper longer-haul contiguous routes. Essentially, if Norfolk Southern did not acquire Conrail, CSX was going to steal their future revenue. Case B, Question 2: How much is Conrail worth? In a bidding war who would be willing to pay more Norfolk Southern or CSX? The stand alone value of Conrail is 6425.50 (the market price of $71.00*the 90.5 million shares). In a bidding war, it seems that CSX would be willing to pay more for Conrail as the incremental gains associated with its acquisition of the company are larger than those that Norfolk southern would achieve. However, it is important to note that CSX will also lose less revenue than Norfolk if they lose out on the deal, therefore Norfolk could be willing to pay more. Ultimately it will come down to whether the deal is done primarily for strategic maneuvering and a strong upside in which CSX is likely to bid more, or if it is done out of fear which would imply that Norfolk would pay more (See exhibits C and D for details). Case B, Question 3: Why does CSX refer to Norfolk’s bid as a non-bid? What should Norfolk Southern do as of Mid-January 1997? CSX refers to Norfolk’s bid as a non-bid because they believe that it would violate the CSX-Conrail “No talk clause” in the merger agreement if Conrail engages in talks with Norfolk. Additionally the required time delays in Norfolk’s proposal implied that, using a 2% discount rate per month, the actual present value of the offer is worth less than $90.00. This is below Conrail’s initial offer of $92.50 and extremely close to its blended offer value of $87.67 thus negating the “fiduciary responsibility” condition of the No talk clause. Additionally CSX contended that the offer was not high enough to stop the CSX-Conrail merger from proceeding or influence the opt out vote. Therefore the board could not engage based on this principal. In mid-January 1997 Norfolk Southern should either offer shareholders substantially more money to sabotage the opt out vote or get the board to support their cause. Because they do not have the necessary time frame to replace the board, they must influence the opt out vote by offering more money. Case B, Question 4: As a shareholder would you vote to opt-out of the Pennsylvania antitakeover statute? What do the capital markets expect to happen? As a shareholder you do not have a win/win strategy anymore. On one hand you have CSX which is obviously scared that shareholders would not vote the opt-out and is increasing the price and extending the no-talk clause to make sure the Norfolk bid is not even considered as a bid by the shareholders. On the other hand
you have Norfolk who keeps increasing the price and is backed by banks – creating incentives for shareholders not to opt-out, and instead force the board to get out of the no-talk clause and consider the Norfolk bid. The 85.5% of shareholders who agree to initially tender in November 1996, before the opt out vote, imply that markets expect CSX will acquire Conrail. This further implies that the market does not believe at this point that Norfolk Southern will put forth what would be necessary to break the “no talk clause” in the CSX-Conrail agreement, and conversely influence the opt out vote-thus stopping the Conrail merger. Later as the vote approaches, the markets seem to be split on what the outcome will be. Case B, Question 5: What are the costs and benefits of regulating the market for corporate control for statutes such as Pennsylvania’s antitakeover law? Potential cost- if the STB requires Conrail to service certain lower profit areas, the overall value of the merger/company would be diminished.