Case Study: Acquisition of Conrail Corp.

by
CSX Group
Course: M&A

Submitted By: Gro

Arun Maithani 11A
Deepika 15A
Navneet Sharma 26
Nitesh Singh 29A
Sahil Taneja 39A
Shobit Mahajan 48A
Bakul 62K

The acquisition of Conrail: case summary

Players:

Company profile: Conrail and CSX

CONRAIL

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
The Game:growth through acquisitions is a
lucrative strategy.
CSX has put forward a two tier offer to acquire
Conrail

The front end offer for 40% of the shares at

$92.50
The second phase offer to acquire remaining
60% shares through stock swap with an exchange
ratio of 1.85619

Conrail is also a potential target for Norolk

Southern (which later offered 14.1% premium
over CSXs offer)
Pennsylvania laws makes a takeover difficult

Formed from the remains of six bankrupt Northeastern railroads

in 1973
Earned its profit in 1981- $39.2 million on revenues of $4.2
billion. Privatized through an IPO in 1987
Major player in the Northeastern cities and their connection with
major mid-western hubs
Major financial indicators (as of 1995)
Operating revenues - $ 3.686 billion
Operating ratio 79.9%
Revenue per share - $ 156,784
P/E ratio 12.9

CSX
A Virginia-based diversified transport company (intermodal
services, ocean-container shipping, contract services and
railroad services
Major player in the Southeastern and Midwestern states and the
Canadian Province of Ontario
In 1995 it operated 18,645 miles of track and controlled 38.5%
of the Eastern rail freight market
Major 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 acquisition

Conrail A lucrative target in otherwise mature US railroad market:
Conrail is provider of Freight transportation in the Midwest region of the U.S
Conrail is the ideal extension for both CSX & Norfolk Southern into the Northeast
Northeast 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 rationale
The 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 rationale
The 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 billion
Will offer front-end shareholders $92.50 in cash for their shares. This
offer is extended to 40% of the shareholders
Remaining 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 offer
Due 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 billion

100.8 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 share
Hence blended price = $89.07

Non 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 offer

Conrail 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
on
Share 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 offering
Breakup 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 Conrail
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. By removing the poison pill, the shareholders made sure
thatnot
CSXs
rights would go unchallenged since no dilution of stake would occur
Why
an ownership
all cash offer?
The two tier offer is designed to pay less to the non tendering shareholders
As the current stock prices of CSX were already at nearly the 1 year high, probability of an upward
revision on deal announcement was low
With 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 Price
Total No of Shares ('000)
Price for 40% share

40% Consideration (amount in $ '000)

Exchange Ratio
New Share to be issued ('000)
Price per share
Value of exchange consideration (amount in $
'000)
Total Value of Consideration
Value per share ($)

90,500
$92.5

3348500
1.85619:1
100791
$46.75

4711985
$8060485
89.07

Poison pill and its cost

Poison pill:
Security against hostile takeover
Gives holders the right to purchase stock at a discount
Can be adopted without shareholder approval
In the Conrail case the trigger level was 10% and the discount factor was 50% of the current
market price
Particulars
Value
NOSH
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 approach

ke = RF +

j (km - RF)
ke
= 16.15%
RF
= 6.80% (US Treasury bond for stedy state)
j
= 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 %)
1994
1995
1996
1997
Revenue
3733
3686
3,714
3,839
Total cost of sales
3127
3230
3,113
3,218
EBIT
532
392
531
549
% Tax rate
35%
35%
35%
35%
EBIT(1-t)
345.8
254.8
345.15 356.76
Less: Capex
311
21
67.0
69.3
Capex as % of sales
Less: Changes in WC
FCFF
FCF Growth Rate

Terminal Value (TV) at the

end of five year

PV (Yr-1996)

8.33%
-73
107.8

0.57%
26
207.8
92.76%

1.80%
31.0
32.0
247.15 255.47
18.94%

228

1998
3,968
3,326
567
35%
368.77
71.6

1999
4,102
3,438
586
35%
381.17
74.0

2000
4,240
3,554
606
35%
394.00
76.5

2000
4,382
3,673
627
35%
407.25
79.1

33.1
264.06

34.2
272.94

35.4
282.13

36.6
291.62

211

195

4350.20

180

167
2,485

Thank You!