The Acquisition of Consolidated Rail Corporation (a) + (b)

FM407 Case2

THE ACQUISITION OF CONSOLIDATED RAIL CORPORATION (A) + (B)

Strategy

1. How does the presence of two bidders (CSX and Norfolk) affect their interest in Conrail? Would their interest be different if they were stand alone bidders?

a. Aspects affected

1) The presence of two bidders leads to continuous increase in bidding prices.

Since both CSX and Norfolk want to merge with Conrail so that it can have a dominant say in the Eastern market, fierce competition exists in the two-bidders-situation. In the beginning, the price offered by CSX is $92.5. But when Norfolk announced that it offered $100, CSX  increased its bidding price from $92.5 to $110 on November 6. In response to the bidding price increase of CSX, Norfolk then increased its own bid to $110 cash per share on November 8. Subsequently, to secure that the opt-out vote can be done, CSX amended its offer by adding $16 of new convertible preferred stock to the back-end offer. Norfolk also took action and it raised its bid to $115 cash per share hoping not to be left out.
However, if in the case of stand alone bidders, the offer price might not increase so sharply during the whole process.

2) The presence of two bidders makes it difficult for Norfolk to execute its merger plan.
To begin with, since the management of Conrail were in favor of the CSX-Conrail merger, Norfolk had to implement hostile takeover strategy. What is more, In the CSX-Conrail merger agreement, there are some provisions such as poison pill and the “no-talk” clause which is designed to forbid Conrail from pursuing merger discussions with any other party for a period of six months. Restricted by this clause, Norfolk had more difficulties to drive the merger.
If in the case of stand alone bidders, the opportunities of both bidders are similar which

3) Legal fees and advertising fees are incurred because of the presence of two bidders.
Firstly, Norfolk sued to stop the CSX-Conrail deal and to force Conrail’s board to consider its offer, which led to the occurrence of legal fees which would not exist in the stand-alone-bidder-situation.
In addition, to persuade shareholders to vote against opting-out, Norfolk criticized the CSX-Conrail deal in a series of advertisements in the financial press. In response to this, and to encourage Conrail shareholders to vote in favor of opting-out, Conrail and CSX countered with their advertisements. In consequence, advertisement fees occurred, which might not exist in the case of stand alone bidders.

b. Aspects not affected

Whether it is the two-bidders-situation or the stand-alone-bidders-situation, CSX and Conrail are in the zero-sum game. To be more specific, since it will be horizontal merger in both cases, the winner will be the dominant corporation in the Eastern railroading market and operation synergies will come from revenue enhancements and cost reductions. As a result, the winner will steal revenue from the loser and that situation will happen in both cases.

Valuation

2. Based on an appropriate choice of comparables and multiples, estimate Conrail’s value per share in a takeover? Explain briefly why you chose those comparables and multiples, and why you discarded others.

We use three companies as multiples and discard other two deals.

a) To begin with, we exclude Kansas City Southern and Santa Fe Pacific as comparables because their offer were withdrawn. Since the offering process was not completed, they cannot be appropriate indicators.

b) What is more, means that the difficulty level of each bidder to drive the merger should be the same.
Although we use Chicago and NorthWestern as a multiple. There are flaws. Because before the second acquisition, the acquirer Union Pacific had already owned (1-72.5%=27.5%) shares of the target, which made this acquisition different from the Conrail's case in nature.

c) Third, we also include Conrail itself into the comparables to make the average more reasonable and accurate. But because we do not have the data of Conrail’s offer price, we can only use it Enterprise value. For the shareholders equity value, we use $71 as Conrail’s current stock price, and 90.5 million as its outstanding shares in 1996. (Exhibit 6)

The calculation is as follows:

As is shown in the table, the price range is from $70 to $148.

3. Based on a DCF analysis, what is the maximum amount that CSX should be willing to pay per Conrail share? What about Norfolk? You can use Conrail’s market capitalization as its standalone value, and discuss the pros and cons of doing so. 

a) DCF analysis

Regarding the DCF valuation, below assumptions are made: