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 industrys 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 Norfolks 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 nations 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 competitors market share and also the
competition for the Norfolk after the deal is tough and even to sustain in the industry is
difficult. Norfolk Sotherns 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

Re = Rf + Beta Mkt Risk Prem
CSX Valuation 1 Required return

15.93% = 6.83% + 1.3 7.00%


1997 1998 1999 2000 2001
Gain in Operating
Income 0 188 396 550 567
TV w. const growth
model at 4% 4943
After tax 35% 0 122 257 358 3581
PV 0 91 165 198 1710
NPV 2164.35
Shares 90.5
NPV per share $ 23.92
Pre-merger $71.00
Total
$
94.92













2. Considering Opportunity Cost:

Conrail Valuation

Re = Rf + Beta Mkt Risk Prem
CSX Valuation 2

Required return 15.93% = 6.83% + 1.3 7.00%

Gain 1997 1998 1999 2000 2001
Gain in Operating Income 0 240 521 730 752
TV w. const growth model
at 4% 6556
After tax 35% 0 156 339 475 4750
PV 0 116 217 263 2268
NPV
2864.45
7
Shares 90.5
NPV per share $ 31.65

Opportunity Cost 1997 1998 1999 2000 2001
Loss if rival gets target 0 -66 -123 -189 -196
TV w. const growth model
at 4% -1709
After tax 35% 0 -43 -80 -123 -1238
PV 0 -32 -51 -68 -591
NPV -742.462
Shares 90.5
NPV per share
$
(8.20)

Pre-merger $71.00
Gain $ 31.65
Opp cost $ 8.20
Total $110.86








Norfolk Southern Buying Conrail:
Conrail Valuation

Re = Rf + Beta Mkt Risk Prem
NS Valuation 2

Required return 15.93% = 6.83% + 1.3 7.00%

Gain 1997 1998 1999 2000 2001
Gain in Operating Income 0 231 429 660 680
TV w. const growth model
at 4% 5928
After tax 35% 0 150 279 429 4295
PV 0 112 179 238 2051
NPV 2579.35
Shares 90.5
NPV per share $ 28.50

Opportunity Cost 1997 1998 1999 2000 2001
Loss if rival gets target 0 -130 -232 -308 -320
TV w. const growth model
at 4% -2790
After tax 35% 0 -85 -151 -200 -2021
PV 0 -63 -97 -111 -965
NPV
-
1235.74
Shares 90.5
NPV per share

$(13.65)

Pre-merger $71.00
Gain $ 28.50
Opp cost $ 13.65
Total $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.



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 Pennsylvanias 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
16
th
Jan. Although this offer is lower than Norfolks 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 shareholders goals and
helps to give fair price and protects from hostile bids.