Conrail – CSX Plays its first move in railroad consolidation
1. Conrail – CSX Plays its first move
Alse, Deepak
Bade, Pavan
Driscoll, Matthew
Tsurumoto, Craig
2. Conrail gives CSX leverage and control
• Economies of scale & scope and Market Control with more than 60% of
market should lead to pricing power
• A strategic synergy exists with its intermodal business; CSX needs this deal
to consolidate its access to East Coast Ports
• In the post-NAFTA scenario, CSX can cross leverage its intermodal and
shipping container business to generate higher levels of utilization as well
as lower operating costs for the post merger entity. This is critical because
post-NAFTA, there will be higher international trade that may land in one
country’s ports but act as raw-material or provide finished goods for
another country. A 3% average growth rate for revenues is most
reasonable given past trends. But, we have to remember that NAFTA will
substantially increase the level of traffic and expand the size of the market
for both railroads and trucking.
• Since this was 1996, a positive impact from the rise of ecommerce could
have been factored in.
Note : Claimed synergies in the case are lower than those claimed by BNSF
for its Union Pacific acquisition; a deal that’s half the valuation.
3. Operations & Productivity Improvements
• Conrail has higher ‘Revenue per Mile of Track Operated’ , ‘Revenue per
Carload Originated’ and ‘ Revenue per Ton Originated’ but it lags on
‘Revenue per Employee’
• This indicates a situation where
– Conrail has substantial pricing power in terms of revenues
– Conrail’s profitability is hurt largely by
• Lower employee productivity
• Higher basis costs per employee on account of location(NE has a
higher cost of living)
• A shift towards moving Conrail’s employee productivity to the levels at CSX
will generate millions in savings.
• Increase in DPO to reduce NWC needs.
– Conrail DPO at 13 days is 1/5th of that for Norfolk Southern.
– An increase of 40 days will free up $350M in working capital
4. The valuations indicate offer is at top end
Valuation in various scenarios
Factor Aggressive Base Worst Case
Enterprise Value $8,953 $8,576 $6,605
Implied Price Per Share $67.85 $63.69 $41.91
We used the Beta of BNSF(BNI) – The other
behemoth of similar size.
The cash offer for 40% of shares is
approximately $3.3 Billion in value . CSX has
less than 700M USD on its balance sheet but a
low D/E ratio.
We can definitely load the target with entire
amount in debt at the risk of taking the target
D/E ratio to 0.79.
8. On multiples, however, we are closer to
the lower end.
0.0
50.0
100.0
150.0
200.0
EPS-‐Based
Book
Value
based
TEV
Based
Offer
Price
TEV as a multiple of EBIDTA shows the lowest error ( std.dev/mean
value). Offer price is at median on this multiple – But at a lower multiple
compared to the $4 Billion BNSF deal. However, none of the recent deals
are of a similar size(8+ Billion USD)
9. However, offer structure is convoluted
Stage119.7%
(17.86M
Shares) at
$92.50
Stage2
20.3% at
$92.5 after
Conrail
Shareholders
approve deal
Stage3
1.85619:1
CSX:Conrail
Stock Swap
The Pennsylvania Law requiring bidders holding 20% or more of company’s
stock to offer all shareholders same price unless target shareholders explicitly
vote to nullify the provision. CSX is attempting to use its first mover advantage
and positive engagement with the management team to achieve two
objectives
Makes it easier for CSX to control offer price by combining with a stock
swap.
Control the total cost of the deal by utilizing a swap against lower valued
CSX shares after 35% control is achieved.
10. Impact of Clauses in Agreement
Clause Impact to Conrail Impact to CSX
No Talk Clause – Six month (no
talk from Conrail)
Difficult to assess – It seems the
board and management are
friendly so that talk clause
seems more like a fiduciary
cloak.
Prevents a bidding war –
Positive control over the
negotiations.
Breakup Fee - $300M – Conrail
to pay to CSX if no transaction
occured
Adds $300M to valuation
expectations if another bidder
emerges
Gets $300M if no deal occurs
Poison Pill Suspended Prevented by executing share
dilution to retain control( It
seems like the board and
management don’t desire to do
this).
Prevents loss of value from
discounted shares hurting
market value of Conrail equity.
Lock-up Options – 15.96M
newly issue common shares at
$92.50 – Options granted by
Conrail to CSX
Guaranteed influx of cash if
options are exercised. Financial
impact depends on more the
stock price moves after deal is
announced.
Allows CSX to acquire 10-20%
at a fixed price even if Conrail
shareholders don’t tender the
required number of shares.
11. A Conrail shareholder should wait and watch..
• Due to the blended nature, and the
expected drop in stock price of
CSX , we will have impact to value
of holdings during the stock swap
• As an individual shareholder, it does
not makes sense to sell against the
first stage $92.50 cash offer.
Multiples for comparable
transactions indicate that the offer is
not in line with other transactions.
• In adopting a ‘wait and watch’
mode till the second stage for
additional 20% opens up, there is
an opportunity to let the non-
individual shareholders negotiate
for a better deal.
12. Principal Agent Problem
Details provided in the case indicate that the Conrail management
failed to fulfill its duties as an agent of its owners and stakeholders.
By agreeing to a set of clauses that limit Conrail’s ability to find the
highest valuation for the firm and by issuing options fixed at CSX’s
offer price in stage 1, the management team seems to have placed its
own interests ahead of those of Conrail.
13. Individual investors are a small segment
of owners
Non
Taxable
48%
Tax-‐Paying
34%
Individuals
17%
Insiders
1%
Other
18%
Ownership
It
seems
quite
likely
that
the
non-‐individual
investors
will
have
a
strong
view/
percepOon
of
undervaluaOon
especially
given
the
monopoly
that
Conrail
holds
in
its
markets.
This
may
lead
to
a
situaOon
where
stage
2
remains
open
and
‘Opt-‐Out’
clause
vote
is
unsuccessful
unOl
CSX
conOnues
to
bid
higher.
14. We recommend that Conrail consider replacing
its management team and investigate options
It is unclear as to why Conrail, with its monopolistic position, seems eager to
be acquired in a closed process at a comparably lower valuation.
• Both acquisition scenarios ( Conrail + CSX, Conrail + Norfolk Southern)
lead to substantially high marketshare and somewhat high Herfindahl-
Hirschman Index (HHI) values ;Purely on HHI index values, the Conrail-
Norfolk Southern deal may have a better chance at going through.
• Given the role of Conrail’s unionized workforce, a split deal will offer better
terms of negotiation with the unions as neither CSX nor NS will have to
negotiate with a workforce larger than their current workforce in terms of
size. An optimally split deal will also help deal with Pennsylvania law
requirements.
• Assuming zero synergies, and purely on current productivity terms, Conrail-
Norfolk Southern deal is a better option. If we tilt the scenario towards
operating scenarios similar to the acquiring firms, NS comes out even
stronger. Note that the synergy calculations at 20% reduction on operating
ratios are very optimistic considering the fact that no one operates at those
levels currently.
A Hybrid deal where Conrail is not completely acquired by either CSX or
Norfolk Southern maybe best.
