G455: Corporate Restructuring Team 7
1) Why does CSX want to buy Conrail?
In an industry beset by limited options to consolidate domestic rail traffic, CSX looked at Conrail as an avenue to increase market share and gain access to the North East rail network. With air travel, road travel and trucking taking an increasing share, significant revenue growth became difficult. As Conrail became profitable, Congress explored ways of privatizing it, giving CSX an opportunity to acquire Conrail. Though Conrail suffered from performance inefficiencies it had certain strengths relative to CSX and Norfolk with respect to highest revenue per mile of track operated, per carload originated etc. Conrail with operating revenue of $3,686 million and 29.4% of Eastern rail freight traffic was attractive enough for CSX to consider the merger. The joint entity would have $8.5b in rail revenue and would control the Eastern market with a market share of 70%. CSX estimated the acquisition to also create synergies resulting in consolidation of overlapping operations and not only increase the joint entity’s revenue through service improvements, but also the operating incomes through economies of scale. Cost synergies was expected to help in increasing the annual operating income by $370m and revenue increases was expected to help increase annual operating income by $180m. (Based on valuation of synergies, taking PV of terminal value, we estimate the gains in Operating Income to be equal to $3,047.13.) CSX expected the acquisition to improve the joint entity’s competitive position vis-à-vis Norfolk Southern as the joint entity’s rail networks would facilitate long-haul, contiguous and therefore low cost service. As Norfolk Southern lacked access to Northeast market it would be less able to provide long-haul routes from South or Mideast. The purchase of Conrail would thus provide CSX with control of the Eastern rail network. From a financial perspective, the projected revenue gains and cost savings was expected to make the joint entity become more efficient than Norfolk Southern. Likelihood of a rival (Norfolk Southern) acquiring Conrail, resulting in competitive disadvantage for Conrail was also a factor.
2) Based on multiples and a premiums paid approach, how much should CSX be willing to pay for Conrail? We took Sales, EBITDA, Book Value Multiples and Four week acquisition Premiums from Exhibit 6. We use number of Conrail’s shares outstanding as 90.5 million at the share price of $32.46 from the same Exhibit 6. Conrail's Value Sales EBITDA Book Value Premium % $3,722 $1,017 $32 $6,516 Multiples High Low 3.6 1.7 13.1 8.5 5.5 1.7 73.0% 34.0% Conrail Market Price Low Average $ 1,032 $ 3,712 $ 3,350 $ 5,465 $ (301) $ 5,398 $ 8,731 $ 9,986
High $ $ $ $
8,104 8,028 10,862 11,273
See ‘Calculations’ spreadsheet for details. As the Conrail is fairly attractive resource for CSX it should be willing to pay on the high side of the Conrail Market Price. We have highlighted the High Price in the above table. We
have also calculated the price by various methods (sales ratio, EBITA, etc). The price calculated by these methods is reasonably close to the bid price of CSX. Within the high price too, there seems to quite a difference in valuations. The multiple analysis methodology assumes that all companies within an industry have similar characteristics. As expected there is wide variance is between low, high and average. Within the rail industry there is wide variance in capital structures, profitability etc, which is reflected in Conrail Market Price. Other than multiple and premium methods, CSX should be detailed financial analysis based on synergies etc. to come up with the price. The synergies given in the case are stated as “Gains in Operating Income.” This is not an unambiguous term. For purposes of this and subsequent questions, assume that these synergies are net of costs (COGS and Capital Expenditures) and the after-tax...