Conrail

Main issues: On October 1996, CSX, the largest railroad company in the Eastern United States announced its merger with Consolidated Rail Corporation (Conrail), the third largest railroad company in the region. A year before CSX’s merger announcement, Burlington Northern and Union Pacific merged, and both reported improved operating efficiency post-merger. Improving profitability and staying ahead of the game were the major motives behind CSX’s pursuit of Conrail. Geographic expansion which would give the CSX-Conrail merger 70% market share in the Eastern states. In November of 1996, CSX was waiting for the result of the second front end cash offer which required at least 19.8% of shareholders to opt out of the Pennsylvania statute for them to proceed with the merger.

Financial analysis: One of the reasons for proposing a two-tier deal would be to curb the free rider problem wherein shareholders are incentivized to hold out for a better offer. Through a freezeout CSX would motivate shareholders to tender their shares in the frontend offer because based on the ratio of 1.85 if CSX share price went below current price of $46.75, backend shareholders would lose money if the merger went through. Also keeping in mind CSX high D/E(CSX D/E=67%, Norfolk = 34%), they would have to go to the capital markets for financing and will have access to only certain level of debt(to avoid downgrading) and can hence only finance a small part the merger with cash(of which they have only $600mn).Thirdly, through a combined valuation with synergies as per our analysis they would realize $44 synergies per share(Appendix 1). Usually, all synergies are not realized and therefore through the two tiered offer CSX can capture some synergy by paying less than the combined value to the back-end 60%  shares.

Norfolk being the most efficient company in the competition a merger would ensure good consolidation measures which would combine rail networks, integration of their numerous subsidiaries, and mainly geographic advantage resulting in a lesser operating ratio(projected)  as seen in Exhibit 10 of the case.  

The provisional clauses are designed to ensure the takeover as a relatively fair game for both the bidder and the target but in this case all four clauses agreed upon work in the favor of CSX giving them some room to up their offer if demanded. Conrail suspended its ‘poison pill’, thus preventing shareholders to gain discounted shares to dilute the market and potentially decrease the bidder % of share ownership. Conrail promised “lock-up” options to CSX, which allowed CSX to acquire diluted shares in the future so as to show target’s intention of moving on in this merger transactions was also promised a “break-up” fee if Conrail terminated the transaction. This provision would eliminate potential abuse of target and encourage the bidder by guaranteeing them a compensation of preliminary expenses. Lastly, “no-talk” clause was included to prevent Conrail from pursuing other bidder plans within 6 months. This provision recognized CSX’s first-opt partner position. However, we believe that this protection for bidder had limited effect because Conrail might be willing to pay the “break-up” fee and accepted a higher bid if Conrail’s offer would potentially harm to board’s interest.

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