Conrail Merger Case Study

5. In a bidding war, who should be willing to pay more, Norfolk Southern or CSX?

On 6 November 1996 CSX increased the front-end offer to $110 per share and two days later Norfolk Southern increased its bid to $110 cash per share. On 19 December 1996 Norfolk Southern increased its bid to $115 cash per share after CSX had acquired 19.9% of Conrail’s shares at a blended value of $102.16, and announced that it was ready to further increase its bid if needed.

In this bidding war, understanding how much they should pay for Conrail’s shares is crucial for both CSX and Norfolk Southern.

To do so, the acquirors calculate the value that would be created after the transaction, i.e. synergies.

1. CSX

CSX would generate both cost and revenue synergies from the acquisition of Conrail. After-tax potential synergies are shown in Exhibit 1.

Exhibit 1 (figures in $ millions)

[pic 1]

Discounting synergies at 13.5% gives a NPV = $3.46bn, which divided by the number of diluted shares of Conrail (90.5m) gives a value of $38.22 per share.

This confirms that CSX would exploit significant synergies from a merger with Conrail, and these synergies have indeed a value that should be included in the bid for Conrail.

The consideration that CSX should offer to Conrail’s shareholders is $109.22 ($38.22+$71.00, where the latter is the price per share pre-merger).

However, this computation does not take into account the negative effect that a Norfolk Southern – Conrail merger would have for CSX. Indeed, the winner of the bidding war would obtain an overwhelming dominance of the Eastern and Midwestern rail markets, whereas the loser would suffer losses in operating income as it is projected that the winner would basically steal a portion of revenues from the loser due to larger market size.

Potential losses in EBIT for CSX in case Norfolk Southern wins the bidding war are shown in Exhibit 2:

Exhibit 2 (figures in $ millions)

[pic 2]

Discounting at 13.5% gives a NPV = $897m → $9.91 per share.

Because of the risk of seeing both its market share and operating profit shrink, which is valued at $9.91 per share, CSX should make a higher bid for Conrail compared to the $109.22 computed previously: the new price per share that should be offered is $119.14 ($109.22+$9.91).

1. Norfolk Southern

As said for CSX, merging with Conrail would allow Norfolk Southern to boast synergies: