Conrail Bidding

March 24, 2017 General Studies

1. Why does CSX want to buy Conrail? How much should CSX be willing to pay for it? Conrail is a significant player in the Eastern rail freight market controlling 29. 4% of the market. More importantly, it had near monopoly control over the lucrative Northeast rail market; its routes connected the major Northeastern cities with major Midwestern hubs. Conrail proves to be an attractive target for CSX for a number of reasons. First and foremost, value could be created by consolidating overlapping operations and increasing revenue through service improvement.

At the moment, Conrail is the least efficient railroad in the East. It faced tough competition from trucking, which had a dominant share of the total Northeast freight market. CSX and Conrail estimated that cost reduction would yield an additional $370 million in annual operating income by the year 2000, net of merger costs. Over the same period, they also projected that revenue increases would yield an additional $180 million in annual operating income. Total gains add up to $550 million in 2000.

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In addition, this merger would improve CSX-Conrail’s competitive position. First, note that CSX’s routes connected 20 South-eastern and Midwestern States and the Canadian Province of Ontario. Same is true for Norfolk, the third major Eastern railroad and the major competitor of CSX. Since Conrail has near monopoly control over the lucrative Northeast rail market, the combined rail networks of CSX-Conrail would facilitate long-haul, contiguous, and therefore, low-cost service between the southern ports, the Northeast, and the Midwest.

Norfolk Southern, on the other hand, lacked access to the Northeast market, would be less able to service long-haul routes from either the South or Midwest. Secondly, in the shorter-haul routes between the Midwest and the South, CSX-Conrail would become more competitive through cost reduction. According to the case, using current cost and revenue data combined with estimates of merger synergies and historical trends, the model projects operating ratios for a combined CSX-Conrail and for Norfolk Southern.

If CSX-Conrail were to achieve its projected revenue gains and cost savings, it would become more efficient than Norfolk Southern. Finally, note that as early as in 1980s, Norfolk had indicated interest in acquiring Conrail. It was clear that if CSX does not act now, Norfolk is likely to acquire or cooperate with Conrail sooner or later. To understand how much CSX would be willing to pay for Conrail, we adopted the DCF and comparables methods. Note that Case A and Case B provide two different sets of projected gains in operating income under Exhibit 7 and Exhibit 6a respectively.

As such, we calculated two sets of synergies in the DCF valuation. Below is a table showing the valuation ranges we got from each of the valuation method: Something worth attention is that, under the intense bidding war, it was likely that either CSX or Norfolk would get Conrail. If Norfolk wins the competition, CSX would suffer a loss in operating income almost for sure in the subsequent years (Exhibit 6b Case B). So the acquisition premium that CSX willing to pay would be even higher than what we saw from Exhibit 6b Case B. Q4. How much is Conrail worth?

In a bidding war, who should be willing to pay more, Norfolk Southern or CSX? The valuation ranges under each valuation method were presented in the table below: Again, under the bidding war, it is likely that either CSX or Norfolk would get Conrail. Norfolk was highly likely to suffer a loss if CSX wins Conrail. As such Conrail worths more for Norfolk than what is suggested by the DCF in the table above. To judge which firm should be willing to pay more, it is necessary to look at both the total gain in operating income in the case if the firm acquires the


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