Case A

Group A7
Case A
1.
2.
We have used three methods to analyze the price CSX paid for Conrail.
Precedent transaction analysis
Although 5 precedent transactions were given, we used only those that have been completed as we
assumed only completed transactions are relevant for the analysis. We have calculated price based on
four multiples, namely EV/EBITDA ($108.19); P/E ($103.57); EV/SALES ($73.40) and M/B ($148.23). The
price based on multiple approach was then obtained after calculating weighted average of given prices.
As there is material difference in the capital structure of companies used in the analysis and the business
is capital intensive, we believe EV/EBITDA and M/B are the most appropriate multiples to be used and
were assigned greatest weights (0.5 and 0.3, respectively). Multiple was determined as a mean of
respective ratios and was multiplied with last 4Q numbers given in the case. Final price was $116.25,
way below $89.07 CSX is actually being, so this represents first proof that CSX is not overpaying.
DCF
As transaction is announced in the October 1996, we performed Discounted Cash Flow method on that
particular date. By doing such an analysis we wanted to assure price on the market truly reflects the
fundamental price obtained by using DCF. First thing we did was projecting 4Q financials for 1996 based
on given data. We have divided 3Q data with 3 to get financials per quarter and then multiplied by 4 to
annualize them. After obtaining ’96 data, we projected next 5 years based on historical performance and
industry outlook. For discount rate we calculated WACC. Equity risk premium was assumed to 7.1%.
Final price was calculated using both EV/EBITDA Terminal multiple (12x, based on precedent
transcations) and Gordon growth formula with the growth rate of 3% (given in the case). The former
method gave us the price of $69.98, meaning that market price just before the merger reflected
company’s fundamental value, while the letter one showed the price of $57.32. However, as $89.07
transaction price per share was much bigger than prices under both methods (25% for first case and
30% for second), we decided to perform NPV analysis of projected gains from the merger and then
come up with final conclusion. DCF model alone does not tell much because synergies from potential
merger are not included in the projections. We used it just to confirm that market price reflects
company’s fundamentals. (Please see the appendix for detailed model, projections and sensitivity
analysis)
SYNERGIES DCF
We discounted given projected gains in operating income after deducting taxes, using the tax rate of
35%. For discount rate, we calculated the WACC of the merged firm, where debt and equity values were
obtained as a sum of each company’s metrics. For debt items we assumed long-term interest-bearing
liabilities and short-term debt. In addition, we used the equity beta of 1.35, as we believe the company’s
risk profile won’t change after the transaction. Betas of both companies are very similar.
After taking into account all these assumptions, we calculated NPV of transaction to be equal to $2,557,
which represents the value created by the merger. The value of the Conrail before the merger was
$6426 ($71 share price* number of shares). The full transaction amount is equal to $8061 ($89.07 share
price*number of shares). Thus, the gain for seller is equal to the difference between the two or $1635,
respectively. Buyer’s gain or CSX’s gain is the difference between the value created and seller gain,
which is equal to $921.9. So, our conclusion is that CSX did not overpay for Conrail. As another argument
for our final conclusion, we built Accretion/Dilution model. Please see the Appendix for
Accretion/Dilution analysis and third proof that CSX is not overpaying.
APPENDIX
DCF Projections
Sensitivity
Accretion/Dilution analysis
3.
A break-up fee is used in takeover agreements as leverage on the seller against backing out of the deal
to sell to the purchaser. A breakup fee is required to compensate the prospective purchaser for the time
and resources used to facilitate the deal. In this case, break-up fees provide compensation as legal fees
and consulting fees. Moreover, break-up fees also offer protection for CSX since the potential buyers
have to offer higher price compared to the break-up fee.
A lock-up option is a stock option offered by a target company to a white knight for additional equity or
the purchase of a portion of the company. A lock-up option will make Conrail less attractive for the
acquirers such as Norfolk Southern.
Poison pill refers to a defense strategy used by a target firm to prevent or discourage a potential hostile
takeover by an acquiring company. In the case of CSX, the poison pill will allow CSX to get control of
Conrail since the shareholders of Conrail cannot dilute their share values and issue discounted shares.
Yet in this case it will make it easier for Norfolk Southern to launch a hostile takeover.
No talk provisions prohibit any discussions or negotiations between the target and unsolicited bidders.

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Group A7

Precedent transaction analysis

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