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Norfolk vs. CSX: Prize is Conrail

News

A takeover battle started in the US rail industry October 23 when Norfolk Southern, the fourth largest railway company, announced a $9.1 billion hostile takeover bid for Conrail, the fifth biggest.

 Norfolk Southern's bid came just eight days after Conrail announced that it had agreed to a friendly takeover by CSX, the third largest railway company, in a deal worth $8.1 billion.

Analysis

 Graphics

What Does "Hostile" Refer To?
A hostile takeover, in contrast to a friendly one, means that the management of the target firm, not necessarily the shareholders, do not approve of the merger. Their disapproval may stem from different factors:

1. tactical: Management hopes for a higher offer from the acquiring company or other potential bidders.
2. self-interest: Management of the target company can potentially lose their jobs if the merger goes through, i.e., the merger is not necessarily in the best interest of management. It is, on the other hand, in the interest of shareholders as reflected by higher wealth due to a surge in the stock price of Conrail. This conflict of interest is referred to as the agency problem.

Bid

Norfolk Southern Chairman David Goode announced a $100-a-share bid in cash for Conrail's common and convertible preferred stock -- a total of $9.1 billion. On the other hand, CSX is offering $92.50 a share in cash for 40 per cent of Conrail's shares and 1.856 CSX shares for each of the remaining 60 per cent of the shares.

Mr. Goode said that, based on the price of CSX stock on October 22, the Norfolk Southern offer is now worth $11.49 a share more than the CSX offer.

Source of Incremental Cash Flows
Both Norfolk and CSX want to use Conrail to form a strong freight link between North and South, partly with an eye to capturing shipments moving on Interstates 95, 85 and 81 through the Washington region.

East-West rail freight traffic has grown rapidly because of the use of truck trailers shipped on flatcars. But on North-South routes, freight has remained on highways because of high costs due to the inability of railroads to exchange freight efficiently when two railroads meet.

There are two sources of incremental (or additional) cash flow from the merger: cost savings and increased revenue. Norfolk Southern estimates that cost savings from the merger will grow from $145 million in 1998 to more than $515 million in 2000. These would result from the elimination of common overheads, and increased efficiency gains from consolidation of maintenance facilities.

The second source is expected to come from extra revenues of $525 million a year by 2000, partly through the diversion of freight from road to rail. The savings and extra revenues would add $175 million to operating profits in 1998, growing to $660 million in 2000.

What Can Prevent The Deal?
Federal regulators will be scrutinizing the deal very carefully as the winner would dominate Eastern railroading. One possible scenario is have Conrail's lines divided between Norfolk Southern and CSX.

Thus, there was no surprise when CSX said last week it would allow Norfolk Southern or some other railroad to operate over its tracks to guarantee that any shipper served by two railroads today would get two-railroad service after the merger. However, they also noted that they would not allow any more access to the New York area, which now is served only by Conrail.

Similarly, Norfolk said today that it would allow other railroads into New York., adding that the Norfolk plan is superior because it has fewer potential anti-competitive problems. CSX replied that the hostile Norfolk Southern bid would face delays that would diminish its value to about $90 a share, less than the CSX bid.

Another possible scenario is the CSX would increase its bid for Conrail.

Financing
According to Norfolk, J.P. Morgan and Merrill Lynch & Co. have promised to each lend the company $2 billion, and have agreed to arrange for an additional $5 billion in loans later.

CSX’s deal will be financed through bank loans from NationalBank, BankAmerica, the Bank of Nova Scotia and Chase Manhattan Bank.

Market Reaction
Conrail's stock, which began last week at $69¾, shot up another $12 1/8, or 14 percent, to $96 5/8 in early trading, indicating that the market believes that the Norfolk deal is even sweeter.

Norfolk Southern shares opened October 23 at $90, more than 4.50 below the previous day’s closing price, right after the company disclosed its Conrail bid. Although this might seem to suggest that the market thinks that that it is too expensive for Norfolk, its stock price climbed throughout the day, ending at $95.125, down only 37.5 cents for the day.

CSX's were unchanged at $46¼.

Sources: Washington Post, Financial Times, Philadelphia Inquirer

Stock Quotes: CSX, Norfolk Southern, Conrail

Hoover's Corporate Information: Conrail Inc., CSX Corporation , Norfolk Southern Corporation

Industry Wide Issues:

• Safety (US Dept. of Transportation)
• Cost of possible new regulation (Transport News)
• Traffic Is Up (AOAR)