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Documentation about Conrail CSX consolidated rail corporation case analysis by studying worth, valuation and cost savings
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 North eastern 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. 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, CSXConrail would become more competitive through cost reduction.
2. How much is Conrail worth? How do you value the cost
savings? Is CSX paying a fair price for Conrail?
i.
How much is Conrail worth?
Valuing Conrail for Year 1996
CFt = Cash flow in year t = St-1 (1+gt) (pt) (1-T) - (St - St-1 )(Ct +Wt)
St-1 1+gt pt T St Ct Wt
3636 1.03 0.22 0.33 3745.08 0 0.01
? St-1 = year 1995 revenue of 3636mn ? gt = CAGR of past 3 years ? pt = profit margin of 1995 is 22% ? T = tax rate is 33% ? St = sales for year 1996 using current growth rate ? Ct = change in net depreciation / change in sales Capital Investment required (net of depreciation) per rupee of sales increase ? Wt = change in net working capital / change in sales net working capital per rupee of sales increase
? STEP 1: Determine Free Cash flow
YEAR Sales
1996 1997 1998 3745.08 3857.432 3973.1554
1999 2000 4092.35 4215.121
?
CFt = St-1 (1+gt) (pt) (1-T) - (St - St-1 )(Ct +Wt)
YEAR
1996 550.934
1997
1998
1999
2000
CFt
567.462 584.4859 602.0204 620.0811
?
Step 2: Estimate a suitable discount rate for the firm
o K = Rf+ beta(RP) ( for asset beta)
Beta Equity D/E E/V Ba = Be(E/V) Rf RP Beta Asset WACC 1.3 0.71 0.584795 6% 6.3% 0.760234 0.107895
WACC = 10.7%
? Step 3: Calculate the present value of cash flows
YEAR
1996 550.934
1997
1998
1999
2000
CFt
? ?
567.462 584.4859 602.0204 620.0811
Step 4: Estimate the terminal Value T.V = [CFt (1+g)] / k-g
? T.V for year 1998
? Assumption:
Future growth after 2000 is assumed to 4%.
? Undiscounted terminal value in year 2000
T.V 5976.926
? Step 5 Add present value of terminal value to arrive at firm value
sum of PV
6360.804
? Step 6: Deduct the current book value of debt to arrive at value of equity
Debt Equity 1911 4449.8
? Step 7: Divide the value of equity by the number of shares to arrive at value per
share
number of shares 77.4 57.4
PRICE
? Step 8: Compare the intrinsic value with the prevailing stock price to make buy or sell decision.
o Prevailing stock price = 70 o Intrinsic value of stock is 57.4
STOCK IS OVERVALUED. Therefore is Conrail is worth $57.4 per share.
ii.
How do you value the cost savings?
To value cost saving, we calculate the value of
SYNERGY
After merger pro forma:
Conrail Operating revenue Operating expenses Operating income 1996 3686.00 3230.00 456.00 1996 4819.00 3951.00 868.00 1997 3796.58 3326.90 469.68 1997 5050.31 4140.65 909.66 0 1998 3910.48 3426.71 483.77 1998 5292.73 4339.40 953.33 188 1999 4027.79 3529.51 498.28 1999 5546.78 4547.69 999.09 396 2000 4148.63 3635.39 513.23 2000 5813.02 4765.98 1047.04 550 2001 4273.08 3744.46 528.63 2001 6092.05 4994.75 1097.30 567
CSX Operating revenue Operating expenses Operating income
synergy
After merger there is an SYNERGY happening: Therefore NEW operating income
Operating income = CSX + Conrail + Synergy CSX+conrail+synergy
1996 1324 1997 1379.344 1998 1999 2000 2001 1625.098 1893.371 2110.276 2192.931
It is CSX operating income + Conrail Operating income + Gain form Synergy
CSX + Conrail + synergy Depri - Capex net WC NOPAT
1996 1997 1998 1999 2000 2001 1324 1379.344 1625.098 1893.371 2110.276 2192.931 0 0 0 0 0 0 85.05 88.46892 92.03204 95.7457 99.61649 103.6513 887.08 924.1605 1088.816 1268.559 1413.885 1469.264 802.03 835.6916 996.7838 1172.813 1314.268 1365.612 802.03 754.7451 813.0357 863.9561 874.3822 820.5386 21118.76 12689.37
CFt PV of CFt
T.V PV of T.V
WACC was = 10.725%
Beta Equity D/E E/V Ba = Be(E/V) Rf RP Beta Asset WACC
1.35 0.401 0.555556 6% 6% 0.75 0.10725
Firm value = Sum of ( PV of CFt ) + T.V
FIRM value 17618.06
Number of shares = 212 + (90.5)*.6*1.85 = 313 million NOTE: 40% shares bought by CSX are torn off.
Value of each share is 56.28 (17618/313)
iii.
Is CSX paying a fair price for Conrail?
FIRM value Number of shares share value
17618.06 313 56.28 17618.06 45*212
current value of CSX current value of Conrail Total Value of both Extra premium that can be paid Extra premium per share
9540
70*77.4 5418 9540+5418 14958 1761814958 2660.06 2660/77.4
34.37
CSX IS paying 92.5 It can pay up to 104.37 ( 70 + 34.37).
The benefit of synergy is very high. It is going to be a very beneficial merger for both the companies.
doc_638158463.docx
Documentation about Conrail CSX consolidated rail corporation case analysis by studying worth, valuation and cost savings
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 North eastern 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. 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, CSXConrail would become more competitive through cost reduction.
2. How much is Conrail worth? How do you value the cost
savings? Is CSX paying a fair price for Conrail?
i.
How much is Conrail worth?
Valuing Conrail for Year 1996
CFt = Cash flow in year t = St-1 (1+gt) (pt) (1-T) - (St - St-1 )(Ct +Wt)
St-1 1+gt pt T St Ct Wt
3636 1.03 0.22 0.33 3745.08 0 0.01
? St-1 = year 1995 revenue of 3636mn ? gt = CAGR of past 3 years ? pt = profit margin of 1995 is 22% ? T = tax rate is 33% ? St = sales for year 1996 using current growth rate ? Ct = change in net depreciation / change in sales Capital Investment required (net of depreciation) per rupee of sales increase ? Wt = change in net working capital / change in sales net working capital per rupee of sales increase
? STEP 1: Determine Free Cash flow
YEAR Sales
1996 1997 1998 3745.08 3857.432 3973.1554
1999 2000 4092.35 4215.121
?
CFt = St-1 (1+gt) (pt) (1-T) - (St - St-1 )(Ct +Wt)
YEAR
1996 550.934
1997
1998
1999
2000
CFt
567.462 584.4859 602.0204 620.0811
?
Step 2: Estimate a suitable discount rate for the firm
o K = Rf+ beta(RP) ( for asset beta)
Beta Equity D/E E/V Ba = Be(E/V) Rf RP Beta Asset WACC 1.3 0.71 0.584795 6% 6.3% 0.760234 0.107895
WACC = 10.7%
? Step 3: Calculate the present value of cash flows
YEAR
1996 550.934
1997
1998
1999
2000
CFt
? ?
567.462 584.4859 602.0204 620.0811
Step 4: Estimate the terminal Value T.V = [CFt (1+g)] / k-g
? T.V for year 1998
? Assumption:
Future growth after 2000 is assumed to 4%.
? Undiscounted terminal value in year 2000
T.V 5976.926
? Step 5 Add present value of terminal value to arrive at firm value
sum of PV
6360.804
? Step 6: Deduct the current book value of debt to arrive at value of equity
Debt Equity 1911 4449.8
? Step 7: Divide the value of equity by the number of shares to arrive at value per
share
number of shares 77.4 57.4
PRICE
? Step 8: Compare the intrinsic value with the prevailing stock price to make buy or sell decision.
o Prevailing stock price = 70 o Intrinsic value of stock is 57.4
STOCK IS OVERVALUED. Therefore is Conrail is worth $57.4 per share.
ii.
How do you value the cost savings?
To value cost saving, we calculate the value of
SYNERGY
After merger pro forma:
Conrail Operating revenue Operating expenses Operating income 1996 3686.00 3230.00 456.00 1996 4819.00 3951.00 868.00 1997 3796.58 3326.90 469.68 1997 5050.31 4140.65 909.66 0 1998 3910.48 3426.71 483.77 1998 5292.73 4339.40 953.33 188 1999 4027.79 3529.51 498.28 1999 5546.78 4547.69 999.09 396 2000 4148.63 3635.39 513.23 2000 5813.02 4765.98 1047.04 550 2001 4273.08 3744.46 528.63 2001 6092.05 4994.75 1097.30 567
CSX Operating revenue Operating expenses Operating income
synergy
After merger there is an SYNERGY happening: Therefore NEW operating income
Operating income = CSX + Conrail + Synergy CSX+conrail+synergy
1996 1324 1997 1379.344 1998 1999 2000 2001 1625.098 1893.371 2110.276 2192.931
It is CSX operating income + Conrail Operating income + Gain form Synergy
CSX + Conrail + synergy Depri - Capex net WC NOPAT
1996 1997 1998 1999 2000 2001 1324 1379.344 1625.098 1893.371 2110.276 2192.931 0 0 0 0 0 0 85.05 88.46892 92.03204 95.7457 99.61649 103.6513 887.08 924.1605 1088.816 1268.559 1413.885 1469.264 802.03 835.6916 996.7838 1172.813 1314.268 1365.612 802.03 754.7451 813.0357 863.9561 874.3822 820.5386 21118.76 12689.37
CFt PV of CFt
T.V PV of T.V
WACC was = 10.725%
Beta Equity D/E E/V Ba = Be(E/V) Rf RP Beta Asset WACC
1.35 0.401 0.555556 6% 6% 0.75 0.10725
Firm value = Sum of ( PV of CFt ) + T.V
FIRM value 17618.06
Number of shares = 212 + (90.5)*.6*1.85 = 313 million NOTE: 40% shares bought by CSX are torn off.
Value of each share is 56.28 (17618/313)
iii.
Is CSX paying a fair price for Conrail?
FIRM value Number of shares share value
17618.06 313 56.28 17618.06 45*212
current value of CSX current value of Conrail Total Value of both Extra premium that can be paid Extra premium per share
9540
70*77.4 5418 9540+5418 14958 1761814958 2660.06 2660/77.4
34.37
CSX IS paying 92.5 It can pay up to 104.37 ( 70 + 34.37).
The benefit of synergy is very high. It is going to be a very beneficial merger for both the companies.
doc_638158463.docx