Copyright

The Acquisition of Consolidated Rail Corporation (A)

Harvard Business School Case N9-298-006 Case Software 2-298-738 Copyright 1998 by the President and Fellows of Harvard College This case was prepared by Research Associate Mathew Mateo Millett under the supervision of Professor Benjamin C. Esty as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Lori Flees (MBA'97) prepared an earlier version of the case.

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Exhibit 1 Exhibit 1
Selected Railroad Statistics (1995)

Norfolk BNSF Railroad Operations Results ($ millions) Operating Revenues Operating Expenses Operating Income Operating Ratio (%)
b a

Union

Contrail

CSX

Southern Pacific

$8,150 6,617 1,533 81.20%

$3,686 3,230 456 87.60%

$4,819 3,951 868 82.00%

$4,012 2,950 1,062 73.50%

$6,602 5,207 1,395 78.90%

Railroad Operations Data Railroad Employees 45,656 23,510 29,537 24,488 35,001 Miles of Track Operated 31,326 10,701 18,645 14,415 22,785 Total Carloads Originated (thousands) 5,967 2,531 4,402 3,435 4,010 Tons Originated (thousands) 388,423 134,651 320,419 223,000 257,483 Railroad Productivity Data ($) Revenue Revenue Revenue Revenue per per per per Employee ####### ####### ####### ####### ####### Mile of Track Operated 260,167 344,454 258,461 278,321 289,752 Carload Originated 1,366 1,456 1,095 1,168 1,646 Ton Originated 20.98 27.37 15.04 17.99 25.64

Financial Ratios (%) Return on Sales Return on Average Equity Leverage (Debt/Equity at book value) Current Ratio P/E Ratio Stock Price ($ per share) High Low Year-end $83.88 47.5 78 $73.88 51 70 $45.63 35.13 45.63 $27.08 20.54 26.46 $47.09 31.59 44.48 9.0% 14.6 84 53.3 11.7 11.4% 9 59.5 108.9 12.9 6.9% 15.5 40.1 64.7 11.6 15.3% 15 33.6 111.4 12.8 12.6% 16.5 110.7 88.4 19.5

Sources:

Union Pacific, Conrail, CSX, and Norfolk Southern 1995 Annual Reports ; Datastream ; Bloomberg ; Association of American Railroads, Railroad Facts , 1996; Value Line Investment Survey , September 20, 1996; Morgan Stanley Dean Witter , U.S. and the Americas Investment Research Report, "Investment Case for Railroads," November 1997; and casewriter's estimates.

Burlington Northern merged with Santa Fe on September 22, 1995, to form Burlington Northern Santa Fe (BNSF). The data provided are either pro forma results, or estimates thereof, for 1995. The operating ratio measures a company's operating efficiency. In this case, it is defined as the ratio of operating expenses to operating revenues.

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Exhibit 1

ey , September 20, ort, "Investment

anta Fe (BNSF). The

atio of operating

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Exhibit 2 Exhibit 2
Conrail Consolidated Balance Sheet ($ millions)

1992 ASSETS Cash Accounts receivable Deferred income taxes Materials and supplies Other current assets Total current assets Property and equipment Other assets Total assets LIABILITIES AND EQUITY Accounts payable $63 Current portion of long-term debt 207 Short-term debt 127 Other current liabilities 882 Total current liabilities 1,279 Long-term debt Deferred income taxes Other long-term liabilities Total liabilities 1,577 644 1,067 $4,567 $40 592 0 121 37 790 6,013 512 $7,315

1993

1994

1995

3Q 1996a

$38 644 227 132 21 1,062 6,313 573 $7,948

$43 646 249 164 23 1,125 6,498 699 $8,322

$73 614 333 158 28 1,206 6,408 810 $8,424

$33 655 337 144 30 1,199 6,408 693 $8,387

$62 146 79 788 1,075 1,959 1,081 1,049 $5,164 2,784 $7,948

$119 130 112 840 1,201 1,940 1,203 1,053 $5,397 2,925 $8,322

$113 181 89 787 1,170 1,911 1,393 973 $5,447 2,977 $8,424

$158 138 65 889 1,250 1,891 1,420 888 $5,449 2,938 $8,387

Total stockholders equity 2,748 Total Liabilities and Equity $7,315

Sources:
a

Conrail 1993 and 1995 Annual Reports, and Conrail Form 10-Q , November 14, 1996.

Nine months ended September 30, 1996.

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Exhibit 3 Exhibit 3
Conrail Consolidated Income Statement ($ millions, except earnings per share)

1992 Operating Revenues Operating Expenses Way and structures Equipment General and administrative Transportation Special Charges Total Expenses Income from Operations Interest expense Other income Loss on disposition of subsidiary Income before taxes Income taxes Changes in accounting principles Net Income Average number of primary shares outstanding (thousands) Total number of fully diluted (Acquisition) shares outstanding (thousands) Fuly Diluted Earnings Per Share before effect of charges
Source:
d,e c b

1993 $3,453

1994 $3,733

1995 $3,686

3Q 1996a $2,771

$3,345

$465 692 348 1,306 $2,811 $534 (172) 98 $460 178 $282 79,742

$492 703 384 1,283 $2,862 $591 (185) 114 (80) $440 206 (74) $160 79,575

$499 815 434 1,379 84 $3,127 $606 (182) 118 $532 208 $324 78,620

$485 766 655 1,324 285 $3,230 $456 (194) 130 $392 128 $264 78,837

$364 614 252 1,048 135 $2,413 $358 (137) 83 $304 109 $195 77,443

90,500

$2.97

$3.00

$4.08

$4.69

$3.01

Conrail 1993 and 1995 Annual Reports; Conrail Form 10-Q , November 14, 1996; CSX Schedule 14D-1, October 16, 1996, and casewriter estimates.

a b c

Nine months ended September 30, 1996. In September 1993, Conrail recorded a loss for disposition of its investment in Concord Resources Group, Inc.

The number of fully diluted shares assumes conversion of the preferred stock and exercise of all outstanding options (except CSX's lock-up opt measured as of the announcement date and equals the total number of shares CSX would have to purchase to acquire Conrail. Based on net income adjusted for the effects of preferred dividends, net of income tax benefits. Adjusted for extraordinary charges, loss on disposition of subsidiary, and changes in accounting principles.

d e

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Exhibit 3

ons (except CSX's lock-up options). It is quire Conrail.

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Exhibit 4

Exhibit 4

CSX and Norfolk Southern Consolidated Balance Sheets ($ millions)

CSXa 3Q 1996b 1995 ASSETS Cash Accounts receivable Deferred income taxes Materials and supplies Other current assets Total current assets Property and equipment Other assets Total assets LIABILITIES AND EQUITY Accounts payable $1,121 Current portion of long-term debt 486 Short-term debt 148 Other current liabilities 1,236 Total current liabilities 2,991 Long-term debt Deferred income taxes Other long-term liabilities Total liabilities Total stockholders equity 2,222 2,560 2,267 $10,040 4,242 $1,073 201 276 1,149 2,699 2,288 2,657 2,182 $9,826 4,815 $14,641 $660 832 148 220 75 1,935 11,297 1,050 $14,282 $515 928 151 217 108 1919 11,720 1,002 $14,641

Norfolk Southern 3Q 1996c 1995

$68 704 145 62 365 1,344 9,259 303 $10,905

$188 776 152 58 284 1,458 9,460 345 $11,263

$733 86 45 342 1,206 1,553 2,299 1,018 $6,076 4,829 $10,905

$747 79 45 338 1,209 1,811 2,351 1,037 $6,408 4,855 $11,263

Total Liabilities and Equity $14,282

Sources:

CSX and Norfolk Southern 1995 Annual Reports ; CSX Form 10-Q , October 31, 1996; and Norfolk Southern Form 10-Q, November 13, 1996.

a b c

Includes all CSX operations, rail and non-rail. Nine months ended September 27, 1996.

Nine months ended September 30, 1996.

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Exhibit 5 Exhibit 5
CSX and Norfolk Southern Consolidated Income Statements ($ millions, except earnings per share)

CSX 1992 Operating Revenues Railway Motor carrier Container shipping Other Total Revenues Operating Expenses Railway Other Total Expenses Income from Operations Interest expense Other income Income before taxes Income taxes Accounting adjustments Net Income 1993 1994 1995 3Q 1996
a

Norfolk Southern 1992 1993 1994 1995 3Q 1996

b

$4,434 $4,380 $4,625

$4,819

$3,661 3,047 1,175 $7,833

$3,777 $3,746 $3,918 $4,012 830 714 663 656

$3,075 515

3,148 3,246 3,492 4,008 968 1,141 1,292 1,477 $8,550 $8,767 $9,409 $10,304

$4,607 $4,460 $4,581 $4,668

$3,590

$4,313 $3,643 $3,696 4,155 4,384 4,531 $8,468 $8,027 $8,227 $266 (276) 3 (7) (27) 0 $20 $913 $1,182 (298) 18 633 274 0 $359 (281) 105 1,006 461 0 $652

$3,951 5,227 $9,178 $1,126 (270) 118 974 356 0 $618

$2,213 4,524 $6,737 $1,096 (188) 19 927 325 0 $602 212,567 $2.83

$2,851 $2,831 $2,875 $2,950 869 769 641 632 $3,720 $3,600 $3,516 $3,582 $887 (109) 98 875 318 0 $558 $860 $1,065 $1,086 (98) 137 899 350 223 $772 (102) 85 1,049 381 0 $668 (113) 142 1,115 402 0 $713

$2,213 490 $2,703 $887 (68) 68 887 317 0 $570 126,912 $4.49

Average shares outstanding (thousands) 103,915 209,303 210,270 102,907 Earnings Per Share before effect of charges Earnings Per Share c $4.61 $4.04 $3.12 $3.73

141,624 139,350 136,367 131,067 $3.94 $3.94 $4.90 $5.44

$0.19

$3.46

$3.12

$2.94

$2.83

$3.94

$5.54

$4.90

$5.44

$4.49

Sources:
a

CSX and Norfolk Southern 1993 and 1995 Annual Reports; CSX Form 10-Q, October 31, 1996; Norfolk Southern Form 10-Q, November 13, 1996, and casewriter estimates.

Nine months ended September 27, 1996.

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Exhibit 5

casewriter estimates.

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Exhibit 5
b c

Nine months ended September 30, 1996.

Adjusted for special charges and accounting adjustments.

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Exhibit 6 Exhibit 6
Recent Railroad Acquisitions and Conrail Financial Data

Target Santa Fe Pacific Kansas City Southern Santa Fe Pacific

Acquirer

Announcement Date Deal Type Offer Status 29-Jun-94 19-Jul-94 5-Oct-94 10-Mar-95 2-Aug-95 Friendly Friendly Hostile Friendly Friendly Completed Withdrawn Withdrawn Completed Completed

Assets ($ millions)

Target Financial Data Revenues Debt/Equity ($ millions) (at book) $2,795 495 2,795 1,116 3,159 0.96 1.42 0.96 3.86 1.38

Burlington Northern Illinois Central Union Pacific

a

$5,941 1,399 5,941 2,203 4,359

Chicago and North Western Union Pacific Southern Pacific Union Pacific

Target Santa Fe Pacific Kansas City Southern Santa Fe Pacific Chicago and North Western Southern Pacific

Offer Price per Share as a Multiple of EPS Book Value 21.4X 14.6 13.4 18.3 18.4 4.5X 1.7 2.8 5.5 3.7

Total Enterprise Value b Four-Week Projected Synergies/Target as a Multiple of Acquisition Merger Synergies Operating Sales EBITDA Premium (%) ($ millions) Expenses (%) 2.6X 3.6 1.8 2.4 1.7 13.1X 9.9 9.2 8.5 12.2 73% n/a 52 34 54
e

$560 n/a n/a $250 $660

22.3% n/a n/a 27.7 24.5

Conrail Financial Data $ in Millions Assets Debt Sales EBITDA $ per Fully Diluted Share $4.84 Debt/Equity 0.71 (at book value) 4.91 5.69 Number of 32.46 Acquisition Shares 90.5 million

$8,387EPS (last 4 qtrs) 2,094 1996 est. EPS 3,722 1997 est. EPS 1017 Book Value

Sources:

Securities Data Company, Inc.; Conrail Forms 10-Q , November 11, 1995, May 13, 1996, August 5, 1996, and November 18, 1996, and 1995 Annual Report, CSX Schedule 14D October 16, 1996; Chicago and North Western Form 10-K , March 22, 1995; NatWest Analyst Reports; Value Line Investment Survey , September 20, 1996; and casewriter's

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Exhibit 6

al Report, CSX Schedule 14D-1 , 20, 1996; and casewriter's

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Exhibit 6
estimates.
a b c

Union Pacific Purchased the 72.5% of Chicago and North Western that it did not already own. All multiples are based on fully diluted number of shares outstaning at announcement. Before extraordinary items. Because Kansas City Southern Railroad was a division of a conglomerate, it did not have traded equity.

Total Enterprise Value = common equity (at market) + preferred equity + cost to retire in-the-money options+ debt (at book) - cash and marketable securities.

d e

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Exhibit 7

Exhibit 7

Projected Gains in Operating Income from a CSX-Conrail Merger ($ millions)

1997E Gain in Operating Income from Cost Reduction$0 Gain in Operating Income from Revenue Increase Gain coming from Norfolk Southern Gain coming from other sources Total Gain from Revenue Increase Total Gain in Operating Income c $0 0 $0 $0
b

1998E $111

1999E $259

2000E $370

2001Ea $381

$50 27 $77 $188

$89 48 $137 $396

$117 63 $180 $550

$121 65 $185 $567

Sources:
a b c

Casewriter's estimates based on data from NatWest, 1996 Analyst Reports.

Grows at the rate of inflation (3%) after the year 2000. Net merger costs.

Pre-tax gain; the applicable federal income tax rate was 35%.

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Exhibit 8

Exhibit 8

Selected Financial Market Data

Week Ending October 18, 1996 Yields on U.S. Treasury Bills, Notes, and Bonds 3-month 6-month 1-year 2-year 5-year 10-year 30-year Yields on Long-term Corporate Bonds Aaa Aa A Baa Interest Rates Federal Funds 3-month Commercial Paper 3-month Certificate of Deposit Prime Rate Value Line Equity Betas Conrail CSX Norfolk Southern 1.30 1.35 1.15 5.22 5.42 5.40 8.25 7.40 7.59 7.71 8.08 5.11% 5.40 5.55 5.91 6.28 6.54 6.83

Sources:

Federal Reserve Bulletin, January 1997; and Value Line Investment Survey, October 11, 1997.

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