ABSTRACT

As part of the
requirement for the
Elective course in
Mergers, Acquisitions
and Corporate
Restructuring in Term 5,
we hereby submit our
response to Questions
under Assignment # 2.

MERGERS, ACQUISITIONS AND

CORPORATE RESTRUCTURING
The Acquisition of Consolidated Rail Corporation
 The Acquisition of Consolidated Rail Corporation

1. What was the structure of the deal between Conrail and CSX?

CSX offered to acquire Conrail in a two-tiered deal worth $8.3 billion. This merger would create
an entity with more than $8.5 billion in rail revenue and almost 70% of the Eastern market.
According to the merger plan, CSX – Conrail would locate the company’s headquarters in
Philadelphia, implement a succession plan allowing Conrail’s CEO David M. LeVan to replace
CSX’s CEO John W. Snow as chief executive officer within two years, and increase LeVan’s annual
compensation by about $ 2 million so that it was commensurate with Snow’s compensation.

The structure of the deal between Conrail and CSX was based on a two-tiered offer; under the
agreement, CSX would purchase 90.5 million Conrail shares to complete the acquisition. This
sum included common shares currently outstanding, preferred shares convertible to common
shares, and employee incentive stock options exercisable in the event of an acquisition. CSX
would pay $ 92.50 per share in cash for the first 40% of Conrail’s acquisition shares (the front-
end offer) and would exchange shares in the ratio of 1.85619:1.0 (CSX:Conrail) for the remaining
60% (the back-end offer). Based on the prevailing stock price of CSX at the time of the merger,
the offer had a blended value of $ 89.07 per share.

Furthermore, CSX planned to operationalise the two-tiered offer by executing the front-end
offer in two stages. The first stage, a cash tender offer for 17.86 million shares at $ 92.50 per
share, began the day after the merger announcement. These shares represented 19.7% of
Conrail’s acquisition shares. The second stage, another cash tender offer for an additional 20.3%
of Conrail’s acquisition shares at the same price, could proceed only after Conrail shareholders
approved the deal as required under the Pennsylvania law.

Besides the two-tiered structure, the merger agreement contained several other important
provisions. Firstly, the agreement contained a break-up fee, which obligated Conrail to pay CSX
$300 million if the transaction did not take place. Secondly, Conrail granted CSX the option to
purchase 15.96 million newly issued common shares at $ 92.50 per share. These options, known
as “lock-up” options, typically allowed bidders to acquire between 10% to 20% of a target’s fully
diluted shares. Thirdly, Conrail suspended its “poison pill”. Finally, the merger agreement also
included a clause forbidding Conrail from pursuing merger discussions with any other party for a
period of six months under a “no talk” clause.

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2. What, if any, were the legal issues with the acquisition?

Pennsylvania’s Business Corporation Law was one of the toughest antitakeover statutes in the
country.

It had 3 provisions:

1. The Fair value statute – Bidders holding 20% or more of a company’s stock needed to offer
all shareholders the same price unless target shareholders explicitly voted to nullify this
provision. This was the reason the front-end offer was executed in 2 stages.

2. The Voting Rights statute - the statute limited a bidder’s voting rights to a maximum of 20%
of total shares outstanding, regardless of the percentage actually owned, unless
shareholders or management approved the right to vote all the shares (the “voting rights”
statute). Because Conrail’s management had approved the merger, CSX satisfied this
requirement.

3. The Constituency statute - this required management to consider and protect the interests
of employees and the community where the target was located in addition to meeting their
fiduciary responsibility to shareholders

Thus, if the opt-out vote for the fair value statute didn’t go through, or if the constituency
statute was violated, the acquisition would not go through.

3. Is there anything Norfolk can do to prevent the acquisition?

Norfolk can make a better bid than CSX, which if Conrail board decides to consider would lead to
the termination of its merger agreement with CSX but under a number of conditions as
mentioned in the case. But it is a plausible scenario since the board will have to consider other
offers even though there was a “no talk” clause with CSX, and if not considered it would make
the board in violation of its fiduciary duty. Also, the board could terminate the merger
agreement if another offer made it unlikely that CSX could complete the merger or win the
upcoming opt-out vote.

Moreover, Norfolk was in a better position to make a better bid than CSX because of the
following few points:

1. Financial Health

a. Operating income of Norfolk was $1062 against that of $868 of CSX; even though
the operating revenues of CSX were slightly higher than Norfolk, the costs were very
less so as to get a better margin.
b. Current ratio of Norfolk was 11.4 against that of 64.7 of CSX.
c. Leverage ratio of Norfolk was 33.6 against that of 40.1 of CSX; which meant that
Norfolk had a better cushion to assume more debt.

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 2. Efficiency

a. Operating ratio (defined as the ratio of operating expenses to operating revenue) of

Norfolk was 73.5% against that of 76.7% of CSX
b. Revenue per employee of Norfolk was $193690 against that of $163155 of CSX.
c. Other productivity ratios i.e. Revenue per mile of track operated, per carload
originated, per ton originated were better in the case of Norfolk than CSX

The synergies of reduced cost as estimated with CSX will probably be lower than that with Norfolk.
Hence if Norfolk doesn’t merge with Conrail, it will lose out on these synergy benefits and along with
that the merger of CSX and Conrail will result in a massive amount of revenue loss to be incurred by
the company.

Also, the Conrail board might opt to go with Norfolk looking at its performance efficiencies along
with the financial health, and if both are going to benefit from the synergies since Norfolk can
sustain more liabilities, it would become a brownie point which will be lucrative enough for the
board to terminate the agreement with CSX.

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