The Blanchard Company

The week was a busy one in The Battle for Conrail. There were two more lawsuits, a partial sweetener from CSX, a rapid counter-offer from Norfolk Southern, and a two-year lockup from CSX. Here's the short form.

Federal Judge Donald VanArtsdalen, the judge who blocked the initial NS suit against the CR/CSX deal a month ago, ruled on Tuesday that Conrail must allow shareholders to vote next Monday on whether Conrail can "opt out" of a Pennsylvania law requiring investors to receive fair value for their shares. A "yes" vote is required to allow CSX Corp., which already owns about 20% of Conrail, to buy another 20%.

Conrail and CSX have maintained that the merger cannot go through without an affirmative vote by shareholders. Conrail attorney Thomas Van Kirk said, "Nobody is being disenfranchised." It is here VanArtsdalen disagreed, ruling, "The harm is that (a delay of the vote) effectively disenfranchises those shareholders who may be opposed to the proposal," adding that such a provision essentially would amount to "a sham election. It says to (shareholders the vote is) merely going to be a formality. I do not think that's the proper way to hold an election or a vote on this particular proposal."

Late Wednesday CSX added a $16 per share kicker in the form of CSX convertible preferred stock to be paid on closure of the deal. Simultaneously CSX announced that they and Conrail have agreed not to discuss competing offers before the end of 1998. Moreover, the CSX tender offer has been extended to close of business 1/22/97. The special shareholder vote on the opt-out (the one Judge VanArtsdalen ruled on, above) has been put off until 1/17. Part of the reason for the postponement may be the fact that, according to the PR Newswire, "CSX has been advised by the depository, on a preliminary basis, that fewer than 100,000 [of the remaining 72 MM shares] have been tendered into the CSX offer as of the close of business on Dec. 18, 1996." That's one hundred thou, according to PRN. Typo or truth?

Run some numbers. CSX has 20% or 18 MM shares. Give them the 12 MM esops. That's 30 MM. Some say as many as 10 MM shares won't vote, so CSX would need half of 80 MM to carry, or only 10 MM of the uncommitted shares. If the 100,000 is accurate (and the newswires say it is) , it's one percent of what CSX needs. It just seems awafully low. (Anybody out there have any other ideas? E-mail me.)

It didn't end there, however. Norfolk Southern responded almost immediately by bumping its cash offer to $115 per Conrail share. The increased offer gives shareholders a premium of more than $14 per share (or 14 percent) over the remaining blended value of CSX's revised cash-and-stock proposal for Conrail which still depends on the uncertain value of CSX stock at some time in the future. More over, the speed which Norfolk responded says something of the seriousness of Norfolk's intent, adding further fuel to push CR's stock price closer to the NS offer.

Also on Thursday Norfolk Southern said it will challenge the legality of a provision in the CSX/Conrail agreement that extends the lockup period until December 31, 1998. Norfolk will head once again into VanArtsdalen's Philly courtroom 1/9/97 for a hearing on that issue. The Court also agreed to consider a second issue regarding whether CSX now owns 20 percent of Conrail's shares thus triggering Penna's Fair Value Statute which would require CSX to pay all Conrail shareholders $110 per share in cash.

Norfolk Southern maintains that the size and scope of the divestitures which would be required to make a CSX/Conrail combination acceptable would impose significant costs on the new company. These costs are for the most part avoidable with a Norfolk Southern/Conrail combination because the two railroads have much less overlap.

Analysts have reacted by blasting the 1998 lockup and saying the sweetened bid for Conrail may still not be strong enough to clinch the deal. This was before the $115 NS offer had been announced. After it had been announced, Philadelphia Inquirer reporter Andrew Cassel wrote,"[a number of] large shareholders remain miffed at the Conrail board's position that it won't talk to Norfolk Southern, despite the gap in offers." Cassel also notes a "developing antagonism towards Conrail 's position. It seems as though Conrail is completely ignoring Norfolk Southern when in fact that might be the better offer."

It's east to see why some may be miffed. When CSX dropped another four bits to close Friday at $43.25 the pre-bump blended value of the CSX offer for CR became $92.17, or $7.71 less than the current share price of Conrail. Would you tender your stock to CSX for $110 cash today for 40% of it and $80.44 for the balance a year out? Not likely. Thus the "sweetener" of $16 in CSX preferred payable a year out. (Or whenever the STB blesses the deal.). Even at face value, the extra sweet 16 leaves the blended value of the CSX deal still shy of Norfolk's enhanced $115 offer by about six percent.

Of course, the fact of the matter is that the two-year lock-out could effectively blow Norfolk completely out of the tub as far as the stock picture is concerned. CSX could then take its sweet old time assembling the votes to get its way. Of course, the down side is that the annual rail industry growth projected at a mere 12% for the next five years and at Friday's close of $99.875 CR trades at more than 17 times First Call's 1997 estimates. Both NS and CSX closed Friday at around ten times next year's earnings. Who's going to sit around waiting for inflated PE's to be legitimized?

Once we get beyond the stock/legal phases, there are the regulatory and market place hurdles. Norfolk Southern, in its "Balanced Rail System" write up (see www.nscorp.com) is committed to establishing the two-rail access to NY originally intended in the "4 Rs Act" and maintaining the other two rail access points now in place. NS notes that more than 60 cities including Pittsburgh and Philadelphia will lose their second rail in a CSX takeover. Also, some 16 shortlines or regional roads will lose their second carrier under a CSX win. States like NY and Penna will wind up with virtually ALL their class I track in CSX/CR hands in that game. NS says it aims to preserve and enhance two rail access.

STB filings for both CSX and NS are expected early Feb. and both will include operating plans and divestiture plans. Please read the respective web sites for what you can glean between the lines.

As for news from other fronts, there isn't any to be found here. I spent the week in Arizona speaking at the BNSF shortline meeting in Scottsdale, hi-railing the Copper Basin Railway with good friend and VP-GM Jake Jacobson, attending No. 3 son's college graduation, and even doing a bit of tourism. It was enough to keep track of Conrail.

Note: The Blanchard Co. is advising NS on certain shortline and local governmental aspects of its bid for Conrail.

--Roy Blanchard