Residency Session Assignment
BADM 534 Managerial Finance
CASE STUDY ONE
Title: Canadian Pacific’s Bid for Norfolk Southern
Use the following link to access the Case assigned:
https://hbsp.harvard.edu/import/668672.
Case study learning objectives
1.) Comprehensive Review: The case uses an interesting and well-publicized bidding situation to cover a wide range of topics such as DCF valuation, bidding strategies, option pricing, payoff diagrams, corporate restructuring, optimal capital structure, and fiduciary duties.
2.) Review of Merger Theory and Equity Consideration: Illustrates the economics motivations for mergers and acquisitions and provides a simple, graphical framework for analyzing value creation. It also illustrates how to value acquisitions with equity-based consideration and highlights a methodological flaw commonly observed in practice.
3.) Valuation Mechanics: Provides opportunities for students to construct three kinds of valuation analysis: discounted cash flow (DCF) analysis to value the merger benefits and Norfolk Southern on a standalone basis; transaction multiples to assess the reasonableness of CP’s offer; and the Black-Scholes option pricing formula to value the CVR, a derivative security. The case highlights discrepancies in how the firms (and industry observers) value acquisitions with equity consideration.
4.) Financial Engineering: Students analyze the mechanics of the CVR and then must explain why CP included it as consideration (how does the CVR “sweeten” CP’s offer?) Once the mechanics and motivation are understood, students must then replicate and value the CVR using option pricing techniques.
5.) Corporate Governance and the Role of Activist Investors: Describes the potential for incentive conflicts between shareholders, boards of directors, and senior leaders such as the CEO, and challenges students to recognize and resolve the conflicts. The case provides an opportunity to discuss what activist investors do, how they affect firms, and whether they create of simply extract value.
Major Case Questions:
1. Why does Canadian Pacific want to acquire Norfolk Southern? Do you believe there is compelling economic rationale for the merger?
2. What is the present value of the projected merger benefits in Table A as of December 31, 2015? Are the projections reasonable? How does the present value of the pre-merger operational improvements compare to the post-merger combination synergies? (Please assume a railroad WACC of 7.9% and a corporate tax rate of 36 %.)
3. Using the data in case Exhibit 9b, analyze the changes in market values of CP and NS in response to the rumors of a pending offer (11/06/15 – 11/09/15) and the initial CP offer (11/17/15 – 11/18/15). Is the market’s reaction consistent with your valuation of the projected merger benefits from Question 2?
4. What is the value of CP’s revised offer on December 8 (before CP “sweetened” its offer by adding the CVR security)? In your analysis, assume the following:
a. A valuation date of December 31, 2015, and year-end cash flows;
b. The stand-alone (pre-merger) values of CP and NS are $134 and $80 per share, respectively;
c. NS shareholders approve the merger and the Surface Transportation Board (STB) approves it;
d. Investors expect 100% of projected merger benefits to be realized. What is the value if investors expect none of the projected merger benefits to be realized?
e. NS must debt finance 100% of the cash portion of the revised offer ($32.86 per share).
5. Why did CP include the CVR security in its “sweetened” offer on December 16? What is CP’s motivation and how does the CVR sweeten the deal?
6. As a Norfolk Southern shareholder, would you accept CP’s “sweetened” offer?
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