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AT&T Negotiation Strategy
SMGT 6050: Mergers, Acquisitions & Strategic Alliances
Ebube Anizor (209347741)
Appendix A: Valuation Using Comparable Companies2
INTRODUCTION AND OVERVIEW
“Anytime, Anywhere” communications surmises AT&T’s strategic vision and represents a clear departure from the ﬁrms local phone and long-distance service provider roots. AT&T’s continued diversiﬁcation into several high tech equipment and service business lines clearly signals the realization that while it’s certainly the largest long-distance provider in the US, growth is slow, market share is eroding and proﬁt margins are poor. It is within this context that the opportunity to enter the ﬂedgling cellular communications industry via the acquisition of McCaw presents itself. McCaw’s cellular network is now national in footprint and has access to largest potential subscriber base amongst competing ﬁrms (see Table A1 in Appendix). Moving into cellular represents domestic top line growth opportunities and an avenue to grow internationally – helping to fulﬁll the mandate of the board. While potential revenue synergies are attractive, the savings in local access fees (enabled by using McCaw’s network) is itself worth hundreds of millions annually. Cellular could bind and enhance the potential of many of AT&T’s other endeavours and provide the infrastructure to achieve its vision. However timing is of the essence. Recent M&A activity signals that local phone companies are moving into the cellular sector and the likelihood of further competition with the advent of PCS is looming. McCaw is currently highly leveraged – which may challenge its growth- and recent talks indicate that at the very least there is a cursory interest in partnering. Presented herein is a report to AT&T’s board that incorporates several approaches in arriving at a valuation of McCaw and a negotiation strategy that addresses both pricing strategy and deal structure. ASSUMPTIONS While various assumptions in McCaw’s valuation are noted in the accompanying appendices, key assumptions worth highlighting are: • The option to purchase the balance LIN shares will be exercised in 1995 (although some consideration in pricing is given to the possibility of McCaw selling its current shares). • Only the cellular portion of the business is being modelled since that is of most importance to AT&T. McCaw cellular business represented 80% and 83% of total revenues in 1990 and 1991 respectively (according to the companies Annual Reports).
Appendix A: Valuation Using Comparable Companies3
VALUATION 1: COMPARABLE COMPANIES When compared to ﬁrms in the broad telecommunications industry using primarily market value- based metrics (i.e. market capitalization against revenues, book value and net income)1 McCaw generates an average valuation of $4.76 billion. See Appendix A for full valuation details. Revenue from the top 7 cellular ﬁrms in the US in 1991 ranged from Vanguard’s $89 million to British Telecom’s (BT) $23.2 billion2 . McCaw, Air Touch and LIN followed BT with revenues of $1.36 billion, $782 million and $468 million respectively. The performance of the aforementioned ﬁrms was used a benchmark in McCaw’s valuation; however the wide spread in ﬁrm size and negative earnings posted by both LIN and Contel (making P/E ratios unusable) renders the resultant valuation of $7.1 billion as a loose guideline at best. Given recent acquisitions by Bell Atlantic and BellSouth, and AT&T’s own interest in the cellular sector a valuation of McCaw was also generated using comparable local phone and long-distance companies. 3 Performing comparables with GTE, MCI and Sprint in addition to the above produced separate valuations of McCaw each nearing $3.8 billion. The arguably low valuations are a result of using ratios from these mature sectors and applying it to a growth sector that requires high capital investments. VALUATION 2: COMPARABLE TRANSACTIONS (USING INDUSTRY RATIOS) Between October 1989 and September 1991 there were 12 M&A transactions in the cellular industry (Appendix B). Most deals were regional in nature and involved small POPS4 (4.9 million or less). The McCaw deal would be national and involve a large number of POPS (up to 71.4 million). Consequently most of the deals were not suitable as comparables in determining a McCaw valuation. There were however three deals that were suitable for comparison in terms of resultant combined POPS and Value per POP; these were Bell Atlantic-Metro Mobile, GTEContel, and McCaw-Metromedia NY (Appendix B). The three transactions produced an
1 2 3 4
Pegged to 1991 audited ﬁnancials and September 1992 share prices Case exhibit 15 Case exhibit 14
While P/E and other ratios are normally used in performing comparables in many industries, in the cellular industry an operators ’Proportion of Potential Subscribers’ (POPS) - the product of a geographical area and a ﬁrm’s fractional ownership - is the accepted metric.
Appendix A: Valuation Using Comparable Companies4 average of $273/pop which when applied to McCaw resulted in a valuation of $15.9 billion. While the average value/POP trended upwards from 1989 to 1991 ($147, $177, and $196 respectively) the value/POP for deals within a particular year varied greatly and was absent of any pattern or clustering. What could be gleaned from the three highlighted transactions was that a higher than average value/POP was paid likely due to the strategic nature of the deals. The Bell Atlantic-Metro Mobile and GTE-Contel deals represented diversiﬁcation within a growing sector; the McCaw-Metromedia deal gave the acquirer a long sought after presence in the New York market. While the number of POPS involved in a potential McCaw acquisition makes the deal unique amongst historical transactions, given the strategic nature of the acquisition and the relevance of the above noted deals the valuation produced by this method offers a reliable estimate of McCaw’s potential acquisition price. VALUATION 3: DISCOUNTED CASH FLOW Given the multitude of variables affecting McCaw’s performance using a Discounted Cash Flow (DCF) allows for a more granular and accurate approach to valuating the ﬁrm. Of particular note is the need to model the potential purchase or sale of LIN shares in 1995 and the resulting affect on cash ﬂow and cost of capital. Consequently the DCF model used is a 10 year projection to account for this particular transaction. Full details of the valuation and its variations are provided in Appendix C. The Base Case (or As-Is) valuation incorporates several key parameters such as a WACC of 13.65% population growth of 1%, penetration growth of 16%, and several costs as a percentage of sales as detailed in Table C1. Should McCaw purchase the balance of LIN shares the ﬁrm is estimated at a value of $7.55 billion dollars (Figure C2). If LIN shares are sold the valuation drops to $7.26 billion (Figure C3). This small gap is misleading. The one time injection of cash in 1996 skews the valuation. As presented in Figure C3 free cash ﬂow is materially hampered beyond 1996 without the LIN shares. Performing a sensitivity analysis (Table C8) revealed penetration, direct costs, marketing expense, WACC and POP growth were key levers in determining ﬁrm value. As such, should McCaw implement reasonable improvements such as new service offerings, operational cost cutting and debt-restructuring its valuation increased by $1.02 billion to $8.57 billion (Table C9). This deal offers AT&T the potential of over $6.75 billion dollars in revenue and cost synergy value (Table C13). Unique to AT&T as the largest long-distance provider is a savings on local access fees valued at $4.3 billion; SG&A, marketing and related expenses generate savings valued at $1.5 billion. AT&T/McCaw Negotiation
Appendix A: Valuation Using Comparable Companies5 Future options estimates are admittedly less reliable as they generally involve revenue improvements and are speculative in nature. Nonetheless these options provide AT&T with $4.3 billion in value. Across all four of the above perspectives, McCaw’s aggregate value is $19.6 billion.
Value (billion) Scenario As Is – LIN purchased Improvements Synergies Future Options Total Value shares $7.55 $1.02 $6.75 $4.28 $19.6
Table 1: DCF Valuation Summary
Appendix A: Valuation Using Comparable Companies6
RECOMMENDATION AND NEGOTIATION
The valuation of McCaw using comparable companies is clearly an outlier (see Table 2). The challenge with this method is that comparable ﬁrms within our without the cellular sector did not exist. As an example, on POPS basis McCaw dwarfed its nearest competitor by nearly 20 million (see Table A1 in Appendix A). Given these challenges, the relatively low valuation can be discarded as providing little insight to a potential value for McCaw. Valuations using the other two methods provide ﬁgures that differ by 23%. However incorporated into the DCF valuation is the future options value ($4.28 billion) which is speculative, difficult to realize and should not be baked into an on offer price. A more appropriate DCF value to use is then $14.8 billion. While McCaw may produce differing DCF projections since assumptions and available information highly inﬂuence the valuation, a comparable transaction analysis (especially using recent, relevant data) serves as a powerful guide to a market value acceptable under current conditions. In this case the adjusted DCF valuation only differs from that of the comparable transactions by 7%; producing an average of $15.4 billion. This valuation now serves as a guideline in structuring the negotiated deal.
Valuation (billions) $4.76 $15.9 $19.6
Valuation Method Comparable Companies Comparable Transactions Discounted Cash Flow
Table 2: Valuation Methods Summary
NEGOTIATION Should AT&T not be able to achieve a negotiated agreement with McCaw the options of buying smaller or regional ﬁrms and/or building a national network still remains. This option carries an estimated price tag of 7 to 10 billion for the licences alone and excludes network infrastructure and opportunity costs. 5 With this in mind, and the strategic and ﬁnancial beneﬁts of purchasing McCaw having been demonstrated, successfully negotiating a deal would be in AT&T’s best interest. Craig McCaw owned 60% of McCaw shares and BT 20%; clearly these two parties should be the focus of negotiation. With Mr. McCaw price and post-acquisition position would be critical; with BT price relative to its initial investment is likely the singular factor considering its current earnings challenges and ownership restrictions in the US.
Case materials, page 12
Appendix A: Valuation Using Comparable Companies7 Fortunately AT&T appears to be the only bidder and possibly the only single telecommunications ﬁrm capable of acquiring McCaw as a whole. Offers A benchmark or ﬂoor for the opening offer is BT’s breakeven price. BT purchased its stake at $41.50 per share ($1.5 billion) dollars. This is 71% premium on McCaw’s share prices as of September 1992 and translates to a valuation of $7.6 billion. Based on McCaw’s As-Is valuation as detailed above and improvements with discounts for prevailing market conditions an appropriate opening offer is $10.5 billion. See Appendix D for details of the acquisition price components. The opening offer does not incorporate any synergy value. Because the noted synergy values are broadly known McCaw will likely negotiate that into the acquisition price; as such negotiating 20% of synergies into the offer price produce a synergy-based offer of $11.8 billion. Given the expected growth in cellular, strategic importance of wireless and considerable time and money required to build an equivalent business in cellular up to 50% of synergies can be accrued to McCaw and baked into the walk-away offer of $13.8 billion. Realizing estimated post merger synergies is typically difficult; so going beyond 50% of its value would be irresponsible.6
Price (billions) Offer Minimum Opening Synergy-based Walk-away $7.76 $10.5 $11.8 $13.8 Value/POP $108.7 $147.1 $165.3 $193.3 Per Share Price Share Premium (based BT Share Premium on $24.30) (based on $41.50) $41.50 71% 0% $57.63 $64.76 $75.74 137% 167% 212% 39% 56% 83%
Table 3: Offer Summary
Highlights of Overall Strategy Pricing: minimize payment for synergies, pay nothing for future options. No exclusivity premium required as AT&T is deemed to be the only bidder for McCaw in its entirety Structure: given McCaw’s high valuation, AT&T’s cash reserves, AT&T’s excellent credit rating and high stock price a deal primarily involving equity with the balance ﬁnanced by debt is ideal
McKinsey reports that revenue synergies are overestimated 70% of the time, 60% of deals don’t meet synergy targets and 25% of deals over estimate synergies by 25%. “Where Mergers Go Wrong”. McKinsey Quarterly May 2004.
Appendix A: Valuation Using Comparable Companies8 Contingencies: partial purchase of McCaw, with option for complete purchase in the future. The offer should be heavily discounted since full control ideal for realizing projected synergies. Furthermore partnership talks could continue to ensure AT&T has some presence in cellular. Post-Merger: Offer Craig McCaw the CEO position (wireless) and a seat on the AT&T board. Include payment incentives (in addition to the equity structure) to ensure successful transition.
Appendix A: Valuation Using Comparable Companies9
APPENDIX A: VALUATION USING COMPARABLE COMPANIES
Figure A1: Comparable Cellular Companies
Figure A2: Valuation of McCaw using Comparable Cellular Company Ratios Sources: case exhibit 15; Book values based on 1991 Annual Reports. Market Prices as of September 30, 1992.
Notes: 1. P/E Ratio not an applicable measure because LIN and Contel posted net losses in 1991 2. Size (i.e. revenue) of companies relatively to each other and McCaw signiﬁcantly differ. Even given the transactions that occurred by the end of 1991 the POP size of the resultant ﬁrms were still notably smaller than that of McCaw (see Table A1).
Firm McCaw Cellular (w/LIN) GTE/Contel BellSouth Bell Atlantic Paciﬁc Telesis Southwestern Bell Ameritech NYNEX Centel US West
POPS (millions) 72.2 52.9 34.4 33.6 31.3 30.8 21.1 18.6 17.5 17.1
10 Appendix A: Valuation Using Comparable Companies
Table A1: Top 10 Cellular Firms by POP (source: LA Times, September 1991)
LONG DISTANCE COMPANIES
Figure A3: Comparable Long Distance Companies
Figure A4: Valuation of McCaw using Comparable Long Distance Company Ratios
Sources: case exhibits 2 and 5; Book values based on 1991 Annual Reports. Market Prices as of September 30, 1992.
Notes: 1. P/E Ratio not an applicable measure because McCaw posted a net loss in 1991 2. AT&T’s 1991 revenue of $63 billion is materially higher than that of MCI and Sprint (both approximately $9 billion; therefore the telecommunications portion of AT&T revenue ($38 billion) was used in Figure A3. While that revenue ﬁgure is still relatively high, taken as a ratio to its market value provides a comparable ﬁgure. 3. AT&T absorbed a re-structuring charge of $2.86 billion in 1991 producing a net income of $522 million. In order to run the comparables the charge was added back to net income and used in Figure A3. The 1991 net income used totalled $3.38 billion which better reﬂects 1989 and 1990 performance of $3.11 billion and $3.10 billion respectively. 4. The ratios of the ﬁrms as presented in Figure A5 are quite similar. This is a reﬂection of the mature long distance phone sector with operationally efficient ﬁrms. Using these ratios to value ﬁrms such as McCaw in a high-growth sector will not provide highly relevant valuations. AT&T/McCaw Negotiation
11 Appendix A: Valuation Using Comparable Companies
12 Appendix A: Valuation Using Comparable Companies LOCAL PHONE COMPANIES
Figure A5: Comparable Local Phone Companies
Figure A6: Valuation of McCaw using Comparable Local Phone Company Ratios
Sources: case exhibit 15; Book values based on 1991 Annual Reports. Market Prices as of September 30, 1992.
Notes: 1. P/E Ratio not an applicable measure because McCaw posted a net loss in 1991 2. Although the above does not include the cellular acquisitions in 1991, they are more representative of McCaw in terms of geographic footprint and POP. Furthermore, their relative performance (sales, net income) is comparable. 3. The ratios of the ﬁrms as presented in Figure A5 are quite similar. This is a reﬂection of the mature local phone sector with operationaly efficient ﬁrms. Using these ratios to value ﬁrms such as McCaw in a high-growth sector will not provide highly relevant valuations.
13 Appendix A: Valuation Using Comparable Companies
Appendix B: Valuation Using Compar
APPENDIX B: VALUATION USING COMPARABLE TRANSACTIONS
Figure B1: Comparable Transactions
Notes: 1. While strategically a scenario in which all LIN shares are purchased in 1995 is the most attractive, valuations using the current portion and even no portion of LIN shares must be accounted for. Therefore an average valuation is appropriate. 2. The majority of the deals occurred during the recession so the resultant valuations are arguably low. The S&P 500 index averaged 335.6 between 1990 and 1991. In 1992 (January through September) the S&P performed at an average of 413.1, 23% better than during the recession (ﬁgures from case exhibit 18). 3. Motivation for the Bell Atlantic-Metro Mobile acquisition was complementary geographies (East Coast, New Mexico, Texas), efficiencies of scale and cash ﬂow challenges at Metro Mobile. The latter arguably contributing to a relatively low value/ pop. 4. GTE Corp.-Contel produced an operator with a national footprint. during the end of the recession. Deal occurred
5. McCaw-Metromedia (NY) was a regional purchase in exchange for the eventual sale of McCaw’s operations in the south). Deal occurred at the bottom of the recession.
APPENDIX C: VALUATION USING DISCOUNTED CASH FLOWS
Appendix C: Valuation Using Discoun BASE CASE (“AS IS”) CASH FLOW The parameters detailed in Table C1 indicate the parameters used in the Base Case valuation of McCaw. The parameter values inform the model used to build the 10 year projected Cash Flow statements under the scenarios in which the balance of LIN shares are purchased or McCaw current ownership of LIN shares is sold in 1995.
Parameter Annual Pop Growth Rate Value Rationale/Source
1% 1% growth consistent with 1990 US census estimates at the time. The McCaw/LIN network had national footprint, so national average population growth appropriate to use. Annual Penetration Growth 16.00% Case exhibit 13. Industry expected to reach 25% total penetration by 2003; so annual growth of 16% required from 1993 forward. Direct Costs & Exp. (except Marketing) 33.19% From McCaw December 31, 1991 Figures. (% Service Rev.) Direct Cost Increment (%) Marketing Expenses (% Service Rev.) Marketing Expense Increment (%) -2.50% AT&T projection reﬂecting operational improvements. 26.43% From McCaw December 31, 1991 Figures. -12.00 AT&T project reﬂecting the need to spend less on marketing as brand % awareness and cellular phone popularity grows
Depreciation + Amortization (% Service 35.24% Amortization represents annual expense of Intangible Assets (provided in case) Rev.) (2) D&A Increment (%) CapEx per Net Subscriber Additions Net Working Capital (NWC) per Subscriber Tax Rate -5.00% $1,190 As per AT&T projection $198 As per AT&T projection 36% McCaw’s current rate
Table C1: Base Case Model Parameters
McCaw Cellular7 10 Projected Cash Flow – LIN Broadcasting Shares Purchased in 1995
As of September 30, 1992 (in millions)
just includes the “cellular” portion of McCaw’s business; Broadcast, RCC and other lines are excluded. Broadcast and RCC combined represented 20% of McCaw’s revenue in 1990 and 17% in 1991.
Appendix C: Valuation Using Discoun
Figure C1: McCaw Cash Flow Projection (LIN Purchased) Assumptions: 1. McCaw must act on its option to purchase the remaining 47.5% of LIN Broadcasting prior to October 1995. If LIN is purchased, approximately 13 million additional Pops will be allocated to the purchaser. If remainder of LIN is not purchased, McCaw will lose approximately 14 million pops. Assume either transaction is effective 1/1/96 (from case materials). 2. The effect on principle and interest expenses resulting from either the purchase or sale of LIN shares in 1995 is not taken into account in the above noted expense ﬁgures. However any change in the cost of capital resulting from the McCaw’s decision re: LIN is factored into the discounted cash ﬂow presented in ﬁgure C3 and further discussed later in this appendix. 3. The potential of PCS approval is modelled via slow growth rates (1%) and declining revenue per subscriber expected as a result of an increased level of competition (Figure C1).
McCaw’s Cost of Capital
Value Market Return Rationale/Source
Risk Free Rate
15.36% S&P average monthly return from 1987 to 1991. Return taken over 5 year period to taken into account the recession of 1990-1991. Using ﬁgures for those years alone would skew market returns and not be an accurate representation of general market performance. 6.71% US 10 year treasury bond yield as of Dec 31, 1991.
Appendix C: Valuation Using Discoun
McCaw Beta 1.75 As of Dec 31, 1991 based on 5 year average (as provided in the case exhibit 15). This beta is more appropriate for use than the value of 3.16 provided in case exhibit 8 because of the general volatility resulting from the recession as noted above. Furthermore the higher beta may not likely to be indicative of McCaw’s future risk. 21.85% COE = Risk Free + Beta*(Market Return – Risk Free Rate)
Cost of Equity
Table C2: McCaw’s Cost of Equity
Debt Source Senior Subordinated Bonds (due 1999) Senior Subordinated Bonds (due 1998) Convertible Senior Subordinated Bonds (due 2008) Other Convertible Senior Subordinated Bonds (due 2008) Cost of Debt
12.95% $528.1 14% $396.1 8% $114.2 11.5% $272.4 12.5% Total = $1,311. Taking weighted average of above the cost of debt is determined. Note: McCaw’s S&P bond rating as of Sep 30, 1992 was CCC+. McCaw 5 -10 year bond issues as of that date offered a Yield to Maturity of 11.69%. Not factored into cost of debt but of consideration should new debt be issued.
Table C3: McCaw’s Cost of Debt
Value Shares Outstanding Stock Price Market Value of Equity (E) Book Value of Debt (D) D/V E/V Cost of Equity Cost of Debt WACC
182,278,779 Class A and B common stock. From case exhibit 7 (McCaw 1991, 1992 Annual Reports) $29.63 From case exhibit 8. $5,400,920,221 Shares Outstanding*Stock Price $5,198,900,000 Long Term Debt from case exhibit 9 49.05% Weight of Debt 50.95% Weight of Equity 21.85% From Table C2 7.48% From Table C3 (after tax) 13.65% Weighted Cost of Debt and Equity.
Total Value of Equity and Debt (V) $10,599,758,221 E+D
Table C4: McCaw’s Weighted Average Cost of Capital (WACC), as of December 31, 1991
Appendix C: Valuation Using Discoun
Discounted Cash Flow (DCF) The terminal value of McCaw (in 2003 foward) following the 10 year cash ﬂow projections is determined as follows:
Value Future Growth Rate Rationale/Source 1% In line with projected population growth which drives POP growth which strongly effects revenue. The value is conservative, but appropriate since access to increase POP is controlled by regulation/licensing and not necessarily the actions of McCaw. $1,690 The 2002 FCF determined in Figure C1 $13,371 Determined by discounting the 2003 FCF byWACC – Growth Rate (i.e. 13.65% - 1%).
2003 Free Cash Flow (millions) Terminal Value (millions)
Table C5: McCaw’s Terminal Value
Figure C2: McCaw DCF Valuation (Base Case) – LIN Shares Purchased
Figure C3: McCaw DCF Valuation (Base Case) – LIN Shares Sold Effective Jan 1, 1996
The Effect of the LIN Divestiture or Acquisition on Valuation
Analysts8 believed that in the share price of LIN would fall between $95 and $120. The September 1992 share price was $67.70 (case exhibit 8). Based on the above assumption the cost to purchase the balance of LIN shares or proceeds from selling current shares is as follows:
LIN Share Price: premium on Sep 1992 price $95 40.3% $100 47.7% $105 55.1% $110 62.5% $115 69.9% $120 77.3% Average 58.8%
Case materials (page 8)
Appendix C: Valuation Using Discoun
Sale Proceeds (000) Purchase Cost (000) $2,733,253 $2,523,002 $ 2,877,108 $3,020,96 $3,452,53 $3,164,81 $3,308,67 3 0 9 4 $2,788,58 $2,921,37 $3,054,16 $3,186,95 $2,655,792 2 1 1 0 $ 3,092,891 $ 2,854,976
Table C6: Accounting for LIN Shares
Figure C3 above depicts the resulting valuation should McCaw sell its current interest in LIN in 1995. In 1996 there is a signiﬁcant improvement to cash ﬂow resulting from the sell. The average sale proceeds of $3.09 billion as detailed in Table C6 were ﬁgured into the valuation. As indicated in Table C6, McCaw will likely require $2.85 billion dollars to purchase the remaining 48% of LIN shares. Obviously the purchased can be ﬁnanced through many means at different cost. Table C7 indicates a possible cash and credit sources available. It is possibly that the LIN shares can be purchased without having to issue new debt and incur an increase in costs likely due to McCaw’s poor credit rating. While circumstance will dictate McCaw’s course of action in 1995 given their current high cost of equity (21.5%, Table C2) and debt (12.5%, Table C3); revolving credit, loans and cash equivalents will be the least costly.
Funding Source Current Assets (Cash, Securities, Receivables) Available Revolving Credit/Loan Agreement Available Credit from LIN Facility Long Term Debt Repayment
Available Credit (millions)
Notes $607 As of September 30, 1992 from case exhibit 7 (Balance Sheet) $1,210 As of December 31, 1991 from case exhibit 9 $299 As of December 31, 1991 from case exhibit 9
Cash Flow From Operations Total Available Funds
up to $1,173 According to case exhibit 9 $1,173 in LTD payments will occur by the end of 1995. A portion of these payments will increase available credit to McCaw. $1,309 1993 to 1995 from Figure C2 $3,425 to $4,598
Table C7: Available Funding Sources
McCaw’s cost of equity (COE) in 1995 will be hard to determine. The pending purchase of LIN shares will likely drive stock price up but BETA will be unknown. The cost of issuing new debt given McCaw’s bond rating in September 1992 will be under 12% (see Table C3); AT&T/McCaw Negotiation
Appendix C: Valuation Using Discoun this is slightly below its current rate 12.5%. Given McCaw’s high COE and current debt-toequity ratio it would be more favourable to issue debt to reduce WACC. Nonetheless the possible rise in COE and decline in COD and weight shift towards COD may in fact produce neglible net change in WACC. Because this is highly speculative the WACC used in the valuation for 1996 and beyond (after purchasing LIN) will remain the same as before (i.e. 13.65%). Note: the effect of an increase or decrease in WACC on valuation is considered in the Sensitivity Analysis below.
Appendix C: Valuation Using Discoun
Appendix C: Valuation Using Discounted Cash Flows22 SENSITIVITY ANALYSIS
Penetration Direct Mktg. D&A CAPEX NWC incr. Tax Growth Cost Expens Incr. (%) incr. per per subs. Rate Incr. (%) e Incr. subs. (%) (%) (%) Initial/Base Case 16% 17% 21% 11% --------2.5% ---2.5% -7.5% -4.5% -3.0% ----12% --------7% -17% --5% ---------0% 0% ----------0% ----------36% ---------------Change in Annual Penetration Growth (+1%, +5%, - 5%) -----------------14.65% 18.65% 12.65% 11.65% 8.65% -----------------------------3% 6% 0% ----------------------------3% 6% -1% $ 7,907.89 $ 9,522.85 $ 5,999.18 $ 5,739.57 $ 8,757.53 $ 8,092.35 $ 7,693.50 $ 6,884.13 $ 7,989.88 $ 8,433.34 $ 6,961.29 $ 7,397.97 $ 7,700.82 $ 7,556.07 $ 7,542.72 $ 7,135.90 $ 7,962.89 $ 7,100.23 $ 5,732.64 $ 8,059.64 $ 8,645.48 $11,107.36 $ 8,247.36 $ 9,978.60 $ 7,277.11 $ 8,399.05 $ 9,856.48 $ 6,789.05 4.8% 26.1% -20.5% -24.0% 16.0% 7.2% 1.9% -8.8% 5.8% 11.7% -7.8% -2.0% 2.0% 0.1% -0.1% -5.5% 5.5% -5.9% -24.1% 6.8% 14.5% 47.1% 9.3% 32.2% -3.6% 11.3% 30.6% -10.1% WACC Growth in1996 Rate beyond POP Valuation Growth Δin Valuation (from base) --
Change in Direct Cost Increment (+5%, - 5%, -2%,-0.5%)
Change in Marketing Expense Increment (+5%,-5%)
Change in D&A Increment (+5%,-5%) ----10% --Change in CAPEX per subscriber increment (+5%,-5%) ----5% --------------5% ---5% -5% Change in NWC per subscriber increment (+5%,-5%)
Change in Tax Rate (+5%,-5%) ------41% ------31% Change in 1996 and beyond WACC (+1%, +5%, -1%, -2%,-5%) -------------------------------------------------------------------------------------
Change in growth rate (+2%,+5%,-1%)
Change in POP growth (+2%,+5%,-2%,-5%)
--AT&T/McCaw 5,800.63 -4% $ Negotiation -23.2%
Appendix D: Negotiations23
Table C8: Sensitivity Analysis
VALUATION INCLUDING IMPROVEMENTS Based on the sensitivity analysis provided in Table C8 several “levers” are available to both positively and negatively effect McCaw’s valuation. The extent to which these levers are available to McCaw as a standalone entity compared to the synergies and future options that could be realized as a merged entity are detailed in the following sections. Improvements (McCaw Standalone)
Type Description Financial Impact (millions) Additional phone services offered (e.g. data) and improved cellular phones may $358.9 attract more customers. Estimated result is 1% increase in penetration and 4.8% increase in valution (see Table C8) Operational improvements post LIN buyout. Estimated result is 0.5% reduction in direct cost and 1.9% increase in valution (see Table C8) Purchase LIN shares with debt (as opposed to equity or cash) to reduce WACC. D/E ratio is currently 0.95, skewing ﬁnancing structure to be more debt weighted could drop WACC from 13.65 to 12.65% (from 1996 forward), resulting in an 6.8% increase in valution Total Financial Impact
Table C9: Value of McCaw Improvements
Based on the above, the base valuation can be increased by$1.02 billion should McCaw execute the noted actions.
Appendix D: Negotiations24 VALUATION INCLUDING AT&T SYNERGIES AND FUTURE OPTIONS AT&T’s Cost of Capital
Value Rationale/Source Market Return 15.36% S&P average monthly return from 1987 to 1991. Return taken over 5 year period to taken into account the recession of 1990-1991. Using ﬁgures for those years alone would skew market returns and not be an accurate representation of general market performance. 6.71% US 10 year treasury bond yield as of Dec 31, 1991. 0.85 As of Dec 31, 1991 based on 5 year average (as provided in the case exhibit 15). This beta is more appropriate for use than the value of 0.97 provided in case exhibit 8 because of the general volatility resulting from the recession as noted above. 14.06% COE = Risk Free + Beta*(Market Return – Risk Free Rate)
Risk Free Rate McCaw Beta
Cost of Equity
Table C10: AT&T’s Cost of Equity
Debt Source 4.50%-5.88% 1995-2006 Bonds 6.12%-6.88% 2000-2024 Bonds 7.00%-7.75% 1994-2025 Bonds 8.25%-9.63% 1996-2024 Bonds Cost of Debt
Rate Amount (millions) 5.88% $500 6.88% $350 7.75% $800 9.63% $2,750 8.64% Total = $4,400. Take weighted average of above to determineCOD
Table C11: AT&T’s Cost of Debt
Value Rationale/Source Shares Outstanding Stock Price Market Value of Equity (E) Book Value of Debt (D) Total Value of Equity and Debt (V) D/V E/V Cost of Equity Cost of Debt WACC 1,309,352,000 Class A & B common stock.From case exhibit 7 (1991/2 Ann. Report) $39.13 From case exhibit 4. $51,234,943,760 Shares Outstanding*Stock Price $8,484,000,000 Long Term Debt from case exhibit 9 $ E+D 59,718,943,760 14.21% Weight of Debt 85.79% Weight of Equity 14.06% From Table C10 5.53% From Table C11 (after tax) 12.57% Weighted Cost of Debt and Equity. Highly negatively skewed by relative weight of equity. Appropriate to use given the likelihood of equity being the primary currency of any negotiated deal.
Table C12: AT&T’s Weighted Average Cost of Capital (WACC), as of December 31, 1991
Appendix D: Negotiations25 Synergies (AT&T and McCaw)
Type Description Financial Impact (millions) Incremental revenue from bundling long distance services with cellular plans. Merger $16.95 would give AT&T access to McCaw’s nearly 60 million potential customers and 1.3 subscribers (in 1992, expected to grow to 79 million and 7.4 million respectively by 2002). See Figure C4 for calculation of incremental long distance revenue. Projection considered quite conservative given the $30 billion plus in revenue long distance generates for AT&T. AT&T’s SG&A expense averaged 24.2% of sales in 1989-1991 (case exhibit 2). McCaws’s $543.4 SG&A expenses are buried in operating expenses and not reported separetly. Nonetheless the consolidation of staff and integration of processes, channels etc will likely produce cost savings. Base case factored a 2.5% decrease with McCaw alone; with AT&T the factor can reasonably decrease a further 2% to 4.5% - increasing the valutionby7.3% (see Table C8) Marketing savings (as a % of sales) from increased advertising power dereived from the beneﬁt of from AT&T brands and consolidated marketing efforts. Base case factored a 12% decrease with McCaw alone; with AT&T the factor can reasonably decrease 5% to 17% - increasing the valutionby5.8% (see Table C8) Local Access Fee Reductions. Access fees are typically 45-50% of long distance revenue. In 1991 fees would have amounted to $17.5 billion on $38.8 billion in telecomms revnue (case exhibit 2). Given McCaw’s national presence fee savings could be conservatively estimated at 5% or $873 mllion annually (since cell network will likely only be used to route long distance calls during off-peak hours). A declining future growth rate of 5% was factored into terminal value. Consideration for this saving will be valued from 1996 forward discounted to 1993 using 12.57% WACC (from above) More aggressive D&A expense increment as assets are consolidated and written off.
Base case factored a 5% annual decrease with McCaw alone; with AT&T the factor can reasonably increase 5% or ﬂatten to 0% - increasing the valutionby11.7% (see Table C8) Financing Reﬁnancing debt at AT&T’s lower WACC of 12.57% as shown in Table C12. Increases valutionby 7.3%. Effective Jan 1, 2006. Total Financial Impact
Table C13: Value of AT&T-McCaw Synergies
Based on the above, an increase in valuation of $6.75 billion can be attributed to potential synergies. Intangible (or soft) synergy beneﬁts also include access to state-of-the-art technology (without the investment), access to customer databases, and access to sales channels.
Appendix D: Negotiations26
Figure C4: Incremental Long Distance Revenue Assumptions: 1. Subscribers from Base Case 2. Monthly roaming revenue per subscriber (case exhibit 13) used as proxy for long distance revenue 3. AT&T’s net proﬁt rate was 5.1%, 5%, 0.8% in 1989, 1990 and 1991 respectively (case exhibit 2). Average rate of 3.6% used in calculations 4. Net Income discounted to 1993 using WACC rate of 12.57% used (see Table C12) with a conservative (relative to growing cellular market) terminal growth of 1%.
Future Options (AT&T and McCaw)
Type Description Financial Impact (millions) Convergence of Cellular/PCS with AT&Ts computer and data services to offer unique -services. Difficult to evalute dollar impact to wireless business. Entry into foreign markets with poor infrastructure and strong population growth. -Difficult to evalute dollar impact to wireless business. Increase in average revenue per subscriber by offering additional service via phone $1,973.85 (supported via upgrade to digital network).Related to ﬁrst point.
Revenue Revenue Revenue
Estimated result is 5% increase in penetration and 21.6% increase in valution (see Table C8) Revenue/Cost Expanding into markets not currently served by McCaw. This will be a future $2,307.48 endeavour because LIN purchase will have to be absorbed and allow for breathing room once (if) regulatory hurdles from purchase are cleared. Expand into markets not currently served: - Not in 5 of 10 most populated metropolitan areas - Room to grow in rural areas (80% of licences in populated areas). Estimated result is 5% increase in POP and 30.6% increase in valution (see Table C8) Total Financial Impact $4,281.33
Table C14: Value of AT&T-McCaw Future Options
Appendix D: Negotiations27 Based on the above, an increase in valuation of $4.29 billion can be attributed to future options if exercised.
Appendix D: Negotiations28
APPENDIX D: NEGOTIATIONS
Table D1 details the components of a possible negotiated offer price.
Item Description Price Impact (+/-) Average of Comparable Transactions of $15,907 (Figure B1) and As-Is + DCF of $7,549 (Figure C2) As detailed in Table C9 + As detailed in Table C13 + AT&T will keep 80% as most other potential suitors are not able to realize similar value of synergies (e.g. access fee savings) • BT owns 20% of McCaw or 36,455,755 shares bought at $41.50/ share. At this rate they need an offer of $1,512,913,866 to break even. Prorated, this translates to a minimum offer of $7,564,569,329. This is covered in the As-Is valuation and requires no additional premium. Price Impact (millions) $11,728 $1,015 $6,755 $5,404 $1,409
As Is Improvements Synergies AT&T keeps part of Synergy Value Transaction and Integration Costs
McCaw’s share price as of Sept 1992 is $24.38.Recent transactions show an average premium of 54.1% on preannouncement stock prices (case exhibit 1); this bumps McCaw’s effective share price to $36.81. At this price McCaw is valued at $6,709,681,855. This is covered in the As-Is valuation and requires no additional premium. Craig McCaw will be offered a position post-acquisition so no extra allocation for payout needed. General T&I deduction of 10% of As-Is, Improvements and Synergy-portion price. Given AT&T’s cash position, high stock price and likely value of the deal a signiﬁcant portion of the deal will have to be ﬁnanced by equity. Prime Rate at 4 year low (case exhibit 18). No premium for capital needs to be considered.
• Transaction Structure and Terms Prevailing Stock Market / Economic Conditions
• • •
S&P 500 performing 23% better in 1992 than 1990-1991 (case exhibit 18), this is already reﬂected in McCaw’s share price (case exhibit 8). No premium needs to be considered. • Dollar value of deals down in 26% in Q392 compared to Q292. Deduct 5% of value of As-Is, Improvements and Synergyportion McCaw may ﬁnd it difficult to purchase balance of LIN shares without a partner given the cost, its debt position and cash position. As-Is valuation without purchasing LIN shares is $7,259 (Figure C3); a difference of $320 million. Attribute 50% of the difference to AT&T. Negotiated Price
Table D1: Components of McCaw Acquisition Price
Appendix D: Negotiations29 Opening Offer (negotiated price excluding entire synergy portion): $10,469 Negotiated Price (including 20% of synergy): $11,820 Walk-away Price (includes 50% of synergies): $13,847
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