Number Contributio
n
Karen Chan z3242429 20
Yifeng Chen z3283995 20
(Nino)
Tony Richardson z3253113 20
Weitao Wu z3284666 20
(Tony)
Wendy (Wenyu) z3241580 20
Yan
1
Multiples versus DCF analysis
Multiples analysis is simple to understand and apply. The inputs for the multiple are
relative value rather than the intrinsic value which DCF valuation produces.
DCF analysis generates an intrinsic value as it relies on data specific to the firm. DCF
General assumptions of multiples analysis are that the other firms in the industry are
comparable to the firm being valued. The market, on average, prices these firms
correctly, but makes errors on the pricing of individual stocks. Exhibit 2 shows a
selection of comparable firms, assuming that these firms have the same growth, risk
and return as Cox Communications. There is also the assumption that financial
fundamentals such as EBITDA are defined identically in all firms, with the same
Invested Capital.
differences
The two analyses both predict the underlying value of the firm. Also, both regression
2
and multiples analyses reflect the past. The future value of the firm is obtained using
historical inputs. Both analyses assume that firms in the same industry are
comparable.
the average multiple among comparable firms, and then applying it to the firm’s
multiple against the fundamentals that affect the value of the multiple. The R
squared of the regression indicates how well that multiple works in the sector. After
Martin’s regression results produced a higher share price of $50 (see A1), indicating
that shares were currently undervalued and so Cox Communications does have
growth potential.
Martin’s heavy reliance on the projection of the ROIC value is troubling. The 0.8%
the variation in Adj. EV/Ave. Invested Capital. However, it does tell us that ROICs are
a substantive prediction of value. The linear relationship between ROIC and the
analysis
Martin’s weighted cost of equity is 10.5%. We have calculated the cost of equity to
be 13.61% (see A2) using a levered beta and a risk premium calculated over a longer
historical period. Using the synthetic rating method, aftertax cost of debt is 4.51%
3
(see A3), which is close to Martin’s estimate. Thus, with a WACC of 12.53% the stock
Martin’s projected EBITDA growth of 16% seems high since her forecasted revenue
growth is only 14.2%. Hence, once other expenses are included, it is unlikely that
EBITDA will retain growth at a higher rate than revenue. Conducting sensitivity
analysis with more conservative EBITA growth at 14% and 12% resulted in share
Martin assumes an increase in capital spending in the first 2 years on new digital
technology services, and then a fall to a constant rate, resulting in a fall in asset
intensity from 2003. But there is still 0.8% increase in ROIC as well as a forecasted
growth in EBITDA of 16% and EBIT of 33%. These forecasts seem contradictory. Also,
Martin has not taken into account the value of the empty cable channels.
Substituting the terminal value into the horizon value formula using a WACC of 9.3%
and 12.53% results in a growth rate of 4.4% and 7.49% respectively (see A7). Both
stable growth rates seem reasonable, as FCF has been growing at a high rate (up to
474% in 2001). So we can conclude that the terminal value of 13x is reasonable, but
Of the 750 MHz capacity in an upgraded cable plant, there are 17 unused channels
(102 MHz), referred to as the “stealth tier”. DCF analysis does not account for these
The real option within this project is the “stealth tier”. It gives the company the right,
but not the obligation, to obtain revenues from the unused cable channels,
depending on market conditions. It allows the firm to calculate the intrinsic value of
the underlying real project, unaccounted for in DCF analysis. Real options analysis
will also allow managers to adjust business strategies according to market situations.
Ways the “stealth tier” can be incorporated into DCF and multiples analysis
4
A qualitative assessment of the real option, which can be added to DCF analysis,
shows that the value of the stealth tier would increase the value per share that is
The “stealth tier” could also be valued using decisiontree analysis (see A9). An
investment timing option could also be incorporated, which would allow Cox
Including the stealth tier option would impact the multiple analyses based on
invested capital (see A10) and also EBITDA. For an effective valuation however, Cox
How is the stealth tier like a call option? Applicability of Martin’s option
analysis
The stealth tier is similar to a call option as the company has the right but not the
Therefore the decision of whether to use this capacity is a real option as the stealth
tier has a value and a cost (see A11), and it is up to management as to it being
exercised or not.
Martin used the BlackScholes model to value this stealth tier. Inputs from the real
option illustration can be obtained as required by the BlackScholes model (see A12).
Thus it appears that the BS model can value the stealth tier due to it resemblance to
a call option, and that the 14% premium on net value of the stealth tier per home
Some issues retracting from the reliability of such analysis include the degree of
since BS model assumes that options are exercised only at maturity, there may be
5
extra value from exercising the stealth tier before maturity.
Conclusion
Looking purely at Martin’s analyses, all her valuation methods show that Cox
multiples, regression and DCF analysis don’t take into account the value of the
stealth tier. The BS model using real option equivalent inputs results in a value of the
stealth tier of $381.65 per home passed which is at a 14% premium. It is advisable
that investors purchase Cox. Most analyses reveal that the stock is undervalued.
There is growth potential for the firm, with new developments in digital technology
APPENDIX
A1. Martin assumed a 0.8% increase in ROIC. This, combined into the regression
Applying this target multiple to fundamentals, and after adjustments were made,
Martin arrived at an implied value of $50 for Cox’s share, higher than the current
price of $37.50. [
reduce the uncertainty in forecasting 10 year EBITDA and free cash flows, though a
A levered beta of 1.54 rather than an equity beta of 1.07 should be used to reflect
the financial risk arising from debt. However, the levered beta is sensitive and
6
Also, a risk premium of 5.51%, calculated over a longer historical period should be
AR GR AR GR
1928
2000 8.41% 7.17% 6.53% 5.51%
1962
2000 6.41% 5.25% 5.30% 4.52%
1990
2000 11.42% 7.64% 12.67% 7.09%
In terms of the cost of debt, the synthetic rating can be an alternative to work out
the spread and then added to the riskfree rate, with an aftertax cost of debt of
7
Hence the Cox Communication is within BBB rating with spread 2.25%
Using a credit scoring model, the Altman Z Score Model, we evaluate the riskiness of
Cox Communications.
Therefore, even with an unknown X1, the Zscore is greater than 2.99. This indicates
12.53%
Thus, with a WACC of 12.53% the stock price becomes a more conservative $41.70.
8
199
Year 8 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 CACG
EBITDA 659 800 924 1047 1214 1408 1634 1895 2198 2550 2958 16.2%
Less: Depn
and Amort 458 607 680 674 644 616 591 569 549 531 515 1%
EBIT 201 193 244 373 570 792 1043 1326 1649 2019 2443 28%
amortization 84.7 104.1 107.2 107 107.1 108 105.6 108.3 108.1 106.7 108.4
Less:
Taxes(EBIT+A
mortization at
35%) 100 104 123 168 237 315 402 502 615 744 893 24%
Plus:
Depreciation
and
Amortization 458 607 680 674 644 616 591 569 549 531 515 1%
Less: Capex 978 1040 750 587 517 261 261 261 261 261 261 12%
1131.99
FCF 419 343.985 51.08 292 460.015 832 970.99 5 1322.015 1545.005 1804.01
growth 21.8% 114.8% 471.7% 57.5% 80.9% 16.7% 16.6% 16.8% 16.9% 16.8%

PV of FCF @ 305.6829 40.337989 204.91695 286.87897 461.08578 478.19479 495.411 514.14999 533.96773 554.05866
WACC 12.53% 419 29 71 55 32 35 43 72 02 97 58
Terminal
Value of
2008E Total 3845
EBITDA 4
Equity Valuation
Analysis Value % DCF Shares Outstanding @ 9/30/99 565.2
2844.319
PV of Unlevered FCF 683 12.07% Discounted Cash Flow Value/Share $41.70
PV of TV discounted 11810.22
to 1999 94 50.11% Current Share Price (4/26/99) $37.50
6
(Long term Debt at
12/21/99E) 3800 16.12% Discount to DCF Value 10.07%
NonConsolidated
Assets, PMV 12292 52.15%
WACC 12.53%
7
A6.
Year 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 CACG
1161.383 2046.754
EBITDA 659 738.08 826.6496 925.8476 1036.9493 2 1300.7491 1456.8390 1631.6597 1827.4589 0 12.0%
Less: Depn
and Amort 458 607 680 674 644 616 591 569 549 531 515 1%
1531.754
EBIT 201 131.08 146.6496 251.8476 392.9493 545.3832 709.7491 887.8390 1082.6597 1296.4589 0 23%
amortization 84.7 104.1 107.2 107 107.1 108 105.6 108.3 108.1 106.7 108.4
Less:
Taxes(EBIT+A
mortization at
35%) 100 82 89 126 175 229 285 349 417 491 574 19%
Plus:
Depreciation
and
Amortization 458 607 680 674 644 616 591 569 549 531 515 1%
Less: Capex 978 1040 750 587 517 261 261 261 261 261 261 12%
growth 9.0% 108.1% 1848.3% 61.7% 94.7% 12.3% 12.3% 12.6% 12.7% 12.7%
 
PV of FCF @ 341.4493 9.632598 149.65317 215.10981 372.2486 371.51683 370.76846 370.98255 372.1447
WACC 12.53% 419 91 22 5 8 62 24 08 4 371.65185 94
Terminal 26607.8016
Value of
2008E Total
8
EBITDA
Equity Valuation
Analysis Value % DCF Shares Outstanding @ 9/30/99 565.2
1823.994
PV of Unlevered FCF 156 9.65% Discounted Cash Flow Value/Share $33.46
PV of TV discounted to 8171.951
1999 96 43.21% Current Share Price (4/26/99) $37.50
NonConsolidated
Assets, PMV 12292 65.00%
WACC 12.53%
Year 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 CACG
EBIT 201 144.26 176.4364 302.3375 469.0247 652.8482 855.4870 1079.995 1330.854 1612.0341 1928.058 25%
9
1 5 8
amortization 84.7 104.1 107.2 107 107.1 108 105.6 108.3 108.1 106.7 108.4
Less:
Taxes(EBIT+Amorti
zation at 35%) 100 87 99 143 202 266 336 416 504 602 713 22%
Plus: Depreciation
and Amortization 458 607 680 674 644 616 591 569 549 531 515 1%
Less: Capex 978 1040 750 587 517 261 261 261 261 261 261 12%
growth 11.5% 111.3% 3335.0% 60.3% 88.0% 14.5% 14.5% 14.7% 14.8% 14.7%

PV of FCF @ WACC 333.8363 5.657158 172.6842 245.9477 410.96007 418.1694 425.4309 433.7246 442.54451 451.2599
12.53% 419 10 25 01 20 1 1 33 97 5 31
Terminal Value of
2008E Total EBITDA 31759.765
2253.542
PV of Unlevered FCF 33 10.77% Discounted Cash Flow Value/Share $37.02
9754.254
PV of TV discounted to 1999 7 46.62% Current Share Price (4/26/99) $37.50
NonConsolidated Assets,
PMV 12292 58.75%
20922.79
Discounted Cash Flow Value 703 100.00%
10
Terminal Multiple 13.00
WACC 12.53%
11
A7. Horizon Value Formula:
TV = FCF(1+g)/(WACC – g)
TV = FCF(1+g)/(WACC – g)
A8. Considering that the current price (or value of the option) is calculated as $23.15
per channel/per home, and the exercise price is $1.22 (opportunity cost of profit
passed) the option is valuable (the current price is significantly larger than the
exercise price).
In addition, the option has an estimated 10 year life, which adds value as the holder
Finally for this scenario, the riskier the underlying, the more valuable the option.
A9. Cash flows for the next 10 years generated under the stealth tier can be
projected under different market condition scenarios. The cash flows under each
scenario can then be discounted back to the current time, and the weighted average
tier”
9
102MHz/750MHz = 13.6% unused 750MHz cable plants
A10. Based on the calculations the driver of enterprise value is the return on
invested capital (ROIC). ROIC would increase should the real option be exercised, as
EBITDA increases therefore increasing the return that is used when calculating ROIC.
A11. This means that for the company, the stealth tier has a potential value (i.e.
value per channel times number of channels) and a strike price (which in this case is
likened to the opportunity cost of profit forgone if the project is not implemented).
A12.
It is estimated that the current value per channel for the stealth tier is $23.15. This
10
is based on calculations using the currently implemented channels and is the current
value because it signifies the value that Cox Communications could receive should
one of the stealth channels be used. The strike price is the cost for Cox
Communications to acquire the asset worth $23.15, i.e. to light up one channel. In
this case, there is no actual cost to be incurred as the capacity is already there, so
opportunity cost of foregone profit is used i.e. if the channels are lit, there is an
= 2.984
d2 = d1 – 0.5√10
= 1.403
BIBLIOGRAPHY
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3. Saunders, A. et al (2007) Financial Institutions Management, McGrawHill.
12