You are on page 1of 13

Case 2: AT&T: The AT&T/McCaw Merger Negotiation

Sean Moore 211 836 509 March 3 2012

It represents the perfect opportunity for Allen to achieve his “Anytime. Key Stakeholders Analysis Careful analysis of each of the key stakeholders in the potential merger is required in order to further analyze this merger. For instance. however US law prohibits foreign firms from owning more than 20% of radio licenses (case page 17). If a merger were to take place. McCaw and his family hold 63% of the company’s voting control (Case. Thus. British Telecom (BT) US Government Valuation Three valuation methods were employed in order to determine a base valuation for McCaw Cellular. as far as McCaw’s valuation is concerned.Introduction McCaw Cellular is a high-growth American cellular firm with a strong national presence. Mr. such as NCR. It is unlikely that the Department of Justice would allow such activity. this opportunity presents more apparent synergies between the two companies than did past acquisitions. and provide a suggested strategy. Allen is “less concerned about the purchase price than the opportunity to enter the cellular market. and to leverage AT&T’s 65% market share (Case page 4) of long-distance communications to achieve explosive growth in the cellular communications industry. BT’s investment basis was at $41. not only to the broader industry. Exhibit 16). who oversaw the divestiture of AT&T’s monopoly. Anywhere” vision. Moreover. McCaw is McCaw Cellular’s founder. It is clearly stated in the case that Judge Greene. analysts would look favourably upon the merger. The comparable transaction valuation. meaning that its investment currently stands at a roughly 40% loss (Case page 17). The following is a list of selected stakeholders: Robert Allen AT&T CEO As mentioned. Allen’s past acquisitions have yielded an ambiguous reaction (Case page 4). would have intended to prohibit this activity had cellular technology existed when he established the current regulation. Anywhere” vision for AT&T. but likely to AT&T. According to the case. Robert Allen is eager to pursue the McCaw acquisition in order to achieve his “Anytime. BT has held a 20% stake in 1989 in order to participate in the growth of the North American telecommunications market (Case page 17). Throughout the case it is implied that AT&T can use McCaw’s cellular network to circumvent local access fees it is forced to pay to local telephone companies. he undoubtedly has a particular number in his head. on page 16. Undoubtedly. high-leverage (Appendix B) growth strategy in order to purchase as many cellular licences as possible. he would likely require a position within the newly merged company and some level of control over its operations (Case page 17). He has pursued an aggressive.50 a share. More importantly. His shrewd acquisitions at low Value/POPs show that he understands the value of cellular. Value Line summarized AT&T’s return potential as “unexciting” (Case page 4). in Appendix A uses information from Exhibit 14 . BT would like control of McCaw. Craig McCaw McCaw CEO Mr.

The only negative statement made about the company is its high leverage. Instead. Finally. in Appendix F.63 Premium to Current 182% 152% -51% Post-Merger Valuation Appendix H summarizes the sensitivity analysis conducted after the valuation. as McCaw likely trades at a considerable discount due to the dual-class share capital structure. Figure 1: Summary of Valuation Results Comparable Transaction DCF Adjusted Comparable Valuation (US$M) 12. based on the Value/POP of past transactions in the cellular sector. the lengthy Discounted Cash Flow (DCF) valuation. due to the poor quality of information in Exhibit 15. based on information in Exhibit 15. McCaw will have the financial strength to purchase LIN by year-end 1995. or $61. and that either involves a considerable premium to McCaw’s current share price. as a share of revenue. separately. A summary of the value of post-merger synergies and strategic opportunities is provided in Appendix J.90 37. rather than the 16% rate in the base case.388 2. As is explained in Appendix K. Synergies used in the valuation include a faster decline in direct and marketing costs.71 61. In the financial model. McCaw’s valuation is much higher when it purchases LIN. This is because there was no indication in the case that McCaw requires operational improvements. Presumably. yields a valuation of $11.388 million. Appendices B to E. This is reasonable because there are likely a number of redundancies between McCaw and AT&T that will become clear to management over time. Finally. comparable analysis is conducted in Appendix K. this valuation will not be used in the post-merger valuation. resulting in a valuation of $12. Note that the option to purchase LIN Broadcasting cannot be incorporated into this valuation.to determine a multiple. Note that the DCF valuation allows us to consider the cases where McCaw purchases LIN. This assumption is based on McCaw’s industry high Debt-to-Equity ratio (Exhibit 15). As noted in Appendix F.210 Share Price 68.753 11. This should not alarm the reader.753 million. Thus the rest of this analysis assumes that McCaw will purchase LIN Broadcasting. it is assumed that AT&T can consolidate McCaw’s debt with its own. this translates into a larger increment for direct and marketing costs. This sensitivity analysis was used to guide estimates for possible post-merger synergistic and strategic benefits. and that the case directly implied that the company’s high leverage has severely limited its financial flexibility. It has been assumed that AT&T has no opportunity to make operational improvements to McCaw.15 193. Next. which is addressed as a synergistic benefit. as it has been assumed that a stand-alone McCaw cannot raise the capital required to purchase the company until the end of 1995.71 per share. Figure 1 below summarizes the results of the three valuation methods. As with each of the three valuation methods. The valuation of LIN is conducted in Appendix E. and divests it. This translates into an 18% penetration growth rate. This multiple is then applied to McCaw’s POPs. key assumptions are explained in the Appendix. An additional synergistic benefit is McCaw’s ability to use AT&T’s brand name and reach. an average of the comparable transaction and DCF valuations will be used as the base value of McCaw.91 Value/POP 217. Using AT&T’s cost of debt. given that its operating cash flows are healthy in the financial forecast in Appendix D. calculated in . and G all explain the assumptions that went into the DCF model.36 11. This table shows clearly that only the DCF and Comparable Transaction valuations are appropriate.

a “fair” offer would incorporate some.608 15. this will likely be an appealing offer. AT&T can offer Mr. If he chooses to hold onto his stake. . as the maximum offer price includes post-merger strategic benefits. but not all of the post-merger synergistic benefits. After the purchase. roughly $1 billion of LIN’s current equity value. Strategic options available to AT&T after the merger include the purchase of LIN sooner than year-end 1995. as is mentioned on page 7 of the case.e. AT&T can shed non-core assets at LIN. As Figure A10 in Appendix H shows. and the divestment of non-core assets. which are highly speculative. McCaw options to sell his stock at the maximum valuation (i. whose investment in McCaw is currently underwater. It is suggested that AT&T offer a stock-swap. Similarly BT. The 100% Synergy-based price serves as an acceptable upper bound for a potential purchase price. It is suggested that Robert Allen do as much as possible to keep the price at or below the synergy-based offer. to raise additional debt to purchase LIN sooner.57 Value/POP 205. and as such it is necessary to offer him generous compensation. in order to ensure that negotiations progress smoothly. it is recommended that AT&T push for a full purchase of BT’s stake. given his invaluable experience in the cellular sector. a driven entrepreneur who is as interested in developing the cellular industry in the US as in the monetary gain associated with the venture. The maximum valuation of over $16 billion is the walk-away price.57 Premium to Current 167% 201% 235% 255% Premium to BT 57% 77% 97% 109% Table 2 summarizes potential offers for 100% ownership of McCaw Cellular.144 16. at 86. In addition.067 Share Price 65. After doing so. Craig McCaw likely has a firm idea of what McCaw cellular.Appendix I. McCaw will be integral to McCaw Cellular’s success. Consequently. resulting in lower direct and marketing expenses. Table 2: Offer Summary Minimum 50% Synergy-based Synergy-based Walk-Away Valuation (US$M) 12. It is suggested that AT&T open with an offer that incorporates 50% of the post-merger synergistic benefits. Mr. Doing so signals to McCaw that AT&T is willing to admit that McCaw is very valuable to the firm. in the form of lower interest payments. it is advised that Robert Allen provide a fair offer to both parties. we arrive at an annual savings of $64. AT&T can grant Craig McCaw the option to sell his stake. Finally.70 257. This is possible because. AT&T must dissolve the dual-class share capital structure.86 273. likely has a firm idea of what McCaw cellular is worth to AT&T.04 73. Negotiation Strategy As noted in the stakeholder analysis.071 13.57 per share). shown in Appendix I. is derived from the non-cellular segment. or to hold onto it after the merger.7 million. For Craig McCaw. given that the opening offer is 77% above BT’s purchase price. in order to gain control of McCaw. as well as incentive to continue on with McCaw after the merger. In my mind.32 81.59 86. it is clearly to McCaw’s benefit to purchase LIN sooner rather than later. Sale of this segment will result in a simpler corporate structure. Using debt or AT&T’s cash reserves is not advisable as the synergistic and strategic benefits are predicated on AT&T’s ability to raise additional debt.53 231. but also signals that AT&T’s participation in McCaw’s growth is very valuable as well. AT&T can leverage its very conservative capital structure.

6 Share Price $61.95% 14.71 Comparable transaction analysis yields a valuation $12.753 Shares Outstanding. a weighted average provides a better approximation of the applicable Value/POP.00% 12. As such.11 217.80 0.91 137.707.84% 0.00% 8. 1998 Convertible SubDebentures.75% 13.86 279. Comparable Transaction Valuation Weighted Mean Value/POPs $ 217.40 $ 528.73 McCaw Value (Mil. 1994 Senior SubNotes. FD (Mil.15 McCaw POPs 58.10 $ 6.90 2.50 6. The resultant share price of $61.43 0.03% 0. Appendix B: McCaw Weighted Average Cost of Capital (WACC) Figure A2: McCaw Long-term Debt Structure (Exhibit 9) Type Revolver LIN Broadcasting Facilities Senior Notes. 1996 Senior SubDebentures.71 represents a 177% premium to McCaw’s share price of $24.22 6.00% 0.14% 0.900 13 35 1.11% 12.38 as at September 30 1992.33 202.50% Outstanding $ 3.04 172.10 $ $ $ $ $ $ $ $ $ $ Value/POP 213.40 Cost of Debt 3.25% 0.76 133.47% 0.82 213.51% 2.00 $ 123.70 3. 1999 Senior SubDebentures.Appendix A: Comparable Transaction Figure A1: Comparable Transactions (Exhibit 14) Purchaser Bell Atlantic McCaw Cellular Comcast BellSouth BTE McCaw Cellular Time Warner Price Communications Contel Weighted Mean Target Metro Mobils Crowley Cellular Metromedia McCaw Cellular Providence Journal Metromedia Pricellular Utica McCaw Cellular (SE) Date Sep-91 Jun-91 May-91 Apr-91 Oct-90 Aug-90 Mar-90 Mar-90 Jan-90 $ $ $ $ $ $ $ $ $ Value 2.90 -$ 48.61 4.5%.76% .24% 0.450 105 675 360 710 1.15 With a correlation of 60. 2008 Other Convertible.93 159.41 30.00 $ 2. it is clear that there is a relationship between the Targets’ POPs and the Value/Pop of the acquisition.40 $ 146.29% 1.40 $ 74.20 $ 272.76% 7.10 $ 114.00% 11.10 $ 396.100.) $ 12.753 million. 2008 Other Current Portion Total Debt Rate 7.50 0.) 185.000.300 POPs 11.00% 8.

41% -12. using the total approved revolver more accurately captures McCaw’s cost of debt.86 417.525 million as of September 30 1992. The arithmetic average return is used to calculate the market risk premium in the CAPM equation. As such.8 Annual Return 36.75. Figure A4: McCaw’s WACC .790 million revolver (Exhibit 9) must be used to finance long-term assets.47% is the yield to maturity on the ten-year T-Bill. we now need its market capitalization as of September 30 1992.000 million (Exhibit 9).6 million Class A and B shares outstanding. starting in 1983.The above analysis yields an average cost of debt of 8. Given that McCaw has been approved for a revolver $3. Its share price is $24. using CAPM. meaning that its outstanding $1. The number of shares outstanding is estimated from the weighted average number of shares outstanding in McMcaw’s income statements in Exhibit 6. These calculations result in an estimated 185.83 271. Using the 5-year beta of 1. According to these assumptions. Normally.73% 7. where the risk-free rate of 6. 1983-92 Date 30/09/1983 28/09/1984 30/09/1985 30/09/1986 30/09/1987 30/09/1988 29/09/1989 28/09/1990 30/09/1991 30/09/1992 Arithmetic Average Close 166. In order to calculate McCaw’s WACC. obtained from Exhibit 15. The beta of 3.02% 9. McCaw’s current assets are only $607 million (Exhibit7).13% -15. whereas this analysis is conducted as of September 30 1992. obtained from Exhibit 18. The outstanding options in Exhibit 16 are used to calculate McCaw’s total fully diluted outstanding shares. Similarly. only long-term interestbearing debt is used to determine the average cost of debt. McCaw’s market capitalization of equity is calculated at $4. fully diluted. The above data is dated December 31 1991.76%.72% 14. LIN Broadcasting has $2.51% 28.16 in Exhibit 8 was not used as it is calculated over a two-year period. and likely yields a biased estimate for beta. and the total outstanding shares in Exhibit 16.04% 39. we can now calculate the required return on McCaw’s equity.62% 27. This is too short of a time period.07 166. Figure A3: S&P 500 Returns.91 349.34% 26. it is assumed that McCaw’s WACC does not change over this period.38.16% 0.32 321.08 231.100 million available. The CAPM equation is as follows: ( ) ( ) . However.1 182. and is obtained from Exhibit 8. It is assumed that no new options are issued from year-end 1991 to September 30 1992.15 306.70% Figure A3 shows the annual returns from September 30 of each year.05 387.

New Subscriber NWC .525 40% 8.5 550 2.0 870 75.35% Equity 20. .19% -2. Subscriber Tax Rate 33.5 500 2.4% 29.0 700 9.4% 13.5% 9.6% 26. whereas black numbers are from formulas. Appendix D: McCaw Financial Forecast The following page shows the soft-coded version of AT&T’s financial forecast for McCaw cellular. the forecast and assumptions were soft-coded so as to yield a dynamic model.8% 25.190 $ 198 36% 1020 150.2% 8. Blue numbers show hard-coded values.3% 26.0% 32.00% NO Actual Q3 1992 As % of revenue Direct costs Increment Marketing Increment D&A Increment C apEx.5 34.232 1.1% 31.5% 11.4% 30.1% 33.00% $ 1. blue numbers are hard-coded values and black numbers are soft-coded (i.8% 29. Note that some values are slightly different from those in Exhibit 17.3% 23. from formulas).5% 15.6% 22. Appendix C: AT&T Assumptions for Financial Forecast Population Growth Rate Penetration Growth Purchase LIN in 1996 1.500% 26.5 450 2.3% 27. The forecast is fully dynamic so that users can change any assumption to test various scenarios.41% Totals 11. Where possible. This is not due to computational errors in this model.87% $4.0 600 2.24% -5. or mistakes in the model found in Exhibit 17.76%.9% 10.e.00 11.0 650 5.00% 35.3% 25. Once again.1% 7.9% 25.2% 31.6% 29.8% 33. The highlighted cell changes when McCaw acquires LIN Broadcasting.00% 16.5 450 2.6% 1992 1993 1994 1995 Forecasted 1996 1997 1998 1999 2000 2001 2002 The above shows AT&T’s assumptions for its financial forecast.0 785 38. Possible explanations include rounding errors.9% 20.9% 17. Note that the cost of debt quoted in Figure A4 is the after-tax cost. where McCaw purchases the remaining shares of LIN. Note also that this is the base case.1% 21.1% 28.0 745 19.6% 19.43% -12.Cost Value Weight Weighted Cost of Capital Debt 5.9% 26.707 60% 3.61% $6.8% 28.6% 24.76% Figure A4 shows that McCaw’s WACC is 11.

98 1999 48.98% 1.53 2.37 76.84 1.89 300 1.70 1.19% 1.56 0.07 1.09 6.724 13% 772 324 1.36% 2.89 5.65 0.42 53.953 26% 582 300 1.44 27.52 28.071 554 517 331 554 671 13 226 3.84 29.62 4.71% 4.18 60. NWC Free Cash Flow 104 .413 904 800 428 2 1.62 3.14 1.554 853 1.48 1997 47.05 0.87 58.34 13.82 75.466 12% 934 320 2.274 5.85 7.385 650 735 471 650 346 10 784 3.02 2.00 3.265 1.54 4.86 5.31 2.397 10% 438 277 682 439 243 155 439 210 48 432 1.66 77.99 0.37% 4.72 28.90% 3.Forecasted YE 1992 McC aw POPs Penetration McCaw Subscribers LIN POPs LIN Penetration LIN Subscribers McC aw Share of LIN Subscribers McC aw Share of LIN POPs Proportionate McC aw POPs Proportionate McC aw Subscribers Beginning Subscribers (millions) 1.56 2.10 0.78 1.32 28.95 57.98 28.87 27.687 45.94 3.41 4.23 27.96% 1.96 3.62% 2.07 After-Tax C ellular Operating Income 13 Sale (purchase) of LIN ownership Depreciation & Amortization C apEx C hange.10% 2.213 800 1.48 3.700 1.553 11% 475 271 807 463 344 220 463 234 29 478 2.10 2.62 55.63 0.63 3.51 2001 49.99 65.36 27.37 6.19 29.53 3.160 742 750 402 2 1.54 74.28 2002 49.43 49.98 1993 45.19 3.00 6.16 26.14 0.30 76.23 1. Net Rev/Sub/Month Total Net Service Revenue % Growth Net Service Revenue Direct C osts & Expenses Marketing Operating C ash Flow Depreciation & Amortization Cellular Operating Income 99 77 124 104 20 407 285 573 418 155 99 418 197 83 404 70 47 0.13 28.304 915 529 3 1.83 1.44 1.01 28.43% 1.47% 0.26 0.40 13.038 1.73 4.83 9.87% 0.26 3.69 1.99 4.47 2.47% 1.77 0.35 51.488 6.66 1996 46.45 72.22% 3.34 8.022 316 2.72 2.17 8.95 78.10 3.32% 0.23 10.32 2.57 28.98% 1.413 24% 701 326 1.47 14.06 1995 46.60 27.34 0.39% 2.55% 1.70 68.37 6.20% 0.95 9.09 75.37 59.21% 3.628 697 931 596 697 374 8 926 4.390 13% 1.23 79.86% 1.18 1.124 313 2.33 3.23 1.19 27.98 1.82 5.73 2.06 1.99 26.086 13% 852 323 1.23 1998 47.02% 1.85 6.70 2.910 750 1.46 1994 46.85 1.55 14.62 62.90 0.089 4.891 12% 1.27 3.83 0.74 2000 48.56 1.21 4.84 5.953 915 2.04 60.02 7.69 28.088 853 451 3 1.11 2.27 Subscribers Added Ending Subscribers Period Average Subscribers Avg.66 8.27 1.90 59.34 1.

25 432 0.25 1. that the purchase of the remaining portion of LIN is subject to negotiation.089 0.25 768 0. In addition.11/share price noted in the case. when McCaw is expected to either purchase or divest the company.687 0.25 3.250.40 307 2001 9. but is there for the reader’s knowledge.808.388 Value Table A6 shows the valuation for McCaw under the base assumptions.213 11.773 $ 2.000 Middle of $95-$120 range on page 8 5.000.25 897 0. LIN Sold Q3 1992 Disc't Pds FC F (mil) Disc't Factor DC F (mil) 0.97 45 1993 1.046.25 1.25 22.25 1.25 47 0.25 432 0.000 67. Neither metric is particularly appealing.36 532 2002 10.25 226 0.474.25 years.50 279 1999 7.78 336 1995 3.777.25 926 0.875.25 13.25 473 0.62 141 1997 5.25 1.259 Table A7 shows the valuation for McCaw under the base assumptions.56 437 1998 6.25 478 0.70 52% 3. the purchase value is not used anywhere in the DCF valuation.70 333 1996 4.349 9.56 264 1998 6.508.586 0.87 351 1994 2.25 47 0.25 404 0.45 486 2000 8. Table A7: Base Case.87 351 1994 2.40 509 2001 9.467 $ 2.534 0. and assuming that it divests LIN Broadcasting.Appendix E: Purchase of LIN Broadcasting Figure A5: Summary of LIN Broadcasting Valuation.125. and assuming that it purchases LIN Broadcasting.32 326 10.295 0. 1996 Shares Owned Current Price % Owned Current Market Cap Shares Outstanding Capital Gains Tax Purchase Price Per Share Basis Value/POP Average Purchase Value (Millions) Sale Proceeds (Millions) Value 27.000 56.45 293 2000 8. Notably.073.25 1.25 478 0. and the average $200/POP valuation estimate for all cellular providers on page 18 of the case.32 540 Terminal 10.000 20% Justification Case page 8 Exhibit 8 Page 8 Calculated Calculated Estimated 6. and need not occur at the $154.017 0.274 0.32 7.934 $200/POP on Page 18 of Case 5. Appendix F: DCF Valuation Table A6: Base-Case DCF Valuation Q3 1992 Disc't Pds FC F (mil) Disc't Factor DC F 0.488 0.25 784 0.403 Factors-in Capital Gains Tax The above table shows the assumptions involved in calculating the value if LIN at the beginning of 1996. The valuation uses the $95-$120 share price range estimated by analysts on page 8 of the case.32 4.78 336 1995 3.25 404 0.62 2055 1997 5.50 462 1999 7.70 333 1996 4.25 558 0.36 321 2002 Terminal Value 10.97 45 1993 1. however the estimate is fairly insensitive to mis-estimation given that the purchase is discounted back by 3. .25 656 0.

130 $ 13.1.330 933 67 0. This yields a terminal value of $22.147 320 3.204 11.21 7. it is in McCaw’s best interest to purchase LIN.449 10.591 $ 17. some time in 2026. and that all costs grow at the same rate as revenue.43 4. and can presumably raise the debt and equity required to purchase the remaining 48% of LIN Broadcasting.76% $ 8. In addition.082 .823 $ 11.76% $ 10.850 $ 20. due to the fact it adds much fewer subscriptions per year. I assume that the tax rate remains constant at 36%.963 13.928 $ 7.953 915 2.213 million.196 Grows at same rate as revenues Grows at same rate as revenues Grows at same rate as revenues Grows at same rate as revenues Grows at same rate as revenues The large change in FCF is due to the fact that McCaw spends much less on CapEx. or roughly 2%.699 12.Clearly.37 2.801 $ 8. Appendix G: Terminal Value Estimation For the terminal cash flows. I estimated that population and penetration growth continue at 1% per annum.913 $ 11.012 933 2.478 . which is this discounted back to September 1992. By January 1 1996.388 $ 12.879 $ 10.1. Appendix H: Sensitivity Analysis Figure A8: Sensitivity Analysis – WACC & Penetration WACC Penetration Rate 9.214 $ 11.079 1.045 $ 11.76% 12% 14% 16% 18% 20% $ 9.687 2003 Notes 49 8 4.390 .76% $ 6. All of these assumptions yield the following: 2002 Avg.222 $ 15.9 1.124 313 2.784 $ 9. The terminal value is then calculated as a perpetual annuity growing at 1% per annum. This yields a revenue growth rate of (1+Population Growth)x(1+ Penetration Growth). yielding a present value of $7.629 $ 15. McCaw will be generating healthy cash flows.724 $ 8.075 $ 17.534 million.038 1.723 $ 9.930 $ 14.209 $ 12. The penetration growth of 1% is equivalent to assuming that it grows at 4% per annum until McCaw achieves 25% penetration.304 915 529 2.611 $ 13. Net Rev/Sub/Month Average Subscribers Total Net Service Revenue Direct C osts & Expenses Marketing Operating C ash Flow Depreciation & Amortization C ellular Operating Income After-Tax C ellular Operating Income Depreciation & Amortization C apEx C hange. NWC Free Cash Flow 49.76% $ 7.

85 from Exhibit 15. The columns show a percentage change in each increment (i.13% $1.83% 0. it 1992 $11.36% The above shows AT&T’s long-term debt schedule.033 $1.86% 1. . Using the same calculation in Appendix A.13% 8. Figure A10: Sensitivity Analysis – When to Purchase LIN Figure A10 shows sensitivity analysis when the time of Year End Purchase Base-Case DCF LIN’s purchase varies.61% 6.850 1.38% 10.609 is clearly in McCaw’s best interest to purchase LIN. As mentioned in Appendix F.626 $ 11. rather than the base of 12%).388 Depreciation & Amortization $ 11. Marketing & D&A Increments Increment Sensitivity -50% -25% Base Direct Costs $ 10. used to calculate its cost of debt. when calculating the post-merger valuation of McCaw. Figure A9: Sensitivity Analysis – Direct Cost.912 $ 11.853 $ 12.59% 6. 1993 $11.181 2.312 $1. net Current Portion Total Outstanding Debt Average Weighted Rate Outstanding Average 4.638 $ 11. Appendix I: AT&T WACC Figure A11: AT&T Long-term Debt Schedule Interest Rates 4 3/8% to 4 3/4% 5 1/8% to 7 1/8% 7 1/2 to 9% 5% to 7 3/4% 7 4/5% to 8 19/20% 9% to 12 7/8% Variable Rate Long-term lease obligations. purchasing LIN as early as possible is 1995 $11. Once again. and AT&T’s beta of .94% $1.754 $ 11.528 the best action.579 This table shows that not only is the LIN purchase a 1994 $11.300 0.388 +25% $ 11.25% $3.136 $ 11.69%.458 superior to all other options.051 $200 $76 $41 $1. this table will be used to calculate the post-merger valuation of McCaw.56% $1. Only AT&T’s cost of debt is used in the post-merger valuation. This table will be used later on.162 +50 $ 11.916 $ 11. and depreciation and amortization.34% Debentures Notes 7. we obtain a WACC for AT&T of 12.802 $ 8.960 Figure A9 shows the sensitivity of the valuation to changes in the increments for direct costs.229 $146 $10.388 Marketing Expense $ 10.870 $ 11.e.297 $ 10.484 0.38% 8. net Other Unamortized discount. marketing expenses.Figure A8 shows sensitivity analysis when varying WACC and McCaw’s penetration growth rate. the marketing expense decreases by 6% or 9% per annum.036 $ 10.

1. the contribution of $249 million to the valuation from the LIN purchase in 1992 is after all of the above sources of value are taken into consideration Appendix K: Relative Valuation Figure A13: McCaw Comparable Companies AirTouch Cellular British Telecom LIN Broadcasting US Cellular Vanguard Cellular Contel Cellular Average 1991 Profits/Share 0.125% per annum Marketing increment increases by 50% .071 $ 1. SG&A.067 Note that the above shows the cumulative valuation assuming that each successive source of value is utilized.144 Strategic Opportunities Purchase LIN at Year End 1992 AT&T has very conservative capital structure. Marketing Costs assumed to fall by 10% from 1993 on. AT&T's after-tax cost of debt 4. Sell non-core assets of LIN and McCaw.43 0. Assume that resultant change in capital structure has neutral effect on valuation. Estimated annual interest savings = $64.75 27. $ 249 Lower SG&A.16.4 million.80 N/A 39.50 .542 $ 277 $ 744 Synergies Penetration growth increases to 18% SG&A increment increases by 50% now drops by 3.now drops by 18% per annum Debt Outstanding = $6707. Leverage to purchase LIN.50 N/A N/A 25.32 .18 Share Price N/A 62.65 .70 million Refinance debt Total $ 510 $ 15.19 . Results in lower overhead costs.1.00 23.2. For instance.60 72.00 19. Marketing Costs after sale of noncore divisions $ 674 Grand Total $ 16. Use proceeds to fund LIN acquisition.31 .00 40.04 5.64% vs McCaw's 5.Appendix J: Post-merger Valuation Figure A12: Summary of Post-Merger Valuation Source Base Valuation Increased penetration SG&A costs fall more quickly Marketing costs drop more quickly Justification Average of DCF and Comparable Transactions valuations Contribution $ 12.87 Estimated P/E Ratio N/A 11.61%.

it is based on only two comparable companies. As was mentioned. to yield a P/E ratio for each comparable company.Figure A12 is adapted from Exhibit 15 in the case. which is a tenuous assumption. No annual reports could be found for any of the above companies.65 period in which it earns positive profit. Using this ratio for 1993 assumes market conditions will be the same. 1993 (mil) 99 income is used because it is the first full-year P/E 25. Discount Factor Valuation (mil) 0. Adapted for McCaw valuation for McCaw. given that most cellular companies yielded negative earnings. No other information was available in the case to conduct other types of comparable analysis.25 years using McCaw’s WACC. This only yields two comparable companies. For these reasons the comparable valuation is not used for the post-merger valuation. Figure A14: Comparable Valuation Figure A12 shows an adapted comparable Comparable Valuation.87 2. The 1993 Valuation (mil) 2. McCaw’s 1993 after-tax McCaw After-Tax Income.539 resultant valuation is discounted back 1. This valuation is fraught with problems. First. the P/E ratio used is presumable from September 1992 (the comparables table in Exhibit 15 is not date-marked). Second.25 Discount Period 1.210 . no other comparable data was provided. Only cellular providers were used as the growth profile of long distance and local telephone companies does not match that of cellular companies.