As S Ignment 2: Mccaw Cellular Communications: The at & T/Mccaw Merger Negotiation
As S Ignment 2: Mccaw Cellular Communications: The at & T/Mccaw Merger Negotiation
As S Ignment 2: Mccaw Cellular Communications: The at & T/Mccaw Merger Negotiation
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SUBMITTED TO: MARIA RADFORD SUBMITTED BY: SONG LI MEMBERS OF GROUP NO. 6 STUDENT NO. 210191716 EMAIL ADDRESS: SLI09 @SCHULICH.YORKU.CA DUE DATE: MARCH 6, 2012
Song Li
Introduction:
Burdened with 5 billion in debt, McCaw Cellular Communications was considering a potential partnership offered by AT&T. It is clearly a great opportunity for McCaw Cellular to access to new technology, realize vertical integration with AT&T and increase advertising power under the well known name. It could also provide McCaw with the ability to refinance company debt at a more favourable AA credit rating. However the major issue for Craig, the Founder and CEO of McCaw is the risk of sacrificing his control of the company. Craig needed to come up with a negotiating strategy for the deal focusing on maximizing premium and synergy value without sacrificing major control of McCaw Cellular.
Song Li
Valuation Approach Discounted Cash Flow Model When I started to value the firm using DCF model, I have made several assumptions: Annual growth rate at 25% assuming the reminder of LIN share will be purchased in 1995; WACC is calculated as 9.78% based on cost of debt of 12% and return on equity 14.3% (calculated at risk free rate plus company beta multiplied with market risk premium). Operating expense is estimated as 63% of sales. Selling and administration expenses are estimated at 2%. The interest rate on debt is calculated based on corporate Bond ratings and Yields with a reasonable spread to reflect McCaw CCC+ rating. I have also performed a sensitivity analysis based on different revenue growth, direct cost, marketing expense and WACC because the variations in those factors would significantly affect the result produced by DCF model. This sensitivity analysis has also formed the base for my calculation of post merger improvements, synergies and future options. (see appendix 6 and 7) Based on the base case parameter, the enterprise value of the company is estimated at 9.055 billion (see appendix 1 to 3 for detailed valuation). However this value is only the value as is. In the next steps I will calculate the post merger improvements, synergy and future option as add on value.
Song Li
Song Li
Appendix 1
McCaw company forecast Assumption Actual 1990 Assumptions Income statement Sales growth rate 68.90 % 2.00% 12.00 % 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% Actual 1991 Foreca st 1992 Foreca st 1993 Foreca st 1994 Foreca st 1995 Foreca st 1996 Foreca st 1997
65.00% 2.00%
63.00% 2.00%
63.00% 2.00%
63.00% 2.00%
63.00% 2.00%
63.00% 2.00%
63.00% 2.00%
Interest on long term debt on average balance Interest income on opening cash balance Income tax rate
12.00%
12.00% 6.25%
36%
36%
36%
Balance sheet Cash and cash equivalents Accounts receivable - days sales Marketable securities Accrued expense % current liability Future income taxes Other assets Good will and other intangibles 1,855,40 7 687,237 15.0% used to plug balance sheet if required - no minimum cash on hand 38.54 assume constant 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% assumed constant amount assumed constant amount constant after this time 71.00 70.00 70.00 70.00 70.00 70.00
Bank indebtedness Accounts payable - days in payable (COGS & S&A) Unearned revenue % of sales Other long term liabilities Future income taxes Capital stock Contributed surplus Cumulative translation adjustment
plug to balance the balance sheet if required 70 70 3% assume constant assume constant assume constant assume constant assume constant 70 3% 70 3% 70 3% 70 3% 70 3% 70 3%
0%
0%
0%
0%
0%
0%
0%
Song Li
Appendix 2
McCaw free cash flows in thousands $'s Forecast 1992 Sales COGS SG&A Depreciation Operating income before tax Taxes Net operating profit after tax depreciation Net operating cash flow after tax 1,706,964 -1,075,387 -34,139 -24,299 573,139 -206,330 366,809 24,299 391,108 Forecast 1993 2,133,705 1,344,234 -42,674 -26,520 720,277 -259,300 460,977 26,520 487,497 Forecast 1994 2,667,131 1,680,293 -53,343 -28,786 904,709 -325,695 579,014 28,786 607,800 Forecast 1995 3,333,914 2,100,366 -66,678 -31,089 1,135,781 -408,881 726,900 31,089 757,989 Forecast 1996 4,167,393 2,625,458 -83,348 -33,409 1,425,178 -513,064 912,114 33,409 945,523 Forecast 1997 5,209,241 3,281,822 -104,185 -35,750 1,787,484 -643,494 1,143,990 35,750 1,179,740 CV
Change in working capital Change in Accounts receivable Change in inventories Change in accrued expenses Change in accounts payable Chang in income taxes payable Net change in working capital Investing activities Total investment in assets Change in goodwill and other assets Cash flow for investing activities Free cash flows -48,616 0 -48,616 220,552 -51,367 0 -51,367 346,280 -54,962 0 -54,962 440,768 -57,667 0 -57,667 557,589 -60,984 0 -60,984 706,074 -63,770 0 -63,770 892,934 910,793 -187,851 0 34,624 39,237 -7,950 -121,940 -77,164 0 -64,011 53,196 -1,871 -89,850 -102,301 0 -80,014 66,496 3,749 -112,070 -127,876 0 -100,017 83,119 2,041 -142,733 -159,845 0 -125,022 103,900 2,502 -178,465 -199,807 0 -156,277 129,874 3,174 -223,036
Terminal growth rate Terminal value Discount factor for WACC WACC = Discounted free cash flow 9.78%
2% 11,706,847 0.9109 200,904 0.8298 287,330 0.7558 333,150 0.6885 383,903 0.6272 442,827 0.5713 510,129 0.5713 6,688,066
Total value of discounted free cash flows assuming end of year flow
8,846,309
76%
Move discounted free cash flows forward 0.25 year Less market value of debt Long term debt and short term debt Less redundant liabilities
9,055,093
(note - (1 + WACC) ^0.25 cash flows fall in the Sept of the year, not at the end) -5,198,838
Song Li
Add redundant assets Value of equity Number of shares outstanding (thousands) Value per share
8,716,696.00 Levered Beta Tax rate Risk free rate Risk Premium R e levered 1.75 36% 5.50% 5% 14.3% (from case material) ( McCaw's current tax rate) ( use five year treasury note close Sept 25,1992) ( assumed) Cost of Equity=risk free rate + Beta x Risk Premium (Since McCaw cellular has CCC+, cost of debt is relatively high, data from the course material.)
Cost of Debt
12.00%
D+E WACC
8,716,696.00 9.78%
* Information obtained from case material Adjust the industry average to reflect McCaw's situation: Size Capital structure Growth profile Profitability Industry position Diversification Off Balance sheet issues Management Team Tax 1 -2 0.5 -1 1 0.5 0 0.5 0 Company scale is relatively large in the industry Heavily burdened by debt, company is over levered Has better growth prospect compared to industry Company has negative earning Has leading position in the industry Reasonably diversified not mentioned in the case Has relatively strong management team Neutral
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Other factors specific Total adjustment factor McCaw's Equity/Revenue ratio Equity value McCaw Outstanding debt Enterprise Value
NA
Appendix 6 Sensitivity Analysis/ Post Merger improvement, synergies and future options
Post Merger potential improvements: Revenue growth Base Case Revenue incr by 1% Direct cost decr by 1% Post Merger Synergies: Revenue growth Base Case Revenue incr by 2% Direct cost decr by 3% Marketing expense decr by 1% Financing WACC decr by 1% 25% 27% 60% 1% 8.80% 13,002,651 3,947,558.00 Direct Cost 63% Marketing Expense 2% WACC 9.78% Valuation 9,055,093 Increase in Value 25% 26% 62% 9,744,396.00 689,303 Direct Cost 63% Marketing Expense 2% WACC 9.78% Valuation 9,055,093 Increase in Value
Song Li
Future options Revenue growth Base Case Revenue estimated at 5% increase Direct cost decr by 3% 25% 30% 60% 12,127,064 3,071,971 Direct Cost 63% Marketing Expense 2% WACC 9.78% Valuation 9,055,093 Increase in Value
Appendix 7
The value of the target:
Value as it is under DCF Post merger potential improvement Post merger synergies Future options The value of the target Outstanding Debt 9,055,093.00 689,303 3,947,558 3,071,971 16,763,925.00 -5,198,838 11,538,087 Value as it is under comparable companies Post merger potential improvement Post merger synergies Future options The value of the target
Equity Value
Sensitivity analysis based on different WACC and revenue growth rate WACC 9.5% 14% 16% 18% 20% 22% 26% 5.9/22.56 6.07/25.32 6.9/28.26 7.4/31.40 8.0/34.75 8.7/38.31 Revenue Growth 10% 5.5/20.48 5.7/23.03 6.4/25.75 6.9/28.66 7.5/31.75 8.1/35.05 10.5% 5.1/18.64 5.6/21.01 6.0/23.54 6.5/26.24 7.1/29.12 7.6/32.17 11% 4.8/17.00 4.98/19.22 5.6/21.58 6.1/24.10 6.6/26.78 7.1/29.63 11.5% 4.6/15.55 4.95/17.62 5.3/19.83 5.7/22.18 6.2/24.69 6.7/27.35