Airthread Connections Case Study

Robert Zimmerman, the senior vice president of business development, for American Cable Communications (ACC) was in the process of looking for a potential acquisition target for ACC. In December 2007, Zimmerman remember a presentation that was made recently by Rubinstein & Ross (R&R). R&R was a boutique investment bank that was well known for doing deals in the media and telecommunications area. During this presentation it was suggested that ACC buy out AirThread Connections (AirThread) which is a large regional cellular provider. The current industry of these companies were moving more toward bundled service offerings and by adding AirThread it would help ACC cover an area of service it does not currently offer. In order to determine if the acquisition should be done an analysis needs to be done.
ACC

was one of the largest cable operators in the United States with its cable systems going through approximately 48.5 million homes and servicing 24.1 million video subscribers, 13.2 million high speed internet subscribers, and 4.6 million landline telephone subscribers. Over the past ten years there was a rapid change due to changes in technological innovation. The success of the company is dependent on economies of scale. This lead ACC to believe that only a few large network providers will survive in the future and smaller companies will be downsized by industry consolidation. With this ACC became an aggressive acquirer in order to gain market share.
AirThread was one of the largest regional wireless companies in the United States. It provided services to more than 200 market located in five geographic regions with its networks covering a total population greater than 80 million people. AirThread provides the wireless services that ACC lacks. The acquisition of AirThread by ACC would provide advantages such as: bundle offerings, business market expansion, cost reduction, and improved network operation.
An analysis of AirThread needs to be done in order to determine the potential synergies and how much value be added to the firm. In order to conduct this analysis the adjusted present value (APV) should be found. The APV method will be the most sufficient for this analysis. This is because the information required for APV is abundant when looking at AirThread’s financial information. The process for the APV valuation of AirThreads consists of six steps. These steps are as follows: find the present value of the unlevered free cash flows, evaluate the WACC, appraise the tax shield value, access the terminal value, estimate the present value of non-operating assets, and applying the illiquidity discount.
The first thing that needs to be done is to determine the weighted average cost of capital (WACC) for AirThreads. Unlevered equity beta needs to be calculated for each of the comparable firms and this is done by using the Hamada Equation. Once all of the comparable companies unlevered equity betas are calculated, the average of the unlevered equity betas are found. The average equity beta is found to be 7.08 which is then plugged into the capital asset pricing model (CAPM). It is assumed that AirThreads is all equity financed which means the CAPM model will be used to find the WACC. The equity risk premium is 5 percent and the current yield on 10 year U.S. Treasury is 4.25 percent. By plugging these numbers into the CAPM formula the WACC is found to be 7.79 percent. To see the calculations for this step refer to Exhibit 1 in the Appendix.
Next the net present value (NPV) of free cash flows (FCF) needs to be calculated for 2008 to 2012. In order to obtain this figure there are several steps that need to be done. The first step is to find the earnings before interest and taxes (EBIT). Only part of an income statement needs to be calculated. This is because operations are the only thing that are being valued and the cash flow from operations are not influenced by a specific capital structure. The net operating profit after taxes (NOPAT) is found by taking EBIT and multiplying it by one minus the tax rate of 40 percent. After the NOPAT is found depreciation and amortization needs to added while change in net working capital and CAPEX need to be subtracted. This will give the unlevered FCF for each year. From this number the PV of FCF can be found. Then the NPV of FCF is found by adding together the PV of FCF for each year. The NPV of FCF for AirThreads is found to be approximately $1.2 billion by using the above process. To see the calculations for this step refer to Exhibit 2 in the Appendix.
The terminal value of AirThread needs to be computed next.

In order to do this the WACC approach will be used based on the assumption that leverage will stay constant after 2012. Industry average of debt/value is 28.1 percent and debt/equity 71.9 percent. These figures will be used as an estimate for long-term leverage because it is expected that AirThread will maintain a leverage ratio that is constant with the industry. From this the relevered equity beta is found to be 0.9847 which will give an equity rate of return of 9.42 percent. The rate of return on debt will be 5.5 percent. This is the percentage of debt because it is the interest rate of the 10 year U.S. Treasury bond. The WACC is now found to be 7.80 percent. Next, the long-term growth rate of 2.9 percent will be assumed to stay constant. In order to determine the FCF 2013 FCF 2012 of $315.60 will be multiplied by the growth rate. This will give a FCF 2013 of $323.48. The FCF 2013 will then be divided by the WACC minus growth rate. By doing this the PV of terminal value is found to be approximately $4.6 billion. To see the calculations for this step refer to Exhibit 3 in the

Appendix.
The value of non-operating assets needs to be calculated next. In order to do this, the multiples approach was used. Non-operating assets value is found by taking the average P/E and multiplying it by AirThreads equity in affiliates. The historical P/E ratio for the industry needs to be determined. Historical P/E is found by dividing equity market value by net income of each of the industry comparisons, excluding Agile Connections. Then each of the P/E ratios should be added together and divided by four. This will give an average P/E of 19.08. AirThreads equity in affiliates is $90 million, found on the Income Statement. The value of non-operating assets is found to be approximately $1.7 billion dollars. To see the calculations for this step refer to Exhibit 4 in the Appendix.
The present value of tax shield should now be calculated. Tax shields for AirThreads are discounted at the discount rate of 5.5 percent. The present value of tax shields should be found for the years 2008 to 2012. Then to get the total PV of tax shields each year will be added together. This will give a NPV of tax shields of $284.78 million. To see the calculations for this step refer to Exhibit 5 in the Appendix.
Keeping the previous steps in mind, the value of AirThread before synergies needs to be found. In order to do this each of the previous steps should be found. Total value is equal to PV of cash flows plus terminal value plus PV of tax shield plus value of non-operating assets. This will give a total value of $7.7 billion. The total value assuming there is an illiquidity discount needs to be calculated. It is assumed that there is an illiquidity premium because AirThread is a private company. The illiquidity discount that will be used is 25 percent. This number will be used because it is between the industry standard of 20 percent and 30 percent. The illiquidity discount is found to be $1.9 billion. Once the illiquidity discount is taken out, this will give a total value before synergies of approximately $5.8 billion. To see the calculations for this step refer to Exhibit 6 in the Appendix.
After finding the value before synergies, the value should be found with the incorporation of synergies. This process follows a similar set up as total value before synergies but has an additional step. The additional step is that the NPV of synergies needs to be found. To do this the backhaul savings is added to the annual business revenue. This will give an increase in EBIT from synergies. FCF increase from synergies is found my taking the increase in EBIT from synergies and multiplying it by 1 minus 40 percent. From the FCF increase the PV of synergies can be found. Then by adding the PV of synergies from 2008 to 2012 it will give the NPV of synergies which is found to be 1.03 billion. To find the total value add PV of cash flows, terminal value, PV of tax shield, value of non-operating assets, and NPV synergies. The total value is found to be approximately $8.8 billion. Once again the illiquidity discount of 25 percent needs be taken out. By subtracting the illiquidity discount of $2.2 billion from the total value it give the total value with illiquidity discount of $6.6 billion.