1. What do you believe McCaw is worth? Prepare a careful DCF using the financial forecast of FCFs given in the case and in the associated spreadsheet. What key assumptions determine the range of high and low values in your valuation analysis? Also draw on any other valuation approaches and information that you can. For the sake of consistency, all groups should use a (low, “Darden”) risk premium of 5.5%.
We performed a DCF Analysis for two scenarios: 1) assuming the purchase of the residual equity of LIN Broadcasting; and 2) assuming the sale of the residual equity of LIN Broadcasting (See Exhibits 1 & 2). The most critical assumptions impacting value were: 1) discount rate and 2) terminal growth rate. We relied on discount rates between 10.0% and 11.0% based on our analysis of the stand alone AT&T WACC (10.4%), the stand alone McCaw WACC (12.3%), and a blended calculation (11.1%). We chose growth rates between 3.0% and 4.0% as an estimate of the perpetual growth of FCF (implied Value/POP was approximately $300, high by industry standards) (See Exhibit 1).
In addition to a DCF Analysis, we performed analyses of recent comparable transactions (See Exhibit 3) and recent premiums paid for publicly traded companies (See Exhibit 4). Results revealed that comparable transactions were executed at approximately $171 / POP and that recent deals were consummated on average at approximately 50% above twelve month average stock prices. In our opinion, the analysis of recent premiums paid is not reliable; as we are not able to evaluate the comparability of the included transactions (i.e. the contemplated transaction is large).
2. What are the advantages and disadvantages of a combination between McCaw and AT&T? What is your best alternative to a negotiated agreement with your counterparty?
Advantages of a combination between McCaw and AT&T:
* The combined company would realize significant synergies through cost savings, increased advertising power, and potential reductions in financing costs through SG&A consolidation
* McCaw would benefit from the use of the well-recognized AT&T name, marketing and global presence and the ability to refinance company debt at AT&T’s more favorable “AA” credit rating
* The merger would allow AT&T to fulfill its plan to create “Anytime, Anywhere” communications by improving its domestic operations and growing its international market share.
* AT&T could greatly enhance McCaw’s customer marketing and provide a global presence that could help McCaw enter emerging foreign markets where poor infrastructure and strong population growth combined to create a great demand for wireless communications services
* The merger would allow AT&T to acquire a significant share in the wireless market without having to build a completely new wireless infrastructure, which could cost significantly more than purchasing McCaw Cellular outright. The estimated cost of a basket of wireless licenses would be equal to $7 – $10 billion. Customer acquisition costs could range from $0.7 – $1.7 billion with a on-going investment in capital expenditures
* AT&T acquisition of McCaw would diversify AT&T’s domestic revenue source and counter its declining domestic market share. AT&T may also be able to acquire McCaw at a relative discount since merger activity has slowed down in the recent quarter
* AT&T could benefit from local access fee reductions and instant access to state-of-the-art technology without directly confronting the RBOC’s or having to infuse capital to build an independent AT&T cellular network.
* If regulations changed the combined company would also preempt other competitors like BT or BellSouth from coming into the market and effectively compete with them in the telecommunications industry.
Disadvantages of a combination between McCaw and AT&T:
* Execution risk
* The combined company may attract FCC monopoly investigation because of the size of combined operations
* The mentioned combined size of the company can lead to bureaucracy
* Good credit ratings of AT&T may suffer which will lead to limited access to working capital
* AT&T’s earnings in the first years after the merger could get diluted
* Merger’s success is questionable because of the strong presence of McCaw family members and their desire for control. If they keep their place in BOD after the merger, management conflicts may occur
* Create own wireless network in PCS sector and start competing with other cellular companies
* Merge with another company which would offer the same growth perspectives in the wireless communication market
* To structure deal as joint venture, which would be an economical approach to entering the market with the access to the technology, cross-marketing and profits. May bring, however, the lack of control to achieving “Anywhere, Anytime” vision.
3. What risks do AT&T and McCaw face in this proposed merger? Consider a range of transactional, financial and operating risks. What effect do these risk factors have on the value of McCaw?
* Other bidders can come in the play to preempt the merger
* AT&T should take advantage from slowing down in the merger activity and lower premiums. If negotiations take a long time, situation can reverse, driving the costs of acquisition up
* To be able to merge, companies need approval from BT which may not want to share the cellular network and lose its chances to capture the US cellular market itself
* To ensure healthy competition, FCC may delay or prevent the transaction
* The merger can be dilutive for AT&T if it acquires McCaw with stock, which can drive the stock price down
* AT&T also acquires McCaw’s debt, which exposes AT&T to the risk of the debt downgrading or refinancing at higher rate
* All projected synergies might not be realized if companies do not integrate successfully or face severe competition from PCS
* Integration of the management structure is a potential problem in the merger because of control ambitions of Craig McCaw
4. From your perspective as a negotiator for your company, what are your goals in this negotiation? What do you expect are the goals of the other team?
Our duty is to pursue the consummation of a transaction at a price that is economically attractive to the current shareholders of AT&T stock. Additionally, it is in the best interests of current management and shareholders that control of the combined entity remain concentrated with current AT&T BOD members and management.
Goals of the other team would be to get maximum value for McCaw shareholders and to maintain some sphere of control of the combined entity.
5. Develop a negotiating strategy including an identification of your opening and walk-away prices. Justify these prices.
Starting price: $28.04 per share ($12,459 billion)
Bargain range: $28.04 – $32.38 per share ($12,459 – $13,293 billion)
Walk-away price: $32.39 per share ($13,293 billion)
Our strategy is as follows:
a). Initiate transaction discussion by offering $28.04 per share for 100% of the equity of McCaw Cellular AND LIN Broadcasting (including the agreement to put/call the residual equity). We are flexible with consideration and are willing to pay a combination of cash and stock (our stock is trading at levels that would be attractive for issuance). Additionally, we will offer Mr. McCaw a seat on the combined Company’s BOD. Even if we offer all cash – we plan to raise capital through issuing equity.
b). Require McCaw to counter with a list price before continuing negotiations.
c). We are willing to pay up to $32.38 per share ($13,293 billion)
Note: We plan to negotiate in terms of Enterprise Value as opposed to Per Share Price to avoid confusion of per share distributions and liquidity preference matters. We are planning to ASSUME all debt at closing and require minimum levels of NWC.
Exhibit 1: DCF Analysis
Exhibit 2: DCF Analysis
Exhibit 3: Recent Comparable Transactions
Exhibit 4: Recent Premiums Paid