Subject: Valuing a Cross-Border LBO: Bidding on the Yell Group Date: April 9, 2014 Yell Group, a holding company created by British Telecom (BT), has two business divisions located in two different countries: Yellow Pages business in the U.K. and Yellow Book business in the U.S. Recently, BT is under pressure to reduce heavy debt load through outright sale of directories business due to its investors’ high leverage concern and adverse condition it faced in the telecom market. This is the chance for us expand presence on the European continent via this deal. Business Descriptions of Two Business lines:
1. BT Yellow Pages in the U.K.:
BT Yellow Pages is the market-leading classified directory business in the UK. Their advertisement revenue represented nearly 85% of the U.K. classified directories advertising revenues. Moreover, advertising expenditures are more stable and do not fluctuate widely with economic cycles as they are considered as a “must buy” by many SME since the yellow pages are their principal means of reaching customers in the United Kingdom. For BT Yellow Pages, their future growth is mainly driven by two factors – number of ads sold in a given year and advertisement prices. Since Yellow Page advertising expenditures are considered as a “must buy” by most SME, the volume growth rate should be stable and close to the growth rate of Classified Directories Advertising Market in the U.K. Unfortunately, even though the total advertising market has seen increasing growth , the real average growth rate of Classified Directories Advertising Market has declined to 3.8% during 1996-1999 from 7% during 1985-1995 indicating a mature stage in the Classified Directories Advertising market in the U.K. The growth in the classified directories advertising market will probably continue to decline in the futures.
For advertisement prices, BT Yellow Pages increase the average price by inflation rate minus 2% for a period of three years in the past. However, The Office of Fair Trading (OFT) plans to impose a limit on the annual increase in rates for advertising in BT Yellow Pages. Although Yell management’s forecast seems optimistic, we have to adjust them to show OFT issue and a decreasing trend of inflation happened in the U.K in the recent years. Compared with the 5% of average inflation rate during the period of 1985-1995, the average inflation rate during the period of in the U.K declined to 2.8%.
2. Yellow Book in the U.S.
The U.S. yellow pages market was a $13bn industry that had been growing at a steady 4%-5% per year. Moreover, 75% SMEs advertised in the yellow pages. The industry had been historically dominated by the regional Bell companies (RBOCs). RBOCs’ directory business served as cash cow rather than a main vehicle for growth for themselves. Over past decade, the independent directory providers had emerged gradually with a rapid growth of 19.8% in 2000 vs 4.3% for the RBOCs. Furthermore, the independents were projected to increase their market share from 11% to 30% over the 2000-2005 period. BT purchased Yellow Book USA in 1999 for $665mn.
For now, it is a market-leading independent publisher of business directories in the U.S. It had approximately $330 million in revenues and $42 million in EBITDA. Recent rapid growth was mainly driven by expansion efforts such as launching new directories into contiguous markets and launching wide area books into cities. The management’s forecast has combined the organic growth with aggressive new product launches strategy. They expected EBITDA margin lower in the first year of new launch operations due to giving new clients free advertisement in the first year, then EBITDA margins would increase to match margins on organic sales from second year of operations. However, new product launches were naturally volatile as a strong incumbent publisher or lack of Yellow Book brand awareness, we need to segregate organic revenues from new launch revenues to make the forecast more accurate.
We prefer CCF method due to a forecasted debt levels also implying a change in capital structure. WACC is not suitable here because this method assumes constant debt-to-equity ratio. Based on the debt repayment schedule, it is unlikely that the firm will be able to maintain a constant ratio. The CCF approach values the tax shield by incorporating it in the unlevered cash flow, then discount at pre-tax WACC.