Different Types of Acquisitions - Assignment Example

AirThread Connections Case Your Name Student ID Course Title & Code Lecturer’s Name Due Date Executive Summary Acquisition can be defined as a process, mostly a corporate action, where a company buys another company by buying most if not all, of the other company`s shares or ownership stakes in order to assume control of the target firm. Most organizations prefer it being beneficial taking over an existing firm`s operation as a growth strategy rather than expanding on its own. Therefore, acquisitions are usually considered as a growth strategy. It is usually paid in terms of cash or the company`s underlying assets such as shares. One of the possibilities of acquiring a company is where a company can buy another company with cash, stock or a combination of the two. Another possibility of acquiring to take place is for a company to acquire all the assets of another company. This is usually common in smaller deals. For example, if company ABC buys all of company XYZ`s assets for cash, company XYZ becomes merely a shell and will liquidate at the end or even enter another area of business. Acquisitions are usually in form of friendly or hostile where in the friendly acquisition, the targeted firm agrees to the terms and allows the other company to acquire it while in the hostile acquisition, the target firm does not agree to the terms laid by the other firm and hence it will be forced to buy shares of the target firm till it gets the majority stakes. In either hostile or friendly type of acquisition, the acquiring firm usually offers a certain premium on the market price of the target firm`s shares so as to get the shareholders to sell their shares. Another type of acquisition is a reverse merger, which states that it is a deal which enables a privately owned company to get publicly listed in a relatively short time period. This type of acquisition called reverse merger usually occurs when a private company which has predicted positively on its decision and is eager to raise financing buys a publicly-listed shell company, usually one with no business ad limited assets. We have observed different types of acquisitions and they are related to merging since it is two firms involved. However, all mergers and acquisitions have one goal in common; they are all meant to create synergy that makes the value of the combined firms or corporations greater and better than the sum of the two parts. Once the synergy is achieved, it will determine the success of the merger or acquisition. In our case study, we are going to look at the acquisition of two firms that is American Cables Communications and Air Thread Connections. The latter is the acquiring firm while the former is the target firm. Introduction We are going to start by briefly discussing the two firms; American Cable Communications Company was one of the largest cable operators in United States in the year 2007. The company has cable systems running through homes, landline telephone subscription, video subscription, and high speed internet services and its net worth is 30.9 billion dollars. Air Thread Connections on the other hand was one of the largest regional wireless companies in the United States, providing services in more than 200 markets in 5 geographic regions. The number of people covered by the firm’snetworth is more than 80 million people Air thread it is worth approximately 3.9 billion dollars. The American Cables is intending to acquire Air Thread Connection business. Question 1. Discuss the strategic rationale for American Cable Communications` (ACC) acquisition of Air Thread Connections (ATC) The American Cable Communications acquired the Air Thread Connections because the firm would be able to sell its goods and services above the competitive level. The acquisition increased the size of the firm by far and its resources and capabilities to compete in the market were enhanced. With the competitive advantage American Cable Communications had, its share of the market would hence increase. The main services that were offered by American Cables were video, internet, land line telephony, but did not have any kind of wireless offering which was currently embraced by all its competitors. The company saw a looming competitive threat from wireless networks. On the other hand, Air Thread was experiencing similar pressure as that of American Cable from its competitors who were gaining the market faster. Air Thread had no landline and internet services which were the main resources its competitors were using to gain market. Therefore, American Cable`s acquisition would help both companies to gain competitive advantage by helping each other compete. Another reason for American Cable acquiring Air Thread Connections is that both firms would help each other expand their business markets and increase their market power. Both firms customer base was basically the individuals with different residents as well as retail. American Cables was not in a condition to get long term contracts which if it acquired, would lead to stability and reliability of the company`s revenues. This means increased network utilization as well as increased cost efficiency. Therefore acquisition of another company would help solve this issues drastically. The American Cable Communication firm acquired Air Thread connections since it was in a good position to acquire the firm. The value of Air thread was low, as compared to its competitors in the wireless network and its continued decrease in value would lead to the firm losing its market. Other than these reasons, the strategic rationale for American Cable Connections` acquisition of Air Thread Connections are, Overcoming the various barriers to entry Increased diversification Reshaping firm`s competitive scope Learning and developing new capabilities Question 2. Estimate the enterprise value of ATC A) Compute ATC’s unlevered cost of capital. (Hint: you will first need to compute ATC’s asset beta). Ru = Rf + βu(Rm-Rf) Where; Ru is the expected rate of return on stock of an unlevered company Βu is the unlevered equity beta Rf risk free return (Rm-Rf) is the market risk premium. Βu=equity Beta/1+(1-T)D/E 1/1+(1-0.4)40.1%=0.8061 Ru=4.25%+0.8061(5%) =0.0828 =8.28% B) Forecast ATC's unlevered free cash flow (i.e., assuming ATC has no debt) for the period from 2008 to 2012.   2008 2009 2010 2011 2012 sales revenue 4508.8 5140.3 5782.9 6361.3 6331.4 less operating cost 838.9 956.3 1075.8 1183.4 1266.3 taxes 1803.52 2056.12 2313.16 2544.52 2532.56 capital expenditures 631.3 719.7 867.4 970.1 1055 free cashflows 1235.08 1408.18 1526.54 1663.28 1477.54 C) Estimate the present value of these cash flows. Formula: CF*(1+r)^-n Where: CF=cash flows R= Risk-free rate And n=no. of years YEAR CALCULATION PRESENT VALUES 2008 1235.08*(1+0.0424)^-1 1184.729 2009 1408.18*(1+0.0425)^-2 1295.7 2010 1526.54*(1+0.0425)^-3 1347.35 2011 1663.28*(1+0.0425)^-4 1408.19 2012 1477.54*(1+0.0425)^-5 1199.94 D) Estimate the present value of interest tax shields for the 2008-2012 period. To simplify your analysis, assume ATC will maintain a constant level of debt in this period, and this debt will equal 4 times ATC’s EBITDA in 2007. Interest tax shield=interest expense*tax rate YEAR INTEREST EXP.*TAX RATE INTEREST TAX SHIELD 2008 89.36*40% 35.744 2009 94.27*40% 37.708 2010 99.46*40% 39.784 2011 104.93*40% 41.972 2012 110.7*40% 44.28 E) Compute ATC’s WACC. Assume here that ATC maintains a constant debt-toequity ratio, and that this debt-to-equity ratio will be determined based on leverage levels in ATC’s industry. (Hint: before computing WACC, you will need to first compute ATC’s projected debt-to-equity ratio, then compute its equity beta, and use it to compute ATC’s cost of equity.) Formula: WACC = E × re + D × (1 − t) × rd (E+D+P) (E+D+P) Where: E = Market value of equity D = Market value of debt P = Market value of preferred stock re = Cost of equity rd = Cost of debt rp = Cost of preferred stock T = Marginal tax rate calculating cost on equity; re = rf + β × (rm − rf) Where: rf = Risk-free rate (represented by 10-yr U.S. Treasury bond rate) Β = Predicted equity beta (levered) (rm − rf) = Market risk premium To calculate the predicted equity beta, this formula is used; Levered β = Unlevered β × [1 + [(D/E) × (1−t) + P/E]] Where: Levered β = β used in CAPM formula for re E = Market value of targeted equity D = Market value of targeted debt P = Market value of targeted preferred stock Levered β = 1*(1+(165164/362691)*(1-0.4)+1404.1/362691) = 0.8771 Cost on equity = 4.25%+0.8771*(5%) = 0.0864 WACC= (362691/(362691+165164)*0.0864)+(165164/(362691+165164)*0.6*0.281) = 0.0594+ 0.05275 = 0.112 = 11.2% F) Estimate ATC's terminal value (based on free cash flows starting in 2013). Assume ATC will maintain a constant debt-to-equity ratio starting in 2013 (i.e., rather than staying constant, its debt will increase at the same rate as its equity), and that this debt-to-equity ratio will be determined based on leverage levels in ATC’s industry. (Hint: you will need to estimate ATC’s long-term growth rate to answer this question.) TV = FCFn × (1+g) WACC − g Where: FCFn = FCF for the last 12 months of the projection period g = Perpetuity growth rate (at which FCFs are expected to grow forever) WACC = Weighted-average cost of capital Terminal value = 1477.54*(1+2%)/(11.2%-2%) =16381.42 G) ATC also has non-operating assets (i.e., non-controlling equity investments). Estimate the value of those assets using the trading multiple approach. (Hint: the earnings on those assets are given by “Equity in Earnings of Affiliates” on the Income Statement.) = 5611.9+157.7 =5769.6 H) Use information from from steps a) through g) to compute your estimate of ATC’s enterprise value. Market capitalization + total debt – cash= enterprise value 5611.9+435.5-204.5 = 6251.9 Read More