7-2. The Hunt for Elusive Synergy - @Home Acquires Excite Background Information Prior to @Home Networks merger with Excite for $6.7 billion, Excites market value was about $3.5 billion. The new company combined the search engine capabilities of one of the best-known brands (at that time) on the Internet, Excite, with @Homes agreements with 21 cable companies worldwide. @Home gains access to the nearly 17 million households that are regular users of Excite. At the time, this transaction constituted the largest merger of Internet companies ever. As of July 1999, the combined firm, Excite @Home, displayed a P/E ratio in excess of 260 based on the consensus estimates for the year 2000 of $0.21 per share. The firms market value was $18.8 billion, 270 times sales. Investors had great expectations for the future performance of the combined firms, despite their lackluster profit performance since their inception. Founded in 1995, @Home provided interactive services to home and business users over its proprietary network, telephone company circuits, and through the cable companies infrastructure. Subscribers paid $39.95 per month for the service. Assumptions Excite is properly valued immediately prior to the announcement of the transaction. Annual customer service costs equal $50 per customer. Annual customer revenue in the form of @Home access charges and ancillary services equals $500 per customer. This assumes that declining access charges in this highly competitive environment will be offset by increases in revenue from the sale of ancillary services. None of the current Excite user households are current @Home customers. New @Home customers acquired through Excite remain @Home customers in perpetuity. @Home converts immediately 2 percent or 340,000 of the current 17 million Excite user households. @Homes cost of capital is 20 percent during the growth period and drops to 10 percent during the slower, sustainable growth period; its combined federal and state tax rate is 40 percent. Capital spending equals depreciation; current assets equal current liabilities. FCFF from synergy increases by 15 percent annually for the next 10 years and 5 percent thereafter. Its cost of capital after the high-growth period drops to 10 percent. The maximum purchase price @Home should pay for Excite equals Excites current market price plus the synergy that results from the merger of the two businesses. Discussion Questions 1. Use discounted cash flow (DCF) methods to determine if @Home overpaid for Excite. 2. What other assumptions might you consider in addition to those identified in the case study? 3. What are the limitations of the discounted cash flow method employed in this case