• Case Questions

  1. Summarize the case (What happened? Who? Why? How?) and identify key strategic

     issue(s).

  2. Discuss AirThreads capital structure and make appropriate assumptions.

     Based on your capital structure assumption, which absolute valuation model would you choose to

     value AirThread? Justify your choice.

  3. Replicate the amortization table as shown in Exhibit 6. In the Excel model, show how the mortgage

     payment, annual interest payment, annual principle repayment and ending balance are estimated.

     Show how to construct the amortization table.

  4. Discuss and justify the revenue projections as presented in the case.

  5. Forecast the financials and replicate the pro forma income statement and pro forma balance sheet for

     20082012 as shown in the Financial Projections worksheet

Note: The projections / answers are provided to you, your task is to reverse engineer the process, in your Excel model, show how each account in the pro forma financial statements is forecasted / estimated. Please refer to the first worksheet in the Case Data_AirThread Excel file for some tips to help you get started with the financial forecasting process.

6. Estimate AirThreads free cash flow to firm (FCFF) and interest tax shields (ITS) for each year in the forecasting period of 20082012.

7. Discuss AirThreads capability to service the debt and justify the estimated credit rating of BBB+ (discussion only, no calculation required).

8. Apple the unlevering beta technique to estimate the discount rate / cost of capital for the forecasting/projection period:

   • - Use the data/information as presented in Exhibit 7, select the appropriate comparables and justify your choices.

   • - Make your own assumptions on the comparables capital structure and justify.

   • - Select the appropriate formula to unlever the comparables beta. The formula sheet is included

     in the case data Excel file.

   • - Calculate the average unlevered beta of selected comparables, and use it as AirThreads

     unlevered beta or asset beta.

   • - Apply the CAPM model, use asset beta to estimate the unlevered cost of capital

9. Estimate the discount rate / cost of capital for the steady-state stage:

   • - Assume that in the steady state, AirThread would keep a target capital structure and bring the

     debt ratio to be in line with industry average. Use the data in in Exhibit 7 to estimate industry

     average debt ratio.

   • - Use industry average debt ratio and select the appropriate formula to relever AirThreads beta.

   • - Apply CAPM model and estimate its cost of equity.

   • - Estimate W ACC in the steady state.

   10. Apply the constant growth model (also called growing perpetuity model) to estimate terminal value. The investment banking team decided to use the fundamental method to estimate LT g. The estimate process is illustrated in the LT g worksheet of case data Excel file.

       Complete the table and estimate the long-term growth rate in the steady state.

   11. Construct the time line:

       • - indicating the valuation / deal year, the forecasting period and the steady state stage;

       • - reporting all the cash flows for each year and terminal value.

   12. Estimate AirThreads intrinsic value of operation and enterprise value at the deal year.

   13. The valuation that you have completed so far is a base case analysis, which has not considered the

       value/benefits of synergies. What are the potential synergies in this M&A deal, as discussed in the case? How would you adjust the valuation model to factor in the synergies? Discussion only, no need to redo the financial models.

   14. What would be your recommendation to Mr. Zimmerman?

       • - Should American Cable acquire AirThread? Justify your recommendation.

       • - If recommending to acquire AirThread, how would you prepare Mr. Zimmerman for

         negotiation? What are the key strategic issues and valuation issues to bring to the negotiation table?

AirThread Financials 2005-2007 2005 2,827.0 203.7 3,030.8 604.1 511.9 1,217.7 Operating Results: Service Revenue Plus: Equipment Sales Total Revenue Less: System Operating Expenses Less: Cost of Equipment Sold Less: Selling, General & Administrative EBITDA Less: Depreciation & Amortization EBIT Less: Interest Expense Plus: Equity in Earnings of Affiliates Plus: Gains (Losses) on Investments Plus: Other Income EBT Less: Taxes Income Before Minority Interest Less: Minority Interest Net Income 490.1 206.9 84.9 66.7 18.1 54.5 261.3 95.9 165.5 10.5 155.0 2006 3,214.4 258.7 3,473.2 639.7 568.9 1.399.6 865.0 555.5 309.5 93.7 93.1 50.8 (46.6) 313.1 120.6 192.5 13.0 179.5 2007 3,679.2 267.0 3,946.3 717.1 640.2 1,555.6 1,033.3 582.3 451.1 84.7 90.0 83.1 7.0 546.5 216.7 329.8 15.1 314.7 Assets: Cash & Cash Equivalents Marketable Securities Accounts Receivable Inventory Prepaid Expenses Deferred Taxes Other Current Assets Total Current Assets 2005 2006 2007 29.003 32.912 204.533 0 249.039 16.352 362.359 407.438 435.497 92.748 117.189 100.99 32.068 34.9551 41.588 8.218 18.566 15.489 13.385 16.227 539.885 854.918 833.753 0 Property, Plan & Equipment Licenses Customer Lists Marketable Equity Securities Investments in Affiliated Entities Long Term Note Receivable Goodwill Other Long Term Assets Total Assets 2553.029 2628.848 2595.096 1362.263 1494.327 1482.446 47.649 26.196 15.375 225.387 4.873 172.093 150.325 157.693 4.707 4.541 4.422 481.235 485.452 491.316 29.985 31.136 31.773 5416.233 5680.616 5611.874 Liabilities & Owners' Equity: Accounts Payable Deferred Revenue & Deposits Accrued Liabilities Taxes Payable Deferred Taxes Note Payable Forward Contract Derivative Liability Other Current Liabilities Total Current Liabilities 254.116 111.407 42.865 36.748 0 135 0 0 82.585 662.721 254.871 260.791 123.344 143.445 47.842 59.224 26.913 43.105 26.326 35 0 159.856 88.84 93.718 97.678 856.71 604.243 Long Term Debt Forward Contracts Derivative Liability Deferred Tax Liability Asset Retirement Obligation Other Deferred Liabilities 1001.385 1001.839 1002.293 159.856 0 0 25.818 0 0 647.086 601.535 554.412 90.224 127.639 126.844 46.234 62.914 84.53 Minority Interest 41.871 36.7 43.396 Common Stock & Paid-In Capital Retained Earnings Total Liabilities & Owners' Equity 1375.016 1378.881 1404.094 1366.022 1614.398 1792.062 5416.233 5680.616 5611.874 AirThread Acquisition Projected Income Statements Operating Results: Service Revenue Plus: Equipment Sales 2008 4,194.3 314.8 2009 4,781.5 358.8 2010 5,379.2 403.7 2011 5,917.2 444.1 2012 6,331.4 475.2 Total Revenue Less: System Operating Expenses 4,509.1 838.9 5,140.4 956.3 5,782.9 1,075.8 6,361.2 1,183.4 6,806.5 1,266.3 Less: Cost of Equipment Sold Less: Selling, General & Administrative EBITDA Less: Depreciation & Amortization EBIT Less: Interest Expense EBT Less: Taxes Net Income 755.5 1.803.6 1,111.1 705.2 405.9 1994 206.5 82.6 123.9 861.2 2.0562 1,266.7 804.0 462.7 183.1 279.7 1119 167.8 968.9 2.313.2 1,425.0 8674 557.6 165.8 391.8 156.7 235.1 1,065.8 2.544.5 1,567.5 922.4 645.2 147.5 497.6 199.0 298.6 1,140.4 2.722.6 1,677.3 952.9 724.4 128.3 596.1 238.4 357.7 Estimate Long-term Growth rate The investment banking team decided to use the fundamental method to estimate AirThread's long-term growth rate. To apply the Fundamental Method: LT g =ROIC x Reinvestment Rate ROIC = NOPAT Reinvestment Rate = Net Reinvestment NOPAT Invested Capital Invested Capital = long term debt + equity - minority interest Net Reinvestment = Change in NOWC + CAPEX - Depreciation 2012 Long-Term Growth Rate NOPAT Invested Capitall ROIC Net Reinvestment NOPAT Reinvestment Rate Est. Growth Rate AIRTHREAD ACQUISITION Comparable Companies: Universal Mobile Neuberger Wireless Agile Connections Big Country Communications Rocky Mountain Wireless Average Equity Market Value 118,497 189,470 21,079 26,285 7,360 Net Debt 69,130 79,351 5,080 8,335 3,268 Debt/ Value 36.8% 29.5% 19.4% 24.1% 30.7% 28.1% Debt/ Equity wity 58.3% 41.9% 24.1% 31.7% 44.4% 40.1% Equity Beta 0.86 0.89 1.17 0.97 1.13 1.00 Revenue 43,882 42,684 34,698 38,896 4,064 EBIT EBITDA 11,795 16,949 7,020 14,099 1,631 9,914 6,702 12,614 510 1,028 Net Income 3,794 4,103 (30) 3,384 240 1) Equity betas were estimated on a weekly based on weekly stock returns over a three year period. Note: The current industry and competitor leverage ratios reflect the historical averages that existed over the past three yeas. Projected Balance Sheets Assets Cash & Cash Equivalents Marketable Securities Accounts Receivable Inventory Prepaid Expenses Deferred Taxes Other Current Assets Total Current Assets 2007 204.5 16.4 435.5 101.0 41.6 18.6 16.2 833.8 2008 86.6 16.4 521.9 135.0 46.9 18.6 16.2 841.5 2009 12.7 16.4 595.0 153.9 53.5 18.6 16.2 866.2 2010 0.0 16.4 669.3 173.1 60.2 18.6 16.2 953.7 2011 0.0 16.4 736.3 190.4 66.2 18.6 16.2 1,044.0 2012 0.0 16.4 787.8 203.7 70.8 18.6 16.2 1,113.5 Property, Plan & Equipment Licenses Customer Lists Investments in Affiliated Entities Long Term Note Receivable Goodwill Other Long Term Assets Total Assets 2,595.1 1,482.4 15.4 157.7 4.4 491.3 31.8 5,611.9 2,521.1 1,482.4 15.4 157.7 4.4 491.3 31.8 5,545.7 2,436.8 1,482.4 15.4 157.7 4.4 491.3 31.8 5,486.0 2,436.8 1,482.4 15.4 157.7 4.4 491.3 318 5,573.6 2,484.5 1,482.4 15.4 157.7 4.4 491.3 318 5,711.6 2,586.6 1,482.4 15.4 157.7 4.4 491.3 31.8 5,883.2 2012 Liabilities & Owners' Equity Accounts Payable Deferred Revenue & Deposits Accrued Liabilities Taxes Payable Other Current Liabilities Total Current Liabilities 2007 260.8 143.4 59.2 43.1 97.7 604.2 2008 335.4 163.3 64.6 43.1 97.7 704.1 2009 382.4 186.1 73.7 43.1 97.7 782.9 2010 430.2 209.4 82.9 43.1 97.7 863.2 2011 473.2 230.3 91.1 43.1 97.7 935.4 506.3 246.4 97.5 43.1 97.7 991.1 Long Term Debt Deferred Tax Liability Asset Retirement Obligation Other Deferred Liabilities 1,002.3 554.4 126.8 84.5 3,467.6 554.4 126.8 84.5 3,161 554.4 126.8 84.5 2,838 554.4 126.8 84.5 2,496 554.4 126.8 84.5 2,459 554.4 126.8 84.5 Minority Interest 43.4 43.4 43.4 43.4 43.4 43.4 Total Equity Total Liabilities & Owners' Equity 3.1962 5,611.9 564.8 5,545.7 732.6 5,486.0 1.063.4 5,573.6 1.471.0 5,711.6 1.623.9 5,883.2 2007 Cash Beginning Cash Plus: Un-Levered Free Cash Flow Less: After-Tax Interest Expense Less: Principal Payments Ending Cash 2008 204.5 291.6 119.7 289.9 86.6 2009 86.6 342.3 109.8 306.3 12.7 2010 12.7 314.5 99.5 323.6 (95.8) 2011 (95.8) 321.4 88.5 341.8 (204.7) 2012 (204.7) 318.6 77.0 2.496.0 (2,459.0) 19- Re-levering Changing Appendix A: Formula Sheet - Unlevering and Relevering Beta Condition Un-levering Hamada formula The company does not plan to keep a target/constant capital structure; Tax shields have the same risk as debt, Lits are: Debt has negligible risk. DE | A Bu De =A (1+@x2-1) RI Bits = a Vit = x D - Ba=0 Practitioner's formula Constant DE Bits = Bu The company plan to keep a target / constant capital structure; Tax shields have the same risk as operating assets / operating cash flows, 1.5=r; Debt has negligible risk Po= R. (1+2 Changing DE The company does not plan to keep a constant capital structure; 1.5=r Debt is risky Be+ Ba(D/ E)(1-1) T 1+63(1-1) Bits = a Be = By+Bi-Ba) = Ba=0 Harris-Pringle formula The company plans to keep a constant Constant De capital structure; Be + Ba(D/E) Bo= But(Pu- Babxf) Pits = Bu Debt is risky. AirThread Financials 2005-2007 2005 2,827.0 203.7 3,030.8 604.1 511.9 1,217.7 Operating Results: Service Revenue Plus: Equipment Sales Total Revenue Less: System Operating Expenses Less: Cost of Equipment Sold Less: Selling, General & Administrative EBITDA Less: Depreciation & Amortization EBIT Less: Interest Expense Plus: Equity in Earnings of Affiliates Plus: Gains (Losses) on Investments Plus: Other Income EBT Less: Taxes Income Before Minority Interest Less: Minority Interest Net Income 490.1 206.9 84.9 66.7 18.1 54.5 261.3 95.9 165.5 10.5 155.0 2006 3,214.4 258.7 3,473.2 639.7 568.9 1.399.6 865.0 555.5 309.5 93.7 93.1 50.8 (46.6) 313.1 120.6 192.5 13.0 179.5 2007 3,679.2 267.0 3,946.3 717.1 640.2 1,555.6 1,033.3 582.3 451.1 84.7 90.0 83.1 7.0 546.5 216.7 329.8 15.1 314.7 Assets: Cash & Cash Equivalents Marketable Securities Accounts Receivable Inventory Prepaid Expenses Deferred Taxes Other Current Assets Total Current Assets 2005 2006 2007 29.003 32.912 204.533 0 249.039 16.352 362.359 407.438 435.497 92.748 117.189 100.99 32.068 34.9551 41.588 8.218 18.566 15.489 13.385 16.227 539.885 854.918 833.753 0 Property, Plan & Equipment Licenses Customer Lists Marketable Equity Securities Investments in Affiliated Entities Long Term Note Receivable Goodwill Other Long Term Assets Total Assets 2553.029 2628.848 2595.096 1362.263 1494.327 1482.446 47.649 26.196 15.375 225.387 4.873 172.093 150.325 157.693 4.707 4.541 4.422 481.235 485.452 491.316 29.985 31.136 31.773 5416.233 5680.616 5611.874 Liabilities & Owners' Equity: Accounts Payable Deferred Revenue & Deposits Accrued Liabilities Taxes Payable Deferred Taxes Note Payable Forward Contract Derivative Liability Other Current Liabilities Total Current Liabilities 254.116 111.407 42.865 36.748 0 135 0 0 82.585 662.721 254.871 260.791 123.344 143.445 47.842 59.224 26.913 43.105 26.326 35 0 159.856 88.84 93.718 97.678 856.71 604.243 Long Term Debt Forward Contracts Derivative Liability Deferred Tax Liability Asset Retirement Obligation Other Deferred Liabilities 1001.385 1001.839 1002.293 159.856 0 0 25.818 0 0 647.086 601.535 554.412 90.224 127.639 126.844 46.234 62.914 84.53 Minority Interest 41.871 36.7 43.396 Common Stock & Paid-In Capital Retained Earnings Total Liabilities & Owners' Equity 1375.016 1378.881 1404.094 1366.022 1614.398 1792.062 5416.233 5680.616 5611.874 AirThread Acquisition Projected Income Statements Operating Results: Service Revenue Plus: Equipment Sales 2008 4,194.3 314.8 2009 4,781.5 358.8 2010 5,379.2 403.7 2011 5,917.2 444.1 2012 6,331.4 475.2 Total Revenue Less: System Operating Expenses 4,509.1 838.9 5,140.4 956.3 5,782.9 1,075.8 6,361.2 1,183.4 6,806.5 1,266.3 Less: Cost of Equipment Sold Less: Selling, General & Administrative EBITDA Less: Depreciation & Amortization EBIT Less: Interest Expense EBT Less: Taxes Net Income 755.5 1.803.6 1,111.1 705.2 405.9 1994 206.5 82.6 123.9 861.2 2.0562 1,266.7 804.0 462.7 183.1 279.7 1119 167.8 968.9 2.313.2 1,425.0 8674 557.6 165.8 391.8 156.7 235.1 1,065.8 2.544.5 1,567.5 922.4 645.2 147.5 497.6 199.0 298.6 1,140.4 2.722.6 1,677.3 952.9 724.4 128.3 596.1 238.4 357.7 Estimate Long-term Growth rate The investment banking team decided to use the fundamental method to estimate AirThread's long-term growth rate. To apply the Fundamental Method: LT g =ROIC x Reinvestment Rate ROIC = NOPAT Reinvestment Rate = Net Reinvestment NOPAT Invested Capital Invested Capital = long term debt + equity - minority interest Net Reinvestment = Change in NOWC + CAPEX - Depreciation 2012 Long-Term Growth Rate NOPAT Invested Capitall ROIC Net Reinvestment NOPAT Reinvestment Rate Est. Growth Rate AIRTHREAD ACQUISITION Comparable Companies: Universal Mobile Neuberger Wireless Agile Connections Big Country Communications Rocky Mountain Wireless Average Equity Market Value 118,497 189,470 21,079 26,285 7,360 Net Debt 69,130 79,351 5,080 8,335 3,268 Debt/ Value 36.8% 29.5% 19.4% 24.1% 30.7% 28.1% Debt/ Equity wity 58.3% 41.9% 24.1% 31.7% 44.4% 40.1% Equity Beta 0.86 0.89 1.17 0.97 1.13 1.00 Revenue 43,882 42,684 34,698 38,896 4,064 EBIT EBITDA 11,795 16,949 7,020 14,099 1,631 9,914 6,702 12,614 510 1,028 Net Income 3,794 4,103 (30) 3,384 240 1) Equity betas were estimated on a weekly based on weekly stock returns over a three year period. Note: The current industry and competitor leverage ratios reflect the historical averages that existed over the past three yeas. Projected Balance Sheets Assets Cash & Cash Equivalents Marketable Securities Accounts Receivable Inventory Prepaid Expenses Deferred Taxes Other Current Assets Total Current Assets 2007 204.5 16.4 435.5 101.0 41.6 18.6 16.2 833.8 2008 86.6 16.4 521.9 135.0 46.9 18.6 16.2 841.5 2009 12.7 16.4 595.0 153.9 53.5 18.6 16.2 866.2 2010 0.0 16.4 669.3 173.1 60.2 18.6 16.2 953.7 2011 0.0 16.4 736.3 190.4 66.2 18.6 16.2 1,044.0 2012 0.0 16.4 787.8 203.7 70.8 18.6 16.2 1,113.5 Property, Plan & Equipment Licenses Customer Lists Investments in Affiliated Entities Long Term Note Receivable Goodwill Other Long Term Assets Total Assets 2,595.1 1,482.4 15.4 157.7 4.4 491.3 31.8 5,611.9 2,521.1 1,482.4 15.4 157.7 4.4 491.3 31.8 5,545.7 2,436.8 1,482.4 15.4 157.7 4.4 491.3 31.8 5,486.0 2,436.8 1,482.4 15.4 157.7 4.4 491.3 318 5,573.6 2,484.5 1,482.4 15.4 157.7 4.4 491.3 318 5,711.6 2,586.6 1,482.4 15.4 157.7 4.4 491.3 31.8 5,883.2 2012 Liabilities & Owners' Equity Accounts Payable Deferred Revenue & Deposits Accrued Liabilities Taxes Payable Other Current Liabilities Total Current Liabilities 2007 260.8 143.4 59.2 43.1 97.7 604.2 2008 335.4 163.3 64.6 43.1 97.7 704.1 2009 382.4 186.1 73.7 43.1 97.7 782.9 2010 430.2 209.4 82.9 43.1 97.7 863.2 2011 473.2 230.3 91.1 43.1 97.7 935.4 506.3 246.4 97.5 43.1 97.7 991.1 Long Term Debt Deferred Tax Liability Asset Retirement Obligation Other Deferred Liabilities 1,002.3 554.4 126.8 84.5 3,467.6 554.4 126.8 84.5 3,161 554.4 126.8 84.5 2,838 554.4 126.8 84.5 2,496 554.4 126.8 84.5 2,459 554.4 126.8 84.5 Minority Interest 43.4 43.4 43.4 43.4 43.4 43.4 Total Equity Total Liabilities & Owners' Equity 3.1962 5,611.9 564.8 5,545.7 732.6 5,486.0 1.063.4 5,573.6 1.471.0 5,711.6 1.623.9 5,883.2 2007 Cash Beginning Cash Plus: Un-Levered Free Cash Flow Less: After-Tax Interest Expense Less: Principal Payments Ending Cash 2008 204.5 291.6 119.7 289.9 86.6 2009 86.6 342.3 109.8 306.3 12.7 2010 12.7 314.5 99.5 323.6 (95.8) 2011 (95.8) 321.4 88.5 341.8 (204.7) 2012 (204.7) 318.6 77.0 2.496.0 (2,459.0) 19- Re-levering Changing Appendix A: Formula Sheet - Unlevering and Relevering Beta Condition Un-levering Hamada formula The company does not plan to keep a target/constant capital structure; Tax shields have the same risk as debt, Lits are: Debt has negligible risk. DE | A Bu De =A (1+@x2-1) RI Bits = a Vit = x D - Ba=0 Practitioner's formula Constant DE Bits = Bu The company plan to keep a target / constant capital structure; Tax shields have the same risk as operating assets / operating cash flows, 1.5=r; Debt has negligible risk Po= R. (1+2 Changing DE The company does not plan to keep a constant capital structure; 1.5=r Debt is risky Be+ Ba(D/ E)(1-1) T 1+63(1-1) Bits = a Be = By+Bi-Ba) = Ba=0 Harris-Pringle formula The company plans to keep a constant Constant De capital structure; Be + Ba(D/E) Bo= But(Pu- Babxf) Pits = Bu Debt is risky