Valuation of AirThread Connections

________________________________________________________________________________________________________________
Valuation of AirThread Connections
In early December 2007, Robert Zimmerman, senior vice president of business development for
American Cable Communications (ACC), was in his office sifting through a number of investment
banking proposals related to potential acquisition targets when he paused to consider the recent
presentation made by Rubinstein & Ross (R&R).
Rubinstein & Ross was a boutique investment bank with a strong reputation for doing deals in the
media and telecommunications sector. During that meeting, Elliot Bianco pitched the idea of American
Cable buying out AirThread Connections, a large regional cellular provider. The basic premise of the
AirThread acquisition was threefold.
First, American Cable and AirThread could help each other compete in an industry that was moving
more and more toward bundled service offerings. American Cable currently offered video, internet,
and landline telephony, but did not have any kind of wireless offerings. This gap in product offerings
had so far been exploited only modestly by competitors—primarily incumbent local exchange carriers
(ILEC’s) with wireless networks—but as those firms grow their video offerings the problem was
expected to become more acute. Additionally, American Cable saw a looming competitive threat from
advanced wireless networks based on the 802.16n standard for mobile WiMAX. Those networks are
expected to be able to deliver not only wireless telephony but also internet service with throughput
similar to that which is currently offered by cable providers. AirThread, for its part, faced similar
pressures with respect to the same set of competitors because it didn’t offer landline or internet service.
However, unlike ACC, AirThread was feeling the pressure more immediately in the form of higher
customer acquisition and retention costs, plus slower growth.
Second, the acquisition could help both companies expand into the business market. Both firms
had customer bases that were heavily reliant on retail/residential customers. In the case of American
Cable, this had resulted in a lack of long-term service contracts, which could have increased the stability
and reliability of the company’s revenues. In turn, this would also have had the beneficial effect of
reducing the risk associated with ACC’s operations. Furthermore, expanding into the business
segment would help each firm increase its network utilization and, as a result, increase its cost
efficiency.
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4263 | Valuation of AirThread Connections
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Third, American Cable was in a unique position to add value to AirThread’s operations. AirThread
had a cost disadvantage relative to its main wireless competitors owned by ILECs. A large portion of
wireless network operating costs related to moving traffic from cell towers to central switching offices
using either landlines leased from competitors or technically cumbersome microwave equipment. A
preliminary study by Rubinstein & Ross estimated that use of American Cable’s fiber lines could have
saved AirThread more than 20% in backhaul costs.
In addition to the strategic fit, R&R believed that it could obtain a significant amount of debt
financing for an AirThread acquisition. Bianco was confident that the high quality of AirThread’s
network assets, its valuable wireless spectrum licenses, and its steady cash flow would merit a debt to
value ratio as high as 45% to 50% based on EBITDA coverage ratios exceeding 5.0x.1
American Cable Communications
In December of 2007, American Cable Communications (ACC) was one of the largest cable
operators in the United States. The company’s cable systems passed roughly 48.5 million homes and
served approximately 24.1 million video subscribers, 13.2 million high-speed internet subscribers, and
4.6 million landline telephony subscribers. Consolidated revenue for 2007 was expected to be $30.9
billion with net income of $2.6 billion.
Overview of Cable Industry Dynamics
The cable industry had been rapidly transforming over the last decade as a result of advances in
technology, changes in regulation, and shifts in competitive dynamics. In turn, these forces had been
driving large investments in network infrastructure that require commensurate increases in the
customer base to effectively utilize the new capacity. It was this need to acquire economies of scale
and scope that led American Cable’s executives to believe that only a handful of very large network
providers would survive into the future. The smaller companies would eventually be weeded out
through industry consolidation. As a result, American Cable became an aggressive acquirer.
American Cable’s Business Development Group
American Cable’s business development group has been tasked with the primary goal of increasing
the company’s customer base as a means to fuel both top line growth and network utilization. From
1999 through 2005, ACC’s business development group spearheaded more than $15.0 billion of
acquisitions and, as a result, the company believed it had developed a strong corporate finance team
with significant acumen in identifying, valuing, structuring, and executing corporate control
transactions. In addition, the company also believed that its experience as an acquirer had allowed it
to develop unique operational know-how in the area of merger integration.
Furthermore, the company believed that its core competency as an acquirer would continue to play
a fundamental role in its future success. With the rapidly increasing costs of acquiring new customers
and the high penetration rates in video and high speed internet, the group surmised that the only way
to achieve meaningful customer growth would be through additional acquisitions.
American Cable’s acquisition process began with the screening of potential communications service
providers that operate in territories adjacent to, or within, the firm’s existing regions. Next, a basic
investment thesis was developed that outlined the acquisition benefits in terms of the strategic fit of a
1 EBITDA coverage ratio is EBITDA/total interest expense.
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target company’s assets and operations with those of American Cable, the potential synergies from a
merger, the likely price of the target relative to an estimate of its intrinsic value, and the acquisition’s
likely effect on the competitive dynamics within the industry.
After the initial screening, a preliminary valuation was done to estimate the target’s underlying
value irrespective of its current market price. The valuation techniques utilized include market
multiple approaches as well as discounted cash flow methodologies, such as WACC-based DCF and
APV. The capital structure assumptions employed were designed to mimic American Cable’s past
investment policies, which were to purchase the target with a significant amount of debt and then pay
down the debt to a sustainable long-term level that was in line with industry norms. The company’s
use of acquisition leverage was modeled after the classic LBO approach used by many private equity
firms. The goal was to use a tax-efficient structure that maximizes investor returns by minimizing the
amount of up-front equity invested in the deal.
AirThread Connections Business
AirThread Connections (ATC) was one of the largest regional wireless companies in the United
States, providing service in more than 200 markets in five geographic regions. The company’s 2007
revenue and operating incomes were expected to be approximately $3.9 billion and $400 million
respectively. The firm’s networks covered a total population of more than 80 million people. In
addition, AirThread had an extensive set of roaming agreements with other carriers to provide its
customers with coverage in areas where the company did not operate a network. Table 1 depicts the
company’s wireless ownership interests.
Table 1 Wireless Licenses
Operating Markets 209
Non-Operating Markets 9
Markets In Which ATC Has A Controlling Interest 218
Markets To Be Acquired Under Existing Purchase Agreements 25
Non-Controlling Investment Interests 17
Total Markets 260
Exhibit 2 provides additional details on the company’s customers and penetration rates by region
for its total consolidated markets and operating markets.2 AirThread also intended to continue to
expand its network operating area by participating in FCC auctions for wireless spectrum in regions
adjacent to its existing networks.
AirThread Connections’ Competitive Environment
The wireless communications market was intensely competitive. AirThread competed directly with
anywhere from three to five major competitors in each of its markets. These competitors included all
of the national wireless carriers, which had substantially greater financial, marketing, sales,
distribution, and technical resources. Competition among the carriers was generally based on price,
service area size, call quality, and customer service.
2 Total consolidated markets are markets for which the company has operating licenses but may not provide service. Operating
markets are markets for which the company provides service.
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4263 | Valuation of AirThread Connections
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Competitive Challenges for AirThread Connections
In addition to the intense competitive atmosphere there were several challenges facing AirThread.
The most pressing of these challenges related to an operating cost disadvantage vis-à-vis the ILECowned
wireless companies. In order to move wireless traffic from a cell tower to a central switching
office required either leasing telephone lines from the local carrier or investing in very expensive
microwave transmission equipment, which was oftentimes technically difficult to employ due to line
of site requirements. As a result, AirThread estimated that its system operating costs were
approximately 20% higher than those of its main rivals.
A second source competitive disadvantage related to the company’s inability to bundle its wireless
service with other offerings such as landline telephony, internet access, and video services. Most of the
national carriers with whom AirThread competed could provide at least two of those services. In order
to effectively attract and retain customers, the firm had to offer superior customer service and
aggressive pricing packages in terms of monthly service fees and equipment subsidies. Consequently,
average revenue per minute decreased from 6.71 cents to 5.95 cents over the past fiscal year, and the
cost of acquiring a new customer had increased from $372 in 2005 to $487 in 2007 (see Exhibit 3).
Finally, because most businesses required reliable high-speed internet and landline telephony
service, the recent trend toward bundled services had, to a large extent, frozen ATC out of the business
market. In turn, this was a limiting factor for future growth and increased network utilization.
AirThread Connection’s Recent Financial Performance
As the income statement in Exhibit 4 indicates, the company had experienced improvements in
revenue growth and operating margins. Management attributed much of the improvement in
operating margins to improvements in the firm’s increased asset efficiency and network utilization
rate, which is evidenced by the increasing return on net operating assets and asset turnover ratios
shown in Table 2 (see balance sheet in Exhibit 5).
Table 2
2005 2006 2007
Return on Net Operating Assets 3.6% 5.0% 7.1%
Return on Equity 5.7% 6.0% 9.8%
Asset Turnover Ratio 87.3% 94.4% 103.4%
Improving financial results notwithstanding, AirThread still faced some significant financial
pressures. As discussed earlier, the wireless communications market was extremely competitive, and
to a large extent it had been commoditized. The company’s CFO, Michael Balistreri, put it best during
a recent board meeting:
“In a commoditized industry, it is usually the low-cost producer that survives and thrives.”
The aforementioned sentiment was particularly relevant in light of the company’s relative
performance. As seen in Table 3, compared with its primary rivals, AirThread had lower operating
and EBITDA margins, which largely reflected the previously discussed competitive disadvantages.
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Table 3
EBIT
Margin
EBITDA
Margin
Net
Income
Margin
Comparable Companies
Universal Mobile 26.9% 38.6% 8.6%
Neuberger Wireless 16.4% 33.0% 9.6%
Agile Connections 4.7% 28.6% -0.1%
Big Country Communications 17.2% 32.4% 8.7%
Rocky Mountain Wireless 12.6% 25.3% 5.9%
Average 15.6% 31.6% 6.6%
AirThread 11.4% 26.2% 8.0%
The net result was that AirThread’s long-term survival as an independent company was in doubt
by a growing number of people within the communications industry. In fact, some had argued that
the company needed to find a suitor before its market position became untenable.
Valuation of AirThread
Given the potential importance and complexity of a possible AirThread acquisition, Zimmerman
decided to tap Jennifer Zhang, an up-and-coming senior associate from the University of Chicago, to
conduct the initial valuation of AirThread. As Ms. Zhang contemplated her new assignment, she
decided to take a methodical step-by-step approach to the valuation by focusing on projecting the
operating results, estimating the appropriate cost of capital and quantifying the potential synergies that
might result from combining the two companies. Further, she wanted to keep things simple by
assuming a stock purchase using the maximum amount of leverage available. Finally, she decided that
the nonoperating assets and liabilities should be valued separately so that the attention remained
squarely on the ongoing operations.
Operating Results
As a starting point, Jennifer decided to create a base case using historical operating results as a
guide, and then create an upside case that considered possible synergies. In both cases, Jennifer based
her projections on AirThread’s most recent financial performance (Exhibit 1 shows the projected
operating results). The decline in the service revenue growth rate reflected continued deterioration in
the revenue per minute of airtime as well as the continued maturation of cellular telephony.
With respect to the income from investments, Jennifer believed that it was primarily due to
AirThread’s cash and marketable securities, which would probably be used to finance part of an
eventual acquisition. Consequently, the cash flows were not included in her projections. As for the
equity in affiliates, the results reflected AirThread’s share in the net income of unconsolidated firms
where no controlling interest existed. This presented two problems. First, the company’s share of the
net income was unlikely to be equal to any cash dividend received. Second, without thorough due
diligence, it would be impossible to project the free cash flows for those minority interest equity
investments. As a result, Jennifer believed that the investments could be valued using a market
multiple approach3.
3 The historic P/E multiple for the industry was approximately 19.095x.
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Potential Synergies
With regard to estimating synergies, Jennifer realized that such efforts are notoriously difficult to
quantify even when there is a reasonable basis for assuming their existence. As a result, she decided
to segregate the potential synergies into various categories. The easiest source of value to identify was
the reduction in AirThread’s backhaul costs, which were approximately 20% of the company’s system
operating expenses. Although Ms. Zhang believed that American Cable could reduce ATC’s backhaul
costs, she also knew the company would still require the use of some leased lines and microwave
transmission in many areas. Moreover, she also knew the cost savings would be gradual.
Consequently, Jennifer estimated the total system operating cost savings to be 6% realized over four
years beginning in 2009 (see Table 4).
Table 4 ($MM)
2008 2009 2010 2011 2012
Backhaul Savings
System Operating Expenses $ 838.9 $ 956.3 $ 1,075.8 $ 1,183.4 $ 1,266.3
Backhaul Percentage 20.0% 20.0% 20.0% 20.0% 20.0%
Estimated Backhaul Costs 167.8 191.3 215.2 236.7 253.3
Reduction in Backhaul Costs 0.0% 7.0% 12.0% 22.2% 30.0%
Backhaul Savings $ 0.0 $ 13.4 $ 25.8 $ 52.5 $ 76.0
A more difficult set of synergies to evaluate were those related to increases in revenue resulting
from cross selling and bundling AirThread’s wireless service with ACC’s internet, telephony, and
video offerings. In particular, Ms. Zhang believed that the combined company would be able to attract
business customers now that wireless, wire line, and internet service could be offered by the same
provider. In estimating the additional business, Jennifer believed that the growth in business
subscribers would be similar to American Cable’s early telephony adoption rate, and the airtime usage
would be similar to that of ATC’s existing customers. However, she also estimated that the revenue
per minute for business customers would be less than that charged to retail subscribers. The estimated
revenue and gross profit for new wireless subscribers is shown in Table 5.
Table 5
2008 2009 2010 2011 2012
Wireless Business Subscribers
Average Monthly Subscribers (in MM’s) 0.30 0.50 0.70 1.00 1.20
Average Monthly Minutes 859 885 911 939 967
Total Monthly Minutes 258 442 638 939 1,160
Revenue Per Minute 0.0506 0.0506 0.0506 0.0506 0.0506
Annual Business Revenue Increase ($MM) $ 156 $ 269 $ 387 $ 570 $ 704
Capital Structure & Illiquidity Discount
Jennifer decided to use Bianco’s recommendation of a 5% equity market risk premium, an EBITDA
interest coverage ratio of 5.0x based on 2007 operating results, and/or a debt to value ratio not
exceeding 50.0% when calculating the initial leverage for AirThread. However, she also wanted her
preliminary valuation to conform to American Cable’s established practice of paying down acquisition
debt to eventually reflect industry norms. As a result, she assumed the acquisition debt would consist
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Valuation of AirThread Connections | 4263
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of a single tranche amortizing monthly over 10 years, but with a bullet payment4 at the end of year 5
(see Exhibit 6). The bullet payment would be in an amount necessary to bring AirThread’s leverage
ratios in line with those of the industry.
Based on the information provided by Rubinstein & Ross, Jennifer estimated that the debt rating
was likely to be investment grade with a rating of BBB+ and have an interest rate of approximately
5.50%, which reflected a 125bp spread over the current yield on 10-year US Treasury bonds.
In order to estimate AirThread’s beta, Ms. Zhang decided to use the comparable company
information contained in Exhibit 7. However, the more troubling issue was how to handle the potential
discount, if any, resulting from AirThread’s status as a private company. In contemplating this issue
Jennifer believed that it may be necessary to follow the customary practice of employing a private
company discount. This discount is primarily related to the illiquidity of private investments, but also
considers certain types of agency costs as well as the financial health and size of the firm. Most of the
academic research of which Ms. Zhang was aware estimated the illiquidity discount to be in the range
of 35%, though rules of thumb often employed by practitioners put the range in the area of 20% to
30%.5 Exhibit 8 provides a graphical depiction of the relationship between revenue and the illiquidity
discount for profitable and unprofitable firms.
On the other hand, there was also a well-established school of thought that believed large profitable
firms with the ability to go public should not trade at a discount due to their status as private
companies. The reasoning is based on the notion that owners wouldn’t accept an illiquidity discount
because they have the public market option.6
Terminal Value
The final consideration for Jennifer was the handling of the terminal value calculation. Ms. Zhang
was well aware that the terminal value was likely to be the single largest component of the valuation.
Consequently, she decided to employ both a growth perpetuity method and a market multiple method
based on the comparable company information contained in Exhibit 7. In terms of the long-term
growth rate, Jennifer understood that it could not exceed that of the macro economy as a whole.
However, she also knew that the long-term growth rate would be a function of the company’s return
on capital7 and reinvestment rate.8
Pending Decisions
Zimmerman had a lot on his plate. There was considerable pressure, both internally and externally,
to scale American Cable’s business. The increased size would not only help insure that ACC would
remain a viable industry player but would also help improve profitability through better network
utilization. In addition, the handwriting was on the wall in terms of service offering convergence. The
other major communications service providers were all making significant investments to build out
4 A bullet payment refers to a single payment to pay off the remaining loan balance at the time of maturity.
5 Moroney examined 146 restricted stock purchases in 1970 (35%); and Silber studied restricted issues from 1984-1989 (33.75%).
6 The average cost of going public is estimated to be 10% of the equity issued.
7 Return on capital is defined as net operating profit after taxes divided by the book value of equity plus debt.
8 The reinvestment rate is defined as capital expenditures plus investments in working capital minus depreciation divided by
net operating profit after taxes.
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4263 | Valuation of AirThread Connections
8 BRIEFCASES | HARVARD BUSINESS SCHOOL
their product offering capabilities; and if American Cable didn’t respond, it again risked being left
behind.
Of course Zimmerman also knew there were considerable risks whenever large investments,
particularly mergers, were involved. He was well aware of several high profile takeovers that ended
in either eventual bankruptcy or considerable loss of shareholder value, and overpaying for a target
company was one of the quickest ways to achieve disaster. As a result, he was really relying on Zhang
to provide a timely concise analysis that would clearly lay out a likely estimate of the intrinsic value of
AirThread’s operations and non-operating assets using ACC’s investment approach.
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Valuation of AirThread Connections | 4263
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Exhibit 1 AirThread Projections ($MM)
2008 2009 2010 2011 2012
Revenue Projections
Service Revenue $ 4,194.3 $ 4,781.5 $ 5,379.2 $ 5,917.2 $ 6,331.4
Service Revenue Growth 14.0% 14.0% 12.5% 10.0% 7.0%
Equipment Revenue 314.8 358.8 403.7 444.1 475.2
Equipment Revenue/Service Revenuea 7.5% 7.5% 7.5% 7.5% 7.5%
Operating Expenses
System Operating Expenses 838.9 956.3 1,075.8 1,183.4 1,266.3
System Operating Exp./Service Revenue 20.0% 20.0% 20.0% 20.0% 20.0%
Cost of Equipment Sold 755.5 861.2 968.9 1,065.8 1,140.4
Equipment COGS 240.0% 240.0% 240.0% 240.0% 240.0%
Selling, General & Administrative 1,803.6 2,056.2 2,313.2 2,544.5 2,722.6
SG&A/Total Revenue 40.0% 40.0% 40.0% 40.0% 40.0%
Depreciation & Amortization 705.2 804.0 867.4 922.4 952.9
Tax Rate 40.0% 40.0% 40.0% 40.0% 40.0%
Working Capital Assumptionsa
Accounts Receivable 41.67x 41.67x 41.67x 41.67x 41.67x
Days Sales Equip. Rev. 154.36x 154.36x 154.36x 154.36x 154.36x
Prepaid Expenses 1.38% 1.38% 1.38% 1.38% 1.38%
Accounts Payable 35.54x 35.54x 35.54x 35.54x 35.54x
Deferred Serv. Revenue 14.01x 14.01x 14.01x 14.01x 14.01x
Accrued Liabilities 6.85x 6.85x 6.85x 6.85x 6.85x
Capital Expendituresb
Capital Expenditures 631.3 719.7 867.4 970.1 1,055.0
Cap-x/Total Revenue 14.0% 14.0% 15.0% 15.3% 15.5%
a Based on a 360-day year. Days Payable, Deferred Service Revenue, and Days Accrued Liabilities are based on total cash
operating expenses.
b Includes investments in property, plant & equipment, as well as licenses and customer lists.
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4263 | Valuation of AirThread Connections
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Exhibit 2 AirThread Customer & Market Data
Total Consolidated Markets (000’s)
Region Population Customers Penetration
Central US 65,096 3,846 5.9%
Mid-Atlantic 11,677 1,180 10.1%
New England 2,830 518 18.3%
Northwest 2,287 431 18.8%
New York 481 147 30.6%
Total 82,371 6,122 7.4%
Total Operating Markets (000’s)
Region Population Customers Penetration
Central US 32,497 3,846 11.8%
Mid-Atlantic 7,346 1,180 16.1%
New England 2,344 518 22.1%
Northwest 2,287 431 18.8%
New York 481 147 30.6%
Total 44,955 6,122 13.6%
Exhibit 3 AirThread Customer Additions & Average Monthly Revenue
2005 2006 2007
Customer Data
Net Customer Additions 301 310 477
Cost Per Customer Addition 372 385 487
Cost of New Customer Additions 111,972 119,350 232,299
Cost of Equipment Sold/Equipment Revenue 251.3% 219.9% 239.8%
Monthly Churn Rate 2.1% 2.1% 1.7%
2005 2006 2007
Revenue Per Minute
Monthly ARPU 45.24 47.23 51.13
Customer Minutes Per Month 625 704 859
Revenue Per Minute 0.0724 0.0671 0.0595
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Exhibit 4 AirThread Income Statement ($MM)
2005 2006 2007
Operating Results
Service Revenue 2,827.0 3,214.4 3,679.2
Plus: Equipment Sales 203.7 258.7 267.0
Total Revenue 3,030.8 3,473.2 3,946.3
Less: System Operating Expenses 604.1 639.7 717.1
Less: Cost of Equipment Sold 511.9 568.9 640.2
Less: Selling, General & Administrative 1,217.7 1,399.6 1,555.6
EBITDA 697.0 865.0 1,033.3
Less: Depreciation & Amortization 490.1 555.5 582.3
EBIT 206.9 309.5 451.1
Less: Interest Expense 84.9 93.7 84.7
Plus: Equity in Earnings of Affiliates 66.7 93.1 90.0
Plus: Gains (Losses) on Investments 18.1 50.8 83.1
Plus: Other Income 54.5 (46.6) 7.0
EBT 261.3 313.1 546.5
Less: Taxes 95.9 120.6 216.7
Income Before Minority Interest 165.5 192.5 329.8
Less: Minority Interest 10.5 13.0 15.1
Net Income $ 155.0 $ 179.5 $ 314.7
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4263 | Valuation of AirThread Connections
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Exhibit 5 AirThread Balance Sheet ($MM)
2005 2006 2007
Assets
Cash & Cash Equivalents $ 29.0 $ 32.9 $ 204.5
Marketable Securities 0.0 249.0 16.4
Accounts Receivable 362.4 407.4 435.5
Inventory 92.7 117.2 101.0
Prepaid Expenses 32.1 35.0 41.6
Deferred Taxes 8.2 0.0 18.6
Other Current Assets 15.5 13.4 16.2
Total Current Assets 539.9 854.9 833.8
Property, Plant & Equipment 2,553.0 2,628.8 2,595.1
Licenses 1,362.3 1,494.3 1,482.4
Customer Lists 47.6 26.2 15.4
Marketable Equity Securities 225.4 4.9 0.0
Investments in Affiliated Entities 172.1 150.3 157.7
Long-Term Note Receivable 4.7 4.5 4.4
Goodwill 481.2 485.5 491.3
Other Long-Term Assets 30.0 31.1 31.8
Total Assets $ 5,416.2 $ 5,680.6 $ 5,611.9
Liabilities & Owners’ Equity
Accounts Payable 254.1 254.9 260.8
Deferred Revenue & Deposits 111.4 123.3 143.4
Accrued Liabilities 42.9 47.8 59.2
Taxes Payable 36.7 26.9 43.1
Deferred Taxes 0.0 26.3 0.0
Note Payable 135.0 35.0 0.0
Forward Contract 0.0 159.9 0.0
Derivative Liability 0.0 88.8 0.0
Other Current Liabilities 82.6 93.7 97.7
Total Current Liabilities $ 662.7 $ 856.7 $ 604.2
Long Term Debt 1,001.4 1,001.8 1,002.3
Forward Contracts 159.9 0.0 0.0
Derivative Liability 25.8 0.0 0.0
Deferred Tax Liability 647.1 601.5 554.4
Asset Retirement Obligation 90.2 127.6 126.8
Other Deferred Liabilities 46.2 62.9 84.5
Minority Interest 41.9 36.7 43.4
Common Stock & Paid-In Capital 1,375.0 1,378.9 1,404.1
Retained Earnings 1,366.0 1,614.4 1,792.1
Total Liabilities & Owners’ Equity 5,416.2 5,680.6 5,611.9
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Valuation of AirThread Connections | 4263
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Exhibit 6 Debt Repayment Schedule
Term Loan Amortization ($MM)
Payment
Annual
Interest Principal Balance
Amortization
Period
Payment
Annual
Interest Principal Balance
Amortization
Period
Date: 41 5.50% 3,758 120 Date: 41 5.50% 2,698 84
1/31/2008 41 17 24 3,734 1 6/30/2011 41 12 28 2,669 42
2/28/2008 41 17 24 3,710 2 7/31/2011 41 12 29 2,641 43
3/31/2008 41 17 24 3,687 3 8/31/2011 41 12 29 2,612 44
4/30/2008 41 17 24 3,663 4 9/30/2011 41 12 29 2,583 45
5/31/2008 41 17 24 3,639 5 10/31/2011 41 12 29 2,554 46
6/30/2008 41 17 24 3,615 6 11/30/2011 41 12 29 2,525 47
7/31/2008 41 17 24 3,590 7 12/31/2011 41 12 29 2,496 48
8/31/2008 41 16 24 3,566 8 1/31/2012 41 11 29 2,467 49
9/30/2008 41 16 24 3,542 9 2/28/2012 41 11 29 2,437 50
10/31/2008 41 16 25 3,517 10 3/31/2012 41 11 30 2,408 51
11/30/2008 41 16 25 3,492 11 4/30/2012 41 11 30 2,378 52
12/31/2008 41 16 25 3,468 12 5/31/2012 41 11 30 2,348 53
1/31/2009 41 16 25 3,443 13 6/30/2012 41 11 30 2,318 54
2/28/2009 41 16 25 3,418 14 7/31/2012 41 11 30 2,288 55
3/31/2009 41 16 25 3,393 15 8/31/2012 41 10 30 2,257 56
4/30/2009 41 16 25 3,367 16 9/30/2012 41 10 30 2,227 57
5/31/2009 41 15 25 3,342 17 10/31/2012 41 10 31 2,196 58
6/30/2009 41 15 25 3,317 18 11/30/2012 41 10 31 2,166 59
7/31/2009 41 15 26 3,291 19 12/31/2012 2,176 10 2,166 0 60
8/31/2009 41 15 26 3,265 20
9/30/2009 41 15 26 3,239 21
10/31/2009 41 15 26 3,214 22
11/30/2009 41 15 26 3,188 23
12/31/2009 41 15 26 3,161 24
1/31/2010 41 14 26 3,135 25
2/28/2010 41 14 26 3,109 26
3/31/2010 41 14 27 3,082 27
4/30/2010 41 14 27 3,055 28
5/31/2010 41 14 27 3,029 29
6/30/2010 41 14 27 3,002 30
7/31/2010 41 14 27 2,975 31
8/31/2010 41 14 27 2,948 32
9/30/2010 41 14 27 2,920 33
10/31/2010 41 13 27 2,893 34
11/30/2010 41 13 28 2,865 35
12/31/2010 41 13 28 2,838 36
1/31/2011 41 13 28 2,810 37
2/28/2011 41 13 28 2,782 38
3/31/2011 41 13 28 2,754 39
4/30/2011 41 13 28 2,726 40
5/31/2011 41 12 28 2,698 41
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4263 | Valuation of AirThread Connections
14 BRIEFCASES | HARVARD BUSINESS SCHOOL
Exhibit 7 Wireless Comparable Companies ($000’s)
Equity Net Debt/ Debt/ Equity Net
Comparable Companies: Market Value Debt Value Equity Beta1 Revenue EBIT EBITDA Income
Universal Mobile 118,497 69,130 36.8% 58.3% 0.86 43,882 11,795 16,949 3,794
Neuberger Wireless 189,470 79,351 29.5% 41.9% 0.89 42,684 7,020 14,099 4,103
Agile Connections 21,079 5,080 19.4% 24.1% 1.17 34,698 1,631 9,914 (30)
Big Country Communications 26,285 8,335 24.1% 31.7% 0.97 38,896 6,702 12,614 3,384
Rocky Mountain Wireless 7,360 3,268 30.7% 44.4% 1.13 4,064 510 1,028 240
Average 28.1% 40.1% 1.00
1) Equity betas were based on weekly stock returns calculated over a three year period.
Note: the current industry and competitor leverage ratios are reflective of the historical averages
that existed over the past three years.
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4263 -15-
Exhibit 8 Illiquidity Discounts
Source: Damodaran, Aswath, “Investment Valuation: Tools and Techniques for Determining the Value of Any Asset 2nd Edition,” John Wiley & Sons (2002), p. 680.
Illiquidity Discounts: Base Discount of 25% for profitable firm with $ 10 million in revenues
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
5 10 15 20 25 30 35 40 45 50 100 200 300 400 500 1000
Revenues
Discount as % of Value
Profitable firm Unprofitable firm
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HBS Professor Erik Stafford and Joel L. Heilprin, Illinois Institute of Technology Finance Professor and Managing Director of 59th Street Partners
prepared this case solely as a basis for class discussion and not as an endorsement, a source of primary data, or an illustration of effective or
ineffective management. This case, though based on real events, is fictionalized, and any resemblance to actual persons or entities is coincidental.
There are occasional references to actual companies in the narration.
Copyright © 2011 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized,
photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.
ERIK STAFFORD
JOEL L . HEILPRIN
Valuation of AirThread Connections
In early December 2007, Robert Zimmerman, senior vice president of business development for
American Cable Communications (ACC), was in his office sifting through a number of investment
banking proposals related to potential acquisition targets when he paused to consider the recent
presentation made by Rubinstein & Ross (R&R).
Rubinstein & Ross was a boutique investment bank with a strong reputation for doing deals in the
media and telecommunications sector. During that meeting, Elliot Bianco pitched the idea of American
Cable buying out AirThread Connections, a large regional cellular provider. The basic premise of the
AirThread acquisition was threefold.
First, American Cable and AirThread could help each other compete in an industry that was moving
more and more toward bundled service offerings. American Cable currently offered video, internet,
and landline telephony, but did not have any kind of wireless offerings. This gap in product offerings
had so far been exploited only modestly by competitors—primarily incumbent local exchange carriers
(ILEC’s) with wireless networks—but as those firms grow their video offerings the problem was
expected to become more acute. Additionally, American Cable saw a looming competitive threat from
advanced wireless networks based on the 802.16n standard for mobile WiMAX. Those networks are
expected to be able to deliver not only wireless telephony but also internet service with throughput
similar to that which is currently offered by cable providers. AirThread, for its part, faced similar
pressures with respect to the same set of competitors because it didn’t offer landline or internet service.
However, unlike ACC, AirThread was feeling the pressure more immediately in the form of higher
customer acquisition and retention costs, plus slower growth.
Second, the acquisition could help both companies expand into the business market. Both firms
had customer bases that were heavily reliant on retail/residential customers. In the case of American
Cable, this had resulted in a lack of long-term service contracts, which could have increased the stability
and reliability of the company’s revenues. In turn, this would also have had the beneficial effect of
reducing the risk associated with ACC’s operations. Furthermore, expanding into the business
segment would help each firm increase its network utilization and, as a result, increase its cost
efficiency.
4263
REV : A PRIL 2 7 , 2 0 1 2
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4263 | Valuation of AirThread Connections
2 BRIEFCASES | HARVARD BUSINESS SCHOOL
Third, American Cable was in a unique position to add value to AirThread’s operations. AirThread
had a cost disadvantage relative to its main wireless competitors owned by ILECs. A large portion of
wireless network operating costs related to moving traffic from cell towers to central switching offices
using either landlines leased from competitors or technically cumbersome microwave equipment. A
preliminary study by Rubinstein & Ross estimated that use of American Cable’s fiber lines could have
saved AirThread more than 20% in backhaul costs.
In addition to the strategic fit, R&R believed that it could obtain a significant amount of debt
financing for an AirThread acquisition. Bianco was confident that the high quality of AirThread’s
network assets, its valuable wireless spectrum licenses, and its steady cash flow would merit a debt to
value ratio as high as 45% to 50% based on EBITDA coverage ratios exceeding 5.0x.1
American Cable Communications
In December of 2007, American Cable Communications (ACC) was one of the largest cable
operators in the United States. The company’s cable systems passed roughly 48.5 million homes and
served approximately 24.1 million video subscribers, 13.2 million high-speed internet subscribers, and
4.6 million landline telephony subscribers. Consolidated revenue for 2007 was expected to be $30.9
billion with net income of $2.6 billion.
Overview of Cable Industry Dynamics
The cable industry had been rapidly transforming over the last decade as a result of advances in
technology, changes in regulation, and shifts in competitive dynamics. In turn, these forces had been
driving large investments in network infrastructure that require commensurate increases in the
customer base to effectively utilize the new capacity. It was this need to acquire economies of scale
and scope that led American Cable’s executives to believe that only a handful of very large network
providers would survive into the future. The smaller companies would eventually be weeded out
through industry consolidation. As a result, American Cable became an aggressive acquirer.
American Cable’s Business Development Group
American Cable’s business development group has been tasked with the primary goal of increasing
the company’s customer base as a means to fuel both top line growth and network utilization. From
1999 through 2005, ACC’s business development group spearheaded more than $15.0 billion of
acquisitions and, as a result, the company believed it had developed a strong corporate finance team
with significant acumen in identifying, valuing, structuring, and executing corporate control
transactions. In addition, the company also believed that its experience as an acquirer had allowed it
to develop unique operational know-how in the area of merger integration.
Furthermore, the company believed that its core competency as an acquirer would continue to play
a fundamental role in its future success. With the rapidly increasing costs of acquiring new customers
and the high penetration rates in video and high speed internet, the group surmised that the only way
to achieve meaningful customer growth would be through additional acquisitions.
American Cable’s acquisition process began with the screening of potential communications service
providers that operate in territories adjacent to, or within, the firm’s existing regions. Next, a basic
investment thesis was developed that outlined the acquisition benefits in terms of the strategic fit of a
1 EBITDA coverage ratio is EBITDA/total interest expense.
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Valuation of AirThread Connections | 4263
HARVARD BUSINESS SCHOOL | BRIEFCASES 3
target company’s assets and operations with those of American Cable, the potential synergies from a
merger, the likely price of the target relative to an estimate of its intrinsic value, and the acquisition’s
likely effect on the competitive dynamics within the industry.
After the initial screening, a preliminary valuation was done to estimate the target’s underlying
value irrespective of its current market price. The valuation techniques utilized include market
multiple approaches as well as discounted cash flow methodologies, such as WACC-based DCF and
APV. The capital structure assumptions employed were designed to mimic American Cable’s past
investment policies, which were to purchase the target with a significant amount of debt and then pay
down the debt to a sustainable long-term level that was in line with industry norms. The company’s
use of acquisition leverage was modeled after the classic LBO approach used by many private equity
firms. The goal was to use a tax-efficient structure that maximizes investor returns by minimizing the
amount of up-front equity invested in the deal.
AirThread Connections Business
AirThread Connections (ATC) was one of the largest regional wireless companies in the United
States, providing service in more than 200 markets in five geographic regions. The company’s 2007
revenue and operating incomes were expected to be approximately $3.9 billion and $400 million
respectively. The firm’s networks covered a total population of more than 80 million people. In
addition, AirThread had an extensive set of roaming agreements with other carriers to provide its
customers with coverage in areas where the company did not operate a network. Table 1 depicts the
company’s wireless ownership interests.
Table 1 Wireless Licenses
Operating Markets 209
Non-Operating Markets 9
Markets In Which ATC Has A Controlling Interest 218
Markets To Be Acquired Under Existing Purchase Agreements 25
Non-Controlling Investment Interests 17
Total Markets 260
Exhibit 2 provides additional details on the company’s customers and penetration rates by region
for its total consolidated markets and operating markets.2 AirThread also intended to continue to
expand its network operating area by participating in FCC auctions for wireless spectrum in regions
adjacent to its existing networks.
AirThread Connections’ Competitive Environment
The wireless communications market was intensely competitive. AirThread competed directly with
anywhere from three to five major competitors in each of its markets. These competitors included all
of the national wireless carriers, which had substantially greater financial, marketing, sales,
distribution, and technical resources. Competition among the carriers was generally based on price,
service area size, call quality, and customer service.
2 Total consolidated markets are markets for which the company has operating licenses but may not provide service. Operating
markets are markets for which the company provides service.
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4263 | Valuation of AirThread Connections
4 BRIEFCASES | HARVARD BUSINESS SCHOOL
Competitive Challenges for AirThread Connections
In addition to the intense competitive atmosphere there were several challenges facing AirThread.
The most pressing of these challenges related to an operating cost disadvantage vis-à-vis the ILECowned
wireless companies. In order to move wireless traffic from a cell tower to a central switching
office required either leasing telephone lines from the local carrier or investing in very expensive
microwave transmission equipment, which was oftentimes technically difficult to employ due to line
of site requirements. As a result, AirThread estimated that its system operating costs were
approximately 20% higher than those of its main rivals.
A second source competitive disadvantage related to the company’s inability to bundle its wireless
service with other offerings such as landline telephony, internet access, and video services. Most of the
national carriers with whom AirThread competed could provide at least two of those services. In order
to effectively attract and retain customers, the firm had to offer superior customer service and
aggressive pricing packages in terms of monthly service fees and equipment subsidies. Consequently,
average revenue per minute decreased from 6.71 cents to 5.95 cents over the past fiscal year, and the
cost of acquiring a new customer had increased from $372 in 2005 to $487 in 2007 (see Exhibit 3).
Finally, because most businesses required reliable high-speed internet and landline telephony
service, the recent trend toward bundled services had, to a large extent, frozen ATC out of the business
market. In turn, this was a limiting factor for future growth and increased network utilization.
AirThread Connection’s Recent Financial Performance
As the income statement in Exhibit 4 indicates, the company had experienced improvements in
revenue growth and operating margins. Management attributed much of the improvement in
operating margins to improvements in the firm’s increased asset efficiency and network utilization
rate, which is evidenced by the increasing return on net operating assets and asset turnover ratios
shown in Table 2 (see balance sheet in Exhibit 5).
Table 2
2005 2006 2007
Return on Net Operating Assets 3.6% 5.0% 7.1%
Return on Equity 5.7% 6.0% 9.8%
Asset Turnover Ratio 87.3% 94.4% 103.4%
Improving financial results notwithstanding, AirThread still faced some significant financial
pressures. As discussed earlier, the wireless communications market was extremely competitive, and
to a large extent it had been commoditized. The company’s CFO, Michael Balistreri, put it best during
a recent board meeting:
“In a commoditized industry, it is usually the low-cost producer that survives and thrives.”
The aforementioned sentiment was particularly relevant in light of the company’s relative
performance. As seen in Table 3, compared with its primary rivals, AirThread had lower operating
and EBITDA margins, which largely reflected the previously discussed competitive disadvantages.
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Valuation of AirThread Connections | 4263
HARVARD BUSINESS SCHOOL | BRIEFCASES 5
Table 3
EBIT
Margin
EBITDA
Margin
Net
Income
Margin
Comparable Companies
Universal Mobile 26.9% 38.6% 8.6%
Neuberger Wireless 16.4% 33.0% 9.6%
Agile Connections 4.7% 28.6% -0.1%
Big Country Communications 17.2% 32.4% 8.7%
Rocky Mountain Wireless 12.6% 25.3% 5.9%
Average 15.6% 31.6% 6.6%
AirThread 11.4% 26.2% 8.0%
The net result was that AirThread’s long-term survival as an independent company was in doubt
by a growing number of people within the communications industry. In fact, some had argued that
the company needed to find a suitor before its market position became untenable.
Valuation of AirThread
Given the potential importance and complexity of a possible AirThread acquisition, Zimmerman
decided to tap Jennifer Zhang, an up-and-coming senior associate from the University of Chicago, to
conduct the initial valuation of AirThread. As Ms. Zhang contemplated her new assignment, she
decided to take a methodical step-by-step approach to the valuation by focusing on projecting the
operating results, estimating the appropriate cost of capital and quantifying the potential synergies that
might result from combining the two companies. Further, she wanted to keep things simple by
assuming a stock purchase using the maximum amount of leverage available. Finally, she decided that
the nonoperating assets and liabilities should be valued separately so that the attention remained
squarely on the ongoing operations.
Operating Results
As a starting point, Jennifer decided to create a base case using historical operating results as a
guide, and then create an upside case that considered possible synergies. In both cases, Jennifer based
her projections on AirThread’s most recent financial performance (Exhibit 1 shows the projected
operating results). The decline in the service revenue growth rate reflected continued deterioration in
the revenue per minute of airtime as well as the continued maturation of cellular telephony.
With respect to the income from investments, Jennifer believed that it was primarily due to
AirThread’s cash and marketable securities, which would probably be used to finance part of an
eventual acquisition. Consequently, the cash flows were not included in her projections. As for the
equity in affiliates, the results reflected AirThread’s share in the net income of unconsolidated firms
where no controlling interest existed. This presented two problems. First, the company’s share of the
net income was unlikely to be equal to any cash dividend received. Second, without thorough due
diligence, it would be impossible to project the free cash flows for those minority interest equity
investments. As a result, Jennifer believed that the investments could be valued using a market
multiple approach3.
3 The historic P/E multiple for the industry was approximately 19.095x.
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4263 | Valuation of AirThread Connections
6 BRIEFCASES | HARVARD BUSINESS SCHOOL
Potential Synergies
With regard to estimating synergies, Jennifer realized that such efforts are notoriously difficult to
quantify even when there is a reasonable basis for assuming their existence. As a result, she decided
to segregate the potential synergies into various categories. The easiest source of value to identify was
the reduction in AirThread’s backhaul costs, which were approximately 20% of the company’s system
operating expenses. Although Ms. Zhang believed that American Cable could reduce ATC’s backhaul
costs, she also knew the company would still require the use of some leased lines and microwave
transmission in many areas. Moreover, she also knew the cost savings would be gradual.
Consequently, Jennifer estimated the total system operating cost savings to be 6% realized over four
years beginning in 2009 (see Table 4).
Table 4 ($MM)
2008 2009 2010 2011 2012
Backhaul Savings
System Operating Expenses $ 838.9 $ 956.3 $ 1,075.8 $ 1,183.4 $ 1,266.3
Backhaul Percentage 20.0% 20.0% 20.0% 20.0% 20.0%
Estimated Backhaul Costs 167.8 191.3 215.2 236.7 253.3
Reduction in Backhaul Costs 0.0% 7.0% 12.0% 22.2% 30.0%
Backhaul Savings $ 0.0 $ 13.4 $ 25.8 $ 52.5 $ 76.0
A more difficult set of synergies to evaluate were those related to increases in revenue resulting
from cross selling and bundling AirThread’s wireless service with ACC’s internet, telephony, and
video offerings. In particular, Ms. Zhang believed that the combined company would be able to attract
business customers now that wireless, wire line, and internet service could be offered by the same
provider. In estimating the additional business, Jennifer believed that the growth in business
subscribers would be similar to American Cable’s early telephony adoption rate, and the airtime usage
would be similar to that of ATC’s existing customers. However, she also estimated that the revenue
per minute for business customers would be less than that charged to retail subscribers. The estimated
revenue and gross profit for new wireless subscribers is shown in Table 5.
Table 5
2008 2009 2010 2011 2012
Wireless Business Subscribers
Average Monthly Subscribers (in MM’s) 0.30 0.50 0.70 1.00 1.20
Average Monthly Minutes 859 885 911 939 967
Total Monthly Minutes 258 442 638 939 1,160
Revenue Per Minute 0.0506 0.0506 0.0506 0.0506 0.0506
Annual Business Revenue Increase ($MM) $ 156 $ 269 $ 387 $ 570 $ 704
Capital Structure & Illiquidity Discount
Jennifer decided to use Bianco’s recommendation of a 5% equity market risk premium, an EBITDA
interest coverage ratio of 5.0x based on 2007 operating results, and/or a debt to value ratio not
exceeding 50.0% when calculating the initial leverage for AirThread. However, she also wanted her
preliminary valuation to conform to American Cable’s established practice of paying down acquisition
debt to eventually reflect industry norms. As a result, she assumed the acquisition debt would consist
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Valuation of AirThread Connections | 4263
HARVARD BUSINESS SCHOOL | BRIEFCASES 7
of a single tranche amortizing monthly over 10 years, but with a bullet payment4 at the end of year 5
(see Exhibit 6). The bullet payment would be in an amount necessary to bring AirThread’s leverage
ratios in line with those of the industry.
Based on the information provided by Rubinstein & Ross, Jennifer estimated that the debt rating
was likely to be investment grade with a rating of BBB+ and have an interest rate of approximately
5.50%, which reflected a 125bp spread over the current yield on 10-year US Treasury bonds.
In order to estimate AirThread’s beta, Ms. Zhang decided to use the comparable company
information contained in Exhibit 7. However, the more troubling issue was how to handle the potential
discount, if any, resulting from AirThread’s status as a private company. In contemplating this issue
Jennifer believed that it may be necessary to follow the customary practice of employing a private
company discount. This discount is primarily related to the illiquidity of private investments, but also
considers certain types of agency costs as well as the financial health and size of the firm. Most of the
academic research of which Ms. Zhang was aware estimated the illiquidity discount to be in the range
of 35%, though rules of thumb often employed by practitioners put the range in the area of 20% to
30%.5 Exhibit 8 provides a graphical depiction of the relationship between revenue and the illiquidity
discount for profitable and unprofitable firms.
On the other hand, there was also a well-established school of thought that believed large profitable
firms with the ability to go public should not trade at a discount due to their status as private
companies. The reasoning is based on the notion that owners wouldn’t accept an illiquidity discount
because they have the public market option.6
Terminal Value
The final consideration for Jennifer was the handling of the terminal value calculation. Ms. Zhang
was well aware that the terminal value was likely to be the single largest component of the valuation.
Consequently, she decided to employ both a growth perpetuity method and a market multiple method
based on the comparable company information contained in Exhibit 7. In terms of the long-term
growth rate, Jennifer understood that it could not exceed that of the macro economy as a whole.
However, she also knew that the long-term growth rate would be a function of the company’s return
on capital7 and reinvestment rate.8
Pending Decisions
Zimmerman had a lot on his plate. There was considerable pressure, both internally and externally,
to scale American Cable’s business. The increased size would not only help insure that ACC would
remain a viable industry player but would also help improve profitability through better network
utilization. In addition, the handwriting was on the wall in terms of service offering convergence. The
other major communications service providers were all making significant investments to build out
4 A bullet payment refers to a single payment to pay off the remaining loan balance at the time of maturity.
5 Moroney examined 146 restricted stock purchases in 1970 (35%); and Silber studied restricted issues from 1984-1989 (33.75%).
6 The average cost of going public is estimated to be 10% of the equity issued.
7 Return on capital is defined as net operating profit after taxes divided by the book value of equity plus debt.
8 The reinvestment rate is defined as capital expenditures plus investments in working capital minus depreciation divided by
net operating profit after taxes.
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4263 | Valuation of AirThread Connections
8 BRIEFCASES | HARVARD BUSINESS SCHOOL
their product offering capabilities; and if American Cable didn’t respond, it again risked being left
behind.
Of course Zimmerman also knew there were considerable risks whenever large investments,
particularly mergers, were involved. He was well aware of several high profile takeovers that ended
in either eventual bankruptcy or considerable loss of shareholder value, and overpaying for a target
company was one of the quickest ways to achieve disaster. As a result, he was really relying on Zhang
to provide a timely concise analysis that would clearly lay out a likely estimate of the intrinsic value of
AirThread’s operations and non-operating assets using ACC’s investment approach.
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Valuation of AirThread Connections | 4263
HARVARD BUSINESS SCHOOL | BRIEFCASES 9
Exhibit 1 AirThread Projections ($MM)
2008 2009 2010 2011 2012
Revenue Projections
Service Revenue $ 4,194.3 $ 4,781.5 $ 5,379.2 $ 5,917.2 $ 6,331.4
Service Revenue Growth 14.0% 14.0% 12.5% 10.0% 7.0%
Equipment Revenue 314.8 358.8 403.7 444.1 475.2
Equipment Revenue/Service Revenuea 7.5% 7.5% 7.5% 7.5% 7.5%
Operating Expenses
System Operating Expenses 838.9 956.3 1,075.8 1,183.4 1,266.3
System Operating Exp./Service Revenue 20.0% 20.0% 20.0% 20.0% 20.0%
Cost of Equipment Sold 755.5 861.2 968.9 1,065.8 1,140.4
Equipment COGS 240.0% 240.0% 240.0% 240.0% 240.0%
Selling, General & Administrative 1,803.6 2,056.2 2,313.2 2,544.5 2,722.6
SG&A/Total Revenue 40.0% 40.0% 40.0% 40.0% 40.0%
Depreciation & Amortization 705.2 804.0 867.4 922.4 952.9
Tax Rate 40.0% 40.0% 40.0% 40.0% 40.0%
Working Capital Assumptionsa
Accounts Receivable 41.67x 41.67x 41.67x 41.67x 41.67x
Days Sales Equip. Rev. 154.36x 154.36x 154.36x 154.36x 154.36x
Prepaid Expenses 1.38% 1.38% 1.38% 1.38% 1.38%
Accounts Payable 35.54x 35.54x 35.54x 35.54x 35.54x
Deferred Serv. Revenue 14.01x 14.01x 14.01x 14.01x 14.01x
Accrued Liabilities 6.85x 6.85x 6.85x 6.85x 6.85x
Capital Expendituresb
Capital Expenditures 631.3 719.7 867.4 970.1 1,055.0
Cap-x/Total Revenue 14.0% 14.0% 15.0% 15.3% 15.5%
a Based on a 360-day year. Days Payable, Deferred Service Revenue, and Days Accrued Liabilities are based on total cash
operating expenses.
b Includes investments in property, plant & equipment, as well as licenses and customer lists.
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4263 | Valuation of AirThread Connections
10 BRIEFCASES | HARVARD BUSINESS SCHOOL
Exhibit 2 AirThread Customer & Market Data
Total Consolidated Markets (000’s)
Region Population Customers Penetration
Central US 65,096 3,846 5.9%
Mid-Atlantic 11,677 1,180 10.1%
New England 2,830 518 18.3%
Northwest 2,287 431 18.8%
New York 481 147 30.6%
Total 82,371 6,122 7.4%
Total Operating Markets (000’s)
Region Population Customers Penetration
Central US 32,497 3,846 11.8%
Mid-Atlantic 7,346 1,180 16.1%
New England 2,344 518 22.1%
Northwest 2,287 431 18.8%
New York 481 147 30.6%
Total 44,955 6,122 13.6%
Exhibit 3 AirThread Customer Additions & Average Monthly Revenue
2005 2006 2007
Customer Data
Net Customer Additions 301 310 477
Cost Per Customer Addition 372 385 487
Cost of New Customer Additions 111,972 119,350 232,299
Cost of Equipment Sold/Equipment Revenue 251.3% 219.9% 239.8%
Monthly Churn Rate 2.1% 2.1% 1.7%
2005 2006 2007
Revenue Per Minute
Monthly ARPU 45.24 47.23 51.13
Customer Minutes Per Month 625 704 859
Revenue Per Minute 0.0724 0.0671 0.0595
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This document is authorized for use only by Hussam Alzahrani in Intermediate Corporate Finance taught by Yue Qiu, Temple University from August 2017 to December 2017.
Valuation of AirThread Connections | 4263
HARVARD BUSINESS SCHOOL | BRIEFCASES 11
Exhibit 4 AirThread Income Statement ($MM)
2005 2006 2007
Operating Results
Service Revenue 2,827.0 3,214.4 3,679.2
Plus: Equipment Sales 203.7 258.7 267.0
Total Revenue 3,030.8 3,473.2 3,946.3
Less: System Operating Expenses 604.1 639.7 717.1
Less: Cost of Equipment Sold 511.9 568.9 640.2
Less: Selling, General & Administrative 1,217.7 1,399.6 1,555.6
EBITDA 697.0 865.0 1,033.3
Less: Depreciation & Amortization 490.1 555.5 582.3
EBIT 206.9 309.5 451.1
Less: Interest Expense 84.9 93.7 84.7
Plus: Equity in Earnings of Affiliates 66.7 93.1 90.0
Plus: Gains (Losses) on Investments 18.1 50.8 83.1
Plus: Other Income 54.5 (46.6) 7.0
EBT 261.3 313.1 546.5
Less: Taxes 95.9 120.6 216.7
Income Before Minority Interest 165.5 192.5 329.8
Less: Minority Interest 10.5 13.0 15.1
Net Income $ 155.0 $ 179.5 $ 314.7
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4263 | Valuation of AirThread Connections
12 BRIEFCASES | HARVARD BUSINESS SCHOOL
Exhibit 5 AirThread Balance Sheet ($MM)
2005 2006 2007
Assets
Cash & Cash Equivalents $ 29.0 $ 32.9 $ 204.5
Marketable Securities 0.0 249.0 16.4
Accounts Receivable 362.4 407.4 435.5
Inventory 92.7 117.2 101.0
Prepaid Expenses 32.1 35.0 41.6
Deferred Taxes 8.2 0.0 18.6
Other Current Assets 15.5 13.4 16.2
Total Current Assets 539.9 854.9 833.8
Property, Plant & Equipment 2,553.0 2,628.8 2,595.1
Licenses 1,362.3 1,494.3 1,482.4
Customer Lists 47.6 26.2 15.4
Marketable Equity Securities 225.4 4.9 0.0
Investments in Affiliated Entities 172.1 150.3 157.7
Long-Term Note Receivable 4.7 4.5 4.4
Goodwill 481.2 485.5 491.3
Other Long-Term Assets 30.0 31.1 31.8
Total Assets $ 5,416.2 $ 5,680.6 $ 5,611.9
Liabilities & Owners’ Equity
Accounts Payable 254.1 254.9 260.8
Deferred Revenue & Deposits 111.4 123.3 143.4
Accrued Liabilities 42.9 47.8 59.2
Taxes Payable 36.7 26.9 43.1
Deferred Taxes 0.0 26.3 0.0
Note Payable 135.0 35.0 0.0
Forward Contract 0.0 159.9 0.0
Derivative Liability 0.0 88.8 0.0
Other Current Liabilities 82.6 93.7 97.7
Total Current Liabilities $ 662.7 $ 856.7 $ 604.2
Long Term Debt 1,001.4 1,001.8 1,002.3
Forward Contracts 159.9 0.0 0.0
Derivative Liability 25.8 0.0 0.0
Deferred Tax Liability 647.1 601.5 554.4
Asset Retirement Obligation 90.2 127.6 126.8
Other Deferred Liabilities 46.2 62.9 84.5
Minority Interest 41.9 36.7 43.4
Common Stock & Paid-In Capital 1,375.0 1,378.9 1,404.1
Retained Earnings 1,366.0 1,614.4 1,792.1
Total Liabilities & Owners’ Equity 5,416.2 5,680.6 5,611.9
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Valuation of AirThread Connections | 4263
HARVARD BUSINESS SCHOOL | BRIEFCASES 13
Exhibit 6 Debt Repayment Schedule
Term Loan Amortization ($MM)
Payment
Annual
Interest Principal Balance
Amortization
Period
Payment
Annual
Interest Principal Balance
Amortization
Period
Date: 41 5.50% 3,758 120 Date: 41 5.50% 2,698 84
1/31/2008 41 17 24 3,734 1 6/30/2011 41 12 28 2,669 42
2/28/2008 41 17 24 3,710 2 7/31/2011 41 12 29 2,641 43
3/31/2008 41 17 24 3,687 3 8/31/2011 41 12 29 2,612 44
4/30/2008 41 17 24 3,663 4 9/30/2011 41 12 29 2,583 45
5/31/2008 41 17 24 3,639 5 10/31/2011 41 12 29 2,554 46
6/30/2008 41 17 24 3,615 6 11/30/2011 41 12 29 2,525 47
7/31/2008 41 17 24 3,590 7 12/31/2011 41 12 29 2,496 48
8/31/2008 41 16 24 3,566 8 1/31/2012 41 11 29 2,467 49
9/30/2008 41 16 24 3,542 9 2/28/2012 41 11 29 2,437 50
10/31/2008 41 16 25 3,517 10 3/31/2012 41 11 30 2,408 51
11/30/2008 41 16 25 3,492 11 4/30/2012 41 11 30 2,378 52
12/31/2008 41 16 25 3,468 12 5/31/2012 41 11 30 2,348 53
1/31/2009 41 16 25 3,443 13 6/30/2012 41 11 30 2,318 54
2/28/2009 41 16 25 3,418 14 7/31/2012 41 11 30 2,288 55
3/31/2009 41 16 25 3,393 15 8/31/2012 41 10 30 2,257 56
4/30/2009 41 16 25 3,367 16 9/30/2012 41 10 30 2,227 57
5/31/2009 41 15 25 3,342 17 10/31/2012 41 10 31 2,196 58
6/30/2009 41 15 25 3,317 18 11/30/2012 41 10 31 2,166 59
7/31/2009 41 15 26 3,291 19 12/31/2012 2,176 10 2,166 0 60
8/31/2009 41 15 26 3,265 20
9/30/2009 41 15 26 3,239 21
10/31/2009 41 15 26 3,214 22
11/30/2009 41 15 26 3,188 23
12/31/2009 41 15 26 3,161 24
1/31/2010 41 14 26 3,135 25
2/28/2010 41 14 26 3,109 26
3/31/2010 41 14 27 3,082 27
4/30/2010 41 14 27 3,055 28
5/31/2010 41 14 27 3,029 29
6/30/2010 41 14 27 3,002 30
7/31/2010 41 14 27 2,975 31
8/31/2010 41 14 27 2,948 32
9/30/2010 41 14 27 2,920 33
10/31/2010 41 13 27 2,893 34
11/30/2010 41 13 28 2,865 35
12/31/2010 41 13 28 2,838 36
1/31/2011 41 13 28 2,810 37
2/28/2011 41 13 28 2,782 38
3/31/2011 41 13 28 2,754 39
4/30/2011 41 13 28 2,726 40
5/31/2011 41 12 28 2,698 41
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4263 | Valuation of AirThread Connections
14 BRIEFCASES | HARVARD BUSINESS SCHOOL
Exhibit 7 Wireless Comparable Companies ($000’s)
Equity Net Debt/ Debt/ Equity Net
Comparable Companies: Market Value Debt Value Equity Beta1 Revenue EBIT EBITDA Income
Universal Mobile 118,497 69,130 36.8% 58.3% 0.86 43,882 11,795 16,949 3,794
Neuberger Wireless 189,470 79,351 29.5% 41.9% 0.89 42,684 7,020 14,099 4,103
Agile Connections 21,079 5,080 19.4% 24.1% 1.17 34,698 1,631 9,914 (30)
Big Country Communications 26,285 8,335 24.1% 31.7% 0.97 38,896 6,702 12,614 3,384
Rocky Mountain Wireless 7,360 3,268 30.7% 44.4% 1.13 4,064 510 1,028 240
Average 28.1% 40.1% 1.00
1) Equity betas were based on weekly stock returns calculated over a three year period.
Note: the current industry and competitor leverage ratios are reflective of the historical averages
that existed over the past three years.
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4263 -15-
Exhibit 8 Illiquidity Discounts
Source: Damodaran, Aswath, “Investment Valuation: Tools and Techniques for Determining the Value of Any Asset 2nd Edition,” John Wiley & Sons (2002), p. 680.
Illiquidity Discounts: Base Discount of 25% for profitable firm with $ 10 million in revenues
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
5 10 15 20 25 30 35 40 45 50 100 200 300 400 500 1000
Revenues
Discount as % of Value
Profitable firm Unprofitable firm
For the exclusive use of H. Alzahrani, 2017.
This document is authorized for use only by Hussam Alzahrani in Intermediate Corporate Finance taught by Yue Qiu, Temple University from August 2017 to December 2017.