Valuation-of-AirThread-Connections-(Case-code-4263

________________________________________________________________________________________________________________HBSProfessorErikStaffordandJoelL.Heilprin,IllinoisInstituteofTechnologyFinanceProfessorandManagingDirectorof59thStreetPartnerspreparedthiscasesolelyasabasisforclassdiscussionandnotasanendorsement,asourceofprimarydata,oranillustrationofeffectiveorineffectivemanagement.Thiscase,thoughbasedonrealevents,isfictionalized,andanyresemblancetoactualpersonsorentitiesiscoincidental.Thereareoccasionalreferencestoactualcompaniesinthenarration.Copyright©2011PresidentandFellowsofHarvardCollege.Toordercopiesorrequestpermissiontoreproducematerials,call1-800-545-7685,writeHarvardBusinessPublishing,Boston,MA02163,orgoto(ACC),wasinhisofficesiftingthroughanumberofinvestmentbankingproposalsrelatedtopotentialacquisitiontargetswhenhepausedtoconsidertherecentpresentationmadebyRubinstein&Ross(R&R).Rubinstein&Rosswasaboutiqueinvestmentbankwithastrongreputationfordoingdealsinthemediaandtelecommunicationssector.Duringthatmeeting,ElliotBiancopitchedtheideaofAmericanCablebuyingoutAirThreadConnections,alargeregionalcellularprovider.ThebasicpremiseoftheAirThreadacquisitionwasthreefold.First,AmericanCableandAirThreadcouldhelpeachothercompeteinanindustrythatwasmovingmoreandmoretowardbundledserviceofferings.AmericanCablecurrentlyofferedvideo,internet,andlandlinetelephony,butdidnothaveanykindofwirelessofferings.Thisgapinproductofferingshadsofarbeenexploitedonlymodestlybycompetitors—primarilyincumbentlocalexchangecarriers(ILEC’s)withwirelessnetworks—butasthosefirmsgrowtheirvideoofferingstheproblemwasexpectedtobecomemoreacute.Additionally,AmericanCablesawaloomingcompetitivethreatfromadvancedwirelessnetworksbasedonthe802.16nstandardformobileWiMAX.Thosenetworksareexpectedtobeabletodelivernotonlywirelesstelephonybutalsointernetservicewiththroughputsimilartothatwhichiscurrentlyofferedbycableproviders.AirThread,foritspart,facedsimilarpressureswithrespecttothesamesetofcompetitorsbecauseitdidn’tofferlandlineorinternetservice.However,unlikeACC,AirThreadwasfeelingthepressuremoreimmediatelyintheformofhighercustomeracquisitionandretentioncosts,plusslowergrowth.Second,theacquisitioncouldhelpbothcompaniesexpandintothebusinessmarket.Bothfirmshadcustomerbasesthatwereheavilyreliantonretail/residentialcustomers.InthecaseofAmericanCable,thishadresultedinalackoflong-termservicecontracts,whichcouldhaveincreasedthestabilityandreliabilityofthecompany’srevenues.Inturn,thiswouldalsohavehadthebeneficialeffectofreducingtheriskassociatedwithACC’soperations.Furthermore,expandingintothebusinesssegmentwouldhelpeachfirmincreaseitsnetworkutilizationand,asaresult,increaseitscostefficiency.4263REV:APRIL27,2012ThisdocumentisauthorizedforuseonlybySkylarFang([e-mail]).Copyingo[e-mail]800-988-0886foradditionalcopies.4263|ValuationofAirThreadConnections2BRIEFCASES|HARVARDBUSINESSSCHOOLThird,AmericanCablewasinauniquepositiontoaddvaluetoAirThread’soperations.AirThreadhadacostdisadvantagerelativetoitsmainwirelesscompetitorsownedbyILECs.Alargeportionofwirelessnetworkoperatingcostsrelatedtomovingtrafficfromcelltowerstocentralswitchingofficesusingeitherlandlinesleasedfromcompetitorsortechnicallycumbersomemicrowaveequipment.ApreliminarystudybyRubinstein&RossestimatedthatuseofAmericanCable’sfiberlinescouldhavesavedAirThreadmorethan20%inbackhaulcosts.Inadditiontothestrategicfit,R&RbelievedthatitcouldobtainasignificantamountofdebtfinancingforanAirThreadacquisition.BiancowasconfidentthatthehighqualityofAirThread’snetworkassets,itsvaluablewirelessspectrumlicenses,anditssteadycashflowwouldmeritadebttovalueratioashighas45%to50%basedonEBITDAcoverageratiosexceeding5.0x.1AmericanCableCommunicationsInDecemberof2007,AmericanCableCommunications(ACC)wasoneofthelargestcableoperatorsintheUnitedStates.Thecompany’scablesystemspassedroughly48.5millionhomesandservedapproximately24.1millionvideosubscribers,13.2millionhigh-speedinternetsubscribers,and4.6millionlandlinetelephonysubscribers.Consolidatedrevenuefor2007wasexpectedtobe$30.9billionwithnetincomeof$2.6billion.OverviewofCableIndustryDynamicsThecableindustryhadbeenrapidlytransformingoverthelastdecadeasaresultofadvancesintechnology,changesinregulation,andshiftsincompetitivedynamics.Inturn,theseforceshadbeendrivinglargeinvestmentsinnetworkinfrastructurethatrequirecommensurateincreasesinthecustomerbasetoeffectivelyutilizethenewcapacity.ItwasthisneedtoacquireeconomiesofscaleandscopethatledAmericanCable’sexecutivestobelievethatonlyahandfulofverylargenetworkproviderswouldsurviveintothefuture.Thesmallercompanieswouldeventuallybeweededoutthroughi