Valuation of Air Thread Connections Case Solution & Answer

Valuation of Air Thread Connections Case Solutions

The industry has made it evident that the rapid technological advancements have made it difficult for the companies to sustain in the market on a long term basis. There are evidences in the market of telecommunication that most of the companies are integrating with each other in order to achieve competitive advantage and to sustain within the technological shifts in the dynamic environment of cellular networks. Thus, the small players in the market would not be able to sustain, hence, assigning a score of 1 if operated separately.

The enterprise value as a percentage of sales and as a percentage of EBITDA will increase by 17.84% and 12.74% respectively if they work as a synergy and if AirThread is acquired, assigning a top score of 5 in this criteria of decision making. However, the enterprise value as a percentage of EBIT and Free Cash Flows will increase only by 6%, therefore, a moderate score of 3 and 4 is assigned to this particular decision making criteria.

Hence, this use of decision making technique clearly identifies the difference between the two options i.e. working individually or as a synergy. The competitive advantage, sustainability and growth criteria reflects positive signals in order of an acquisition to be carried by the American Cables. Apart from non-financial factors, the financial criteria of a decision making tool also justify a firm acquisition to be conducted.

Financial Analysis

                The total sales revenue of AirThread has increased from 3030MM to 3946MM that shows a 30.2% increase from 2005 to 2007 respectively. The operating expenses have increased by 18.7% from 2005 to 2007 due to the increase in demand of cellular networks. However, AirThread has been able to successfully manage its costs effectively compared to the increase in total sales volume and revenue from 2005 to 2007.

The selling and general administrative expenses have been increased by 27.7% from 2005 to 2007 that could be a matter of concern regarding the financial situation of Air Thread. However, Air Thread has still managed to remain within the limits of the increased percentage of sales volume and sales revenue.

The Earnings before tax, interest, depreciation and amortization have increased from 697 $MM in 2005 to 1033 $MM in 2007 showing an increase of 48.2% that is exceptionally good in financial terms as it is significantly above the percentage increase in sales volume and sales revenue. The Earnings before Interest and Tax have significantly increased from 206.9 MM in 2005 to 451.1 MM in 2007, showing an increase of 118% that is exceptionally well in financial terms.

This substantial increase in earnings before interest and tax is due to the lower depreciation rate from 2005 to 2007. The assets have depreciated on a marginal trend of 18.8% increase from previous years which was significantly lower than the increase in earnings before interest, tax, depreciation and amortization of 48.2%.

The Earnings before tax have also increased substantially from 261.3 MM in 2005 to 546.5 MM in 2007 showing an increase of 109.1%. This significant increase in earnings before tax is due to the significant increase in gains from investments of 359.1% from 2005 to 2007. However, the interest expense and other incomes have stayed consistent from 2005 to 2007.

The net income increased from $155 MM in 2005 to $314 MM in 2007 showing an increase by 103% regardless of taxes increasing by 126% from 2005 to 2007. The return on net operating assets increased from 3.6% in 2005 to 7.1% in 2007, the return on equity increased from 5.7% in 2005 to 9.8% in 2007. Finally, the asset turnover ratio increased from 87.3% in 2005 to 103.4% in 2007.

The average net income margin of similar companies in the industry was 6.6%, whereas, Air Thread was generating a net income margin of 8%. The margin pertaining to earnings before interest, tax, depreciation and amortization is 31.6% as an average comparison in the industry, whereas, Air Thread was operating at a marginally lower earnings before interest, tax, and depreciation and amortization i.e. 26.2% which was just above Rocky Mountain Wireless, and lower than four of the other comparatives.

The earnings before interest and tax were also relatively lower for Air Thread i.e. 11.4% as compared to the average earnings before interest and tax margin of 15.6%. It was only higher than Agile Connections i.e. 4.7% and was lower than all other market competitors which was a matter of concern. However, the ability to convert from lower earnings before interest, tax, depreciation and amortization into a significantly higher net income margin than its competitors is a commendable prospect in financial terms.

Valuation without Synergy

The sales revenue in 2012 is fore casted to be 6806.4MM, the EBITDA is fore casted to be 1677.3MM in 2012, and the EBIT is expected to be 724.4MM in 2012. The net operating profit after tax is fore casted to be 434.6MM in 2012; resulting in fore casted free cash flows of 318.6MM in 2012. Then discount rate is calculated by weighted average cost of capital that is 8.9% resulting in a net present value of 1233.5MM.

The terminal growth rate is calculated to be 2.9% which is calculated by multiplying return on capital with the reinvestment rates assumed. The terminal value is calculated by applying the terminal growth rate and weighted average cost of capital, on the last free cash flow forecasted; resulting in a terminal value of 5712.2 MM and the Enterprise Value of 8663.4MM………………

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