Valuation of Radio One, Inc. Corporate Valuation: Assignment 1 Professor: Dry. Oliver Splat Submission date 24-09-2013 1 . Company description of Radio One Radio One is a large radio group in the US, their strategy is to provide urban-oriented music, entertainment, and information to a primarily African-American audience in as many major markets as possible. The African-American population expected to experience an extensively growth in population and income.
Furthermore, the African-American is listening 23,6% hours more to the radio and purchases, despite heir lower average income, more of certain goods and services than the general population. Consequently, advertisers are willing to pay more for advertising than they do to the general public, what results in a higher power ratio for Radio One. The growing population and high consuming behavior of the African American creates many growth opportunities for Radio One, consequently, they are expanding their business by acquiring radio stations. Radio One pursues a clustering strategy to serve their markets efficiently.
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By building these clusters, Radio One can acquire ore stations in the same region to reach a greater audience. Furthermore, by acquiring more stations, Radio One becomes more attractive to advertisers since they cover a larger market, and it is able to cut costs and create more efficiency. The resulting larger national footprint would bring greater advertising revenue and serve as more meaningful platform for the company’s planned expansion into other forms of media, including cable, the recording industry, and the internet. On the other hand, the acquisitions of the in total 21 stations brings many risks.
The stations can e overvalued and therefore the acquisition does not add much value to the value of Radio One. Another huge risk, which would affect whole African-American market, is that the forecasts about the population growth, the growth of income or the percentage of listeners fall short. This reduces the expected revenues of Radio One and makes it less attractive to expand their business. 2. Valuing the acquisition with the Discounted Cash Flow Method When applying the Discounted Cash Flow Method (DC-Method), the Free Cash Flow to the Firm (FCC) of the 21 stations should be lactated for each year.
To calculate this FCC projected statements from 2001, 2002, 2003 and 2004 are used and add the calculation of the terminal value of the FCC (See Appendix 2. 1). As shown in Appendix 2. 2, the Net Working Capital (NC) is calculated as a percentage from the gross revenues from Radio One in 1997 and 1998. The year 1999 is excluded, since the large stock issue was an abnormal event, impacting NC significantly. In addition to the FCC of the projected period, the terminal value growth rate is equal at the growth rate of Gross Domestic Product (GAP) which is on average 4%.
However the Cash Flows of a company do not grow with the same percentage, but usual less than the growth of the revenue. As the stations produces significant cash flows, it is assumed that the growth rate is 1% lower than the growth in gross revenue and therefore be 3%. This growth rate is used to calculate the Terminal Value. To calculate the present value of the terminal values, the terminal value from either the pure WAC method as well as from the Hybrid method needs to be discounted. To determine the discount rate, a WAC of 11,5% is calculated (see Appendix 2. ).
First, the weights of debt (0,20) and equity (0,80) are weighted and the tax rate is assumed to be 35%. The cost of debt are founded by calculating the average interest rate of investment grade bonds. Furthermore a risked rate equal to a 10 years government bond is used, which was 6,28%. Historically, US stocks have outperformed bonds by about 7. 5%, however, recently research finds lower rates of 3-5% and therefore it is assumed 5 % to be an appropriate rate. The equity beta was calculated with the Human method, which assumes the debt stays equal and never be paid down.
The Miles & Gazelle method is tested as well, which assumes the debt stays equal to the firm value and this resulted in a slightly higher equity beta of 1,03 in contrast to the equity beta of 0,95 from the Human formula. Since the Human method is most commonly used and it seems to be a fair assumption, the equity beta of 0,95 is used. By using both methods, it is more certain that the right direction is chosen to calculate the WAC. Using this equity beta in the CAMP gives a cost of equity of roughly 11%. The CAMP used to be a good measure in the past, but has some shortcomings.
One of these shortcomings is that the CAMP does not take the size of the firm into account. Since the CAMP does not correct for this size premium that has to be paid by small companies, the size premium of this low-cap firm is increased with 1,7%. Applying the WAC formula, a cost of capital of is obtained for Radio One. The use of the pure WAC method results in a total value of approximately 1,73 billion and the hybrid method results in a total value of approximately 1,74. The fact that these values are remarkably close to each other, increases the reliability of this value.
However it should be taken into account that a change in the assumptions made in this valuation process, has a huge impact on the value. Especially the growth value of FCC, which is hard to determine can change the value considerably. In appendix 2. 4, you can find the details of these values and the results of the pure WAC method per division. In addition, an estimation is made about the impact on a change in depreciation after 2015. The reason for this test is that the depreciation till 201 5 is remarkably in comparison with the capital expenditure.
Depreciation of goodwill of the acquired stations could be an explanation for these high amounts. In the long run, depreciation should be equal to the capital expenditures. This estimation clarifies that a decrease in depreciation after the year 2015, has an impact on the value of the firm. However, this impact is approximately only billion according to the test. This does not change the earlier forecasted value significantly and therefore it is acceptable to rely on a valuation of During the divestiture of Clear Channel, Infinity Broadcasting paid 21. X 2000 BCC to acquire, Cox Radio paid 18. Xx 2000 BCC. The 12 stations of Clear Channel, targeted by Radio One, are of similar quality to those purchased by Infinity, so a multiple of 21. Xx 2001 BCC would be realistic, which means a price of $1. 551. 462. 000. For the radio stations of Davis Broadcasting and Shirk, the average multiple is the most reliable multiple since it is unknown if the quality of those stations is comparable to those acquired by Infinity Broadcasting and Cox Radio.
An offer of 19. Xx 2001 BCC results in a price of $36. 708. 000 for Davis Broadcasting and a price of $48. 578. 000 for Shirk. For the 21 stations targeted, the total offer based on the transaction multiples is round $1. 64 billion. However, there are Just two examples of current transactions in the radio market, despite the low dispersion between the two current transactions, more research is required before making conclusions. See Appendix 3. 1 for a more detailed clarification.
According to a sample of 14 companies, including Radio One, three different multiples are obtained and used to value the adjusted market values of the 21 radio stations targeted: (1) BCC multiple of 17,2 with an adjusted market value of 1,38 billion, (2) EBITDA multiple of 19,4 with an adjusted market value of 1,44 lion, and (3) After-tax cash flow multiple of 26,1 with an adjusted market value of 3,00 billion. The adjusted market values based on EBITDA- and after cash flow are very close together. The EBITDA multiple (See Appendix 3. For EBITDA calculation) provides a crude estimate of the firms cash flows, it does provide a relatively good measure of the before-tax cash flows that are generated by the firms existing assets. The after-tax cash flow multiple values the earnings potential of the entire firm using the FCC. However, FCC for most firms is very volatile, because it reflects discretionary expenditures for UAPITA investments and working capital. BCC is a method used in the broadcasting industry to compare companies with each other. BCC a better multiple since it is better linked to operational activities than EBITDA.
As a result, regarding the BCC transaction multiple, the value of the 12 stations of Clear Channel is $1. 306. 114. 000, the value of Davis Broadcasting is 33. 304. 000, and the value of Shirk is $44. 074. 000. The value of the 21 stations targeted based on the best fitting multiple (BCC) is $1,38 billion. For a more detailed clarification, see Appendix 3. 3. Xx BCC After Clear Channel’s divestiture announcement, Radio One’s stock increased from $40 to as high as $97 per share, which implies a 30 times forward BCC.
In comparison with the typical trading multiple for radio companies, Xx multiple is significantly greater. This implies that shareholders expect that Radio One is worth Xx BCC after acquiring their targeted radio stations. The lowest price Radio One has to pay is the sum of the stand-alone cash flows of the 21 targeted stations. The highest price Radio wants to pay is Xx BCC to avoid dilution. The difference between Xx BCC and he sum of the stand-alone cash flows is called synergies. However, it is questionable if the shareholders are estimating the magnitude of the synergies correct.
Altogether, the acquisition of the 21 targeted stations is valuable Recommendation The acquisition of the 21 radio stations from Clear Channel will definitely increase the value of Radio One station. The price that should be paid to Clear Channel should multiples of comparable companies, the value is expected to be lower. According to the BCC (net operating income) multiple, the value is 1,38 billion and following the EBITDA multiple, this value is 1,44 billion. The after-tax cash flow multiple is left out, since this value is largely increased by the high depreciations & amortization and deviates too much from the other multiples.
Concluding, the price that should be paid by Radio One for the 21 radio stations should be between 1,38 billion and 1,73 billion. Moreover, Radio One wants to make a preemptive offer, since it does not want to miss the unique opportunity to acquire 21 valuable stations at once. Offering a price that is too low, will increase the chances that other companies are willing to pay ore. In addition, the 1,38 billion which is obtained by using the BCC multiple, is a not a very complicated calculation and can easily be applied by investors without too much effort.
Accordingly, it is suggestible that Radio One offers to pay 1,5 billion to Clear Channel. This margin should be high enough to compete with other companies interested in the acquisition and still create substantial extra revenues. In addition to the 230 million margin of the value of the discounted cash flow, Radio One can create generous additional income from the advantages of merged operations, called wineries. Nevertheless, the risk exists that the calculated values are too optimistic and the synergies turn out to be less valuable than expected.