All three questions answered for Radio One , Inc. HBR Case Study Solved
Should Liggins and Royster buy the 21 radio stations? What are the benefits and the risks of acquiring them?
Radio One was considering making an offer to acquire 12 radio stations that Clear Channel would be required to sell as a result of the proposed merger between Clear Channel and AFMF Inc. In addition, Royster and Liggins were in the process of negotiating with Davis Broadcasting to purchase one station in the state of North Carolina and five stations in the state of Georgia. They were also in the process of negotiating with Shirk, Inc., and IBL, LLC to purchase three stations in the city of Indianapolis, Indiana. Therefore, they were considering the possibility of purchasing a total of 21 radio stations with the objective of doubling the size of Radio One and contributing to the construction of its national platform. On the other hand, there are a number of advantages and disadvantages to the same, some of which are listed below:
The potential advantages include helping to build a national platform and doubling its current membership, both of which were mentioned earlier in this paragraph.
• After completing the purchase of the 12 stations from Clear Channel, Radio One would have a greater audience comprised of African-Americans than any other media platform explicitly aimed at this demographic, including the media company Black Entertainment Television (BET).
• Because a few stations’ formats were comparable to that of Radio One’s urban format and because their management teams had a great deal of untapped potential in the markets in which they operated, this was a lucrative opportunity.
The 12 stations were all within the top 50 of the African-American market, and it was extremely rare for urban stations, especially in these markets, to become available for purchase. As a result, for Radio One to make the most of this opportunity would have been extremely beneficial.
As a result of the consolidation, broadcasters would be able to provide a reach comparable to that of television, and advertisers would be able to purchase appealing “packages” as a result. This would help to increase the allure of radio advertising. As a result, the expansion would contribute to further increasing the amount of money made from advertising. In addition, it is important to note that consolidation helped reduce costs by reducing duplicate staffing in markets that had more than one station, reducing the number of vendors used, and creating a national representation agreement. Programming was syndicated, and products were purchased, from vendors. Therefore, Radio One would be able to save more money as a result of these cost benefits in the event that additional stations were acquired.
• As a result, we anticipate that our costs will not rise by as much, and we will also benefit from synergies in terms of our revenues.
It was the only company that could purchase such a significant group of stations because it was the only one with the necessary experience and access to capital. As a result, it could use this information to its advantage during negotiations. More importantly, after the acquisition, it would serve as a more meaningful platform for the company’s planned expansion into other forms of media, including cable, the recording industry, and the internet. Lastly, this was in line with the company’s strategy to “provide urban-oriented music, entertainment, and information to a primarily African-American audience in as many major markets as possible.”
Possible Dangers – The most significant danger associated with any acquisition is the possibility that it will fail for a number of different reasons.
Integration may prove difficult given the magnitude of the transaction, which would result in an increase in the number of stations by one.
• There is a possibility that the expected synergies will not necessarily fall into place, which would result in Radio One’s expectations not being met.
• In order to finance the transaction (Exhibit 6), the company might choose to raise debt, which could prove to be a difficult task.
• Despite the fact that we are aware of the fact that this acquisition would assist it in expanding into other forms of media, such as cable, the recording industry, and the internet, this is not their area of expertise, and it may cause them to stray from their core business.
• As a result of consolidation in the radio industry, the price at which radio stations can be purchased has significantly increased, and Radio One may be required to pay more as a consequence.
Therefore, in light of the aforementioned advantages and disadvantages, we believe that Liggins and Royster should move forward with the acquisition because it represents a lucrative opportunity that is in line with the company’s strategy to broaden its market and increase its profits.
How much are the stations worth? Use the weighted average cost of capital (WACC) valuation method to estimate value. [For the purposes of this case, assume a market risk premium of 6%, a beta for Radio One debt of 0.2, and a closing date of December 31, 1999, which changes the amortization expense in 2000 to 90,048 from 45,024.] Do you think the cash flow forecasts are reasonable?
The stations have an estimated value of $12,15,094,000 based on our calculations, provided the following assumptions are met:
1. We need to make an estimate of the appropriate credit rating for the company’s debt in order to calculate the cost of the debt the company is carrying. The company’s historical solvency position has not been ideal because a significant portion of the total capital was comprised of debt, and the operating profits were only just able to cover the interest costs. However, as a result of the initial public offering (IPO) that took place in May of 1999, the proportion of debt to capital (also known as the “Debt/capital ratio”) has decreased from 1.01 to 0.16, as shown in exhibit 7.
2. In addition to that, it is anticipated that the new acquisitions will contribute to an increase in the company’s profitability. As a result of these modifications, the corporation might be able to secure any additional borrowing at a more favorable interest rate. As a result, we have determined that a credit rating of BBB is consistent with the cost of debt that is appropriate.
3. For the purpose of calculating the terminal value, it is assumed that the after-tax cash flows will increase at a constant rate of 4%, which is in line with the GDP growth rate in the late 1990s in the United States.
4. For the purpose of calculating depreciation, the useful life was estimated to be five years using a straight-line basis.
5. In order to determine the current market value of the company’s equity, we used the most recent stock price, which was $97, and made the assumption that all outstanding classes of shares trade at the same price.
6. For the purposes of the WACC calculation, the risk-free rate has been assumed to be the interest rate on 10-year government bonds, which is currently 6.28%
|MV of Equity||00|
|BV of Debt||8,26,26,000|
|Risk Free Rate||6.28%|
|Levered Equity Beta||0.77|
|Market Risk Premium||6%|
|Cost of Equity||10.90%|
|Debt Market Premium||1.42%|
|Cost of Debt||6.56%|
|Cost of Debt Adjusted for taxes||4.27%|
|Broadcasting Cash Flows (BCF)||59,014||65,041||76,436||89,711||1,01,966||1,15,277|
|Depreciation & Amortization||45024||90048||90420||90840||91260||91680|
|Less : Changes in Net Working Capital||0||2,097||3,396||3,869||3,720||3,795|
|Less : Capex||0||0||2,100||2,100||2,100||2,100|
|Add : Depreciation & Amortization||45024||90048||90420||90840||91260||91680|
|Terminal Value 15,17,987|
|Total Cash Flow||51,851||69,511||73,315||81,213||89,053||16,15,292|
|Terminal Growth Rate||4%|
|NPV/ Enterprise Value||12,15,094|
We strongly feel that the cash flow forecasts are reasonable as the growth is also not extremely high, given the company is expected to have synergy benefits as well because of the acquisitions. Moreover, sensitivity analysis has been done for the terminal growth rate to have a better idea.
Royster anticipated offering 30X BCF to buy the stations. Is this a reasonable amount to pay given the acquisition prices for other radio stations and the value you calculated in Question 2?
|Terminal Growth Rate||NPV|
We can gain an understanding of the multiples that would be fair according to the same based on the precedent transactions that have been completed. We can see that Infinity Broadcasting paid Clear Channel $1.4 billion, which is equivalent to approximately 21.5 times 2000 BCF, to acquire 18 stations, while Cox Radio paid approximately $380 million, which is equivalent to approximately 18.4 times 2000 BCF, to acquire 7 of the stations. In addition, given that the quality of the 12 radio stations owned by Clear Channel was comparable to that of the stations acquired by Infinity, this would be an excellent precedent to take into consideration.
As a result, based on the precedent transactions and the valuation multiples based on our calculations, we get a range of 18.4x – 21.5x BCF 2000 Multiple. [Cause and effect] Therefore, it is safe to say that a multiple of 30x is considered to be overvalued, and the same amount of money should not be paid for the acquisition consideration. Furthermore, bearing in mind our calculation of the EV/EBITDA 2000 multiple as well, we advise that the multiple that Radio One should not go higher than 21.5x, and this is without taking into account the premium or the synergies that are in play.
In addition, we already know from the case that Radio One is trading currently at a multiple of 30x is only because of the stock price increase and the expectation that Radio One would submit a bid, and by the beginning of March 2000, analysts were speculating on the scope of Radio One’s acquisition. This is something that we already know. The fact that Radio One had already begun negotiations with Davis Broadcasting, Shirk, Inc., and IBL, LLC contributed further to an increase in the price of the stock’s individual shares. Therefore, a multiple of 30x would not be sustainable and, in the long run, it would normalize to its previous level.
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