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Arch Communications

Arch Communications. Analysis of a Security Valuation Derek Webb, Darryl Kraemer. Agenda. Background Strategy Analysis Accounting Review Ratio Analysis Cash Flow Analysis Forecasting Review Valuation Post Script. Background. Background. Arch Communications Group Inc. founded in 1986

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Arch Communications

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  1. Arch Communications Analysis of a Security Valuation Derek Webb, Darryl Kraemer

  2. Agenda • Background • Strategy Analysis • Accounting Review • Ratio Analysis • Cash Flow Analysis • Forecasting Review • Valuation • Post Script

  3. Background

  4. Background • Arch Communications Group Inc. founded in 1986 • 3rd largest paging company in USA in 1996 • 3 million subscribers in 1996 • Local, regional and nationwide basis • 180 of 200 major metro cities

  5. Background • Current competitive positioning: • Low cost provider • Economies of scale for ops, size of subscriber base • Standard, reliable technology • Fast follower, proven and somewhat dated tech • Prompt and efficient delivery • Resellers, retailers and direct sales • Invested in expanded networks, and capacity • Integrate acquisitions successfully

  6. Strategy

  7. Strategy • Return on Capital  Business Strategy + Corporate Strategy • Business Strategy  Industry Choice + Competitive Position

  8. Corporate Strategy • Goals • To become dominate player in wireless paging segment • Aggressive growth through strategic acquisitions and internal additions • Strengthen distribution channels and increase capacity • Invest in select technologies • Geographic expansion

  9. Competitive Positioning • Product Market Focus • Local, regional and nationwide • Major metro areas • Every pager type - 87% digital • Direct, retailer and resellers for distribution channels

  10. Competitive Positioning • Core Activities • Build networks • Distribute through reseller and retailers • Sell via direct channel • Support and service • Backend billing operations • Marketing through direct channels

  11. Competitive Positioning • Value Proposition • Proven, reliable service at a low cost • Fast delivery of messages • Limited to no network downtime • Large geographical coverage

  12. Industry Choice • Degree of Rivalry – HIGH • Limited product differentiation • Oligopoly market structure • Rapid consolidation • Fragmented markets • Low switching costs

  13. Industry Choice • Ease of Entry - MED • Capital intense • Can acquire license, or company • No strong barriers to entry other than capital expenditure

  14. Industry Choice • Threat of Substitute Products – HIGH • Cellular technology improving • Battery life extending • Improved feature set • Advancements in voice networks (PCS) • Mobile satellite communications

  15. Industry Choice • Power of Suppliers – MED • Manufacturers are supplying same product to all competitors • Duopoly market structure (Motorola, NEC) • Strong brand equity

  16. Industry Choice • Power of Customers – HIGH • Low switching costs • Growth driven by consumers, not business • Fickle group • Price sensitive

  17. Class Discussion

  18. Class Discussion • What are the implications of our strategy analysis on the forecasting and valuation of Arch over the next 5yrs?

  19. Implications of Strategy Analysis • Industry unlikely to have abnormal growth and profits in long range • High cap expenditures required: • To continue growth through expanded coverage and acquisitions • To upgrade existing networks • Debt or equity? • Product is commoditizing with consumers • High threat of cellular and competitive tech replacing the paging market

  20. Accounting Analysis

  21. Accounting Analysis • No unusual accounting measurement issues are evident

  22. Ratio Analysis

  23. DuPont Analysis

  24. DuPont Conclusions • ROE improving because of reduced financial leverage • Net profit margin declining • Asset utilization declining because of large investment in plants, higher inventories and higher AR

  25. Common Sized Statements

  26. Class Discussion

  27. Class Discussion • What conclusions can be drawn from a review of the Common Sized Statement?

  28. Common Sized Conclusions • SG&A increasing due to acquisitions, and increase of $100M of revenue • Margins decline because of increased debt to fund acquisitions, inventory and operating expenses • COGS showed insignificant increase from 1994-1995

  29. Cash Flow Analysis

  30. Cash Flow Analysis

  31. Class Discussion

  32. Class Discussion • What are the implications of our cash flow analysis on the forecasting and valuation of Arch over the next 5yrs?

  33. Cash Flow Implications • 1995 showed a decrease in cash from ops • Took on huge debt financing to acquire companies for growth, fund operations and to increase inventory • Cash from ops can’t cover the $154M operating expenses • Going forward, will they be able to grow cash from ops to meet debt covenants post-acquisition, and fund operating expenses?

  34. Forecasting

  35. Forecasting • Very detailed forecast  down to the subscriber growth level • Revenue growth rates used were inline for a maturing industry • In this era, a lot of positive analysis for technology companies

  36. Forecasting

  37. Class Discussion

  38. Class Discussion • Which assumptions in the analyst’s forecasts would you question and why based on the previous analysis and implications we discovered?

  39. Forecasting Issues • Subscriber estimates

  40. Forecasting Issues • Compound annual growth rate = 380% • # of households with pager if industry grows at Arch’s rate unrealistic: • 14,226,000 x 3.808 + 14,226,000 = 82,635,258 • % of household  82,635 / 95,000 = 86% • # of households with pager if industry grows at ½ Arch’s rate still unrealistic: • 82,635,258 / 2 = 41,312,304 or 43%

  41. Forecasting Issues • No use of balance sheet (DuPont) in analysts forecast, unrealistic ROE and Asset Turnover • Didn’t account for increase in cap ex (assets) in relation to revenue forecasts, which distorts valuation

  42. Forecasting Issues

  43. Forecasting Issues

  44. Forecasting Issues • Backing into Analysts forecast of $37.60 • Avg. # of subscribers in 1995  538,000 + 1,468,000 / 2 = 1,272,000 • Net revenue = $141,800,000 • Rev/sub  $141,800,000 / 1,272,000 = $111.48 / 12 = $9.29/month

  45. Forecasting Issues

  46. Forecasting Issues

  47. Forecasting Issues • Based on backing into analysts predication: • Arch would have 109M customers in 2004 (rev/avg. rev per customer) • Arch is 14% of market  489M customers if industry grows ½ as fast as Arch • Population in 2004 at 3% growth/yr = (1.03)^9 * 255M = 332M • 489M / 332M = 1.47 pagers / person!! • Unrealistic

  48. Forecasting Issues • EBITDA not an accurate measure of firm • Interest expense for growth • Depreciation on fixed assets in tech industry with rapid change • Shareholders only get what’s left after paying all debt and taxes • EBITDA good for short-term credit risk analysis

  49. Valuation Conclusion

  50. Valuation Conclusion • We don’t agree with analysts price • Subscriber growth rates unrealistic • NOPAT estimates unrealistic • Didn’t account for increase in capital expenditures – no DuPont or balance sheet • 10yr forecast is a long period to forecast out • We came to a stock price of $3.61 • Market may be using Option pricing model based on future expectation of growth

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