Acquisition: The board of directors of Quicker com Inc. is considering an acquisition of Honest Communication Inc. (HCI) for a total price of $3 billion, to be finalized January 1, 2016. After thorough due diligence, the financial experts at Quicker com are concerned that HCI's value could decrease significantly in the next year and make the deal unprofitable. To make sure they receive a gain on the deal, they put an exit clause into the contract. The exit clause states that if the earnings before interest, taxes, depreciation, and amortization (EBITDA) falls below $80 million for the fourth quarter of 2015, this will be considered a material adverse change in the position of HCI, and Quicker-com can exit the contract and not have to complete the deal.

HCI is a 19-year-old telecommunications firm specializing in long-distance service. Revenues have been steadily declining at HCI over the past six years because many customers are going to cell phones for their long-distance service, prices have been steadily declining, and the number of minutes per month per customer is decreasing. From 2008 to 2014, they early EBITDA at HCI has fallen from $633 million to $418 million, which represents a decrease of more than 50%. Industry analysts believe that revenues will continue to fall for at least the next 3 years. Experts believe that HCI, on average, will continue to lose customers at a rate of 0.6% per quarter, with a quarterly volatility of 0.07. They also think that HCI will continue to see a decrease of 1.4% per quarter in the total minutes used per customer per quarter, at a quarterly volatility of 0.10.Finally, those same experts believe strongly that HCI will continue to decrease its prices per minute charged at a rate of 1.2% per quarter, with a quarterly volatility of 0.09. The price per minute includes sign-up fees and any other revenue HCI will make each quarter. Because we are already more than halfway through the first quarter of 2015, financial experts have a better idea of HCI's first-quarter 2015numbers. Their best guess for the average number of customers is 17.1million, with a minimum of 16.5 million and a maximum of 18.3 million. They believe that the average number of minutes used per customer for the quarter will be 259, the least amount of minutes will be 250, and the most will be 269. Lastly, they believe that the average price HCI will charge per minute for the quarter will be 13.1 cents, with a minimum of 12.7 cents and a maximum of 13.9 cents. The cost of goods sold (COGS)has remained steady for the past 6 years at 56% of total revenue, and the cost of SG&A has been constant at 27% of total revenue.

The following represents the EBITDA for HCI for the fourth quarter of 2014:

To find out the current value of HCI, the financial experts used 7.45for the EBITDA multiple, which, when multiplied by the effective yearly EBITDA of $399.9 million, gave them a current company value of $2,979 million. Quicker com's financial experts believe that this deal will develop synergies worth at least $616 million for Quicker com, making the total deal worth $3,595 million today. Because the value of HCI has been steadily declining, for Quicker com to have any chance of making a profit, the EBITDA must not fall below $80 million per quarter; hence, the need for the exit clause.
The board of directors of Quicker com has asked you to develop a simple Monte Carlo simulation to model the uncertainties associated with this deal. For simplicity, ignore the time value of money. Do the following:
a. Develop a continuous model to find the expected EBITDA for each quarter of 2015 and the deal value for Quicker com for the fourth quarter of 2015, using the effective yearly EBITDA and$616 million for the synergies.
b. For the fourth quarter of 2015, calculate the expected value of the deal while including the exit clause at an EBITDA of less than $80 million.
c. What is the value of the exit clause for Quicker com and how likely is the company to invoke it?
d. How would HCI value this deal using the same model?

Transcribed Image Text:

04 2014 # of customers (millions) Total minutes used per customer S per minute Total revenue (Smillions) COGS (Smillions) SGCA (Smillions) Q4 EBITDA (Smillions) Effective yearly EBITDA (Smillion) HCI ) 17.2 259.0 S0.132 $588.0 $329.3 S158.8 $100.0 $399.9 $2,979.0 value millions