Analysis of the Adelphia Acquisition

In applying Swiderski’s taxonomy of financial theory to the above purchase strategy, it is noted that only two of the theories listed can be applied based on the information available from Form 8-K: Accounting Model of Valuation and Modgliani & Miller's Irrelevant Propositions (Swiderski, 2006). The Accounting Model of Valuation "contends that Wall Street sets share prices by capitalizing a company’s earnings-per-share (EPS) at an appropriate price/earnings multiple (P/E). " (Stewart, 2001 cited in Swiderski, 2006, p. 1). Modgliani & Miller's Irrelevant Propositions “argue[s] that a coporation's financial decisions and/or policies have no material impact on the value of its shares. The only decisions that do are those that are relevant, such as investment and operating decisions that directly affect the entity's cash flows” (Swiderski, 2006, p. 1). By focusing on key analysis, such as leverage ratios, Time Warner is projecting the impact of the acquisition on its consolidated financial statements. More specifically, the CFO is concerned with how the balance sheet will look like and how many shares the buyers will have upon close. In addition, through an increased market share and profitability through the classification of the buyout on the balance sheet as a purchased asset (Form 8-K, 2005), earnings are projected to be higher over time, which yields a higher EPS and P/E ratio. The CFO’s comments on From 8-K serve two purposes: first, to explain the implications of the buyout in financial terms and, secondly, to reassure investors that the company is not making a mistake purchasing Adelphia. Hence, there will be some salesmanship presented in his comments. When eliminating the sales puffery, one can see by reading the Form 8-K that the CFO is stating only relevant information related to the implications of the buyout and the concerns of the investment community. To be more convincing, a comparison in financial data indicating the projection for Time Warner with and without the buyout could be presented, thereby incorporating the Economic Model of Valuation, which determines the corporation’s real market value “by calculating the future cash flow from operations outside of any new capital invested for growth (future cash flows) back to a present value that reflects the rate of return needed to pay back investors for bearing risk (cost of capital)” (Stewart, 2001, paraphrased in Swiderski, 2006). There are other areas of additional research that could be presented or conducted (if not done so previously) which would provide useful to this case study. Key calculations, such as the internal rate of return (IRR) on the investment, would provide a better indication of how profitable the acquisition really is. A regression analysis of stock prices in response to any news/press releases relating to the acquisition may also provide some insight as to whether the investor perception is positive or negative. Finally, historical analysis of financial implications of acquisitions of similar companies within the industry may also provide some insight as to what the ramifications of this buyout may be. Post-transaction Analysis As of the time that this essay was written, the acquisition has not yet closed. The FCC is scheduled to vote on whether to approve the transaction on July 13, 2006. “[T]he FCC has been considering putting conditions on the sale that would require Comcast and Time Warner to provide competitors with access to their local sports programming. The conditions could be similar to those placed on News Corp.'s (NWS) acquisition of DirecTV Group Inc. (DTV). As part of that approval, the FCC stipulated that News Corp. couldn't use DirecTV to withhold programming from competitors, charge higher prices or refuse to carry competing programs. Regulators also stipulated that News Corp. submit to a neutral third-party arbitrator in case of program disputes with cable and satellite operators” (FCC to vote on Comcast, Time Warner’s Adelphia buy July 13, 2006, par. 2). One ramification for Adelphia is that “[i]f the deal fails to wrap up by Sept. 1, Adelphia could be required to pay Time Warner $382.85 million or lower its price by the same amount. The company would also have to pay Comcast $87.5 million” (FCC to vote on Comcast, Time Warner’s Adelphia buy July 13, 2006, par. 4). Upon successful completion of the acquisition, additional research should be conducted to determine the financial implications of the buyout. First, Swiderski’s taxonomy of financial theory should be reapplied to determine if the previously identified theories will still be applicable after the transaction, whether they were properly incorporated, and whether theories were omitted. Second, an analysis should be conducted to determine how the use (or misuse) of financial strategy and risk analysis affected the transaction. Finally, an objective analysis should be conducted to determine whether any of the arguments and theories presented herein appear to be supported upon the outcome of the acquisition. Implications and Conclusions In this essay, the buyout of Adelphia Communications Corporation was evaluated to determine why it has become an attractive purchase. More specifically, the purpose of this essay was to evaluate the acquisition of Adelphia Communications Corporation by Time Warner and Comcast. Upon presenting background information on the company, an evaluation of the processes enacted to complete the strategy was conducted. No data on the measures used to value the acquisition could be found, except for the information contained on the company’s Form 8-K. However, one should be hesitant to make the determination that no analyses outside those previously mentioned in this report were conducted. Such an assumption would be merely speculative and should be made pursuant to the successful closing of the deal. The assumption was made, based on data contained in the Form 8-K, that Time Warner has taken the necessary risk management precautions, yet further research should be conducted after the transaction is complete to test that hypothesis. Additional research upon close should also be conducted to determine what specific valuation techniques were employed that lead to Time Warner’s decision to acquire Adelphia, in conjunction with proposals for research discussed in the post-transaction analysis section of this report. Ample time after close should be given prior to conducting such research to produce more accurate and reliable data.
References Adelphia (2006). Wikipedia. Retrieved June 20, 2006, from the World Wide Web: http://en.wikipedia.org/wiki/Adelphia. Adelphia Communications Corporation (2006). Retrieved June 20, 2006 from the Datamonitor MarketLine Business Information Center. Corporate scandal (2006) [list of recent corporate scandals], Wikipedia. Retrieved July 5, 2006 from the World Wide Web: http://en.wikipedia.org/wiki/Corporate_abuse. FCC to vote on Comcast, Times Warner’s Adelphia buy July 13 (2006, July 7) [Market Watch online]. Retrieved July 7, 2006, from the World Wide Web: http://www.marketwatch.com/News/Story/Story.aspx?dist=newsfinder&siteid=google&guid=%7BE04DE037-1D35-48C8-B4AD-A6CD6668EA6E%7D&keyword= Form 8-K [Time Warner, Inc., filed April 21, 2005] (2005). Retrieved July 4, 2006 from the World Wide Web: http://www.shareholder.com/Common/Edgar/1105705/ 1105705-05-33/05-00.pdf. Hay, D. A. & Liu, G. S. (1998, May). When do firms go in for growth by acquisitions? Oxford Bulletin of Economics & Statistics. 60(2). Retrieved from the EBSCOhost database on July 5, 2006. Higgins, J. M. (2006) Hey, Time Warner: Walk Away From Adelphia. Broadcasting & Cable 136(20). Retrieved from the EBSCOhost database on July 5, 2006. Swiderski, P. R. (2006). Taxonomy of Financial Theory.

In the midst of the multitude scandals of corporate corruption around the turn of the century, including those of Enron’s accounting fraud, Halliburton’s overcharging of government contracts, and the Compass Group’s bribery of the United Nations to win business (Corporate scandal, 2006), there have been a variety of financial ramifications. On one end of this spectrum, organizations ceased operations, while others have become bait for acquisition. What makes a company attractive to others to pursue a merger, acquisition or partnership after its downfall is an issue that needs further examination beyond typical speculative reasoning. In this essay, the buyout of Adelphia Communications Corporation is examined. As explained in subsequent sections, Adelphia made headlines in 2002 when it filed a petition for Chapter 11 bankruptcy after the Rigas family (then majority shareholders of the company) misused corporate assets. Currently, the company is under contract by multiple firms to sell its assets in the U.S. and Puerto Rico (Adelphia Communications Corporation, 2006). Rather than shutting down operations, the corporation underwent a serious restructuring effort. This essay examines why Adelphia has become an attractive purchase, rather than another company, such as Enron, that has closed its doors after its corporate scandal has made press. More specifically, the purpose of this essay is to evaluate the acquisition of Adelphia Communications Corporation by Time Warner and Comcast (Adelphia Communications Corporation, 2006). First, an overview of Adelphia is presented, providing a history of the company, summarized details of the events resulting in the company’s petition for bankruptcy, and the strategy used to restructure the corporation afterwards. The processes enacted to complete the acquisition will be also evaluated, including an identification of the key leadership and management transactions. Valuation strategies used by the buyers prior to acting and the financing method(s) used to perform the transactions will be assessed as well. The following section will examine applicable financial theories that relate to the purchase of Adelphia, as well as any theories that were omitted that could have benefited the buyers. Finally, a proposal for post-transactional analysis will be presented. Company Background Adelphia Communications Corporation, founded in 1952, provides a variety of services under the umbrella of telecommunications, including cable television, high speed Internet, and media services, to over 5 million customers in over 30 states and Puerto Rico. It is currently the fifth largest cable operator in the U.S and is under contract “with Time Warner and Comcast, to sell all of its US assets for $12.7 billion … [and] along with its Puerto Rican partner, ML Media Partners LP, [Adelphia] entered into an agreement with two private equity firms, Crestview Partners of New York, USA and MidOcean Partners of London to sell its jointly owned San Juan Puerto Rico cable operations for $520 million” (Adelphia Communications Corporation, 2006, par. 16). History The company incorporated in 1972. “In the early 1990s, the company began building fiber optic networks to deliver communications solutions to the business community. In 1999, Adelphia and its majority-owned subsidiary Hyperion Telecommunications… announced their decision to operate Hyperion under the name Adelphia Business Solutions” (Adelphia Communications Corporation, 2006, pars. 9 - 10). Adelphia expanded by acquiring competitors in various markets later in the same year and in 2000 (Adelphia Communications Corporation, 2006). “Adelphia launched Wink Interactive TV in 2001. In the same year, Gemstar-TV Guide International and Adelphia signed a 20 year agreement with a commitment to deploy TV Guide Interactive in substantially all Adelphia systems” (Adelphia Communications Corporation, 2006, pars. 10 - 12). Scandal Adelphia filed for Chapter 11 bankruptcy protection in 2002, after it became known that “John Rigas and his family, who earlier controlled a majority stake in the company's shareholding, fraudulently used the company's funds for personal loans, manipulated financial figures to conform with analysts' expectations, funded non-corporate projects using Adelphia's line-of-credit for personal purchases, creation of fictitious companies and sham transactions for inflating the company's earnings and concealed increasing debts” (Adelphia Communications Corporation, 2006, par 34). Several lawsuits have been filed against Adelphia in relation with the Rigas scandal. The Rigas family subsequently gave up their shares of the corporation. Restructuring The organization also worked on restructuring efforts, and it has filed four restructuring plans with the bankruptcy court, with its most recent amendment in July, 2006. In 2004, the entity announced that it has decided to sell all of its assets as part of its restructuring plan to satisfy its creditors. (Adelphia Communications Corporation, 2006). The acquisition agreement between Adelphia and its buyers was approved by the Federal Trade Commission and is awaiting approval from the Federal Communications Commission. A deadline for the sale of the company’s assets to Time Warner is set for July 31, 2006. In opposition to the sale are several of Adelphia’s key bond holders and some Wall Street analysts. Buyout Strategy Despite some analyst’s opinion that Time Warner should walk away from the deal, executives at Time Warner “remain confident that the value that drove this transaction in the first place is still there” (Britt, cited in Higgins, 2006). “Time Warner Cable will gain systems passing approximately 7.5 million homes, with approximately 3.5 million basic subscribers… [to increase its subscriber base to] approximately 14.4 million… Time Warner will own 84% of Time Warner Cable's common stock, and the cable company will become a publicly traded company at the time of closing. Comcast will emerge from these transactions with approximately 1.8 million additional basic subscribers… [to increase its subscriber base to] a total of approximately 23.3 million customers” (Form 8-K, 2005, p. 7). “We… are paying around $2,700 to $2,800 per basic subscriber. This is 9 to 11 times expected first full year Adjusted OIBDA, which reflects approximately $200 million of realized cost savings... On a free cash flow basis, we expect the transactions to be… around breakeven in the second year… approximately $11 billion of net debt [will be added] at the… consolidated parent company level... Most of [which]… will be funded by existing cash on hand of over $7 billion [through inter-company loan] and availability under current credit facilities… [L]everage ratios… [are estimated to] be at or below the low-end of… previously-stated target range of 2.25 to 2.75 times” (Pace, cited in Form 8-K, 2005, p. 20). It may be determined that ratio and free cash flow analyses were conducted to estimate the profitability of the acquisition and the impact on the consolidated financial statements. One may become concerned as the valuations expressed focus more on the perceived value from the investor point-of-view to prove that Time Warner can afford the acquisition and that the purchase will not significantly impact the buyer’s stock/company value, as quantitative values were used to ease the qualitative concerns of current and potential investors. By exploiting Jensen’s free cash flow theory, Time Warner is banking on the assumption “that shareholders may be willing to accept takeover bids for companies that they suspect of not using excess cash wisely” (Hay & Liu, 1998, par. 6). From a risk management standpoint, Time Warner’s use of research to defend its position and explain to investors that it is can effectively acquire Adelphia with insignificant perceived financial impact may ease the minds of some investors, which provides an excellent method of preventative risk management. Further Britt states that Time Warner “performed extensive operational, financial and legal due diligence, which has given us a good understanding of the assets we're acquiring… [and] we had our operating people in the field inspecting contiguous systems” (Form 8-K, 2005, p. 23). There is a good indication that Time Warner has a solid understanding of the risks involved, as many of the risks were identified in the Form 8-K.