Valuing the AOL Time Warner Merger Harvard Case Solution & Analysis

VALUATION OF TIME WARNER COMPANY

The valuation of Time Warner as a standalone company has been performed on the basis of the discounted free cash flow method. Earnings before tax, depreciation and amortization have been taken for the expected future years from 2000 to 2004. These have been projected by taking the average growth rates. Tax has been deducted from this to arrive at the free cash flow attributable to the firm. The terminal value for the company has been calculated based on the weighted average cost of capital for the company and the terminal growth rate. These have been estimated in the Appendix C1 by Salomon Smith Barney Analysts. The free cash flows have been discounted and the terminal value has been added to calculate the enterprise value of Time Warner as a standalone company which is around $76 on a per share basis. The enterprise value based on zero present value of growth opportunities is $71.16 and based on the present value of growth opportunities more than zero is $58 per share.

VALUATION OF AOL COMPANY

The valuation of AOL as a standalone company had been done on the basis of discounted cash flow technique. The earnings before interest, tax, depreciation and amortization have been used from Exhibit 2 to calculate the free cash flows. Tax has been deducted to arrive at the free cash flow. The assumptions related to the weighted average cost of capital and the terminal growth rate of AOL have been used from Appendix C1 which has been estimated by Salomon Smith Barney Analysts. The net present value of the free cash flow and the terminal value have been added to arrive at the enterprise value of the company which is around $178 per share. The enterprise value on the basis of zero present value of growth opportunities is $174 per share and on the basis of present value of growth opportunities greater than zero is $163 per share.

VALUATION OF AOL TIME WARNER MERGED COMPANY

The financial used for AOL TIME WARNER valuation after the merger has been taken from Exhibit 7. The earnings before interest, tax, depreciation and amortization have already been estimated in this exhibit. These values have been used and tax has been deducted. The synergies that would be created after the two companies merge have been forecasted by the Lehman Brother and Salomon Smith Barney Analysts. All the synergies related to the revenues, costs and EBITDA have been simplified in a total synergy of 9% that would be created over EBITDA. This has been incorporated after the deduction of tax which gives us the free cash flows of the merged company. The free cash flows have been calculated for 6 years starting from 2000 to 2005. The terminal value has also been calculated. All these cash flows have been discounted at the terminal growth rate and the cost of equity which has been estimated in Appendix C1. Based on this data the enterprise value on a per share basis after the merger is $51 per share which is low as compared to the standalone value of both the companies.

MULTIPLE COMPARABLE ANALYSES

The multiple comparable analyses is the approach to value the company on some important metrics of other businesses that are similar in size and also in nature of industry. This method is based on the assumption that if the companies are similar then their valuation multiples would be also similar. Therefore, comparisons are made on that basis such as EV/EBITDA. The multiple comparable analyses has been performed in the spreadsheet. The comparisons have been made between Time Warner, AOL, News Corp, Dish Network, CBS, Fox Entertainment, Disney, Vivendi, Comcast, Cablevision, Amazon, eBay, Yahoo. The actual enterprise value has been calculated at 1st October 2000. A range of variables have been included such as earnings, sales, EBIT, EBITDA and based on these variables the multiples such as EV/EBIT, EV/Sales have been calculated. These multiples show that the performance of AOL is much better than the performance of Time Warner, however, the future growth potential of Time Warner as shown by its PE ratio of 63 times as compared to PE ratio of AOL of 49 times. However, eBay and Yahoo have some of the outstanding PE ratios in the industry.............................

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January 11, 2000, AOL and Time Warner announced their intention to merge, creating what AOL CEO Stephen Case and CEO of Time Warner, Gerald Levin called the 21st century's first fully integrated communications, media and entertainment company. This case is made from open sources, allows in-depth analysis of the value of AOL Time Warner, from the point of view of managers and analysts to their merger six months later. "Hide
by Lynda M. Applegate Source: Harvard Business School 38 pages. Publication Date: January 3, 2002. Prod. #: 802098-PDF-ENG

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