Finance for M&A and Take Over

Case: Cox Communications, Inc., 1999

1

What are the Options Available for Cox in Funding the Forthcoming Acquisition ?

Options

Debt

Equity

Sale of Non‐Strategic Assets

Equity Linked Instruments

Funding to be consistent with firm’s long‐run capacity to future activities

Need to protect the impact of funding actions on firm’s 

investment‐grade bond ratings

Respect the preferences of the Cox family (owned more than 2/3rd of Cox through their ownership of the 

privately held CEI)

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1996 1997 1998 99Q1 99Q2Revenue 1460 1610 1717 499 510Costs of goods sold 468 496 540 168 159Selling, general and administartive 436 505 518 142 156EBITDA 556 609 659 189 195Depreciation and Amortization 335 405 458 123 159Non-operating income -104 -193 2115 384 890Interest expenses 146 202 223 54 69Income tax 23 -54 883 144 352Net income -52 -137 1210 252 505

1996 1997 1998 99Q1 99Q2Revenue 100% 100% 100% 100% 100%Costs of goods sold 32% 31% 31% 34% 31%Selling, general and administartive 30% 31% 30% 28% 31%EBITDA 38% 38% 38% 38% 38%Depreciation and Amortization 23% 25% 27% 25% 31%Non-operating income -7% -12% 123% 77% 175%Interest expenses 10% 13% 13% 11% 14%Income tax 2% -3% 51% 29% 69%Net income -4% -9% 70% 51% 99%

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1996 1997 1998 99Q1 99Q2Total Assets 5784 6557 12879 14727 16169Cash and marketable securities 42 28 31 90 23Total current assets 165 377 197 265 210Current liabilities 250 245 336 334 362Deferred taxes 294 722 2887 3668 4152Long-term debt 2824 3149 3920 3383 3587Other liabilities 155 84 359 485 439Total laibilities 3523 4200 7502 7870 8540Total shareholders equity 2261 2357 5377 6857 7629

1996 1997 1998 99Q1 99Q2Total Assets 100% 100% 100% 100% 100%Cash and marketable securities 1% 0% 0% 1% 0%Total current assets 3% 6% 2% 2% 1%Current liabilities 4% 4% 3% 2% 2%Deferred taxes 5% 11% 22% 25% 26%Long-term debt 49% 48% 30% 23% 22%Other liabilities 3% 1% 3% 3% 3%Total laibilities 61% 64% 58% 53% 53%Total shareholders equity 39% 36% 42% 47% 47%

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1996 1997 1998 99Q1 99Q2Capital expenditures -579.00 -708.00 -809.00 -225.00 -277.00Cash flow from operations 309.00 555.00 666.00 176.00 18.00Cash flow from investing activity -552.00 -1108.00 -1600.00 515.00 -292.00Cash flow from financing activity 246.00 539.00 937.00 -631.00 207.00Shares outstanding (all classes, in mn) 540.00 541.00 545.00 555.00 555.00LT debt / EBITDA 5.10 5.20 5.90 4.50 4.60EBITDA interest coverage 3.80 3.00 3.00 3.50 2.90Free cash flow / LT debt -9.60% -4.90% -3.70% -1.40% -7.20%LT debt / (LT debt + equity) 55.50% 57.20% 42.20% 33% 32%ROE (%) -2.30% -5.80% 23.60% 3.70% 6.60%Price / book 2.76 4.61 3.64 3.11 2.72D/E (book value) 1.25 1.34 0.73 0.49 0.47D / E (market value) 0.45 0.29 0.20 0.16 0.17

What are the Financing Objectives of Cox?

Double the size of the company every 5 years

Preserve family’s economic ownership of 

Cox

No ownership dilution of CEI (owns 67.3% of 

common shares controlling 76.8% of 

voting stock)

To align Cox’s family’s interests as 

management with those of other shareholders

Reluctance to increase the leverage of the firm

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What are the Issues involved in Issuing Common Shares?

To public for all or part of the required amount of 

funding

June 1995: IPO, raised little less than $400 million 

through private and public placement – the first and 

only share issuance

IPO from rivalryExpected down fall in 

market (DJIA: fell 10% in two weeks)

Classes of shares (firm’s unique ownership 

structure)…

Class A: one vote, no dividend paid, Cox family owned 379.2 million out of 533.8 million shares

Class C: ten vote, no dividend paid, Cox family owned all the27.6 million 

shares

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Anticipated issuance of 38.3 million shares as part of TCA transactions in next 

fiscal quarter

CEI would own 67.3% of Cox’s common shares, 

controlling 76.8% of Cox’s voting stock

Proposed issue might get affected by…

Upcoming (in Fall) Charter 

Communications’ IPO

Expected correction in the market due to 

prolonged economic expansion in US

Direct costs of equity issue…

Underwriting fees: 2% to 3% of amount raised

Under pricing the issue: 3% to 4%

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What are the Issues involved in Issuing Common Shares?

What are the Issues involved in Raising Debt to Fund Gannett Cable Acquisition?

•Public debt or •Bank borrowingThrough..

•Source of debt•Maturity structure• Level of cash coupons•Various options – redeem, convert, call at par, sinking fund provision

Structure

•Maturity ranging from 5 to 30 years• Yields ranging from 65 to 115 bps above US treasury obligations

Since 1995 raised $1.9 billion in 

debt

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Cox family conservative about 

use of debt

Cox already had the highest level of debt financing of all CEI subsidiaries

Publicly articulated goal of maintaining a high debt rating

Wanted to get the right balance of debt and equity

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What are the Issues involved in Raising Debt to Fund Gannett Cable Acquisition?

Continuing to be investment grade by maintaining required 

financial variable at a level

Targeting a Debt/EBITDA ratio of no greater than 5 

going forward

Debt‐market for companies rated investment grade 

larger and more stable than for non investment grade 

firms

Non investment grade firms found difficult to obtain 

access to credit

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What are the Issues involved in Raising Debt to Fund Gannett Cable Acquisition?

Sub‐investment grade debt cost more

30‐year treasury yield had increased more 

than half a percent over past six months

Direct and indirect costs of a debt issuance 

would be less than that for issuing equity

Transaction costs would be less than 2%

Market impact of issuing debt on stock price 

would be around 1% to 2%

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What are the Issues involved in Raising Debt to Fund Gannett Cable Acquisition?

Increased credit spreads = A rated: 56bps to 

135bps and BBB rated: 95bps to 181bps

Recent weakness in the bond markets and 

cancellation of previously announced deals by 

Great Lakes Power Inc.,

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What are the Issues involved in Raising Debt to Fund Gannett Cable Acquisition?

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1 Year 2 Year 3 Year 5 Year 10 YearTreasury bonds 5.38 5.64 5.70 5.83 5.83US Treasury strips 5.38 5.66 5.71 5.88 6.16A-rated industrial bonds 5.99 6.33 6.44 6.70 6.93BBB-rated industrial bonds 6.30 6.62 6.81 7.05 7.37BB-rated industrial bonds 6.84 7.51 7.71 8.00 8.80

Yields for Governemnt and Corporate Bonds for July 15, 1999

What are the Issues involved in Sale of Non‐Strategic Assets?

Sell / swap / monetize non‐strategic equity investments

Selling in market will attract capital gain tax (35%)

Cox’s shares in AT&T had a tax basis of ‘0’

Monetizing or obtaining 

equivalent cash –tax efficient deal

Sprint PCS: $4.1 billion (Taxable 

base: $0)

Discover communications: 

$2.5 billion (Taxable base: $34 Million)

@Home: $1.5 billion (Taxable base: $7 Million)

Flextech: $300 million (Taxable base: $48 Million)

Smaller stakes in other firms

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Tax effective transaction: Cox had effectively swapped its AT&T shares for shares in AT&T subsidiaries that 

owned cable assets without triggering a taxable event

Received cash equivalent in value and also postponed the capital gain taxes from any sale for a number of 

years

Sprint PCS – cannot be sold till Nov.

Stakes in Sprint PCS, @Home, and Flextech –larger than daily trading volumes in the market

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What are the Issues involved in Sale of Non‐Strategic Assets?

FELINE Income PRIDESFinancial Reporting Advantages

Debt would not appear on the balance sheet 

as debt

‘Minority shareholders Interest’ appears 

reflecting the preferred equity issuance

Tax deductible on interest payments 

made on debt issued to trust

FELINE Income PRIDE appears to be equity in 

reports

Rating agencies treat the debt like equity

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CCI Trust

IncomePRIDESInvestor

1.1962 1.1962*S$50

1.4414*S

No. of Cox Shares Delivered Value of Cox Shares Delivered

1.4414$50/S

Cox Share Price in 3 Years

S <= $34.6875$34.6875 < S < $41.7984

S >= $41.7984

FELINE PRIDES Structure: Income Prides

Debt:7% Coupon

$50 $50

Preferred equity: 7% payments + Cox shares

Conversion Schedule of FELINE PRIDES

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CCI Stock Price

Cash

flow

in 3

Yea

rs

Slope: 1.4414

Slope: 0

Slope: 1.1962

Decomposition of FLINE PRIDESMaturity of call = point in time investors are required to convert FELINE PRIDES into 

equity

Equity content of options can be calculated by 

computing delta of each option

Delta can be computed using Black‐Scholes 

model

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FLINE PRIDES = 1.4414 shares– 1.4414 calls (34.69) + 1.1962 calls (41.80)

CCI Stock Price

Cas

hflo

w in

3 Y

ears

Slope: 1.4414

Slope: 0

Slope: 1.1962

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Currrent stock price of CCI $40.69 As on July 31 , 1999

Risk free rate 5.63% log(1+5.7 1%/2)^2 Exhibit 6

Volatility 47%Time-to-maturity (years) 3Delta of call (34.69) 0.79 CCI shares

Delta of call (41.80) 0.72 CCI shares

Equity content in FELINE PRIDES 1.1664Delta of FELINE PRIDES 1.1664Model used BSM

Delta of Options

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Equivalent CCI stocks issued through FELINE PRIDES 1.166Issued at (Per unit) $50No. of units issued ($720 million / $50 million) 14.4Total no. of equivalent shares issued (14.4 million * 1.166 CCI shares) 16.7904Recomputed Economic Stake of Cox FamilyOld shares 621Shares issued through FELINE PRIDES 16.7904Total shares outstanding 637.7904Shares owned by COX family 406.7Stake of COX family after issuing FLINE PRIDE (406.7/(621+16.79)) 63.77%

Dilution Effect of FELINE PRIDES

Whether insistence to maintain an investment grade rating make sense?

152

Deal Financing

Firms which believe that their stock is undervalued will not use stock to do 

acquisitions

Given that the exchange ratio in a stock acquisition is set before the exchange take place, there is an element of 

uncertainly in a stock acquisition

Premium paid is larger when an acquisition is financed with stock rather than cash

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Deal Financing

Cash transactions are taxable — require higher premiums to compensate for taxes

Signaling effect — use of cash indicates that target has better 

investment opportunities

Securities transactions involve regulatory approval and longer acquisition interval

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Company’s Life Cycle and Capital Requirements

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Cost of Capital Considerations

157

Financing

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