global communications gaap summit 2014 - pwc...global communications gaap summit june 2014 2 -50 100...

Global Communications GAAP Summit 2014 Eurostars Madrid Tower, Madrid 23-24 June 2014 Workshop 1: Inorganic growth

PwC

Bigger transactions are taking place in telecoms – uptick in activity anticipated

June 2014 Global Communications GAAP Summit

2

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50

100

150

200

250

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10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

2012Q1

2012Q2

2012Q3

2012Q4

2013Q1

2013Q2

2013Q3

2013Q4

2014Q1

£m

GLOBAL TELECOMS TRANSACTIONS

Value Volume

£m

Biggest deals $bn Period

Vodafone/ Verizon 130 Q1 2014

Liberty/Virgin Media 26 Q1 2013

Softbank / Sprint 22 Q3 2013

Telefónica / E-Plus 11 Q3 2013

Vodafone / KDG 10 Q3 2013

Vodafone / ONO 10 Q1 2014

AT&T / Leap Wireless 4 Q3 2013

VTB / Tele2 4 Q1 2013

Nokia / NSN 2 Q3 2013

DISH / Light Squared 2 Q3 2013

Cukurova / Turkcell 2 Q3 2013

PwC

The deal continuum

Global Communications GAAP Summit

3

June 2014

Market and competitor analysis

Fit within strategy assessment

Identifying deals

Evaluating deals

Executing deals

Making deals successful

Harvesting deals

Due diligence

Valuation

Due diligence

Pre-PPA

SPA signing

Stakeholder communication

Integration

Acquisition accounting (incl PPA)

Accounting policy conversion

Divesting non-core activities (sale or IPO)

A new standard for mergers and acquisitions

What has been your experience with acquisitions to date?

PwC

Meet Topline

Topline is an innovative communications company that offers a broad range of services including fixed and mobile telecommunications, internet, and cable TV.

The Company has been looking to expand its mobile capacity in one particular market through an acquisition.

The Board is looking to understand:

• The accounting for the purchase consideration and the impact of any terms in the Sale & Purchase Agreement

• The valuation of the acquired assets and liabilities

• The priorities to integrate the acquired company

June 2014

4


PwC

Topline acquires WellTell

What is the consideration?


5

PwC

Global Communications GAAP Summit 6

June 2014


WellTell

Bottomline

90%

Management

10%

Topline is to acquire WellTell

• Topline acquires 70% of WellTell from Bottomline and a further 10% from management.

• Topline acquires a 20% symmetrical put/call option on the remainder of WellTell.

• The previous structure was as below:

PwC


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June 2014


Slide 7

Excluded elements

Non-controlling interest

Previous interest

Consideration

Assets, liabilities and contingent liabilities

Goodwill

Accounting entries for a business combination

PwC

Consideration

• Consideration paid for 80% interest of WellTell:

- EUR 500 million paid in cash

- 50 million Topline shares

- EUR 10 million fees paid to external advisors


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June 2014

1 Jan

Negotiations start

Value of the Topline shares

EUR 350m

Letter Of Intent signed

Sale & Purchase Agreement signed

Regulatory approval and share transfer

EUR 300m

1 Mar 1 Jun 1 Dec

EUR 250m

EUR 400m

PwC

Question time: Acquisition cost


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June 2014

How much is the consideration paid by WellTell? a) €750m b) €760m c) €900m d) €910m

• Consideration paid for 80% interest of WellTell:

- €500m paid in cash

- 50 million Topline shares with value of:

◦ €250m when Sale & Purchase Agreement signed

◦ €400m when shares are transferred

- €10m fees paid to external advisors

PwC


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June 2014

What forms part of the consideration?

Principles:

• Paid to vendor : Assets transferred, liabilities incurred and equity issued.

• Measured at fair value (FV) at date control passes.

• Exclude items not part of consideration.

• Contingent consideration: recognised at FV. Subsequent fair value changes are recognised in the Income Statement

PwC


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June 2014

Slide 11

Contingent

Consideration

Indemnification

Seller represents truth, accuracy and good faith

Payment for a litigation contingency leads to a purchase price adjustment

Any payment for tax contingencies related to issues prior to the acquisition date will be reimbursed

Acquirer pays additional consideration if EBITDA level is exceeded

Terms within a Sale & Purchase Agreement

Or

PwC

Question time: Terms within a Sale & Purchase Agreement

• Topline will pay an additional €50m in cash if annual churn in 2014-2016 is on average lower than 15%.

• The present value of the future payment is €40m on the acquisition date.

• Topline assesses the fair value of future payment to be €10m as the probability of reaching this target is low


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June 2014

What amount should be included in the consideration? a) €50m b) €40m c) €10m d) €0m

PwC


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June 2014

Slide 13

Arrangement related to a specific asset or liability arising from a past event?

Contingent consideration or Indemnification

Contingent consideration Obligation or right of acquirer

Indemnification Obligation of seller

Arrangement related to future events or conditions?

NO YES

NO YES

Neither contingent consideration nor indemnification


Solution: Terms within a Sale & Purchase Agreement

PwC

• Topline also agreed to acquire 10% of WellTell from management

• If management continued to work for WellTell then an additional earn-out payment is payable by Topline based on 2015-2017 EBITDA.

• The payment is payable on 1 April 2018 – as long as management still work for WellTell at this time.

• The maximum amount payable is EUR 50m. The discounted value of the maximum payment is EUR 40m and the probability weighted value of this earn out obligation is estimated to be EUR 30m.


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June 2014

Question time: Terms within a Sale and Purchase Agreement

What amount should be included in the consideration? a) €50m – being the maximum amount payable b) €40m - being the discounted value of the maximum amount c) €30m - being the probability weighted value of the payment d) €0m

PwC


15 Slide 15

Solution: Shareholder or employee ?

Contingent consideration?

Continuing employment

required?

Payments forfeited when employment

terminates?

Contingent consideration

Post-acquisition employment

expense

Allocate, to consider: • Duration (of employment

vs contingency) • Level of remuneration • Incremental payments • Linkage to valuation/

formula used

NO

YES

YES

NO

June 2014

PwC

Question time: Put/Call option structure

• Topline also acquired a put/call option for the remaining 20% of WellTell.

• The option is exercisable between 2016-20 at an exercise price of 20% of 7 times the EBITDA in the year of exercise.

• Based on the current business plan that underlies the acquisition, this would amount to €30m (€20m discounted value)

• The fair value of the put/call option amounts to €1m


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June 2014

How should Topline account for this situation? a) Value the option at its fair value of €1m - fair value changes in P&L b) Value the option at its fair value of €1m – fair value changes in equity c) Recognize a liability of €20m – fair value changes in P&L d) Recognize a liability of €20m - fair value changes in equity

PwC

Solution: Put/Call option structure


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June 2014

Non Controlling Interest = equity instrument

Obligation to purchase equity instruments = liability

Recognize Fair Value changes in P&L

PwC


What are the identifiable assets and liabilities?


18

PwC


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June 2014

Recognition of Intangible Assets

1. Separability Criterion

2. Contractual- Legal Criterion

Separability, i.e. is capable of being separated or divided from the entity

Contractual-Legal, i.e. arises from contractual or other legal rights

Probable Future Benefit

Reliably measurable

Definition of an intangible asset:

Recognisable if:

Identifiability Control Future

Economic Benefits

+ + or

Assumed in a business

combination!!

PwC


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June 2014

Valuation Approaches for Intangible Assets

Value estimate based on multiples or

prices from market transactions involving the sale of comparable

assets

Market approach

Value estimate

reproduction/replace-

ment cost-adjusted for

depreciation and

obsolescence

Cost approach Income approach

Value estimate present value of earnings

attributable to the asset or costs avoided as a result of

owning the asset

Relief-from-Royalty Method

Multi-Period Excess Earnings Method (MEEM)

Incremental Cash Flow Method

Valuation approaches

Hierarchy

PwC

Spectrum licences are a key asset – some debate over most appropriate methodology

Telecoms licences

(e.g. GSM, UMTS, CDMA)

Customer contracts & relationships

(e.g. voice, data, VAS)

Rationale

Carrier and spectrum licences enable provision of mobile, fixed & broadband services.

Tradenames Brand perception can be a determinant factor in customer purchasing decisions

Existing contracts and expected future renewals are the primary source of cash flow

Software

(e.g. ordering, provisioning, billing)

Typical valuation method

Build-Out Approach / Market Multiples

Multi-Period Excess Earnings Method

Relief from Royalty

IT platforms that enable business functioning and customer scalability

Replacement Cost Approach

Intangible asset

Licence valuation


June 2014

PwC

PwC

Slide 22

For spectrum held, the existing business plan forms a basis for the Build-out model

Revenue Network Non-Network

Cash Flow

Time

Business plan is the starting point of the model A fair value of the licence, i.e. to an “average” market participant must be assessed

The inputs and assumptions made are applied to the original business plan in order to transform it into a startup business plan.

Original Business Plan

Inputs & Assumptions

Build-out Business Plan

Cash Flow

Time

Licence valuation


June 2014

PwC

PwC

Question time: Telecom licence

• Topline and WellTell are both active in the same market and have acquired mobile telecom licence in the past

• Based on recent transactions, it is estimated that a company without an existing licence would be willing to pay €800m for the licence.

• The acquired licence will no longer be used after the transaction. However, the licence conditions do not permit these to be traded to other companies.


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June 2014

How should Topline account for this situation? a) Value the WellTell licence at nil b) Value the WellTell licence at €800M and impair it immediately c) Value the WellTell licence at €800M and impair its own licence d) It depends

PwC

Slide 24

Software is often significant – particularly billing systems

Telecoms licences

(e.g. GSM, UMTS, CDMA)

Customer contracts & relationships

(e.g. voice, data, VAS)

Rationale

Carrier and spectrum licences enable provision of mobile, fixed & broadband services.

Tradenames Brand perception can be a determinant factor in customer purchasing decisions

Existing contracts and expected future renewals are the primary source of cash flow

Software

(e.g. ordering, provisioning, billing)

Typical valuation method

Build-Out Approach / Market Multiples

Multi-Period Excess Earnings Method

Relief from Royalty

IT platforms that enable business functioning and customer scalability

Replacement Cost Approach

Intangible asset

Licence valuation


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June 2014

PwC

PwC

Cost approach methods

Replacement Cost Cost savings approach

Cost approach... ... valuation methods

cost avoided by owning the asset

Compare costs incurred by owning the asset vs. not owning it

cost to replace the asset

Acquisition of a similar asset from a third party that fulfils the same function

Need to include Tax Amortisation Benefit

Already includes Tax Amortisation Benefit

June 2014

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PwC

Question time: Software valuation

• WellTell developed its own billing system. It spent €50m developing the system five years ago. This has now been amortised in full so there is no balance sheet value relating to this asset.

• Recreating the same billing system today would cost €40m, given efficiencies in the way such systems are developed.

• Approximately 20% of the billing system is obsolete and no longer relevant in today’s market.


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June 2014

What is your estimate of the fair value of the billing system today? a) Zero – it has been written off in full and therefore has no value b) €50m – this is what it cost to develop originally c) €32m – this is the cost today of recreating the still relevant technology d) €40m – this is the cost of recreating everything that is in place today

PwC

Network valuation

June 2014

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Depreciated replacement cost is typical approach

Book value

Labour Cost

Equipment Cost

Replacement Cost New

Adjust Depreciation

Fair value

The assets must be generating sufficient income to support

the cost approach value as described above

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June 2014

Other important aspects to consider

• Contingent liabilities

• Indemnifications of seller

• Restructuring

• Change of control provisions

• Debt valuations

• Deferred tax

• Acquisitions achieved in stages

• Alignment of accounting policies

PwC

Question time: Deferred revenue

• WellTell had recognised a significant amount of deferred revenue in the balance sheet for deferred connection fees and outstanding call credits


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June 2014

How should Topline account for this deferred revenue in the Purchase Price Allocation?

Deferred connection fees Outstanding call credits

a) Nominal Nominal

b) Nil Nil

c) Nil Nominal

d) Nil Fair value

e) Fair value Fair value

PwC


30

June 2014

Intangible items left in goodwill

• Part of synergies

• Assembled Workforce

• Customer service capability

• Presence in geographic markets or locations

• Ongoing training or recruiting programs

• Outstanding credit ratings

• Access to capital markets

• Favourable government relations

PwC


31

June 2014

Areas to challenge an external valuer…

• How do the values benchmark against Purchase Price Adjustments done by other telcos? If different why is this case?

• What is represented by the goodwill value?

• What is the most valuable intangible? Why is this asset more important in driving value than others?

• Which synergies have they included in the intangible values? Why?

PwC


How do you integrate the deal?


32

PwC

Post deal experiences

• You are the Corporate Controller of Topline. You have just been told about the acquisition.

• The CFO wants you to take a lead role on the finance integration workstream.

• This is completely confidential as you are one of only seven people in the company who know about this.

• There is an initial meeting in 30 minutes which you are to attend.


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June 2014

What do you do to prepare for the meeting?

PwC

Post deal experiences

What do you want to know?

• What does this mean?

• What are key success factors in making integration a success?

• How does finance fit in with the other areas?

• Major areas to be addressed in work plan?

• Where in the finance work plan do you intersect with IT and HR?

• How will the integration be structured?

• How governed?


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June 2014

PwC

Typical Acquisition


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23-24 June

Short-Term Longer-Term Pre-close

Investigate Integrate,

Operate Execute Strategic

Screen

Str

ate

gy A

rtic

ula

tio

n

Evaluate

Growth

Strategy

Analyze

Target

Markets

Identify

M&A

Candidates

Financial Diligence

Tax, Legal

and Regulatory

Valuation and

Structure

Synergies and

Value Drivers

Operations and

Systems Diligence

Initial Integration

Planning

Close

Integration Management Office

Synergy Planning and Realization

Transition Team Deployment

Governance/

Org Structure

Merger

Communication

Risk/Issue

Management

Employee/

Customer

Retention

Project Team

Structure

Day 1

Plan and

Execution

Negotiation

and Closing

Execute

100 Day Plan

Operations Integration/Optimization

Organization/Cultural Alignment

Cultural

Alignment

Comp./

Benefit

Alignment

Org.

Design

Customer

Integration

Supplier

Integration

Systems Integration/Optimization

Communication and Change Management

Facility

Alignment

PwC

Challenges Facing Acquirers


36

June 2014

Po

ten

tia

l D

eal

Va

lue

Start too Late

Failure to Address Soft Issues

Working in Silos

Lost in Details

Closed Minded

Market Awareness at Lower Levels

Delayed Decision-Making

Issues that Diminish Deal Value

Value can be diminished by through the impact of multiple factors. While acquirers focus their efforts to address the most prevalent issues, they often lose focus of others.

PwC

How to ensure a successful integration .

High

Low

Low High Probability of Success

Financial Impact

Value Drivers

Initiatives are ranked according to financial impact and probability of success. Those with the highest financial impact and highest probability of success receive resource priority.

1. Accelerate the transition.

2. Define the strategy first, then execute.

3. Focus on 20% of work that drives 80% of the value.

4. Prepare for Day One, then the larger Integration.

5. Communicate to all stakeholders.

6. Establish leadership at all levels.

7. Manage the integration as a business process.

Value Driver Selection

Global Communications GAAP Summit June 2014

37

PwC

The Deal is proceeding – what next?

• A week later the CEO has publically discussed over €100m of savings in year one.

• You have seen some indicators of savings and synergies but nothing that seems to come to this in the first year.

• You are aware that Cost synergies include cost reduction from the combined finance functions of 30%.

• You are both wireless carriers in a market where there are currently four active competitors. There is some network and spectrum duplication and overlap which is considerable in some regions.

• The regulator has instructed you to sell one part of the business in a region where there would be concentration levels in terms of subscribers approaching 75%.


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June 2014

PwC

The Deal is proceeding – what next?

• WellTell uses an antiquated ERP system which Topline used until recently. Topline has almost finished an ERP system conversion to a completely new system which is expected to be fully completed by mid year close.

• The deal will be closing mid quarter and then reporting for first time will be in 30 days on June 30.


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June 2014

What are the implications for the financial integration, reporting, disclosure and planning? How do you go about dealing with this?

PwC

Reporting of different sales approaches

• Topline and WellTell had very different approaches to sales.

• WellTell’s sales team saw individuals responsible for customer relationships in the retail market and then other individuals focused on the corporate market.

• Topline focused on product type with multiple sales people approaching the same customers.

• The new Head of Sales wants to follow the WellTell reporting approach.


40

June 2014

You have just been asked for the sales financials for the year.- including actuals and budget. What do you do?

PwC

Workshops

• After lunch you will attend your second workshop

• You are in the same break out room as before.

• After your workshop there is a coffee break followed by closing remarks for the day

Global Communications GAAP Summit June 2014

41

Thank you

This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

© 2014 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom) which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.

global communications gaap summit 2014 - pwc...global communications gaap summit june 2014 2 -50 100...

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