Radio One: Case Study

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The benefits and risks to acquire other radio stations for Radio One

From the onset, Radio One has been aggressive in growing its business by attracting the African-American population. The merger of Clear Channel with AMFM Inc provides several opportunities to stay in line with that strategy. Radio One is aggressive in pushing the companys platform through acquisitions. This is another important step in building the reputation of Radio One as the primary provider of AM and FM Radio to several African-America markets.

The acquisition of the stated radio stations from Clear Channel has several benefits for Radio One. In terms of competition, the possible deal will eliminate a big player in the market. Prior to the Clear-AMFM merger, there were several radio stations that existed in one area. Through the acquisition, Radio One will eliminate one player in the industry. In addition, the market is covered by the targeted station will be included in the current market being served by Radio. The possibility of expansion is evident and improvement in market dynamics is highly possible.

Based on demographic statistics, the African-American segment is the largest minority group in the US. The figures state that growth in the African-American population has been figured at an average of 60% annually. Moreover, the income generated from the segment is 150% higher than what can be gained from the actual population. Through the acquisition, Radio One will be given a huge piece of the untapped market. The market covered by Radio One can potentially double in the next 5 years once the acquired radio stations are integrated with the system.

In 1999, the total advertising revenues of radio companies reached USD1 billion. Reaching such a level is a major breakthrough for an industry that has been heavily regulated by the FCC. Assuming that there are 5,000 radio stations in the US at the end of 1999, this means that a radio station can incur as much as USD200 thousand of advertising revenues. Since Radio One is targeting 21 stations, the additional stations will boost the revenues of the company. As of December 1999, the revenues of Radio One reached USD82 billion. The additional stations targeted by Radio One can provide 6-12% more of the companys total revenues.

The deal with Clear states that Radio One will cover capital expenditures for radio stations. Each radio station will need USD100 thousand aside from the cost of assets purchased. Radio One plans to acquire 21 stations and capital requirements will total to USD2.1 million. In 1999, the operating expenses of Radio One amounted to USD16 million. The capital needed to run the 21 additional stations is approximately 14% of the total operating expenses in 1999. This is exclusive of the other expenses that will be incurred once the stations become operational.

In 1999, Radio One has recorded capital expenditures of USD3.3 million. This shows a 50% growth as compared to the capital expenditure recorded by the company in 1998. The proposed acquisition of 21 radio stations will further increase the capital expenditure of Radio One. Aside from boosting capital expenses, Radio One has increased property assets by more than 100% in 1999. The intangible assets have also upped by over 100% in 1999. The acquisition of the 21 stations will further increase the balance sheet of the company. Such growth is needed to sustain the stability of Radio One in the long run.

Despite the clear benefits provided by the deals, there are potential risks that are attributed to the transaction. Although there is enough supply of cash to push for the deal, Radio One needs to search for other funding sources. The first option involves the flotation of debt instruments. Based on Federal Reserve statistics, corporate bonds have rates starting at 7.1% for AAA bonds to 9.68% for B bonds. The credit risks involved in financing the acquisition through debt are high. Another option provided for the company is financing through additional stocks. The proposed acquisition of Clear channels has increased the stock value of Radio.

The biggest threat to the Radio industry is the substitutes that compete with advertising deals. Television, although limited in terms of market coverage is an effective medium to deliver advertisements. Newspapers are slow in delivering the message but cheap. The biggest threat for radios comes from a budding industry. The emergence of the Internet has the potential of controlling the advertisement industry. In 1999, the Internet has yet to reach full development. Technological advancements and other developments can decrease the number of advertisements on radios.

What price should Radio One offer based on a Discounted Cash Flow Analysis

The initial offer made by Radio One for the 21 stations of Clear Channel involves 20x BCF. This means that a station costs the projected broadcasting cash flow multiplied by 20. Exhibit 9 shows that the total BCF for Radio One New Markets is valued at USD 59,041 Using the 20x formula, the acquisition of the will cost Radio one USD 1.18 billion. The projections of BCF in the next 5 years totaled USD million. Given the cost incurred, the company will recover the cost in 10 years.

Given the competition in the market, the 10-year recovery period is considered as the benchmark. Unlike other industries, the radio business is strictly limited to revenues from advertisements. The inflow of cash from the additional business is critical in weighing the feasibility of the business. The 20x BCF appears to be the logical value that the radio stations from Clear Channel hold. Raising the USD 1.18 billion is another matter for Radio One. In the last 3 years, Radio One has experienced losses. The most logical source of funding for the company is debt.

The most logical price of the Clear Channel Radio stations is 16.5x BCF. There are several justifications for this price tag. First, the radio stations in the deal include areas where advertising revenue is still low. Second, the deal states that Radio One will cover for the capital expenditures to run the stations. Finally, Radio One will acquire only the assets of the stations, which means that there are other expenses that will be incurred once the stations become operational.

What price should Radio One offer based on a transaction and trading multiple analyses

Analyzing the transaction requires the process of dissecting the possible financial impact of the deal to Radio One. As a collective entity, Clear Channel has a BCF of 17.2 and AMFM has a BCF of 14.7. Since the initial offer provided is at 20x BCF, it appears that Radio One is overvaluing the targeted radio stations. There are several ways in which Radio One can still decrease the potential cost of the deal. The first involves the use of AMFM BCF. This is likely since the stations to be acquired by Radio One are from the former AMFM. There is also a possibility that the BCF of Clear Channel will be used as the basis for the transaction.

The most logical offer, however for Radio One pertains to the average BCF of AMFM and Clear. This will provide a clear view as to the actual value of the stations. The closet BCF multiple that can be used for the deal is 16x. Using the cash flow model, the value of the 21 radio stations is set at 16.5x BCF. Using the transaction analysis, the value of the stations is at 16x BCF. This shows that the second option will save Radio One more money without understating the targeted assets. The 20x BCF price appears to be high for uncertain markets.

Assuming that Radio One stock price is 30x BCF, can it offer 30x BCF for the new stations

There are several misconceptions as to the impact of stock price increase on the capacity of companies to acquire. Given that Radio One stock is expected to rise, the thought of increasing the offer for the Radio station is being floated. But it is important to state that the increase of stock price is more on investor confidence instead of company fundamentals. In the long run, however, the increase in stock price can provide Radio One the needed stability. The best way for the company to gain from such an event is to issue additional stocks. The strategy will increase the cash flow of the company and provide more resources for further expansions.

Given the BCF of future stations, the cost of the transaction will reach USD 1.77 billion. Since the BCF in the next years remains the same, Radio One is expected to recover the amount spent for the transaction in the next 15-16 years. The length of recovery provides more exposure to risks and uncertainties. In addition, the increase in Radio One stock price can change depending on the growth of the industry and the dynamics in the economy.

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Radio One: Case Study

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