Case
North American Cable
Case prompt
Our client is a major media provider called North American Cable (NAC) that is considering the acquisition of a niche, sports content blog, Sports Analysts Worldwide (SAW). SAW is a unique blog that leverages analytical expertise to craft one-of-a-kind stories about sports teams across all major leagues and divisions.
After an initial due diligence process, NAC has uncovered some initial facts:
- Wall Street analysts estimate SAW's enterprise value at ~$200M.
- NAC has determined that there will be synergies from the merger of the two businesses but is unsure of the size and scope of these synergies.
- NAC believes it can generate synergies from acquiring new paying users.
- NAC also believes it can generate synergies from reducing overhead costs and the cost to serve the customer.
NAC would like to know if they should bid to acquire SAW and if so, what the appropriate bid would be.
Detailed solution
Paragraphs highlighted in orange indicate hints for you on how to guide the interviewee through the case.
Paragraphs highlighted in blue can be verbally communicated to the interviewee.
Paragraphs highlighted in green indicate diagrams or tables that can be shared in the “Case exhibits” section.
Suggested case structure
Key question: Is there a benefit to be derived from NAC’s acquisition of SAW?
Exhibit 1
Suggested steps ranked by priority:
- Revenue synergies: Top-line synergies should be the easiest to get at. What uplift will we see in subscribers/ viewers as a result of the acquisition?
- Cost synergies: What benefits will we see from the integration on fixed costs (i.e., pooling of resources)? Does this merger reduce the cost of serving the customer (lower variable cost)?
- Additional benefits: Are there other benefits that are harder to quantify? Is the acquisition a preemptive measure to hold off competition? Does the acquisition give us leverage in other discussions we’re having? Note - this is not perfectly MECE, in a perfect world, these benefits would manifest in revenue/ cost synergies.
Make sure the interviewee builds a solid structure with at least two levels of logic. Ensure the interviewee at least touches upon the internal components (revenue/ cost) and has some acknowledgement that there may be other important, harder to quantify factors.
If needed, share Exhibit 1 with the interviewee
1. Revenue synergies
a. Revenue growth
Allow the interviewee to point to the reason for revenue synergies (ability to exclusively display/ stream SAW content). Ensure the interviewee talks about the different types of revenue synergies (new paid subscribers, subscribers trading up from unpaid viewing). Ensure the interviewee asks about new subscriber estimates.
Share Exhibit 2 with the interviewee to estimate potential revenue growth
Exhibit 2
Interviewee should recognize that we care about paid subscribers as this is where revenue comes from. Interviewee should be able to calculate incremental paid subscribers from these numbers.
Incremental paid subscribers = Total subscribers using comp. products * (1 - % using free services) * SAW loyalty rate
Hence,
Incremental paid subscribers = 500M * (1 – 80%) * 10% = 10M
Interviewee should inquire about revenue from each subscriber (or better yet, contribution margin, showing that they understand the bottom-line impact of adding a new paid subscriber).
Share that contribution margin is $ 20 per year per paid subscriber
Interviewee should calculate total contribution margin uptick from top-line growth is $200M. Interviewee should make some statement of the impact of this uptick as being significant, as current contribution margin from subscriber base is $600M (30M*$20).
Interviewee may use incorrect numbers from Ex. 1 or make errors in math – see if they self-correct before offering guidance. Note that part of this table is irrelevant for this question (NAC subscriber information). It’s important that the interviewee realize they must ignore this data for now.
b. Trading up
Interviewee may recognize that providing exclusive SAW content could have current NAC free users “trade-up” (i.e., upgrade) to paid services. If the interviewee recognizes this, it’s very astute and reflects well on their business acumen. If the interviewee does not recognize this, simply move on.
The interviewee should inquire as to whether or not we have any information on the rate of current free subscribers that would “trade-up”.
From customer survey data, we know that 5% of free customers would “trade-up” to paid services if NAC were the exclusive provider of SAW content.
Interviewee should be able to calculate the impact of this on contribution margin using this assumption and figures from Exhibit 1.
Total incremental contribution margin from “trade-up” = Total unpaid NAC subscribers * % willing to trade-up * contribution margin per paid subscriber
Hence,
Total incremental contribution margin from “trade-up” = 270M * 5% * $20 = $270M
Again, the interviewee should recognize that this is a significant impact for the company as current contribution margin from paid subscribers is $600M and current number of subscriber is 30M (and we’re increasing that by 13.5M from the integration of SAW).
2. Cost synergies
a. Structure
Let’s investigate cost synergies
Allow the interviewee to structure an approach to cost synergies. If the interviewee needs help, brainstorm the various types of cost and how to bucket them (fixed vs. variable).
Exhibit 3
The interviewee should recognize that there will be fixed cost and variable cost synergies. The interviewee need not match the exact example synergies included above but should distinguish between synergies that result from a combination of overhead costs (fixed costs) and synergies that reduce the cost to serve the customer (variable costs).
If needed share Exhibit 3 with the interviewee
b. Fixed costs
Interviewee should inquire about any information we have on the fixed costs of each company. Once asked for, share Exhibit 4 with the interviewee.
Share Exhibit 4 with the interviewee
Exhibit 4
Interviewee should be able to calculate the total combined cost of NAC and SAW.
Combined costs of the company: 100 + 50 + 90 + 10 + 150 +50 = 450m $
Interviewee may ask for an assumption of how much the combined company can save. Ask the interviewee to make an assumption. If interviewee is unable to come to a solid assumption, provide a 20% savings.
Fixed cost savings from the merger: 90 m $
The interviewee should recognize that the $90M in cost savings (or whatever they’ve estimated) is quite significant and an additional gain from the merger. Compared to the $600M in revenue for NAC, this is a 15% figure and would have an impact on the bottomline.
Note- if the interviewee gets stuck, brainstorm the various types of fixed costs that the companies would face. Push the interviewee to make a reasonable assumption re: cost savings as a result of the merger.
c. Variable costs
Interviewee should start by brainstorming types of variable costs. Once they have, interviewee may inquire about variable cost figures or assumptions.
Once the interviewee asks, share Exhibit 5 below with interviewee.
Exhibit 5
Note that SAW content accounts for 5% of the cost of content for NAC and with the acquisition, one-twelfth of hosting and transmission costs will be eliminated. The cost to serve unpaid users is negligible.
Interviewee should be able to calculate cost savings per customer:
Contribution margin - not affected
Cost of content- reduced by 5% to 47.5, $2.5
Hosting and transmission costs- reduced by one-twelfth to 27.5, $2.5
Total cost savings per paid subscriber: $5
The interviewee should recall that NAC has 30M paid subscribers but is going to gain 10M from customers switching due to the acquisition and 13.5M from customers trading up (so 53.5M in total). If interviewee does not use the correct numbers, allow them to make an assumption and push them through questions to account for all of the existing and new paid subscribers.
Total variable cost savings from the merger: 53.5M * $5 = $267.5M
The interviewee should recognize that this number is significant considering the total contribution margin from paid subscribers is $600M
3. Additional benefits
a. Competitive defense
Interviewee may also discuss the importance of preventing a customer from acquiring SAW. The interviewee may ask for assumptions for a scenario where a competitor acquires SAW.
Competitive information to be shared:
- Assume International News Corp (INC) is also considering acquiring SAW
- Analysts estimate that if INC were to acquire SAW, they would steal 10% of all NAC’s users (paid and unpaid)
- Analysts also estimate that 5% of current paid subscribers will trade down to the unpaid subscription
The interviewee should be able to calculate the total cost of a competitive acquisition of SAW in two parts:
- “Stolen users” = 10% * Paid users * Contribution margin per paid user = 10% * 30M * $20 = $60M
- “Trade-down users) = 5% * Paid users * Contribution margin per paid user = 5% * 30M * $20 = $30M
Total cost of competitive acquisition = $90M in contribution margin
The interviewee should be able to get to this $90M loss and acknowledge it as a potential loss that NAC should be looking to avoid through the bid.
b. Others
The interviewee should now discuss other potential benefits that we haven’t touched upon.
If the interviewee attempts to size these benefits, that is above and beyond what is expected and should be incorporated into the interviewee’s response on the final question.
Examples of other benefits the interviewee may name:
- Tax benefits: as a result of being a larger company, NAC-SAW may have a lower overall tax burden
- Negotiating leverage: as a result of being a larger company, NAC-SAW can negotiate lower rates with suppliers or higher prices for licensing its content
- Lower cost of capital: as a result of diversifying the business, NAC-SAW has less business risk and a lower cost of capital that makes it possible to pursue additional NPV-positive projects
- Lower cost of future acquisitions: if the NAC-SAW integration goes through successfully, it may lead to an easier time influencing future acquisition targets to acquiesce to an acquisition
4. Estimating a bid
The interviewee should now move to estimating a fair bid for SAW.
The interviewee should now move to estimating a fair bid for SAW. If interviewee is unable to come to a bid, brainstorm key components with them such as analysts estimate of the standalone value of SAW, the benefit from synergies and any potential premium NAC would like to add to secure the bid.
Exhibit 6
The fair market value, if the interviewee believes all of the synergies and cost estimates that we’ve worked through, is at least $1,117.5M.
The interviewee may feel that some assumptions are too high or too low or may have made different assumptions through the case. Those should be reflected here and the key is that the interviewee is using the case analysis to add to analyst estimates of the standalone value of SAW to come up with a fair bid. As long as the interviewee is able to provide a fair bid price based on sound logic and is able to defend their assumptions, then that is a satisfactory answer to this question.
If needed share Exhibit 6 with the interviewee
