4 Background Arch Communications Group Inc. founded in 1986 3rd largest paging company in USA in 19963 million subscribers in 1996Local, regional and nationwide basis180 of 200 major metro cities
5 Background Current competitive positioning: Low cost provider Economies of scale for ops, size of subscriber baseStandard, reliable technologyFast follower, proven and somewhat dated techPrompt and efficient deliveryResellers, retailers and direct salesInvested in expanded networks, and capacityIntegrate acquisitions successfully
7 Strategy Return on Capital Business Strategy + Corporate Strategy Business Strategy Industry Choice + Competitive Position
8 Corporate Strategy Goals To become dominate player in wireless paging segmentAggressive growth through strategic acquisitions and internal additionsStrengthen distribution channels and increase capacityInvest in select technologiesGeographic expansion
9 Competitive Positioning Product Market FocusLocal, regional and nationwideMajor metro areasEvery pager type - 87% digitalDirect, retailer and resellers for distribution channels
10 Competitive Positioning Core ActivitiesBuild networksDistribute through reseller and retailersSell via direct channelSupport and serviceBackend billing operationsMarketing through direct channels
11 Competitive Positioning Value PropositionProven, reliable service at a low costFast delivery of messagesLimited to no network downtimeLarge geographical coverage
12 Industry Choice Degree of Rivalry – HIGH Limited product differentiationOligopoly market structureRapid consolidationFragmented marketsLow switching costs
13 Industry Choice Ease of Entry - MED Capital intense Can acquire license, or companyNo strong barriers to entry other than capital expenditure
14 Industry Choice Threat of Substitute Products – HIGH Cellular technology improvingBattery life extendingImproved feature setAdvancements in voice networks (PCS)Mobile satellite communications
15 Industry Choice Power of Suppliers – MED Manufacturers are supplying same product to all competitorsDuopoly market structure (Motorola, NEC)Strong brand equity
16 Industry Choice Power of Customers – HIGH Low switching costs Growth driven by consumers, not businessFickle groupPrice sensitive
18 Class DiscussionWhat are the implications of our strategy analysis on the forecasting and valuation of Arch over the next 5yrs?
19 Implications of Strategy Analysis Industry unlikely to have abnormal growth and profits in long rangeHigh cap expenditures required:To continue growth through expanded coverage and acquisitionsTo upgrade existing networksDebt or equity?Product is commoditizing with consumersHigh threat of cellular and competitive tech replacing the paging market
24 DuPont Conclusions ROE improving because of reduced financial leverage Net profit margin decliningAsset utilization declining because of large investment in plants, higher inventories and higher AR
25 Common Sized Statements $ thou% of rev$ thou% of rev$ thou% of revRev162,598100%67,24745,308COGS20,78916.7%ñ10,12415.1%ñ4,0318.9%SG&A94,62358.2%ñ16,59124.7%ò29,96266.1%Interest Exp22,56013.9%ñ4,2216.3%ò3,0366.7%Margin(36,602)-22.5% ò(5,069)-7.5%ñ(5,725)-12.6%
27 Class DiscussionWhat conclusions can be drawn from a review of the Common Sized Statement?
28 Common Sized Conclusions SG&A increasing due to acquisitions, and increase of $100M of revenueMargins decline because of increased debt to fund acquisitions, inventory and operating expensesCOGS showed insignificant increase from
30 Cash Flow Analysis (000’s) 1995 1994 1993 From Ops 14,749ò 14,781ñ 8,721Used to Invest192,549ñ28,982ò30,998From Financing179,092ñ14,636ñ11,268Net Inc/Dec1,292ñ435ñ(11,009)Cash end of period3,643ñ1,927ñ1,492
32 Class DiscussionWhat are the implications of our cash flow analysis on the forecasting and valuation of Arch over the next 5yrs?
33 Cash Flow Implications 1995 showed a decrease in cash from opsTook on huge debt financing to acquire companies for growth, fund operations and to increase inventoryCash from ops can’t cover the $154M operating expensesGoing forward, will they be able to grow cash from ops to meet debt covenants post-acquisition, and fund operating expenses?
40 Forecasting Issues Compound annual growth rate = 380% # of households with pager if industry grows at Arch’s rate unrealistic:14,226,000 x ,226,000 = 82,635,258% of household 82,635 / 95,000 = 86%# of households with pager if industry grows at ½ Arch’s rate still unrealistic:82,635,258 / 2 = 41,312,304 or 43%
41 Forecasting IssuesNo use of balance sheet (DuPont) in analysts forecast, unrealistic ROE and Asset TurnoverDidn’t account for increase in cap ex (assets) in relation to revenue forecasts, which distorts valuation
47 Forecasting Issues Based on backing into analysts predication: Arch would have 109M customers in 2004 (rev/avg. rev per customer)Arch is 14% of market 489M customers if industry grows ½ as fast as ArchPopulation in 2004 at 3% growth/yr = (1.03)^9 * 255M = 332M489M / 332M = 1.47 pagers / person!!Unrealistic
48 Forecasting Issues EBITDA not an accurate measure of firm Interest expense for growthDepreciation on fixed assets in tech industry with rapid changeShareholders only get what’s left after paying all debt and taxesEBITDA good for short-term credit risk analysis
50 Valuation Conclusion We don’t agree with analysts price Subscriber growth rates unrealisticNOPAT estimates unrealisticDidn’t account for increase in capital expenditures – no DuPont or balance sheet10yr forecast is a long period to forecast outWe came to a stock price of $3.61Market may be using Option pricing model based on future expectation of growth
52 Post ScriptIndustry continued its decline based competition from cell phonesTrend towards consolidation continued1998 Arch acquired MobileMedia, who earlier filed for bankruptcyFrom , Arch report revenue increases from $397M to $642MSignificant losses over the same period from ($182M) to ($288M)
53 Post Script Arch’s stock continued to decline They announced a 1 for 3 reverse stock split in June 1999In Nov. 1999, Arch and PageNET agreed to merge, with combined 16M subscribersMerged placed Arch’s value at 0.11 times revenue, or ~$75MFCC approved merger, as did Arch shareholders