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EXECUTIVE SUMMARY

Statement of the Problem


Two of the largest owners of radio stations in the nation proposed to merge in October 1999.
Under regulatory requirements, one of the participating companies – Clear Channel, would need
to dissociate some of its assets after the merger. As the largest radio group with the African-
Americans as the primary target audiences, Radio One was interested in twelve of the radio
stations dissociated from Clear Channel. Radio One needs to decide if it should acquire those
divestures and how much it should pay.

Discussion
The targeted radio stations were in the top 50 African-American markets. By acquiring them,
Radio One can become the market leader in this segment. This helps the company to generate
more advertising revenue as it will have a greater bargaining power with its market status. In
addition, this potential acquisition is also in line with the corporate strategy, and it provides the
company a channel to expand its business to other forms of media such as cable and Internet.
Given that Radio One already has an extensive coverage in the African-American market,
purchasing those divestures can create synergies in the company. This can be achieved by
merging departments with similar natures, for example, Human Resources and Finance.
However, the culture of the acquired business may not be similar to the existing business lines.
This may lead to a failure after the acquisition. Furthermore, Radio One may not have the
expertise in expanding its business in other media; the acquired business may not perform well
without proper management.
The cost of equity should be determined before approaching the Discounted Cash Flow (DCF)
analysis. It is foreseeable that the investment time frame will be longer than 10 years, so a
government bond yield of a 10-year maturity will be used in estimating the risk-free rate. With
the assumption of a risk premium on 7.2%, the cost of equity should be 12.2%. By the DCF
analysis, if assumed a 4% or a 6% growth in perpetuity, it is estimated that a present value of
$1.24 billion or $1.56 billion, which is about 16.7x or 20.8x 2001 Projected BCF. This valuation
is further supported by using alternative assumption – approximately a 10% growth in first 15
years and 3% onwards. In 2000, Radio One was trading at a multiple of 22.1x, equivalently a
market value of 1.69 billion. Therefore, an offering price of $1.6 billion for the 21 targeted
stations is affordable. However, the current cash flow is not sufficient to pay the acquisition
price, Radio One will need to seek a bank loan or issue bonds to raise fund for the acquisition.
Issuing bonds with maturity of 10 years can lower the WACC of the company, as the cost of debt
is only 4.84%.

Conclusion
Radio One should offer 0.91 billion for the acquisition of the 12 targeted radio stations. The
acquisition allows the company to become the market leader, and offers a valuable opportunity
for market expansion, which is highly beneficial to the company.

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