FBE 421 Plotts

Valuing the 2000 AOL Time Warner Merger

Salomon Smith Barney March 22, 2000 Lanny Baker, DCF Valuation (page 89 of Baker research)
From page 72 of Lanny Baker’s March 22, 2000 AOL TW report: We believe that free cash flow will turn out to be
the most credible and reliable fashion in which to evaluate and appraise a combined AOL Time Warner. The
combined company will be a free cash flow machine, with over $5 billion in free cash flow projected for 2001, the
first year of combined operations. With strong underlying EBITDA and cash earnings growth, limited mandatory
capital expenditure requirements, and cash generating negative working capital balances we believe AOL Time
Warner’s free cash flow can grow 50% per year for the next several years. To value AOL Time Warner by its free
cash flow production and growth, we look to compare the company to its high quality, mega-capitalization
brethren at the top of the US equity markets.
The following DCF forecast and assumptions were prepared by Lanny Baker.
AOL/TW "Combined Company" 2001E 2002E 2003E 2004E 2005E
EBITDA $11,588 $14,254 $17,818 $22,272 $27,841
Cash Taxes -$230 -$240 -$252 -$265 -$278
Corporate Expense -$500 -$563 -$625 -$688 -$750
Unlevered Cash Flows $10,858 $13,451 $16,941 $21,319 $26,813
Capital Expenditures -$3,000 -$2,400 -$2,200 -$2,000 -$2,000
Change in non-cash WC $740 $1,000 $1,250 $2,000 $2,500
Unlevered Free Cash Flow $8,598 $12,051 $15,991 $21,319 $27,313
Combined WACC 15%
Terminal EV/EBITDA multiple 35.0x
Excess cash and marketable securities $56,634
*Non-controlling Interest 30,203
Debt 16,528
Shares Outstanding 4,786

*Minority (Non controlling) interest: Media One’s 25.51% ownership of Time Warner Entertainment Partnership
and Advance/Newhouse’s interest in the TWE-A/N Partnership)

Assignment:
Perform a DCF valuation using these assumptions and estimate the equity value per share of the merged company.
Are the assumptions made by Baker appropriate? Why or why not?

Mergers Acquisitions March 2000 Analyst Valuation AOL Time Warner Discussion
FBE 421 Plotts
Perform a DCF valuation using these assumptions and estimate the equity value per share of the merged company.
Are the assumptions made by Baker appropriate? Why or why not?

Mergers Acquisitions March 2000 Analyst Valuation AOL Time Warner Discussion
FBE 421 Plotts

Mergers Acquisitions March 2000 Analyst Valuation AOL Time Warner Discussion