Iridium Writeup

Financial Decisions FINC - 442

Iridium LLC Antonio Ascar, Carolina Camargo, Daniel Loureiro, Daniel Medeiros, Jean Paul Paul Cordahi Cordahi and Larissa Larissa Mattos

Problem Statement Iridium LLC is a $5.5 billion venture backed by Motorola that offers global phone fa! and paging services via satellite. "hey operate in a fairly ne# and gro#ing segment of telecommunications. arriers to entry are considerably high but they are still facing some competition from both established and upcoming companies. "here a number of strategic decisions to be made in this capital%intensive industry such as capital structure technology to be used distribution and marketing strategy. &ccording to Iridium's o#n management they managed to get everything #rong from technological glitches and management turnover to marketing marketing and distribution distribution mishaps. "hese errors led the company to file for bankruptcy in &ugust &ugust of ())) only one year after they launched the ne# service in a $(*+ million advertising campaign.

,acts and &ssumptions Motorola Motorola had a bold strategy #ith Iridium trying to tap into a ne# and promising promising market #ith investments investments initially estimated estimated at $-.*. perating in a promising market and using a differentiated technology Iridium #as set to be a very profitable venture if all the e!pectations #ere met. ,urthermore being able to negotiate several agreements #ith local providers and being very successful in its satellite deployments the pro/ections for the future seemed very positive. "o fund these investments Iridium had been adopting an opportunistic approach #here it #ould raise debt #henever it thought the terms #ere favorable. It also decided to target a much higher leverage ratio based on the assumption that once operating it #ould resemble a utilities company #ith high margins and steady cash flo#s. ecause of the use of debt and the changing capital structure due to the opportunistic approach #e decided to use &P0 as the method to value the company. &lso to better separate ho# much value stems from the operations and ho# much comes from financing decisions. "his #ill be key in assessing the correct leverage ratio for the firm. "he critical assumptions used in the valuation are described belo#1

0alue 0alue of 2nlevered Company Comp any 34!hibit ( •

Levered return on 46uity1 (*.(7. Calculated using C&PM based on a risk%free rate of *.857 3(+%year 2S treasury bill e6uity of (.59 and market premium of 87.

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:eturn on ;ebt1 ((.-7. Calculated as a #eighted average of the interest rates on the actual debt in balance sheet. 2nlevered return on 46uity1 (-.-7. Calculated using the un%levering formula based on a ta! rate of (57 according to pro/ections and a ;ebt to 0alue ratio of -*7 346uity<0alue of 887. "hese ratios #ere calculated on market value based on current financial information.

&P01 34!hibit = •

2sed Iridium financial pro/ections and capitali>ation provided in the case including estimates of subscribers revenue

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depreciation capital e!penditures and change in net #orking capital. ,or terminal gro#th #e assumed 57. eing a relatively ne# industry its long%term gro#th should be e!pected to be

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higher than inflation 3=7 so #e considered -7 above long term inflation. ?e also added back the interest e!penses since #e need to consider an all e6uity firm.

0alue of "a! "a! Shield1 34!hibit =

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Iridium LLC Antonio Ascar, Carolina Camargo, Daniel Loureiro, Daniel Medeiros, Jean Paul Cordahi and Larissa Mattos

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Started from the current interest e!penses based on the provided forecasts. 2sing a ta! rate of (57 #e calculated the ta! shields and discounted those the same return on debt of ((.-7 described

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above. "o compute the terminal value of ta!es shield #e also use gro#th rate in perpetuity of 57.

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Cost of ,inancial ;istress % C,;1 34!hibit = •

Probability of default1 557. 2sed the probability of a CCC rated company. Loss given default1 =+7. &ssumed that the only ma/or loss in case of a default #ould be the need to sell assets in #hich

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case a =+7 discount should be applied. C,; @ Pr ;efault A Loss given default A 40

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ptimal Leverage :atio1 34!hibit -

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?e used leverage ratios for each credit rate as on SBP -%yr medial financial ratios 34!hibit *. Probabilities of default for each leverage ratio #ere estimated based on the e6uivalent credit rates on 4!hibit *. &ssumed =+7 loss given default for all levels of debt
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enterprise value 340 ?e applied the same ;<0 ratios used to calculate probability of default and ta! rate of (57 in order to compute ta! shield

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benefits. "a! Shield @ 40 A ;<0 A ta! rate ?e used book enterprise value 340 of $-.- for ta! shield calculations 340 calculated dividing the total debt $=.95 by

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the debt%to%total capital market value -*7 "he costed.

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&nalysis Company valuation:

Iridium has raised substantial debt at different stages each debt #ith a different structure maturity and interest rate. iven the fluctuations in leverage ratios #e decided to value the firm using the &P0 method. "his #ill allo# us also to better understand the impact of debt on the company's cash flo#s. ?e started the analysis by computing the free cash flo#s based on the management estimates described in the case and additional assumptions presented above. ?e also calculated the return on e6uity unlevered in to order to discount those cash flo#s and terminal value to present value. "he return on e6uity unlevered used to discount the cash flo#s #as (-.-7. "he total discounted cash flo#s totali>e $=-.-*. &fter#ards #e calculated company's benefits from debt ta! shield. ?e used managers' estimations of interest e!penses and its terminal value to present using return on debt of ((.-7. "he total present value of the ta! shield benefits is e6ual to $=9(M. In addition to ta! shields #e calculated the cost of financial distress 3C,; by computing probability of distress 3557 for CCC and costs on distress 3=+7 of all e6uity enterprise value. "he C,; is e6ual to $=.5D. "he enterprise value of Iridium as of year%end ())9 assuming the all e6uity cash flo#s the ta! shield benefits and cost of distress is then estimated in $=(.

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Maximum leverage Ratio:

Iridium is highly leveraged #ith around 987 debt to book value. "o decide on a ma!imum leverage ratio #e have looked at the optimal ta! shield to C,; ratio for given levels of debt and compared #ith similar firms' debt to value ratios in the case. ,or the first approach #e computed the credit rating classes Iridium #ould be in and their estimated corresponding debt to value ratios. ,or each credit rating #e obtained its average default rate for the past (5 years for the SBP chart industrial financial ratios chart. 34!hibit *. ,or each ;<0 ratio #e computed the net effect of ta! shield and C,; and plotted the results on a chartE the ma!imum optimal ratio #as at *=.87 of debt to book value ratio. 34!hibit * "o calculate the C,; #e considered a loss in default of =+7 given that the main assets to be li6uidated are PP4 and the satellites have a shelf life of 5 years. "he C,; #ill be the product of the probability of default obtained from the SBP chart the loss given default and the enterprise value. &lso for this calculation #e computed the ta! shield as the product of enterprise value by the leverage ratio and the (57 ta! rate. Looking at similar firms as displayed in the case #e find that 5 out of D firms have leverage ratios that range bet#een ==7 and *(7E firms #ith a comparable asset base such as IC lobal Communications Pan&mSat Corp. and Comsat Corps have lo#er a #eighted average leverage ratio of =87. ,inally as discussed in the case Iridium could have raised e6uity for $(illion instead of $=++MM. "he e!tra $9++MM if the company #ould have raised e6uity instead of high yield debt as they did in ())D the leverage ratio #ould have been 8=7. &ssuming this is the minimum they could lo#er it to they #ould then have been in a much better position to manage their debt.

:ecommendation &s #e think about Iridium's capital structure #e have reasons to believe that it #as one of the reasons of company's failure. ased on our pro/ections the Cost of ,inancial distress more than offset the benefits of ta! shield to the point that Iridium's capital structure #as destroying company value at that level. &lso understanding the funding needs of the firm and considering the advantages and disadvantages of e6uity issuance #e still believe that managers didn't considered properly the effects of debt that led the company to bankruptcy. Fo#ever Iridium's capital structure #as not the only reason for company's failure. "heir overall strategy #as based on a number of interdependent deals and variables and if any of those failed it #ould make the #hole business unfeasible. "hey managed to launch all satellites #ith a perfect record but couldn't get through #ith deals for service #ith all targeted local providers across the globe. "heir product and services #ere #ay off the market average #ith big and e!pensive phones and e!orbitant per minute fees. "hey made crucial mistakes in their go%to%market strategy #ith a huge advertising campaign but faulty distribution and customer service. In the end Iridium made mistakes in all aspects of the business eventually leading to their bankruptcy.

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Ehi!its Exhibit 1: Discount Rate

Exhibit 2: APV

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Exhibit 3: Optimal Leverae Ratio

Net +a hield - Cost o Financial Distress )"" ()""*

Tax Shield - COFD

(',"""* (',)""* (2,"""* (2,)""* "#"$

2"#"$

4"#"$

%"#"$

&"#"$

'""#"$

Leverage Ratio - D/V

Exhibit 4: !"P #inancial Ratios

$

Iridium Writeup

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