Cox Communications

NOVA School of Business and Economics
Spring Semester 2013/2014
REPORT TO THE BOARD OF DIRECTORS

Recommendations on Gannets acquisition and Capital Structure
Applied Corporate Finance

Professor: Paulo Pinho
T.As: Raul Afonso; Ricardo Barahona
Group 8:
Daniela Gameiro #701
Lus Faria #715
Catarina Batista #750
Frederic Muller #774
APPLIED CORPORATE FINANCE
Cox Communications, Inc.
TABLE OF CONTENTS
Executive Summary......................................................................................................................3
1. Cox Communications, Inc. And the Market ...............................................................................4
2. Computing the NPV within Gannets Acquisition.......................................................................4
2.1. Weighted Average Cost of Capital (WACC) .............................................................................................. 5
2.2. Estimating Cash Flows .............................................................................................................................. 7
2.3. Discounting the cash flows ....................................................................................................................... 7
3. Short-term and Long-term Financing ........................................................................................9

4. Constraints on the financing needs ......................................................................................... 10
4.1. Cox Family............................................................................................................................................... 10
4.2. Financial Flexibility ................................................................................................................................. 11
4.3. Strong Balance Sheet .............................................................................................................................. 12
4.4. Strong credit rating................................................................................................................................. 13
4.5. Market behavior ..................................................................................................................................... 14
5. Type of financing choices ........................................................................................................ 15

6. Feline Pride Securities ............................................................................................................ 16
7. Final Recommendation ........................................................................................................... 19
8. Appendices ............................................................................................................................ 22
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EXECUTIVE SUMMARY
The underlying report will focus on Cox Communications, Inc. (CCI) a major U.S. telecommunications
conglomerate. Hereby we will mainly assess the companys cable operating segment which is serving almost
3.7 million subscribers by the beginning of 1999. Regarding its cable systems CCI is facing substantial
technological innovations and deregulations which increased the segments competitive dramatically.
Therefore the firm was obliged to adapt its intended acquisition strategy to react to the changing market
characteristics and maintain or even increase its market share. In addition to acquisition plans already
implemented CCI discovered the opportunity to expand its cable systems even further through the purchase
of Gannett Co. In order to accomplish this acquisition CCIs management team has to keep in mind the
interest of two important stakeholders, namely the Cox family that doesnt want to see its majority stake
being diluted and the Board of Directors which is mainly concerned to retain a favorable investment grade.
Initially we focused on an evaluation of the existing cable market conditions and their future implications to
assess if an acquisition of Gannett would be beneficial. In order to evaluate Gannetts acquisition value of
$2.7 billion we analyzed its NPV discounting the cash flows with a WACC of 9.65% considering different
scenarios for growth rates ranging from 3 5%. Our results indicate negative NPVs for the respective
growth range which signifies that an acquisition price of $2.7 billion is too high in relation to future cash
flows generated. Subsequently we examined the various funding options and their implications on long- and
short term financing CCI is confronted with in case the firm wants to undertake the transaction. Those
options, more precisely the issuance of common class A shares, the issuance of debt, asset sales or a hybrid
product off-balance sheet financing option called Feline Prides where then compared to each other to
determine the most advantageous alternative for CCI.
It is our opinion that the best alternative would be to initiate a deal through financing with Feline Prides.
Although this product may not align perfectly with the interests of the financial department it is definitely
favorable to the conditions stated by the Board of Directors and the Cox family. Unfortunately Feline Prides
issued amount of $720 million would not be enough to finance the acquisition in total. Therefore we advise
to structure a combination of Feline Prides, debt and equity since it can be adjusted more easily and
considers the long-term financing needs of CCI. Conclusively we recommend CCI to acquire Gannett
overlooking the negative NPV and focusing merely on future benefits of the deal especially in terms of
competitiveness and market growth. Ideally CCI would be able to renegotiate the deal with Gannett in order
to define a more legitimate acquisition price.
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1. COX COMMUNICATIONS, INC. AND THE MARKET

To understand Cox Communications intentions behind its aggressive acquisition plan throughout 1999 it is
important to examine the profound changes taking place in the cable industry during the late nineties.
Founded in 1898 as a newspaper publisher Cox Communications had been starting to diversify its business in
1962 with the purchase of several television cable systems. By 1999 the cable business had been expanded
to reach almost 3.7 million viewers being accountable for a substantial stake of Cox Communications
revenues. Therefore the company was eager to maintain and even expand its market share significantly and
drew an acquisition plan that intended to spend between $7 $8 billion over the next three to five years.
Due to significant changes through technological innovations such as fiber optics, the Internet, wireless
communication and deregulations the late nineties constituted a major challenge for cable operators.
Especially fiber optic bundles had a great value because they provided 1.000 times more capacity. This so
called broadband allowed cable operators to provide pay per view and digital cable television, high speed
internet and digital telephony. All these products were seen as the future of cable companies. Furthermore
the industry was facing deregulations in form of the Telecommunications Reform Act of 1996 which allowed
cable operators and telephone companies to enter each others field of business.1 This act was the first
significant overhaul of the U.S. telecommunications law in over 60 years.2 Therefore the market had been
grown highly competitive and Cox Communications was facing tremendous competition by various cable
operators seeking to acquire valuable cable systems. Due to the growing competition numerous acquisition
objects of the company had come into play earlier than initially expected because it would be a vast
disadvantage if Cox Communications would lose these properties that could be combined with its existing
network to reach more viewers and create cost savings. Considering the changes aforementioned it
becomes obvious why the company had committed to over $7 billion in acquisitions until the end of 1999.
Acquisition targets during 1999 included established companies like Media General for $1.4 billion, TCA for
$4.1 billion and AT&T for $2.1 billion which amounted to a total of $7.6 billion. The purchase of Media
General would scale up CCIs subscriber base by 260.000 customers and expand the companys presence in
the Southeast.3 An eventual acquisition of TCA would leave CCI with 883.000 additional subscribers and
increased market share in Texas, Arkansas and Louisiana.4 Highly interesting would be a purchase of AT&Ts
http://transition.fcc.gov/telecom.html
http://www.ntia.doc.gov/legacy/opadhome/overview.htm
3
http://money.cnn.com/1999/04/22/technology/cox/
4
http://www.nytimes.com/1999/05/13/business/cox-to-acquire-tca-cable-for-3.26-billion.html
2
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cable business through a $2.1 billion share swap which would elevate CCIs subscriber base by 495.000
viewers and further strengthen the firms market share in the Southwest.5
Additionally Cox Communications found out that Gannett Co. was going to put his cable properties on the
market for an approximate bid price of about $2.7 billion. The considered acquisitions of Gannetts cable
business accumulated with the others Cox Communications had recently committed to would increase the
subscriber basis by 60% compared to levels at the beginning of the year and make 1999 a truly extraordinary
year for the company. Gannett was particularly attractive because Cox Communications was focusing on its
strategy of concentrating viewers in geographical areas to achieve precious economies of scale and scope.
The acquisition of Gannett would not come cheap though. With an estimated price of $2.7 billion Cox
Communications would have to pay over $5.000 per subscriber which was remarkably higher than the usual
$4.000 per subscriber. Taking a closer look at the development of price per subscriber we can determine an
increasingly competitive market since these values have been growing from $2.000 as recently as 1998 to
over the aforementioned $4.000 in 1999.
2. COMPUTING THE NPV WITHIN GANNETS ACQUISITION

Given the unexpectedly aggressive competition by its rivals, Cox could not afford to be left behind and
speeded up its acquisition plan. The firm is considering buying Gannetts cable properties and would need to
bid about $2.7 billion to win the auction process. This indicates a price paid per customer of $5,172, clearly
superior to the average price between 1994 and 1999. In this fashion, in order to assess the feasibility of this
project one may evaluate if at a price of $2.7 billion the acquisition project has a positive NPV. To do that, we
discounted the cash flows from 2000 to 2003 at the unlevered cost equity and the terminal value at WACC.
2.1. WEIGHTED AVERAGE COST OF CAPITAL (WACC)

(
To obtain the WACC one should make several assumptions regarding the marginal tax rate, the cost of debt,
the cost of equity and the debt-to-equity ratio at market values.
Marginal Tax Rate (
): The corporate tax rate in the US in the year of 1999 is 35%.
http://money.cnn.com/1999/07/07/deals/cox/
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Cost of debt (
): Considering the Coxs bond rating (A-/Baa2), one may use as the opportunity
cost of debt the 10-year yield for an A- rated industrial bonds, which is at 6.93% in July 15, 1999. This seems
to be a reasonable value, as it is consistent with the rating, the currency, same implicit inflation and maturity
(given it is a long-term project).
Cost of equity (
): Regarding the cost of equity, it is assumed that the investors are well
diversified, measuring the risk of the company through its sensibility to systematic risk. Thus, we calculated
the cost of equity through the Capital Asset Pricing Model (CAPM):
(
To keep consistency, the risk free rate is assumed to be the 10-year US Treasury bonds for July 15, 1999 at
5.83%. The market risk premium is 7%, which reflects an approximation for the average risk premium from
1982 to 1998, by using the S&P as a proxy for the market portfolio and the long-term US Treasury Bonds as
the risk-free rate (Harris and Martson 1999)6.
To calculate the levered beta for Cox we took into account the changes in the debt structure from 1998 to
1999. To do so, we unlevered the beta at a debt-to-equity in market values of 0.20 and then re-levered at a
debt-to-equity ratio of 0.177. By doing this we obtained an unlevered Beta equal to 0.59 and a levered beta
of 0.666. Given all the inputs, by applying the CAPM, we end out with a cost of equity equal to 10.52%.
Debt-to-equity in market values (
): The DCF approach implies a constant debt-to-equity ratio,
which means that the annual amount of debt depends on the total value of the firm in market values, having
the resulting tax shields the same risk as that of the assets. In this way, we are assuming the value of 17% for
the last quarter available as the target for the coming years. Certainly, this value is not constant over time
and its changes have impact on the tax shields that would not be captured by the DCF. However, this seems
to be a fair approximation, as we are not considering the funding options behind Gannetts acquisition,
which may change drastically the results.
Harris, Robert and Felicia Marston (1999) "The market risk premium: Expectational estimates using analysts'
forecasts." University of Virginia Darden Graduate School of Business, Working Paper 99-08.
7
Un-levering u = e*( /D+E) + Bd*( /D+E) and re-levering: e = u + (u d)* /E. d is equal to 0.15 and was obtained by
using the CAPM (using the available cost of debt, risk-free rate and market risk premium).
d is equal to 0.15 and was obtained by using the CAPM (already had cost of debt, risk free and market risk premium)
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2.2. ESTIMATING CASH FLOWS

In order to estimate the incremental cash flows with the purchasing of Gannett, one may focus on the cash
flows from operating activities and investing activities as they allow to capture the incremental changes (the
cash flow from financing is just the inverse of the sum from the cash flow from operating and investment
activities).
Cox Communications already provides pro forma cash flows regarding four different possible scenarios,
dependent on the funding strategy between 1999 and 2003. As we only need the unlevered cash flows, the
information provided is sufficient to understand what is incremental by acquiring Gannett. In this fashion, by
ignoring the debt structure and subsequently the interest expenses, one may estimate the unlevered cash
flows in the case Gannetts purchase goes through (see Appendix 1) or in the case it does not (see Appendix
2), and by simply taking the difference obtain the incremental cash flow with the acquisition (see Appendix
3). Adding the operating to the financing activities cash flows, the undiscounted cash flows are -$2,579,
$138, $151 and $165 million from the year 2000 to 2003.
2.3. DISCOUNTING THE CASH FLOWS

Since Cox did not anticipate paying taxes between 1999 and 2003, we do not need to take into consideration
the tax shields and may apply the unlevered cost of equity of 10%8 from 1999 to 2003. Note that in 2000 we
are discounting the cash flow in two different periods, considering the acquisition to be paid six months from
now (in 0.5 years) and the cash flows from Gannett to be received one year and a half from now (in 1.5
years). For the period from 2004 onwards, we had to estimate the cash flows to discount. In this case, we
need to consider taxes and the subsequent tax shield in order to apply WACC. To do that, we re-estimated
the cash flow from 2003 simulating the impact of paying taxes and then applied a constant growth rate until
perpetuity:
Obtained through the CAPM using the 0.59 as the unlevered beta, 5.83% as the risk free rate and 7% as the market
risk premium.
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EBITDA 2003
190
-Depreciation
-5
EBITDA - Depreciation
185
-Tax Expense
-64.75
= Noplat
120
+ Depreciation
- Capex
-25
Free Cash Flow
100
Consequently, the present value of the growing perpetuity in 2003 is calculated in the following way9:
(
The company is expecting to have some growth after 2003 coming essentially from the expected rate
increase of 3% to 5% in the natural growth of the subscriber base. In that way, we took into consideration
three different scenarios to estimate the NPV (see Appendix 4), getting a NPV of -$1118 million, -$924million
and -$647 million for the 3%, 4%, 5% growth rates respectively. As we can see, within the expected growth
range while keeping the previously estimated WACC we never get a positive NPV.
Therefore, due to the sensibility of the NPV to the discount factor in the denominator we also tested for
changes in WACC. Actually, the calculation of the cost of capital is based on several assumptions and the
obtained result is just an approximation to the appropriate discount rate. Given our inability to consider all
the unpredictable changes, instead of overloading the model with more assumptions, we made a sensitivity
analysis allowing for small changes in the growth rate and WACC (see Appendix 5). As expected, given the
sensibility of the perpetuity to the denominator, small changes have a considerable impact. However, we
conclude that within the established growth rate, the only way to have a positive NPV is to consider WACC
two percentage points inferior to the one we obtained and a growth rate close to 5%
Once more, it is important to mention the limitations of the model we are applying. The assumptions
regarding the debt structure, the opportunity cost of debt, market risk premium or maturity of the risk free
rate may lead to significantly different NPVs. Despite the model being very sensitive to the denominator, the
Gannetts cable properties does not look to be a good investment as it does not provide a positive NPV, even
when allowing for some changes in the WACC and the growth rate. Clearly, as we are going to discuss
Given the Terminal Value for 2003 we still would need to discount 4.5 periods more, as we did in Appendix 4
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further in this report, the price of $2.7 billion seems to be too high when considering the future cash flows
generated by Gannett.
3. SHORT-TERM AND LONG-TERM FINANCING

Assuming that the Gannet acquisition goes through at $2.7 billion it is important to analyze the short and
long term financing needs in order to see if the company is able to comply with its obligations. When valuing
a company through time, the total uses of funds must always be equal to the total sources of funds. Uses of
funds consist of all the money that the company expects to spend in its operating, financing or investment
activities. In order to carry out these activities, the company can use the cash obtained from its operation
activities or from other external sources, such as equity or debt.
In this specific case (Appendix 6-9), it was considered as uses of funds the interest expenses and taxes that
came from the operating activities of the company. The payment of taxes was considered only in 1999 since
from 2000 and onwards it became a tax credit, which is not an actual cash flow. Also in this section the costs
with investing activities such as acquisition expenditures, capital expenditures and other asset acquisitions,
were considered. Finally, financing activities such as principle payments and debt retirement were also taken
into account. Regarding sources of funds, these were divided into internal and external sources of funds. The
internal sources of funds are EBITDA, monetization of non-strategic assets owned by Cox Communications
and other asset sales. The external funds considered in this case consist in equity and debt issues. Finally, the
entry called Other uses of funds was computed in order to have the amount of uses equal to the sources
of funds.
In order to make the analyses of the financing needs the short-term was taken as the period until 2000 and
the long-term the one from 2001 to 2003. As it can be seen in the appendix 10, the scenario that does not
account for the acquisition of Gannet is the one that has the lowest need for funds, while the other
scenarios require more funds. Specifically, the scenario of the acquisition by issuing equity is the one that
needs more funds in the short-term while the scenario where the company acquires Gannet by issuing debt
requires more funds in the long-run than the other scenarios.
It is important to analyze which of the activities in the company contributes the most for the total amount of
uses of funds, which we have done in appendix 11. The section that contributes the most is the Investing
Activity, especially as expected in the scenarios where the company acquires Gannet. Also, the impact that
this section has on the company is higher in the short-term, especially in the scenarios where Gannet is
acquired (2000).
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Finally, it is of interest to analyze if the company has enough internal funds to fulfill its obligations or if it
needs to consider alternative funding sources. As it can be seen in the graph in appendix 12, the company
can almost fulfill its obligations by recurring to EBITDA, monetization and other asset sales. However it is in
the short-run that the acquisition has the biggest impact, coinciding with the time at which the company has
to resort to external financing solutions. This happens because Cox Communications requires an inflow of
external capital to finance Gannetts assets. In the long-run the necessity to resort to external funds
diminishes. In fact, in the four scenarios presented, the one that issues equity is the one that has the lowest
percentage of need to finance by external sources of funds.
Despite the negative impact that recurring to external funds has on the company, the acquisition (compared
to the scenario with no acquisition) improves the pace of the company in the long-run as it reduces the need
of Cox for funding in the following three years.
4. CONSTRAINTS ON THE FINANCING NEEDS

Choosing the type of financing in order to meet the obligations of a company is very hard and the job is
further hampered if there are more constraints that need to be taken into account. Clement and his team
faced several challenges besides choosing the type of financing. They would need to balance five major
constraints:
Cox Family
Strong
Balance
Sheet
Strong
Credit
Rating
Constraints
Financial
Flexibility
Market
Behavior
4.1. COX FAMILY

Clements team would need to take into account the preferences of the Cox family since they were the
major owners of the company and wanted to maintain its majority in the firm. Through CEI, the Cox family
owns 379.2 million out of 533.8 million Class A shares (which give the right to one vote each) and all the
Class C shares (which give the privilege of 10 votes each). The family requested a minimum of 65%
ownership in the company, implying they had majority and thus avoiding problems that could arise in the
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decision making process, for example when choosing the firms management. In this company it can be
noted the power of persuasion that the family holds over the chairman of the Coxs Board, James Kennedy,
regarding the desire of the family to maintain their large majority in the firm. Moreover, this shareholder
strategy allows for the control of agency costs through the combination of the interests of the management
and the shareholders. The fact that the company did not want the dilution of its position limited the issuance
of new equity. After the anticipated issuance of an additional 38.3 million shares of Class A to finance the
TCA transaction, the Cox family will own 67.3% of Coxs common shares and 76.8% of the voting rights. In
this sense, Clement and his team could only issue a marginal amount of equity in order to maintain the
minimum of 65% ownership level in the company required by the family.
4.2. FINANCIAL FLEXIBILITY

In this company it has always existed an entrepreneurial spirit and the proof of that was the statement that
James Kennedy and James Robbins, the firms president and CEO, wrote in the annual report where the
company is constantly searching for new opportunities taking into account the value that these
opportunities could create for their shareholders. Nevertheless these initiatives by the companys
management can be difficult to put in motion in the sense that it could be difficult to create sufficient
financial flexibility to continue to fund planned and unexpected business opportunities.
The concern is how to balance the amount of debt and equity in order to maintain enough financial flexibility
in the company. Having financial flexibility allows for the decrease in the risk of the company, while at the
same time allowing the company to take advantages of opportunities that may arise.
Financing a company through debt increases rigidity in the sense the company has always to fulfill the strict
repayments and covenants. On the other hand, financing the companys project with equity despite the
inexistence of direct repayment decreases the leverage of the company through the probability of default.
Moreover, using equity is more expensive in terms of cost of capital compared with debt. There are issuing
costs that need to be taken into account that can range from 3% to 4% of the company share prices, as well
as the fall in share price that precedes a capital increase in the markets. Also, using equity has the
disadvantage of being more dependent on the fluctuations of the market, making it less easily accessible.
Funding Gannets acquisition by issuing debt (public debt issue or bank borrowing) has less transaction costs
of 2% as stated above; nevertheless as with equity there are constraints when using this type of financing.
Cox has the highest debt outstanding among all other Cox subsidiaries, which could make it difficult to
maintain the goal of a high debt rating.
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11
The company could partly finance itself by selling some noncore assets that Cox has. Cox could sell, swap or
monetize some of its equity investments. However, only selling these investments in the market would imply
a considerable tax burden and that is why the company should be more tax efficient by recurring to
monetization and swaps. Nevertheless there were some limitations to dispose of these non-strategic equity
investments. For example, the Spring PCS investment could not be sold or hedged until November 1999.
Also, Cox owned large stakes in these firms where the average daily trading volume was low (lack of
demand), making it difficult to trade these positions.
Finally, there is the problem of management to double the size of the company every five years. The
problem is exacerbated when the good results that equity faced with the economic expansion suffers a
correction in the future. So it would not make sense to increase the number of new shareholders at a higher
price than the one that has been practiced. In this scenario, it is going to be difficult for the company to find
a perfect source of financing under the conditions mentioned.
4.3. STRONG BALANCE SHEET

Other major concern is related with the impact of the acquisitions in the balance sheet of the company
(known for having strong balance sheet). If the company does not go through with Gannets acquisition,
the internal cash flow of the company in the future may not be enough to fund the acquisitions that the
company announced to enter.
In order to finance its capital expenditures for network upgrades, acquisitions, capital investments and new
products the firm spent $1.9 billion from internal cash flow, $1.9 billion from net issuance of debt, $900
million from sales of non-strategic assets, and $370 million from issuing equity. Additionally, if the deals that
Cox announced in the beginning of 1999 go through, they would require approximately $7.6 billion10 in gross
funding.
As mentioned above the company has as financial objective to double the size of the company every five
years which coupled with the minimum required by the Cox family ownership would limit the amount of
equity financing that the company could incur. Since this problem exists, the increase of the firms leverage
is a solution that once again can have its downsides. Regardless, CCI has exhausted its budget for
acquisitions it had planned for the next three to five years within only six months, and this clearly will have
an impact on the balance sheet.
10
Represents almost 60% of CCIs total assets as of 1998
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4.4. STRONG CREDIT RATING

Following the debt financing constraints, it is important to mention the importance that this company gives
to financial leverage. For example, the company wants to keep a high debt rating since investment grade
debt markets are less volatile and more liquid when compared to non-investment grade, that are known for
being very inefficient. If the company is able to have an investment grade rating it will have better financing
conditions.
The requirement that the company thought was adequate to achieve the preferred rating was through a
long-term debt-to-EBITDA not larger than 5. However, from 1996 to 1998 the company had a debt-toEBITDA larger than the target, which can have a negative effect on the investment grade rating of Cox.
Currently the management and the board were concerned with the debt level and increasing the financial
leverage of the firm. Being investment grade would not only allow for easier access to credit but also give
more flexibility to the firm as previously discussed. If the company is able to have a rating above the majority
of its competitors it will be able to finance itself at a below the average cost, even if the credit spread and
the treasury yields increase.
Currently the rating grades of the company are A- by Standard & Poors and Baa2 by Moodys. The
company has so far maintained a strong balance sheet making decisions in order to balance the proportion
of debt and equity. In fact, the debt-to-equity ratio has been decreasing since 1997 allowing the companys
bonds to be classified as investment grade.
The issue present is whether the company will be able to maintain its investment grade. If not, this would
result in higher interest rates due to a higher probability of default and an illiquidity premium. The increase
that would happen in the cost of debt would be disproportionally large in the case of a downgrade to a
speculative grade.
Clement and his team have to pay close attention to guarantee that this does not happen and they can do so
by controlling some ratios such as the interest cover ratio and debt-to-EBITDA. As it was mentioned above
the company has not been able to fulfill the maximum imposed for the debt-to-EBITDA ratio, so when
choosing new investments they have to consider the contribution that it will have in the EBITDA and the
required debt to finance it.
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4.5. MARKET BEHAVIOR

Besides the concerns that could appear due to problems within the company, there are also other external
factors that can constrain the funding. These external factors are market-related. Firstly Clements team was
worried that an IPO made by its rival, Charter Communications, would make it harder for Cox
Communications to issue debt. Charter Communications attracts the same type of investor that Cox does
and this firm is planning to do an IPO in the fall of 1999. If this actually happens, it would make Coxs own
equity issue more difficult, in particular because the desire of the investors for its stocks would diminish,
potentially driving the price downwards. Clement knew that the equity issuance should be made before this
IPO, which created an important timing constraint.
Also there were concerns of how markets would perform later in the year. There are several examples that
could explain the concerns that arouse, such as:
In the fall of 1998, the capital markets had almost melted down when the Russia defaulted on part
of its debt
The Down Jones industrial average decrease 10% in the next two weeks
Credit spreads approximately doubled over the next five months
For A-rate borrowers, spreads increase from 56 to 135 basis points, while the spreads of BBB-rated
issuers increased from 95 to 181 basis points (Source: Bloomberg)
All these scenarios lead to the decrease of debt issues by the end of 1998. Although the markets recovered
somewhat in the beginning of 1999, the weakness in the bond markets led to the postponement of some
deals that were already announced. That is why Clements team should take into account the impact that
the acquisitions can have on the firms investment-grade bond rating. Finally, they were afraid that
computers that used two digits would malfunction when 2000 began. Despite this concern being unfounded,
the truth is that markets would be hostile to new issues that could be made until some of the risks had been
resolved.
The increase in economic uncertainty led to the concern that credit markets would impose higher spreads.
These expectation about the market behavior predicted a downturn in the markets after a decade of growth
and thus made Clements team very anxious, implying they should act very cautiously when finding the final
solution.
To sum up, Clement and his team have to find a solution that is consistent with the firms long-term ability to
grow further, cannot conflict with the companys goal protecting the current investment grade rating, effects
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of market behavior, maintain the ownership requirements and a strong balance sheet with financial
flexibility.
5. TYPE OF FINANCING CHOICES

To raise capital for the upcoming Gannett deal CCI did come up with a pool of four appropriate financing
options. These scenarios are depicted by the issuance of debt, issuance of fresh common class A shares,
emerging on an alternative called Feline Income Prides which represents a novel hybrid security recently
established by Merrill Lynch, through asset sales or lastly by disregarding the acquisition. However there are
several conditions Clements team has to take into consideration when evaluating the diverse financing
options. First of all it is of importance that the financing decision has to be consistent with CCIs long-term
capacity for future activities. Secondly the team has to evaluate eventual impacts of their financing options
regarding CCIs investment-grade bond rating. Finally the intentions of the Cox family which is eager to
maintain its super majority ownership of more than two-thirds of the company have to be taken into
account.
The first financing choice to be analyzed is the issuance of debt which could be through public debt issue or
bank borrowing. A major advantage of the debt issuance is that the costs would be less compared to an
issuance of equity due to the fact that transaction costs would be less than 2% effectively. Furthermore the
negative effect on CCIs stock is estimated to be around 1% - 2% which is considered to be moderately low.
At first sight the debt option seems favorable with regards to the Cox family because it is not decreasing
their majority stake and maintains the voting rights. But on a closer look it becomes obvious that the good
investment grade of CCI is likely to be decreased due to the fact that the Debt/EBITDA ratio will increase, this
is a major concern of the Cox family. Currently CCI is targeting a Debt/EBIDTA ratio of no greater than 5
which enables the company to finance itself with yields ranging from 65 to 115 basis points above U.S.
Treasury obligations yields. Even though CCI is expecting these yields to increase in the future an increasing
Debt/EBITDA ratio will worsen the situation. Another fact that has to be taken into consideration is that CCI
is expecting to benefit from a significant amount of income tax refunds during the upcoming business
periods. Therefore the company would not fully benefit from the tax shield generated through debt
issuance. Conclusively we can adhere that even though the exact conditions of the debt issuance such as
coupon payments and maturity are not known there will be substantial disadvantages. According to this
debt issuance doesnt seem as the most attractive option to exercise.
Secondly CCI has the choice to finance the transaction through the issuance of class A shares to the public.
The options of $2.7 billion class A shares requires the company to issue around 78 million additional shares
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15
with a stock price of $34.6875 as of 8/9/99 taken as basis. Undertaking this option would be beneficial
regarding the companys investment grade since it would actually affect the Debt/EBIDTA ratio positively.
Consequently outstanding class A shares rise from 533.8 million up to 650 million adding not only shares
from the Gannett deal but also 38.3 million shares from the TCA merger executed in May 1999. The Cox
family owns 397.2 million class A shares and 27.6 million of class C shares which implicates a problem
regarding the option to finance the Gannett acquisition with the issuance of class A shares. In case CCI would
go through with this choice the Cox family would see its economic stake be reduced to 59% and the voting
rights be decreased to 70%. Hence it would be highly unlikely that the Cox family would approve this
arrangement. Another negative characteristic of this transaction includes fees and expenses of about 2% 3% of the amount raised. In addition a large equity issue might trigger a market impact which would affect
the stock price to decrease by 3% - 4%. Considering the enumerated negative effects of this option we can
see that financing through the issuance of class A shares is unfavorable for CCI.
As a third choice CCI could realize a sale, swap or monetization of its non-strategic assets for example the
$4.1 billion equity held in Sprint PCS, the equity investment of $2.5 billion in Discovery Communications, the
equity investment of $1.5 billion in @Home and the equity investment of $300 million in Flextech.
Nevertheless simply selling those assets to the market would leave CCI behind with a tax burden of 35%.
Therefore it is more efficient for CCI to look into methods of monetization for these assets. Regarding the
AT&T investment there is the possibility of a tax efficient disposal due to the fact that CCI had effectively
swapped its original AT&T shares into AT&T cable operator shares without triggering a taxable event.
Regarding a monetization of the other assets there are various practical limitations. The PCS investment for
example cant be hedged or sold until November. In addition to that the stakes in @Home, Sprint and
Flextech are relatively large and will therefore be hard to liquidate on the market.
Finally CCI has the choice to issue a hybrid product created by Merrill Lynch called Feline Income Prides.
Those products have the characteristics of both debt and equity, comparable to preferred stock or
convertible bonds. In fact Feline Income Prides are considered to be extremely valuable regarding the
financing of the Gannett deal. Thus we will examine their structure and generated benefits in the following
part of this report.
6. FELINE PRIDE SECURITIES

One of the funding possibilities considered by Cox was the issuance of hybrid securities, in particular of a
recent innovation that resulted in a mandatory convertible and trust preferred security. On the one
hand, in mandatory convertible securities the investor is obligated to convert the contract into company
GROUP 8
16
stocks; on the other hand, trust preferred securities combine both aspects of preferred equity and
subordinated debt, and are issued by a trust the company creates. Within this category Merrill Lynchs
FELINE Income PRIDES were suggested to Coxs treasurer. FELINE stands for Flexible Equity-Linked
Exchangeable and PRIDES for Preferred Redeemable Increased Dividend Equity Security. They are an equitylinked hybrid product, each unit consisting of
An obligation by the investor to purchase a fixed dollar amount of Coxs Class A Common Stock in
three years
Preferred equity
Thus one obvious benefit of issuing these types of securities comes from the way in which they are reported
in the balance sheet the preferred equity component would be tax deductible. Moreover since the investor
would be forced to buy Coxs equity at maturity, these securities were seen as equity for financial reporting
purposes and thus the transaction did not appear as debt on the balance sheet. So Cox was able to fund
itself by issuing something that looked like equity to debtholders and like debt to shareholders, but in reality
it was both. Through the Trust created, CCI was able to sort of issue debt to itself in the form of bonds with a
7% coupon, which the Trust bought. Then the Trust would issue preferred equity that paying 7% dividend
yield as previously mentioned and with the income from the PRIDES securities sale it would purchase CCIs
bonds. Basically by using this method Cox would finance itself off-balance sheet, as it would be hidden in the
balance sheet the Trust appears on the right side of Coxs balance sheet in a minority shareholder interest
account (by the value of the preferred equity issue), and on the left side would appear the revenue obtained
from issuing the securities.
When looking into more detail at these securities it is possible to see that their payoff resembles real
options. The investor pays $50 for a unit of PRIDES and is entitled to receive a 7% preferred dividend yield on
that amount this is the interest bearing deposit component. Then at maturity he is faced with the
purchase obligation, which he can deal with by either purchasing the shares with preferred equity or with
cash. Independently of his choice the number of shares delivered by Cox for each unit of the security will
depend on the stocks market price at maturity (t = 3):
GROUP 8
Cox Share Price (t = 3)
Number of shares delivered
Value of shares delivered
S3 $34.6875 = S0
1.4414
$1.4414* S3
$34.6875 < S3 < $41.7984
$50
S3 $41.7984
1.1962
$1.1962* S3
17
Hence the higher Coxs share price at maturity, the lower the number of shares it had to deliver to PRIDES
holders thus reducing dilution for existing shareholders. This makes it clear how the contract is priced along
the underlying asset Coxs stock and how it could be related to options. If we take a replicating portfolio
with the full value issued in Feline PRIDES securities ($720 million spread in 14.4 million units) we would
obtain the same payoff (represented in Appendix 10) by holding Coxs Common Stock, being long on calls
with strike price 41.7984 and short on calls at-the-money (of K = 34.6875). To determine the amounts of
each on the portfolio, the Black-Scholes model was used to value the options (due to only being exercisable
at maturity the securities resemble European options) with the assumption that the risk-free rate was 5.71%
(as the 3-year US Treasury Strip).
Replicating Portfolio
Asset
Position
Unit price
Quantity
Price
Call K = 41,7984
Long
$10.78
22 201 523
$239 380 533
Call ATM
Short
$13.04
22 201 523
- $289 495 878
Common Stock
Long
$34.69
22 201 523
$770 115 345
Total
$720 000 000
This result can be scaled for a single contract of Feline PRIDES as well knowing that each unit was priced at
$50.
Replicating Portfolio for one unit of PRIDES
Asset
Position
Unit price
Quantity
Price
Call K = 41,7984
Long
$10.78
1.54
$16.6
Call ATM
Short
$13.04
1.54
$-20.1
Common Stock
Long
$34.69
1.54
$53.5
Total
$50.0
Nevertheless for the holder of the security, the obligation part of the contract resembles more a forward
contract to purchase the underlying stock than an option. One further consideration it should be made
when assessing this funding alternative relates to both the leverage ratio and Coxs familys equity stake in
CCI.
On the one hand, Coxs family stake will inevitably be diluted when the securities come to maturity. Despite
this, because the conversion of the securities into stock is dependent on Coxs stock price 3 years after their
issue, this dilution effect will probably be lower than that achieved with the equity issuance. Furthermore if
employees and managers are aware of the need to preserve the familys equity stake they will have an
GROUP 8
18
incentive to perform at their best in order to keep the companys stock price growing (assuming markets are
efficient and will see their effort as a good indicator that the company value is increasing).
On the other hand, due to the aforementioned benefits of this financing alternative not entering the balance
sheet as debt, the leverage ratio should remain more or less the same with Gannetts acquisition. Moreover
it would most likely not deteriorate the debts investment grade rating, which was one of the companys
concerns. Since there is an obligation to buy shares, rating agencies will expectedly only give an equity credit
rating.
Assuming Cox is interested in financing itself by combining several of the financing alternatives proposed, it
is possible to better assess the impact on Coxs family stake. With a funding combination of $680 million in
equity, $720 million in Feline PRIDES and some debt the pro forma financial statement suggests that Coxs
Familys Economic Equity stake, although at first apparently unchanged at 65.1%, will in the worst possible
scenario conversion at 1.4414 shares per unit of PRIDES decrease to 63% when the Feline PRIDES reach
maturity. Coxs family is very reluctant to have its stake diluted and risk losing their economic ownership of
the company so even though this is a small change it is still worth taking into consideration.
The issuance of these securities seems nevertheless a worthwhile alternative in terms of funding the
Gannett acquisition. Chemmanur, Nandy and Yan (2006)11 found that firms facing less information
asymmetry but greater probability of financial distress tended to issue more securities of the mandatory
convertible type instead of pursuing other more traditional financing alternatives. This is the case here
right now, at the moment where CCI has to finance all its investments, it faces a greater chance of incurring
financial distress. On top of that, the viewpoint of Coxs family is that they would rather not put themselves
in such a potentially risky position financially wise which could kill some of the projects that would be
beneficial in its long-run success. But the pursuit of these projects and in particular of Gannetts acquisition
are almost certain to guarantee some degree of growth for the company, thus its also possible to bet on the
success of the company and reduce the asymmetric information problem a little. A company that was not
able to do this would be more reluctant to enter a mandatory convertible contract due to a higher
probability that its stock price would fall and its equity stake further diluted.
One potential issue that we do not consider here for lack of information are the fees that Merrill Lynch will
eventually charge Cox for the placement, coverage and advisory services they will provide with these
securities issuance. Regardless, if CCIs main concerns are with their debt rating and the familys equity stake
then it could be a necessary investment to obtain the required funding.
11
Chemmanur, Nandy and Yan, Why Issue Mandatory Convertibles? Theory and Evidence, SSRN working paper, 2006
GROUP 8
19
7. FINAL RECOMMENDATION
Clement and his team are aware of the importance that this company gives to attractive growth
opportunities and thus they needed to find the perfect funding solution, taking into account the firms longrun capacity to fund future activities. Their challenge from the beginning was how to finance the projects
taking into account several constraints that existed in the company.
The financing option has to respect the preferences of Cox family, who owns a super-majority in this firm,
and does not want its ownership interest diluted further than the established 65% floor. Also, the company
wanted to maintain its investment-grade bond rating since this would have a major impact on the flexibility
of the company to pursue new growth opportunities. In order to maintain the current rating, it is important
for the company to not allow the Debt-to-EBITDA ratio to be higher than 5. The non-compliance with this
target would put the company as a non-investment grade firm, making it harder to access credit markets
since for this rating they tend to be illiquid and inefficient.
Regarding the acquisition of Gannett by $2.7 billion the estimated NPV of this project is negative. Usually
when a NPV is negative the project is automatically abandoned, nevertheless this case is more complex. The
market has been growing and competition increasing as competitors are acquiring valuable cable systems
due to the technological innovations and deregulation that came from the Reform Act of 1996. Hence, the
desire of Cox to acquire Gannetts cable business is essential to survive this new era in the industry. Gannet
would be the perfect acquisition since it was estimated that it would lead to an increase of 60% in users
while benefiting from economies of scale and scope.
We know that if the company does not acquire Gannet it will probably go out of business, so in this case is
not as linear to reject this project due to its negative NPV. We believe the company is overpaying for the
investment and that the final price should take into account a possible bubble in the market. From where we
stand, the growth of the price per subscriber in the market does not make sense from $2,000 as recently as
1998 to over $4,000 by 1999. In fact, it is said that Cox would have to pay the $2.7 billion or, if it went to
auction, more than $5,000 per subscriber to win which we consider unreasonably high. We recommend
management to renegotiate this price downwards due to the factors previously mentioned.
Despite the negative NPV the company is facing with this project, we feel that the best funding alternative
for future acquisitions are the Feline PRIDES since they provide funding while keeping dilution at a minimum
and preserving their debts rating. Nevertheless the amount issued in PRIDES $ 720 million would not be
enough given the amount of funding needed so our recommendation would be to use a combination of
GROUP 8
20
PRIDES, Debt, and Equity, since it allows for a certain degree of flexibility for future acquisitions. This
alternative would not compromise the investment grade rating as can be seen by the behavior of the
leverage ratio that varies between 2.4x and 4.2x between 1999 and 2003. This mechanism would allow Cox
to fund itself by issuing something that looked like debt to shareholders and equity to debt holders, where in
fact it was a mix of both. This method would also allow Cox to finance itself off-balance sheet, as due to its
hybrid characteristics it would be hidden. Nevertheless, in the worst-case scenario, this combination would
not allow Cox family to own a minimum of 65% of ownership in the company in 2002 and 2003, although
they would still have control of the company through its voting rights. Since the family is adamant in
preserving its majority in the company we would recommend a share repurchase program in the future.
We finalize by emphasizing the importance that the Gannet acquisition has for the future of the company.
We insist that a renegotiation of this deal would be in both companies best interest if a fair agreement is
reached, and if it is we recommend that the company use the financing mechanism mentioned above
combining debt, equity and the issuance of Feline PRIDES.
GROUP 8
21
8. APPENDICES
Appendix 1 Pro forma unlevered cash flows if it purchases Gannett
OPERATING ACTIVITIES
EBITDA Cox + Acquisitions
EBITDA Gannett
Interest Expense
TOTAL CASH FROM OPERATIONS
INVESTING ACTIVITIES
Acquisitions
Gannett Acquisition
CapEx
Total Other
TOTAL CASH FROM INVESTMENTS
1999 E
2000 E
2001 E
2002 E
2003 E
878
0
0
878
1.344
151
0
1.495
1.490
163
0
1.653
1.697
176
0
1.873
1.913
190
0
2.103
-2.673
0
-983
-122
-3.778
0
-2.700
-1.334
48
-3986
0
0
-1.103
34
-1069
0
0
-847
10
-837
0
0
-759
10
-749
Appendix 2 Pro forma unlevered cash flows if it did not purchase Gannett
EBITDA Gannett
Interest Expense
Acquisitions
Gannett Acquisition
CapEx
Total Other
1999 E
2000 E
2001 E
2002 E
2003 E
878
0
0
878
1.344
0
0
1.344
1.490
0
0
1.490
1.697
0
0
1.697
1.913
0
0
1.913
-2.673
0
-983
-122
-3.778
0
0
-1.304
48
-1.256
0
0
-1.078
34
-1.044
0
0
-822
10
-812
0
0
-734
10
-724
Appendix 3 - Pro forma incremental unlevered cash flows if it purchases Gannett

1999 E
2000 E
2001 E
2002 E
2003 E
EBITDA Gannett
Interest Expense
0
0
0
0
0
151
0
151
0
163
0
163
0
176
0
176
0
190
0
190
Acquisitions
Gannett Acquisition
CapEx
Total Other
0
0
0
0
0
0
-2700
-30
0
0
0
-25
0
0
0
-25
0
0
0
-25
0
-2730
-25
-25
-25
GROUP 8
22
Appendix 4 Discounted cash flows considering different growth rates

Appendix 4.1 NPV = -$1118 million
g=3%
Period t
Cash flows
DISCOUNTED CASH FLOWS
2000 E
2000 E
2001 E
2002 E
2003 E Terminal Value
0,5
-2700
1,5
121
2,5
138
3,5
151
4,5
165
4,5
1554
-2574
105
109
108
107
1027
2000 E
2000 E
2001 E
2002 E
0,5
-2700
1,5
121
2,5
138
3,5
151
4,5
165
4,5
1847
-2574
105
109
108
107
1221
2000 E
2000 E
2001 E
2002 E
0,5
-2700
1,5
121
2,5
138
3,5
151
4,5
165
4,5
2267
-2574
105
109
108
107
1498
Appendix 4.2 - NPV = -$924 million

g=4%
Period t
Cash flows
Appendix 4.3 - NPV = -$647 million

g=5%
Period t
Cash flows
Appendix 5 Sensitivity Analysis to WACC and growth rate

7,64%
8,64%
9,64%
10,64%
11,64%
-1.203
-1.346
-1.458
-1.547
-1.620
1%
-1.050
-1.232
-1.371
-1.479
-1.565
2%
-843
-1.084
-1.261
-1.394
-1.499
3%
-547
-884
-1.118
-1.288
-1.417
4%
-89
-598
-924
-1.149
-1.314
5%
718
-153
-647
-961
-1.179
6%
2.507
627
-218
-692
-997
7%
9.889
2.360
536
-275
-737
GROUP 8
23
Appendix 6 Uses and Sources of Funds with no acquisition

(Measured in $ million)
USES OF FUNDS
1999
2000
2001
2002
2003
Operating Activites
397
540
443
472
432
Interest Expense
312
540
443
472
432
Taxes
85
Investing Activites
3778
1304
1078
822
734
Acquisition expenditures
2673
Capital Expenditures
983
1304
1078
822
734
Other Asset Acquisitions
122
Financing Activites
1048
341
412
757
Principle Payments (1)
431
341
200
277
Debt Retirement
617
212
480
Other Uses of Funds
104
Total Uses of Funds
4279
2892
1862
1706
1923
SOURCES OF FUNDS
1999
2000
2001
2002
2003
Internal Funds
2121
2892
1524
1707
1923
EBITDA
878
1344
1490
1697
1913
Monetization
1243
1500
Other Asset Sales
48
34
10
10
External Funds
2158
337
Debt issued
2158
337
Equity issued
4279
2892
1861
1707
1923
Total Sources of Funds
Notes:
(1) Principle Payments are the payment of entry Maturing Debt

(2) Debt Retirement considered only the payments of the entry New Debt Financed (Retired) and if the Debt issued was negative it
was considered in this part
(3) Debt issued: Ending Total Debt Maturing Debt Beginning Debt (considered only the positive values)
GROUP 8
24
Appendix 7 Uses and Sources of Funds with Gannets acquisition by issuing Debt
USES OF FUNDS
1999
2000
2001
2002
2003
Operating Activites
397
540
657
667
640
Interest Expense
312
540
657
667
640
Taxes
85
Investing Activites
3,778
4,034
1,103
847
759
2,673
Gannet Acquisition
2,700
983
1,334
1,103
847
759
122
Financing Activites
431
341
369
714
Principle Payments
431
341
200
277
Debt Retirement
169
437
Other Uses of Funds
104
Total Uses of Funds
4,279
5,005
2,101
1,883
2,113
SOURCES OF FUNDS
1999
2000
2001
2002
2003
Internal Funds
2,121
3,043
1,687
1,883
2,113
EBITDA
878
1,495
1,653
1,873
2,103
Monetization
1,243
1,500
Other Asset Sales
48
34
10
10
External Funds
2,158
1,963
414
Debt issued
2,158
1,963
414
Equity issued
4,279
5,006
2,101
1,883
2,113
Notes:

GROUP 8
25
Appendix 8 Uses and Sources of Funds with Gannets acquisition by issuing Equity
USES OF FUNDS
1999
2000
2001
2002
2003
Operating Activites
343
310
413
420
377
Interest Expense
258
310
413
420
377
Taxes
85
Investing Activites
3,778
4,034
1,103
847
759
2,673
Gannet Acquisition
2,700
983
1,334
1,103
847
759
122
Financing Activites
596
431
341
615
977
Principle Payments
431
341
200
277
Debt Retirement
596
415
700
Other Uses of Funds
104
Total Uses of Funds
4,821
4,775
1,857
1,882
2,113
SOURCES OF FUNDS
1999
2000
2001
2002
2003
Internal Funds
2,121
3,043
1,687
1,883
2,113
EBITDA
878
1,495
1,653
1,873
2,103
Monetization
1,243
1,500
Other Asset Sales
48
34
10
10
External Funds
2,700
1,733
169
Debt issued
1,733
169
Equity issued
2,700
4,821
4,776
1,856
1,883
2,113
Notes:

GROUP 8
26
Appendix 9 Uses and Sources of Funds with Gannets acquisition by issuing Debt, Equity and PRIDES
USES OF FUNDS
1999
2000
2001
2002
2003
Operating Activites
395
580
591
521
Interest Expense
310
580
591
521
Taxes
85
Investing Activites
3,778
4,034
1,103
847
759
2,673
Gannet Acquisition
2,700
983
1,334
1,103
847
759
122
Financing Activites
431
341
445
833
Principle Payments
431
341
200
277
Debt Retirement
245
556
Other Uses of Funds
104
Total Uses of Funds
4,277
4,465
2,024
1,883
2,113
SOURCES OF FUNDS
1999
2000
2001
2002
2003
Internal Funds
2,121
3,043
1,687
1,883
2,113
EBITDA
878
1,495
1,653
1,873
2,103
Monetization
1,243
1,500
Other Asset Sales
48
34
10
10
External Funds
2,156
1,895
336
Debt issued
756
1,895
336
Equity issued
1,400
4,277
4,938
2,023
1,883
2,113
Notes:

(2) Debt Retirement considered only the payments of the entryNew Debt Financed (Retired) and if the Debt issued was negative it
GROUP 8
27
Appendix 10 Uses of Funds

12000
10000
8000
6000
4000
2000
0
Short-Term
No Acquisition
Long-Term
Issuing Debt
Issuing Equity
Debt, Equity and Prides
Appendix 11 Percentage of each activity on the uses of funds

120.00%
100.00%
80.00%
60.00%
40.00%
20.00%
0.00%
Shortterm
Longterm
No Acquisition
Operating Activites
GROUP 8
Shortterm
Longterm
Shortterm
Issuing Debt
Investing Activites
Longterm
Issuing Equity
Financing Activites
Shortterm
Longterm
Debt, Equity and

PRIDES
Other Uses of Funds
28
Appendix 12 Impact of sources of funds on the companys needs

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
00%
Short- Longterm term
No Acquisition
Issuing Debt
Internal Funding
Issuing Equity
Debt, Equity
and PRIDES
External Funding
Appendix 10 Feline PRIDES Securities payoff at maturity (T = 3)
Payoff in dollars ($)
100
80
60
40
20
0
0
10
20
30
39
49
59
69
79
Cox Common Share Price ($)
GROUP 8
29

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Applied Corporate Finance

APPLIED CORPORATE FINANCE