T-Squared Financial
Financial Analysis of SBC Communications
Prepared by: Eric Hall, Eric Rems, Abby Alexander, Ben Brantmeier,
& Laura Foster
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Analysis of SBC Corporation
Report by T- Squared Financial: BB, ER, EH, AA, LF
Investment Reccommendation: Buy
SBC-NYSE (11/1/04) $25.97
52 Week Range
$22.95-27.73
Revenue
Net Income
Market Capitalization
Shares Outstanding
40.8B
6.23B
85.6B
3.31B
Current Div. Yield
Dividend Per Share
4.8
1.25
Book Value Per Share 12.13
Return on Equity
15.85%
Return on Assets
6.18%
EPS Forecast
FYE 12/30
EPS
Ratios
P/E Ratio
PEG Ratio
P/S Ratio
2003 2004E 2005E 2006E
$2.56 $1.45 $1.36 $1.32
Firm
13.75
3.59
2.13
Competitors Averages
17.15
1.24
1.28
Valuation Predictions
Actual Current Share Price
P/E Valuation
M/B Valuation
DPS/PPS Valuation
P/S Valuation
AEG Valuation
Residual Income Valuation
Discounted Free Cash Flows
Discounted Dividends Valuation
Long Run Avg. of RI
$25.97
$30.42
$23.26
$20.16
$16.37
$107.87
$68.94
$76.74
$20.92
$61.32
% Change in SBC Share Price Compared to S&P 500:
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We Recommend SBC as a Buy as its current market price is significantly below our predicted
market prices based upon our valuations.
SBC has great future potential due to its focus on expanding into more prominent areas of interest,
such as its acquisition of Cingular Wireless in the cellular services industry.
With an increase in net income from 5.7 to 8.5B over the past 2 years, we feel that this growth will
remain and increase.
SBC’s profitability ratios have indicated a turn around in their overall profitability throughout the
past five years.
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Business Summary
Industry and Competitors
With annual revenue of over 41 billion dollars, SBC is taking strides in becoming
the current and new leader in the telecommunications industry. SBC is one of the largest
and fastest growing telecommunications companies in the industry. They have built a
diversified network of products and services that can be used for all of the consumer’s
communication needs. Focusing on service innovations, cost efficiency, customer
relations, and service quality are SBC’s four main success factors. These factors are used
in order to sustain a competitive edge of their competitors. Because the
telecommunications industry is difficult to enter, SBC needs to focus mainly on those
already existing competitors. In order to gain market share over these competitors, SBC
needs to direct their attention to a cost-leadership strategy. It is also important to drive
costs down because of the high bargaining power that consumers possess. Although over
the past few years SBC has done a poor job in organizing their cost structure, they
recently have focused major efforts in this area of management. Another area where SBC
has focused their attention is innovation. With the development of their new fiber optics
network, they will be able to move forward while maintaining a cutting edge advantage
over their competitors because of their growing size and ability to offer a wide variety of
products and services. Overall, the telecommunication industry is a highly competitive
market and SBC continues to be a leader in the industry.
Accounting Analysis
While doing the accounting analysis we identified the significant accounting
policies in relation to SBC’s key success factors. SBC’s most important policies concern
recognizing revenues, allowance for uncollectibles, directory accounting, depreciation
accounting, goodwill and other intangible assets accounting, property, plant and
equipment, and software costs. After assessing that SBC has some degree of accounting
flexibility, we determined that its flexible policies are similar to industry norms. These
policies and estimates were found to be reasonably accurate and realistic with no major
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adjustments or illegitimate changes. SBC’s quality of disclosure was observed to be
clearly conveyed and adequately broken down into more understandable terms. While
reviewing their policies and disclosure, no evidence of economic manipulation or
distortion was found. Since no accounting distortion was revealed, it was not necessary
to undo any distortions.
Ratio and Forecast Analysis
The ratio analysis is a very important aspect of the overall valuation of a company
because it is a good indicator of how SBC compares to its major competitors in the
industry. After evaluating SBC and comparing their results to those of their competitors
and the averages of the industry, we found that, overall, SBC is fairly consistent with the
industry averages. While SBC’s liquidity ratios showed they did not have much ability to
liquidate quickly and turn their assets to cash easily, their profitability ratios showed, for
the most part, that they were consistently outperforming the industry averages. The
capital structure ratios also show significant signs of outperforming the industry. We also
used the EBITDA and PP&E turnover ratios because they are applicable to our industry.
Sometimes outperforming the industry average and sometimes performing below the
industry average, SBC is a solid company that has a track record of consistent
performance in the marketplace and their industry.
The forecasted revenues for SBC were estimated to steadily climb back to a
sustainable growth rate. It starts in a lower dip, then increases in the next ten years; this
is due to a slowly rising growth percentage which peaks at 5.50%. The rest of the income
statement figures correspond directly with this growth rate; although, certain expenses
were estimated to remain fairly constant through the forecast. The forecasted balance
sheet consists of moving averages of historical figures. Total assets as well as total
liabilities and stockholders’ equity remain very steady through the next ten years
maintaining numbers around $95,000 (in millions). The statement of cash flows was
determined to generate free cash flows that eventually start to increase steadily in the next
four years to peak at approximately $5,000. Overall, SBC forecasted financials are
estimated to steadily grow over the next ten years.
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Valuation Analysis
Throughout the valuation analysis we were able to estimate what SBC was
actually worth and decide whether they under, over, or properly valued. After performing
intrinsic valuations as well as the method of comparables, we determined that SBC is
currently being undervalued. Almost all of the intrinsic valuations indicated that SBC is
worth almost double what the market place is currently stating. This is possible because
many of our valuations were based upon future growth which gives SBC the opportunity
to expand. We found this to be accurate because of their recent merger with Cingular
Wireless, and their aspirations for future growth. By instituting a “sensitivity analysis”
we were able to vary SBC’s growth rate and cost of equity. This gave us the opportunity
to factor in errors in our WACC and cost of equity computations. After performing the
analysis we felt more confident in our accusation that SBC is being under-valued because
almost all reasonable growth rates and cost of equities, displayed SBC to be undervalued.
Overall, we placed a buy on SBC’s stock because of our estimations.
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Company Overview
SBC Communications is a telecommunications company based out of San
Antonio, Texas, and through its subsidiaries provides communications products and
services in about one third of the United States and holds investments in more than 25
countries. SBC offers a variety of products and services such as voice and data
telecommunications products and services for consumers and businesses, local and long
distance telephone service, DSL, and wireless, data networks, satellite television and
directory. They currently serve more than 54 million access lines nationwide while
employing about 168,000 people. In the 2003 year, SBC obtained $41 billion in revenue
with $8.5 billion in net income. SBC offers its products and services to businesses,
consumers, and other service providers of telecommunications services. The company’s
products and services are marked under several brands including SBC, Cingular
Wireless, and SBC Yahoo, and just recently, AT&T Wireless Service. SBC is a Fortune
50 company that is one of the 30 stocks that make up the Dow Jones Industrial Average,
and is currently sold on the New York Stock Exchange.
Industry Overview
The telecommunications industry has been a rapidly growing industry that has
resulted from the existence of many small companies to the takeover and control of a few
select larger powerhouse companies. Some of the major competitors of SBC
Communications are MCI, AT&T, Cox Communications, AOL Time/Warner, and
Verizon. Over the past 10 years, there have been a series of mergers and acquisitions that
have increased the size of certain companies while reducing the current number of
companies within the telecommunications business. The acquisition of AT&T and
Yahoo by SBC has enabled them to become one of the stronger and faster growing
companies within the telecommunications industry. The telecommunications current
ratio industry average has been decreasing in the past five years while SBC’s current ratio
has been steadily increasing over the past five years.
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Rivalry Among Existing Firms
SBC Communications is one of the largest telecommunication companies in the
world. They directly compete with many other firms in their various sectors of operation,
although their main competition comes from other telecom powerhouses such as MCI
and AT&T. Due to the high demand for their products and services, SBC and their
competitors are seeing a rapid growth in the overall telecommunications industry, mainly
due to the de-regulation of the industry and many new technological advancements. This
rapid growth in the industry gives SBC a competitive advantage in gaining market share
because of their extensive product bundling. In the telecommunications industry there are
many competitors but only a few leaders. These leaders are able to dictate and set the
overall prices for the others to follow. Product differentiation is limited, therefore, staying
competitive with pricing and customer service is necessary to gain and maintain market
share. Due to the infrastructure of the telecommunications industry as a whole, leaving
the industry can be a costly venture because of its specialized equipment and expansive
networks. This makes for an incentive for the companies to stay competitive in the
industry by setting prices at a reasonable level and keeping their customers content.
Threat of New Entrants
Today, the telecommunications industry as a whole has a huge market opportunity
but, due to the high costs of equipment, few companies are able to enter and compete
effectively. Probably the biggest barrier to entry into the telecom industry is finding a
source of financing. This is a capital-intensive industry where fixed costs are high and a
lot of cash is a must. Because SBC was one of the first movers in the industry, they have
been able to create a vast, loyal customer base, which makes it hard for new entrants to
gain market share. However, because the switching costs are so low, SBC must provide a
quality product and quality customer service in order to retain its customer base. Due to
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the strong relationships between existing telecom firms and their customers, new entrants
find it difficult to steal market share from these already dominant companies. Legal
barriers are also a major factor in entering the telecom industry. The current FCC laws
and licensing regulations make entering the industry a difficult and drawn out process
because new, start-up companies must apply for both regulatory approval and licensing.
Threat of Substitute Products
SBC is in a very high-tech, fast moving industry that sees major changes and
innovation in a short period of time. Because of this, SBC must always be worried about
the threat of substitute products. Whether it is cable television over satellite or dial-up
Internet over DSL, this industry is moving in directions in which nobody can predict.
Cable companies have now become a threat to traditional telecom companies because
they have their own direct line into the homes and offices of their customers, allowing
them provide high speed, broadband Internet that can substitute for many businesses
networking needs. Because price is such an important factor in customers choosing a
service, SBC must always be watching out for their competitors developing new ways to
produce a product or service at a lower cost. For example, fiber-optic technology is the
newest innovation in the telecommunication industry and is replacing the old copper
cables. Given that this is the new way to communicate, SBC just invested 6 billion
dollars in their fiber-optics research and development in order not to lose customers to
substitute products.
Bargaining Power of Buyers
Bargaining power of buyers is dependent upon the price sensitivity and the
relative bargaining power. The services provided by SBC are widely treated as a
commodity, and for the most part, do not vary much regardless of who is selling them,
whether it be SBC or a competitor. Therefore, buyers have more bargaining power if the
product between companies is similar, and the cost of switching service providers is low.
In addition, relative bargaining power is associated with the cost of the consumer and the
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cost of the supplier not doing business with each other. In other words, will either party
be affected if business is done elsewhere? Within the telecommunications business,
consumers have a high bargaining power over buyers. This means that at the highest level
of bargaining power by the consumers, they have the ability to bargain for the best
service provider and the cheapest cost of service while continuing to maintain similar
products and services. However, in some areas of the telecommunications industry,
consumers sign a binding agreement to remain with the service provider for a time of one
to two years, and there is a high cost of switching service providers. At this point,
consumers loose their bargaining power regarding price of the product and service from
the company. Consumers also have a high relative bargaining power. In other words,
there is a large quantity of consumers looking for a service, and only a few service
providers. However, with the ability to provide an unlimited supply of service their
relative bargaining power remains high. Because SBC’s customer base ranges from
residential consumers to big corporations and businesses some buyers may have less
bargaining power over SBC than others, due to the amount of their switching costs.
While residential consumers generally remain unaffected because of their low switching
costs, corporations, universities, and other big organizations’ bargaining power can be
greatly affected due to their need of highly customized products and services, which
increases their switching costs. With this increase in switching costs the buyer will be
less likely to switch service providers giving SBC an advantage in their bargaining power
with their buyers.
Bargaining Power of Suppliers
With the way the telecom industry is set up, one might think that the suppliers
would have considerable bargaining power over the telecom operators because without
high-tech broadband equipment, fiber-optic cables, and various types of software, it
would be vary hard for them to transfer information from place to place. But because
there are so many makers and suppliers of equipment, for instance Nortel, Lucent
Technologies, Cisco Systems, Nokia, and Ericsson, the bargaining power of these
suppliers is dramatically reduced due to the fact that SBC has so many different options
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from which to buy their supplies. This gives SBC, along with its competitors, a
substantial advantage when dealing with their suppliers.
Cost Competitive vs. Differentiation
Based on our five forces model, SBC and the industry is classified as a
competitive, cost leadership market. Their competitive advantage is generated from
keeping service costs low and supplying a similar or better product and service.
Throughout the telecommunications industry, the products and services offered by SBC
and other companies are relatively the same. From wireless communications and local
and long distance service to Internet and satellite TV, the products and services are nearly
the same with no detectable differences. For this reason, the most important factor for
SBC is keeping product and service costs low and maintaining efficient low cost
production of the products and services they offer.
Key Success Factors
SBC’s key success factors are service quality, service innovation, cost efficiency,
and customer relations. SBC has made many recent moves in order to shore up their key
success factors and allow them to maintain their competitive advantage. According to
SBC’s 2003 annual report, Cingular, a subsidiary of SBC, announced on February 17,
2004, that they would acquire AT&T Wireless Services by the end of the fiscal year. This
acquisition will enhance Cingular’s ability to compete by strengthening both its network
coverage and quality. This along with their new interLATA long-distance service in the
mid-west and fiber-optic technology to transfer data faster and easier will greatly enhance
SBC’s service quality and service innovation, two of SBC’s key success factors.
According to the San Antonio Business Journal, SBC was recently recognized as a leader
in customer relations by IDG’s CIO Magazine. They were given this award for their
commitment to provide e-business tools and data services to their customer along with a
customer service program that is unmatched by anyone in the industry. Another way that
SBC supports their customer relations is through philanthropy. According to the
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Chronicle of Philanthropy and the Foundation Center, the SBC Foundation is consistently
ranked among the nation’s top corporate leaders in donations to charitable organizations.
In 2003 alone the SBC Foundation contributed $45 million to programs that support
enhancement of education and the community through technology. Another key success
factor of SBC is that they are striving to become more cost efficient and thereby
becoming a more profitable company. From 2001 to 2003, Verizon, SBC, and BellSouth
have reduced their workforce by 25%. However, Verizon saw a slight reduction in actual
operating expenses, but SBC and BellSouth actually saw an increase in actual operating
expenses. The reason for this is that there is inefficiency within the operating process of
SBC rather than within their high employee expenses. The operating costs are high
because copper-based network infrastructures incur a large quantity of costs. For this
reason, SBC is beginning to move towards a fiber optic infrastructure in order to reduce
the high operating costs and become more cost efficient. By continuing and pressing
SBC’s goals to exceed these factors, SBC will continue to hold a strong competitive
advantage over the remaining telecommunications industry.
Strengths
SBC Communications controls and maintains a large and diverse network of
telecommunication products and services for consumers and businesses. Because of
SBC’s size and ability to reach nearly any consumer, they are able to focus and exceed
their key success factors. Since SBC is such a large and diverse network of
telecommunication products and services, they can offer higher service quality, newer
service innovation, better cost efficiency, and closer customer relations. SBC is the first
major telecommunications provider to offer a wide range of services such as satellite TV,
combined with wireless, broadband, local and long distance phone services all in one
monthly bill, SBC DISH Network. By offering a bundle of services, SBC can boost
service quality and customer relations by giving their customers easier access to a one
stop shopping communications provider. Another way SBC has expanded its bundle of
services is by the recent acquisition of Cingular and its even more recent acquisition
AT&T for 41 billion dollars**. SBC owns 60% of Cingular, which serves 25 million
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people in the U.S. Long distance is one of the company’s fastest growing areas serving
13.4 million access lines. This will complete the network and there will be one less
competitor for SBC. SBC is a leader in data services with annual revenues of 10 billion.
It is also the largest DSL provider to 4.3 million subscribers. Another way SBC is taking
strides in becoming a leader in service quality, cost efficiency, and service innovation is
through research and development. In the future SBC will spend up to 6 billion on new
fiber optic technology. The new fiber optic technology will give customers better service
quality, and reduce operating expenses for SBC and therefore help them become more
cost efficient. This will be less costly and more capable for handling voice, video and
data services.
**See appendix for detailed information**
Weaknesses
SBC has a lot of strengths that are building them into a better company.
However, there are some weaknesses that SBC needs to overcome. Over the past four
years, SBC has had steadily increasing wireline cash expenses of 1.5%. In order to
maximize a better cost efficiency, SBC should attempt to decrease their wireline cash
expenses. Another weakness that is contributing to having adverse benefits with cost
efficiency is that SBC is attempting to enter into other industries and is having trouble
internally with understanding how to operate their company efficiently. They also have
an out of date network that is hard to maintain. SBC needs a new infrastructure; most of
their competitors have a lower cost structure. However, as stated above SBC is in the
process of restructuring a fiber optics infrastructure so this will no longer be a weakness
in the future.
Opportunities
With the growth of SBC Communications, small and even big companies are
being forced to reduce in size or even back out of the market. This gives SBC the
opportunity to take over more markets. SBC is going to have the ability, based on a
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ruling from the Texas Public Utility Commission, to collect 2 to 3 cents from dial-up
users for using SBC’s phone lines for internet use. This will allow an increase in revenue
from local internet providers. AT&T has withdrawn from its consumer long distance
business, which is over crowded with competitors, giving SBC the opportunity to gain
more customers. By SBC’s recent gain of the market by AT&T, they can provide their
customers with higher service quality and customer relations by increasing the bundle of
products and services they provide.
Threats
AT&T has launched a new nationwide internet calling service which will be a
threat to SBC’s internet service. In order to maintain their customer base without loosing
customers to AT&T’s new internet service, SBC should boost customer relations and
service quality to retain their customer base. With increasing competition, the product
market is becoming more confusing for customers. Customers are having difficulty
deciding on products based on their price and quality. This is another reason why SBC
should emphasize on customer relations and service quality. Some companies, such as
Skype Technologies, are entering into markets that SBC currently does not operate but
could move towards in the future. Skype Technologies could be dominating a market
before SBC even gets there.
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Accounting Analysis
Significant Accounting Policies
These accounting policies were specifically chosen in accordance with SBC’s key
success factors, to supply evidence of the management of their economics.
Revenue Recognition
Revenues and expenses dealing with nonrefundable, activation services are
deferred and recognized over the average customer life of five years. Revenues
associated with telephone, data, and wireless services are billed monthly in advance and
later recognized when services are provided. EITF 00-21 became effective July 1, 2003
and has not had a significant effect on our consolidated financial statements. It addresses
certain aspects of accounting for sales involving multiple revenue generating products/
services sold under a single agreement.
Revenue policies are key to any company’s success because sales alone are vital
to the performance of the company. Revenues are important to SBC because its key
success factors rely heavily on revenues. To supply quality service, cost efficiency, or
innovative new services revenues are necessary funds.
Allowance for Uncollectibles
Estimation for bad debt allowances is primarily based on analysis of history and
future expectations of their retail and their wholesale customers. Their estimates are
based on their actual historical write-offs and the aging of accounts receivable balances
for retail customers. The assumptions are reviewed quarterly and adjustments are made
to their bad debt allowance. They use a statistical model based on their aging of accounts
receivable balances for wholesale customers. Risk percentages and reserve balance
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assumptions built into the model are reviewed monthly and the bad debt allowance is
adjusted accordingly.
Managing a well-balanced allowance for bad debt is essential to maintaining a
productive consumer base. Since this account is a contra balance to accounts receivable,
it is actually a part of sales. SBC reviews its write-offs and assumptions often so that the
most accurate allowance can be accounted for in their books.
Directory Accounting
They changed their method of recognizing revenues and expenses related to
publishing directories to the “amortization” method from the “issue basis” method. The
amortization method has now become the more prevalent method used among significant
directory publishers.
Directories are a major subdivision of SBC’s company, and this segment’s
income for 2003 is $2,301(in millions). Also, by changing the method of accounting for
directories lowered their operating expenses; translating into a consolidated segment
income increase of 5% from Directories.
Depreciation Accounting
Plant, Property, and Equipment are accounted for under the straight-line method.
Certain subsidiaries follow composite group depreciation methodology, when a portion
of their depreciable property, plant and equipment is retired in the ordinary course of
business, the gross book value is reclassified to accumulated depreciation; no gain or loss
is recognized on the disposition of this plant. Property, Plant and Equipment includes
capitalized software costs that are amortized over three years. In addition, FAS 143 was
adopted to change depreciation rates which lowered expenses in 2003.
Depreciation methods are useful points of flexibility in a firm’s financials. Most
companies have choices in the method they employ. Different methods create different
advantages to a company; SBC has chosen a simple straight-line method for its property,
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plant and equipment, which gives the same sum for every year of depreciation and a
capitalization policy for software.
Goodwill and Other Intangible Assets
They adopted the Statement of Financial Accounting Standards No. 142,
“Goodwill and Other Intangible Assets” (FAS 142). As a result, they stopped amortizing
goodwill, and at least annually they will test the remaining book value of goodwill for
impairment. The impairments following the adoption of FAS 142 will be recorded in
operating expenses. They also stopped amortizing goodwill recorded on their equity
investments.
SBC’s goodwill is specifically tied to its recent purchase of Cingular Wireless.
Goodwill is important to SBC because it increases the firm’s value. In the
telecommunications industry, acquisitions are integral to maintaining competitive
advantages. Also acquiring goodwill, then determining how to account for it could be
more profitable for the firm.
Property, Plant, and Equipment
Property, plant, and equipment are stated at cost. The cost of additions and
substantial improvements to property, plant and equipment are capitalized. The cost of
maintenance and repairs of property, plant and equipment are charged to operating
expenses.
Property, plant, and equipment are the core of the physical assets of a firm. These
are the keys to generating revenues for SBC, which directly connect to its key success
factors.
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Software Costs
Their policy is to capitalize certain costs incurred in connection with developing
or obtaining internal use software. The software costs that do not meet capitalization
criteria are expensed immediately.
Software is the main tool used in SBC’s business. This internal intelligence is the
backbone of their services and the management of their services. Software relates to
service quality and innovation.
Assessment of Accounting Flexibility
SBC has a degree of flexibility in choosing their accounting policies but are still
strictly limited by FCC regulations. Through SBC’s flexibility, their accounting
information shows the reader some insight into the management of their economics. In
determining methods used for depreciation and amortization, recognizing revenue and
expense, capitalization, and directory accounting, the most beneficial method was
applied.
SBC uses the common method of straight-line depreciation for the property, plant
and equipment, and they do not recognize any gain or loss on retired equipment. In
respect to amortization, they stopped amortizing their goodwill and amortize their
capitalized software over three years, which decreased operating expenses. Since
customers are billed in advance, revenues are deferred and recognized when earned.
Expenses are deferred and recognized over an average customer life determined by SBC.
The company’s capitalization policy includes software costs that are directly related to
their internal use software. They changed their directory accounting policy to a more
popular method, which decreased operating expenses. SBC’s accounting flexibility is
embedded in the policies above and related to their recent improvements in cost
efficiency, as well as other success factors.
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Evaluating Accounting Strategies
SBC’s accounting policies are similar to MCI, one competitor, in that both
companies recognize revenues when earned. For both companies, most expenses are
recognized when incurred. Like SBC, MCI also depreciates its long-lived assets over the
straight-line method. Allowance for bad debt is periodically evaluated for adjustment as
well as estimated using historical trends and known events. SBC and MCI are different
in that MCI uses a less accelerated method of amortization on capitalized software costs.
They maintain a software life of six years in comparison to SBC, who uses a three year
life. In contrast AT&T, another competitor, uses a group depreciation method based on
estimated useful lives of specific assets. AT&T also accounts for expenses during any
recognized period.
The managers within SBC face some incentive to use accounting discretion to
manage earnings because they are a cost competitive firm. As noted before they have
changed some accounting policies which have lowered their costs. They have also
recently gone through restructuring in which they downsized the amount of employees.
The company’s policies and estimates have been realistic in the past. Looking
through recent financial documents no changes in estimates have been stated, with the
exception of changes in accounting policies handed down by FASB. No business
transactions that have been reviewed have shown any evidence of being structured only
to achieve certain accounting objectives.
SBC has made a few changes in its policies and estimates (see appendix for the
cumulative impact of these accounting changes). One of the significant policies that went
through a change was in directory accounting. SBC changed their method of recognizing
revenues and expenses related to publishing directory from the “issue basis” method to
the “amortization method.” The decided to change methods in order to be more
consistent with their quarterly income and the amortization method has now become the
more prevalent method used among significant directory publishers. The change in
directing accounting resulted in a non-cash charge of *$1,136, net of an income tax
benefit of *$ 714. The reason behind this change was to increase consolidated pre-tax
income and the directory segment income by *$80.
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Another change they made was in depreciation accounting. On January 1st 2003,
SBC changed the way they account for the removal of long lived assets when those assets
are no longer used in the company’s business. The justification for the accounting
change resulted when SBC adopted financial account standards number 143 because they
were required to by the FASB. In connection with FAS 143, all existing accrued costs of
removal for those plant accounts where SBC’s estimated costs of removal exceeded the
estimated salvage value were reversed. The non-cash gain from the reversal was
*$3,684, net of deferred taxes of *$2,249. For these plant accounts, costs of removal are
expensed as incurred; where previously the costs were recorded in their depreciation
rates.
Goodwill and other intangible accounting also went through changes. SBC
stopped amortizing goodwill and will test the remaining book value of goodwill for
impairment annually. They also stopped amortizing goodwill recorded on their equity
investments. SBC made this change in accounting by adopting statement of financial
accounting standards number 142, “goodwill and other intangible assets.”
*All dollars are stated in millions.
Evaluating the Quality of Disclosure
SBC uses their Annual Report for shareowners in order to clearly convey its
industry conditions, its competitive position, and their management’s plans for the future.
In this section of their annual report they use the Management’s Discussion and Analysis
of Financial Condition and Results of Operations and Notes to Consolidated Financial
Statements to break down the complex terms and conditions discussed throughout the
companies annual report. The footnotes in SBC’s annual report clearly and adequately
explain their key accounting policies. It also lists and explains the many changes in their
accounting policies and how these changes have affected the company. The Management
Discussion and Analysis section of the annual report does adequately explain its current
performance. It goes into detailed summaries of each area of increases or decreases in
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the financial statements and gives a valid explanation of the preceding events. SBC does
provide adequate additional disclosure of the accounting rules and conventions to help
understand how the factors are being managed. SBC uses a very segmented analysis of
their separate departments. In the Management of Discussion and Analysis section, SBC
gives a detailed explanation of the wireline segment, Cingular segment, Directory
segment, and the International segment. SBC also includes the current position of these
segments and the percent and numerical change within the segment. The management
responds to bad news as quickly as possible. The quicker management responds to
imperfections, the quicker they are able to recover from bad news. This also keeps their
stock value from dropping considerably if they choose to not disclose bad news as soon
as they are aware of it. SBC includes a section within the annual report that is specialized
to summarize and clarify information for the shareholders interests. SBC also sends out
the annual report routinely to the shareholders each year.
Identifying Potential Red Flags
The graph below illustrates different key ratios in determining a possible
manipulation of sales. In observing the graph, the first four years remain fairly consistent
in all ratios, but the most recent year has an increase in every ratio. The increase in the
net sales/ net cash flow ratio is primarily due to an increase in net sales and a decrease in
net cash flow. The rise in net sales/ net accounts receivable is due to a decrease in
accounts receivable, and the increase in net sales/ unearned revenues is a result of the rise
in net sales. The main component that has affected all of the ratios, the increase in net
sales, is a combination of a decrease in taxes and a decrease in operating expenses.
Because of the legitimate reasons for the accounting number shifts, the ratios were not
evidence for a possible sales manipulation.
19
Sales Manipulation Diagnostics
2.50
2.00
2.36
2.10
values
1.79
1.73
1.58
1.50
1.00
0.50
1.38
0.87
0.49
0.79
0.56
0.75
0.47
0.66
0.63
0.37
0.00
1999
2000
2001
year
2002
2003
Net Sales/Net Cash
Flow
Net Sales/Net Accounts
Receivable
Net Sales/Unearned
Revenues
The graph below illustrates different key ratios in determining a possible
manipulation of core expenses. The declining asset turnover, changes in cash flow from
operations/ NOA ratio, and the other employee expenses/ selling, general, and
administrative expenses ratio were all very consistent over the past five years. In
addition, the pension expense/ S,G&A ratio decreased down toward the firm’s norm. The
only ratio to increase was changes in cash flow from operations/ operating income. This
ratio has been steadily rising over the past three years as a result of a continual decrease
in operating income. In review of the financial statements, the lower numbers come from
a corresponding decrease in operating revenues. Because revenues in and of themselves
are not affected by expenses, there is no evidence showing a manipulation of core
expenses.
20
Core Expense Manipulation Diagnostics
2.50
2.09
2.00
1.76
value
1.50
1.00
0.50
0.00
1.43
1.41
1.33
1.06
1.07
1.05
0.43
0.26
0.10
0.49
0.43
0.21
0.08
0.20
0.07
1999
2000
2001
ye ar
Declining Asset Turnover
1.47
1.29
Changes in Cash Flow From
Opertions/Operating Income
0.37
0.19
0.06
2002
0.37
0.16
0.08
Changes in Cash Flow From
Operations/ NOA
Pension Expense/SG&A
2003
Other Employee
Expenses/SG&A
Undo Accounting Distortions
After evaluating both the quantitative and qualitative factors within SBC, we
found no current red flags. There were no unexplained changes in accounting. SBC’s
profits decreased in the last year, so there were no were no unexplained transactions that
could have possibly boosted profits. There also were no unusual increases in accounts
receivable in relation to any increase in sales. The accounts receivable and sales were
both decreasing. SBC has no inventories, so, there is no increase in inventories in
relation to an increase in sales. The gap between both SBC’s income in relation to its
cash flow from operating activities, and also its income in relation to its tax income is
decreasing from 1999- 2003. We found no large asset write-offs or large fourth quarter
adjustments, therefore, the amount of assets remain fairly consistent. There was also no
change in independent auditor or any transactions between related parties. Therefore,
there is no need to undo any accounting distortions within SBC’s annual report.
21
Introduction to Ratio and Forecasting Analysis
The ratio analysis and forecasting section of a valuation analysis is very important
to the overall valuation of SBC. The purpose of the ratio analysis is to identify past and
current trends, not just with SBC, but with its main competitors also. These ratios identify
the overall profitability, liquidity, and capital structure of all the main companies in the
telecommunications industry. By finding these values, current and future investors of
SBC can see just how their company has performed against their competitors and the
industry average. These values are also important to the future valuation of the company
by identifying past trends and using them to form a rough estimate of future trends.
Another key component of a valuation analysis is forecasting the financial statements. By
forecasting SBC’s future balance sheet, income statement, and statement of cash flows
current and future investors have a basis for future decisions and investment in the
company.
In order to find the various ratios for SBC and its five main competitors we used
three main liquidity ratios (excluding inventory turnover and working capital turnover
because they do not apply to this industry), six main profitability ratios, and three capital
structure ratios. We also felt it was beneficial to use the EBITDA margin ratio and the
PP&E turnover in order to get a better view of SBC and the overall industry. In regards to
forecasting the future financial statements we used the moving average, random walk,
and trend analysis methods. These methods were chosen because they best depict the way
SBC operates.
At the conclusion of this section of the valuation analysis we hope to provide
investors with an accurate view of past trends and fluctuations throughout the industry as
well as a reasonable estimate of SBC’s future performance.
22
Ratio Analysis
Years
Liquidity:
Current Ratio
Quick Asset Ratio
Receivable Turnover
Day Sales Uncollected
Inventory Turnover *
Working Capital Turnover *
2003
2002
2001
2000
1999
0.98
0.825
6.61
55.21 Days
N/A
N/A
0.96
0.797
5.05
72.27 Days
N/A
N/A
0.53
0.45
4.55
80.2 Days
N/A
N/A
0.76
0.35
5.07
72 Days
N/A
N/A
0.62
0.51
5.28
69.1 Days
N/A
N/A
59%
24.10%
20.80%
0.41
22.23%
8.50%
62%
22.20%
13.10%
0.45
17%
5.90%
43.50%
20%
15.70%
0.476
22.30%
7.50%
40%
21%
15.50%
0.52
26%
8%
40.70%
21%
16.50%
0.6
30.50%
10%
1.62
7.17
7.194
1.86
7.57
4.34
1.96
8.1
1.67
2.24
6.75
1.36
2.11
8.1
4.91
35%
0.78
40%
0.89
56.50%
0.92
60%
1.09
59%
1.06
Profitability:
Gross Profit Margin
Operating Expense Ratio
Net Profit Margin
Asset Turnover
Return on Equity
Return on Assets
Capital Structure :
Debt-to-Equity Ratio
Times Interest Earned
Debt Service Margin
Other Relevant Ratios:
EBITDA Margin
PP&E Turnover
Sustainable Growth Rate
7.65%
*Since SBC Communications is predominately a service company, they do not
depend on having physical inventory in stock. This causes working capital to be a
negative number which makes Inventory Turnover and Working Capital Turnover
inaccurate.
Along with using the 14 basic Liquidity, Profitability, and Capital Structure
Ratios, we also used 2 other ratios that were important to SBC and our industry.
EBITDA Margin is important for SBC and the telecommunications industry as a
whole because it displays earnings without the subtraction of depreciation, and
amortization as well as no interest or income tax subtraction. But most importantly,
23
with the deduction of depreciation and amortizations, the public receives a better
overview of the company’s true earnings. This is because many companies depreciate
their assets differently over a certain amount of time. This way all of the companies
being compared to SBC, as well as SBC by themselves will have a fair overview of
their earnings. Also, PP&E turnover was used to show how well SBC is using there
Property, Plant, and Equipment to generate sales. This is a very important ratio
because in the telecommunications industry you carry little to no inventory because
you use your Property, Plant and Equipment to help generate sales.
With the use of the above Ratio Analysis for SBC Communications, we were able
to analyze the overall Liquidity, Profitability, and Capital Structure of the company.
To begin with, Liquidity Ratios were used to show the overall liquidity of SBC.
Although, liquidity is not nearly as important in the Telecommunications Industry due
to the low amount of current assets Telecom companies carry. The Current Ratio and
the Quick Asset Ratio show how well SBC’s short- term assets can cover their
Liabilities. Both of these increased slightly over time, which shows that they are more
able to cover their debt now, and then they have in the past. Another positive aspect
in SBC’s liquidity is their increase in Receivable Turnover. This shows that they have
been collecting cash sooner as time carries on. This helps them increase the overall
flow of cash into the business. We also used the PP&E Turnover to show how they
are generating sales from their Property, Plant and Equipment. Over the past five
years SBC has been experiencing a decrease in this ratio which leads us to believe
that they are not generating sales well from the above assets. When looking at SBC’s
overall liquidity, we can see the increase that they have received over time, which
leads us to believe that they are more able to pay their debt now then they have in the
past.
Another, probably more important, aspect is SBC’s overall profitability. Gross
Profit Margin is used to show the extent to which revenues exceed direct costs
associated with sales. Although there was a decrease between 2003 and 2002, the
overall Gross Profit Margin has been increasing over time. The Operating Expense
Ratio, which deals with how SBC’s operating expenses take over sales, has been
24
constantly increasing over the past five years. This is not a good aspect in SBC’s
profitability because operating expenses are eating up its sales. SBC just recently had
a major increase in their Net Profit Margin over the most recent year. They managed
to increase by 7% over the previous year, as well as a 5 % increase in the past five
years. Return on Equity and Return on Assets show how well SBC uses its Assets and
Equity to generate income. Recently, both of these have increased over the past year,
but still are below where they were in the past. The recent increase in could be due to
their recent purchase of Cingular Wireless, which would explain how they are using
there assets more efficiently in another sector and how their asset base has grown
relative to shareholders’ investment. Another Profitability Ratio we used, that was
relevant to our company was the EBITDA Margin. Before looking at this ratio one
might think SBC has been, for the most part, a profitable company. There has been a
constant decrease in SBC’s EBITDA Margin over the past five years which shows
that their cash operations have been declining. This ratio can be misleading, but in the
telecommunications industry it is an important ratio to look at because it takes out a
lot of areas that do not involve cash related expenses. Overall, SBC’s profitability
took a dip a few years ago, but has recently been increasing over the past year. We
must be skeptical though, because this recent increase good have occurred from their
recent purchase of Cingular Wireless, which could have inflated its earnings. We
must also watch out for their increase in operating expenses, because if those continue
to increase, SBC is going to have a major problem in its profitability.
The final area we covered was SBC’s Capital Structure. Debt- to- Equity Ratio
shows how much debt SBC carries in comparison to the amount of equity they are
holding. SBC has been constantly decreasing this ratio which leads us to believe they
have less debt then they have in the past in comparison to their equity. Also, SBC’s
Times Interest Earned has been steadily decreasing over the past five years. This
shows that their interest expenses have been eating up their NIBIT. SBC has been
experiencing an increase in their debt service margin steadily. This shows that their
operating cash flow has been increasing comparatively to their current notes payable.
Overall, we can see that SBC has been seeing an increase in its capital structure,
which shows how well they have been covering there debt.
25
Liquidity Charts:
Current Ratio
2.5
2
SBC
AT&T
Verizon
AOL/TW
Cox
MCI
IND AVG
Value
1.5
1
0.5
0
2003
2002
2001
2000
1999
Year
Over the past five years SBC has seen a rise in their current ratio. By raising their
current ratio they are better able to cover their debts with their assets. In 1999 SBC was
well below the industry average but in 2003 they were more than ten points over the
industry average.
26
Quick Asset Ratio
7
6
SBC
5
Value
AT&T
Verizon
4
AOL/TW
3
Cox
MCI
2
IND AVG
1
0
2003
2002
2001
2000
1999
Year
As with their current ratio, SBC’s quick asset ratio has followed a similar path. It
was just below the industry average in ’99, dipped well below the industry average at the
turn of the century and climbed near the tops in the industry by 2003. This ratio is
important because it shows how much of SBC’s current liabilities and be covered by their
quick assets: cash, accounts receivable, and securities. This is crucial because, in the
event of an emergency where cash is needed quickly SBC can cover 82.5% of their
current assets.
27
A/R Turnover
16
14
12
SBC
AT&T
Value
10
Verizon
AOL/TW
8
Cox
6
MCI
IND AVG
4
2
0
2003
2002
2001
2000
1999
Year
Over the past five years SBC has consistently been below the industry average. A
lower than average A/R Turnover ratio means that a company is not collecting their
accounts receivable as fast as their competitors. This applies to SBC because they are
below the industry average, therefore not collecting their money as fast as their
competitors, which keeps them from reinvesting that money from their accounts
receivable.
Inventory Turnover
Because of the nature of SBC and the telecommunications industry, neither SBC
nor any of its main competitors had any significant measurable inventory. This is due
mainly to the telecommunications industry being a service intensive industry.
Working Capital
The working capital ratio did not apply to SBC or its competitors because, for the
most part, everyone in the industry had a negative working capital ratio. This is due to
SBC and its competitors being in a service industry where it is not an asset intensive
industry.
28
Profitability Charts:
Gross Profit Margin %
100
90
80
SBC
70
AT&T
Value
60
Verizon
50
AOL/TW
Cox
40
MCI
30
IND AVG
20
10
0
2003
2002
2001
2000
1999
Year
In 1999 SBC was well below the industry average but by the end of 2003 they
raised their GP Margin by nearly 19% points to 59%. This is due SBC reducing their cost
of goods sold in proportion to their revenue. This, in turn, gives them more available
income to re-invest back into the company to generate future revenues.
29
Operating Expense Ratio %
70
60
SBC
50
Value
AT&T
Verizon
40
AOL/TW
30
Cox
MCI
20
IND AVG
10
0
2003
2002
2001
2000
1999
Year
SBC is below the industry average, which is a positive aspect in their profitability.
This shows that their Operating Expenses are eating up less of their sales than other
companies. Also, over time, the company itself has been decreasing Operating Expenses
while increasing its sales.
30
Net Profit Margin %
100
80
60
SBC
AT&T
Value
40
Verizon
20
AOL/TW
Cox
0
MCI
2003
2002
2001
-20
2000
1999
IND AVG
-40
-60
Year
SBC blows all other companies out of the water with their immaculate Net Profit
Margin. Not only has SBC’s greatly increased over the past year, but they have taken an
even larger gain over their competition. This shows that their sales are generating more
net income, which leads us to believe fewer expenses are being used in comparison to
sales.
31
Asset Turnover
1.4
1.2
SBC
1
Value
AT&T
Verizon
0.8
AOL/TW
0.6
Cox
MCI
0.4
IND AVG
0.2
0
2003
2002
2001
2000
1999
Year
Asset Turnover shows how well our company is turning over there assets in
relation to their sales. SBC is always exactly at, or just above the industry averages on
this ratio. This ratio is very important includes all assets relevant to the industry, which
does give a more accurate insight because it involves those assets crucial in the telecom
industry such as Property, Plant, and Equipment.
32
Return on Assets %
100
80
60
SBC
Value
AT&T
40
Verizon
AOL/TW
20
Cox
MCI
0
IND AVG
2003
2002
2001
2000
1999
-20
-40
Year
SBC is a giant when it compares itself to its competitors in its generation of
profitability from its Assets. They recently have pulled further and further away from
their competition over the past few years. This leads us to believe that SBC has been
using their assets more efficiently then the others in the telecom industry.
33
Return on Equity %
300
250
200
SBC
Value
150
AT&T
Verizon
100
AOL/TW
50
Cox
MCI
0
2003
2002
2001
2000
1999
IND AVG
-50
-100
-150
Year
SBC also has been crushing the competition in utilizing its assets in relation to its
shareholders’ investment. This is very important because it shows how efficiently a
company has been using their funds to generate returns. Having this good ROE gives
SBC, in the long run, market values that exceed their book values.
34
Capital Structure Charts:
Debt-Equity Ratio
6
5
4
SBC
Value
3
AT&T
Verizon
2
AOL/TW
1
Cox
MCI
0
2003
2002
2001
2000
1999
IND AVG
-1
-2
-3
Year
The Debt-to-Equity ratio displays how much debt a company is carrying in
comparison to its equity. Having the lowest Debt-to Equity ratio is what is needed to
strive for, and SBC does just that. They have, for the most part, been below the industry
average as well as below their top competitors. This gives them more room to finance
other activities, than worrying about paying off debt.
35
Times Interest Earned
10
9
8
SBC
7
AT&T
Value
6
Verizon
AOL/TW
5
Cox
4
MCI
3
IND AVG
2
1
0
2003
2002
2001
2000
1999
Year
Times Interest Earned shows how much a company is being eaten up by interest
owed on debt. This is one aspect that SBC has been recently struggling on. Since SBC is
constantly moving into different parts of their industry, they are required to be constantly
investing. Having a lot of debt is not necessarily a bad thing because it shows that they
are staying on top of their industry by investing in future outlooks.
36
Debt Service Margin
120
100
SBC
Value
80
AT&T
Verizon
60
AOL/TW
Cox
MCI
40
IND AVG
20
0
2003
2002
2001
2000
1999
Year
A company’s Debt Service Margin displays how well their current cash flows can
cover their current debt. Although SBC has been steadily increasing their Debt Service
Margin, they have been below their industry average. This again could be because SBC
carries a lot of debt in order to stay on top of their industry. Because other companies
may not hold as much debt as SBC does, it is tough to compare SBC to some of the other
competitors.
37
Additional Valuation Charts:
EBITDA Margin %
70
60
50
SBC
AT&T
Value
40
Verizon
30
AOL/TW
Cox
20
MCI
IND AVG
10
0
2003
2002
2001
2000
1999
-10
Year
EBITDA Margin portrays how a companies earnings before interest, taxes,
depreciation, and amortization in comparison to their sales. SBC has been recently
declining their EBITDA Margin, but is still staying above the industry average. This
shows that their “cash” earnings are generating sales better than that of their competitors.
38
Property, Plant & Equipment Turnover
2.5
2
SBC
AT&T
1.5
Value
Verizon
AOL/TW
Cox
1
MCI
IND AVG
0.5
0
2003
2002
2001
2000
1999
Year
PP&E Turnover is the most important long-term asset in a firm’s balance sheet.
SBC is suffering in this element, which shows that they are not efficiently utilizing their
property, plant, & equipment to generate sales. This is definitely a negative aspect for
SBC because in the telecom industry, PP&E are some of your most important assets.
39
Forecasting Methodology
Income Statement:
•
Revenue Growth: A regression method was used to calculate future values of
Revenue based on past revenue growth.
•
Cost of Sales: The most appropriate method to forecast the cost of sales was to
take an average of the past three years of Cost of Sales to Revenue ratio and use
this percentage to calculate future cost of sales based on revenue.
•
Remaining Portion of Income Statement: Moving averages were used in
proportion to short, intermediate, and long term forecasted values of the Income
Statement.
* The 1999 and 2000 S, G, and A expenses were not separately provided with their
financial statements, but were bundled with the Cost of Sales.
** The 1998 Revenue was used with the 1999 Revenue to calculate the percentage of
revenue growth in 1999.
Balance Sheet:
•
Assets (Current and Long Term): A five year moving average was used to
forecast the future values of the current and long term assets. Since future growth
of Assets is very unpredictable, a moving average of actual asset growth was
determined to be the most appropriate way to project accurate information.
•
Liabilities (Current and Long Term): A five year moving average was used to
forecast the future values of the current and long term liabilities. Since future
changes of Liabilities is very unpredictable, a moving average of actual liabilities
was determined to be the most appropriate way to project accurate information.
•
Shareholders’ Equity: A five year moving average was determined to be the most
accurate and appropriate method to determine future values of shareholders’
equity.
40
*** The long term liabilities includes long term debt, total deferred credits and other
noncurrent liabilities, and redeemable preferred securities of subsidiary trusts.
Statement of Cash Flows:
• Cash Flows from Operations: Using a five year moving average of the total
adjustments added to the calculated forecasted values on Net Income we were
able to project future values of cash flow from operations.
• Cash Flows from Investing: A simple random walk was used to forecast the
future values of cash flow from investing. Taking in consideration the past two
years, we calculated more accurate future values using a simple random walk
instead of using a five year moving average.
• Cash Flows from Financing: Using the average of the most relevant historical
information, the past three years, and projecting that number through the next ten
years, we were able to forecast a more consistent free cash flow.
The forecasted financial statements were formulated using ratios found in the
common sized income statement, and analytical information taken from trend
analysis of historical values.
Certain limiting factors including forecasted values which are projected and are
only as accurate as our forecasting methods, limit us from having a perfectly accurate
forecast. Certain methods including random walk model do not account for any
growth. The simple random walk method limits the total amount of information used
to project future values. Taking averages of past information does not take into
account any future changes in the company that would significantly affect its
financial statements. The consistency of the methods used strengthens our
forecasting model as a whole because each individual part is consistently related to
every other aspect of the model. Due to the fact that the revenue growth forecasted
values are derived using historical trends, the educated estimates of the forecast are
still only estimates. Since the estimates of the model are based heavily on forecasted
revenue growth, a different growth pattern would result in different forecasted values.
41
Although there are limiting factors and weaknesses to the forecasting model, the
forecasting methods and assumptions that were used were appropriately used for SBC
Communications.
42
Valuation Analysis
The process of valuation analysis entails converting our previous forecasts into
estimates for the valuation of the firm. We begin the valuation process by using the
methods of comparables which compares other companies p/e, p/b, d/p, p/s ratios to our
company’s and intrinsically finds the estimated value of the firm. We also will be using 4
other intrinsic valuation methods including discounted dividends, discounted free cash
flows discounted residual income, and the long run average residual income perpetuity.
These methods will be calculated using our estimated WACC and cost of capital. We
found our cost of capital through CAPM, which then helped us to find our WACC. After
employing these methods, we will be able to find what our company is actually worth.
Once we find what the company is actually worth, we will compare it to the actual share
price and determine whether our company is over, under, or reasonably-valued. Also,
because the WACC and the cost of capital may vary, we will use “sensitivity analysis” to
attempt to reach the actual share price, and compare other possible share prices.
43
Calculation of WACC and Cost of Equity
Finding Ke:
Rj=Rf+Bj(Rm-Rf)
Rf=2.1%(3yr. T-Bill)
Rm=5.08%(S&P 500 Avg.)
*Bj=.759(Published Beta)
Rj=4%
Finding WACC:
Vd/Vf(Kd(1-T))+Ve/Vf(Ke)
Ke=4%(computed above)
Vd=$61,918,000
Vf=$302,620,945
Kd=6.1%(avg. cost of debt for short and long term
debt)
Ve=$240,702,945
WACC=4%
* We decide to use the published Beta in order to gain a more accurate estimate for our
WACC and cost of equity. This is because are computed beta was so low that it would
give us a very low WACC and cost of equity
In computing our cost of equity and WACC, we noticed that they were rather low
in relation to what they should have been. Because of a weak economy and lack of
confidence in the marketplace, market returns were extremely low. Due to the fact that
our Beta is closely related to market returns, our calculated cost of equity was also low.
This, in turn, caused our WACC to also be relatively low because it is dictated by cost of
equity. We feel that these calculations may be inaccurate due to the above factors and to
gain a more accurate reading we will perform a “sensitivity analysis” which will vary
these rates.
44
Discussion and Analysis of Method of Comparables
Forward P/E Ratio Valuation- Table 1
Derived Value= $30.66
The derived value of the forward price to earnings ratio is higher than the actual
price of SBC Communication’s stock ($25.97). The expected share price was found
using the average forward P/E ratio of SBC’s five main competitor’s (MCI, AT&T, Cox,
Time Warner and Verizon) as a benchmark. The expected share price is higher because
there was such a wide range of forward P/E ratios. Cox had a forward P/E ratio of
$46.62. We chose to leave it in the average because only three of the companies had P/E
ratios. We wanted to use at least three for the average. This valuation model is not as
accurate because of this.
Trailing P/E Ratio Valuation- Table 2
Derived Value= $18.26
The trailing P/E ratio valuation determined a new price for SBC ($18.26) which
was much lower than the actual price ($25.97), and also much lower than the new price
using the forward P/E ratio valuation. When determining the industry average, we did
not include Cox Communication’s trailing P/E ratio of 144.96. It was much higher than
the other competitors and it made the industry average raise by about half. Because we
took out Cox and two other competitors did not have trailing P/E ratios, we only included
two competitors in the industry average. This shows why this valuation model might not
be as accurate as one of the other valuation models.
M/B Ratio Valuation- Table 3
Derived Value= $23.26
The new price using the market to book ratio valuation is $23.26, which is the
closest to SBC’s actual price of $25.97. The average M/B ratio of SBC’s competitors is
1.9. We used this and the book value of SBC to get the new price. There is a close range
45
of M/B ratios for the competitors from 0.68 (MCI) to 3.15 (Verizon). This valuation
model would be the best to use since the new price is so close to SBC’s actual price.
DPS/PPS Ratio Valuation- Table 4
Derived Value= $20.16
The dividend yield ratio valuation lowered the new price for SBC. The estimated
price using this valuation was $20.16. This was found by using the average of SBC’s
competitors DPS/PPS ratios which was .062. This is not very accurate because only three
of SBC’s competitors had this ratio. Cox and Time/Warner do not pay dividends so they
did not have this ratio. This may explain why the new price is lower than the actual price
and why this valuation would not be the best to use.
P/S Ratio Valuation- Table 5
Derived Value= $16.36
The price to sales valuation lowered the estimated price for SBC. The estimated
price using the price to sales ratio valuation was $16.36 which is a lot less than the actual
price of $25.97. The price to sales ratios for the competitors were all close, ranging from
0.23 (MCI) to 3.48 (Cox) but there is a significant difference in the amount of sales for
each of the companies. SBC’s price to sales ratio is in the middle of that range but their
amount of sales is considerably less than some of its competitors. This could be the
reason for the new price being so far off from the actual price for this valuation.
Ratio Conclusions
After completing these five valuation methods, we concluded that to determine
the new price for SBC the best valuation model to use would be the market to book ratio.
By using this ratio the new price for SBC was $23.26, which was the closest to the actual
price of $25.97. The forward P/E ratio derives a new price of $30.66, which is higher
than the actual price. The other three valuation models determine new prices that are
lower than SBC’s actual price.
46
Table 1: Forward Price to Earnings Ratio
Competitor
Symbol
MCI Inc.
AT&T Corp.
Cox Communications Inc.
Time Warner Telecom Inc.
Verizon Communications
SBC Communications Inc.
MCIP
T
COX
TWTC
VZ
Price Per
Share 1
17.25
17.44
34.50
5.4
40.56
Earnings Per
Share 2
1.76
0.74
2.65
Forward P/E
Ratio 3
N/A
9.91
46.62
N/A
15.31
SBC
Industry
Average P/E 4
23.95
Earnings Per
Share 2
1.28
Expected
Share Price 5
30.66
1- Price per share as reported in yahoo finance on 11/3/04.
2- Earnings per share estimated for current year based on the forward P/E.
3- Calculated by (price per share)/(EPS).
4- Average of competitor’s forward P/E ratio excluding SBC.
5- Average of competitor’s forward P/E ratio times SBC’s earnings per share.
47
Table 2: Trailing Price to Earnings Ratio
Symbol
MCI Inc.
AT&T Corp.
Cox Communications Inc.
Time Warner Telecom Inc.
Verizon Communications
SBC Communications Inc.
MCIP
T
COX
TWTC
VZ
Price Per
Share 1
17.25
17.44
34.50
5.4
40.56
Earnings Per
Share 2
69
N/A
2.13
Trailing P/E
Ratio 3
0.25
N/A
N/A
N/A
19.07
SBC
Industry
Average P/E 4
9.66
Earnings Per
Share 2
1.89
Expected
Share Price 5
18.26
1- Price per share as reported in yahoo finance on 11/3/04.
2- Earnings per share estimated for current year based on the trailing P/E.
3- Calculated by (price per share)/(EPS).
4- Average of competitor’s trailing P/E ratio excluding SBC.
5- Average of competitor’s trailing P/E ratio times SBC’s earnings per share.
48
Table 3: Market to Book Ratio
Book Value 2
M/B Ratio 3
MCIP
T
COX
TWTC
VZ
Price Per
Share 1
17.25
17.44
34.50
5.40
40.56
25.37
8.19
15.83
3.97
12.88
0.68
2.13
2.18
1.36
3.15
Book Value 2
SBC
Industry
Average M/B 4
1.9
Expected
Share Price 5
23.26
Competitor
Symbol
MCI Inc.
AT&T Corp.
Cox Communications Inc.
Time Warner Telecom Inc.
Verizon Communications
SBC Communications Inc.
12.24
1- Price per share as reported in yahoo finance on 11/3/04.
2- Book value estimated for current year.
3- Calculated by (price per share)/(book value)
4- Average of competitor’s M/B ratio excluding SBC.
5- Average of competitor’s M/B ratio times SBC’s book value.
49
Table 4: Dividend Yield
Competitor
Symbol
Price Per Share 1
MCI Inc.
AT&T Corp.
Cox Communications Inc.
Time Warner Telecom Inc.
Verizon Communications
MCIP
T
COX
TWTC
VZ
SBC
SBC Communications Inc.
DPS/PPS 3
17.25
17.44
34.50
5.40
40.56
Dividend Per
Share 2
1.60
0.95
N/A
N/A
1.54
Industry Average
DPS/PPS 4
.062
Dividend Per
Share 2
1.25
Expected
Share Price 5
20.16
0.93
.054
.038
1- Price per share as reported in yahoo finance on 11/3/04.
2- Dividend per share estimated for current year.
3- Calculated by (price per share)/(DPS)
4- Average of competitor’s DPS/PPS ratio excluding SBC.
5- SBC’s dividend per share divided by the average of competitor’s DPS/PPS ratio.
50
Table 5: Price to Sales Ratio
Competitor
Symbol
MCI Inc.
AT&T Corp.
Cox Communications Inc.
Time Warner Telecom Inc.
Verizon Communications
SBC Communications Inc.
Sales Per
Share 2
75
39.64
9.91
6.07
25.67
P/S Ratio 3
MCIP
T
COX
TWTC
VZ
Price Per
Share 1
17.25
17.44
34.50
5.40
40.56
SBC
Industry
Average P/S 4
1.324
Sales Per
Share 2
12.36
Expected
Share Price 5
16.36
0.23
0.44
3.48
0.89
1.58
1- Price per share as reported in yahoo finance on 11/3/04.
2- Sales per share estimated for current year.
3- Calculated by (price per share)/(sales per share)
4- Average of competitor’s P/S ratio excluding SBC.
5- Average of competitor’s P/S ratio times SBC’s sales per share.
51
Discounted Dividends
Ke
Growth
0
0.01
0.03
0.05
0.04
20.92
25.29
59.95
n/a
0.05
17.83
20.21
32.14
n/a
0.07
14.74
15.7
19.06
29.92
0.09
13.55
14.03
15.45
18.29
The discounted dividends model uses future dividends along with the cost of
equity to determine the estimated value per share. Our estimated price per share, using a
4% cost of equity, came out to be $20.92, which is approximately $5 less then the actual
share price. In performing our “sensitivity analysis” we noticed by throwing in 1% of
growth and keeping our current cost of capital we receive a share price of $25.29, which
successfully captured our current share price of $25.97. Incorporating growth into our
evaluation is an accurate assessment for SBC because of SBC’s recent purchase of
Cingular Wireless and other future purchases that will cause their growth rate to increase.
In turn, we believe that SBC is reasonably valued according to this model.
Discounted Free Cash Flows
WACC
Growth
0
0.01
0.03
0.05
0.04
76.74
100.75
287.95
n/a
0.05
57.62
70.5
134.86
n/a
0.07
35.23
40.4
58.5
112.82
0.09
22.93
25.49
33.15
48.47
The discounted free cash flows valuation uses the WACC in order to determine
the company’s intrinsic value per share. This is the only valuation model that uses the
WACC, which makes it more subject to variation then the other methods. Because of our
company’s beta being so close to 1 (.759), we basically followed what the market was
providing for returns. Also since our cost of capital was so low (4%), our WACC was
also considerably low. This, in turn, gave our evaluation an extremely inflated share
value of $76.74 per share, which was mostly due to the very high terminal value derived
from the WACC. After performing our “sensitivity analysis” we were more able to assess
52
the worth of SBC by fluctuating the growth rate and the WACC. With a WACC of 9%
and a growth rate of 1% we came up with a share price of $25.49, which is very close to
our current share price of $25.97. Although, because SBC basically follows market
returns, which are currently, close to 5%, we felt that using a 5% cost of equity would
give us a good assessment of SBC’s value. This would indicate SBC to be a highly
undervalued company.
Discounted Residual Income
Ke
Growth
0
0.01
0.03
0.05
0.04
68.94
83.98
201.26
n/a
0.05
55.39
63.14
101.9
n/a
0.07
39.86
42.7
52.72
82.73
0.11
26.54
27.18
28.95
31.9
The residual income method finds the companies estimated value per share by
using their cost of equity, in relation to their equity. For this model we used SBC’s
published beta (.759) in relation to the market’s return (4.55%) and the risk-free rate
(2.3%) in order to calculate our cost of equity (4%). After doing the valuation we came
up with an estimated value per share of $68.94. This number was approximately double
that of the actual share price. This leads us to believe that SBC is undervalued, but these
results could also be due to the low cost of capital in which was used for the evaluation.
In order to validate our assumption, we performed a “sensitivity analysis” to compare
other possible cost of equity’s and growth rates. After doing this we decided we would
need an 11% cost of equity to reach our current share price. Because this is such a high
cost of equity, and highly unlikely, we can assume that SBC is obviously undervalued
after looking at the other, more reasonably lower, cost of equity’s and growth rates.
53
Abnormal Earning Growth
Ke
Growth
0
0.01
0.03
0.05
0.04
107.87
144.52
431.93
n/a
0.05
59.58
74.3
147.91
n/a
0.07
21.92
25.5
38
75.52
0.09
9.2
10.31
13.65
20.31
The AEG model uses intrinsic valuation base upon the fact that dividends paid
will be re-invested at the current cost of equity. Although for our evaluation, most
investors would probably pass up this opportunity because our cost of equity is so low
(4%). We faced another major problem in computing the terminal value. Because of the
low cost of equity, the terminal value was calculated to be almost $100. This gave us an
overall share price of $107.87 per share which is almost 400% of the actual share price.
By comparing other reasonable cost of equity’s and growth rates we were more able to
determine the true value of SBC’s share price. After performing our “sensitivity analysis”
we would need a cost of equity of 7% and a 1% growth rate in order to reach our current
share price. We now believe that SBC is still undervalued according to the more
appropriate growth rates and cost of equity’s.
Long Run average residual income perpetuity based on the P/B ratio
Growth
Ke
0
0.01
0.03
0.05
0.04
61.33
78.05
n/a
n/a
0.05
58.54
49.06
105.93
n/a
0.07
11.12
39.03
52.96
94.78
0.1
11.03
26.02
30.26
37.91
This analysis is considered a perpetuity that converges to the residual income
model. We intrinsically found this by taking SBC’s p/b ratio and compared it to their long
run perpetuity in order to estimate the share price. We used 11.15 for our BE per share
and an ROE of .22. According to our estimated cost of capital (4%), SBC’s share price
should be $61.33. This indicates that SBC is highly undervalued. Although because there
are some limitations in computing cost of equity and determining the growth rate of SBC,
we performed a “sensitivity analysis” which will vary these two factors. In order to
54
capture our most recent share price we would need a 10% cost of equity and a 1% growth
rate. After examining our analysis we felt it to be more appropriate to use the “lower”
cost of equity’s when trying to get an accurate estimate for SBC. This is because they are
closer to our computed rate as well as closer to the market rates, which leads us to believe
that SBC is an undervalued company.
55
Discussion and Summary of Valuation Results
Our overall assessment indicates that SBC is currently being undervalued in the
marketplace. In order to determine this we used two different types of analyses. The
method of comparables, which uses the industry averages for the p/b, p/e, d/p, and p/s
ratios to come up with a reasonable market price for SBC as well as, various intrinsic
valuation methods, which included the discounted dividends model, the discounted cash
flows model, the residual income model, the abnormal earnings growth model, and the
long-run average residual income model. Although all of these methods and models used
in our evaluation determined an estimated share price, the factors going into those models
did differ. This causes us to determine those models that, we believe, best assess SBC’s
value as a whole. After running a “sensitivity analysis” on our intrinsic valuation models,
excluding discounted dividends, we found that by simply adding a growth rate or
increasing our company’s cost of equity by 3%-4% would bring SBC’s estimated stock
price to around the level of the its current stock price. This gave us a more accurate look
at our company, as well as, helped us to determine an accurate share price. As for the
different comparables methods, the most accurate for us was the market-book ratio which
gave us an estimated share price of $23.26 compared to the actual share price of $25.97.
In fact, the dividend yield method was fairly accurate also, resulting in an expected share
value of $20.16. These different methods performed well and helped us more accurately
determine what we believe to be an accurate share price.
As far as our intrinsic valuations are concerned, overall they show that SBC is
currently undervalued. Four of our five methods, including discounted free cash flows,
residual income, abnormal earnings growth, and long-run average residual income valued
SBC at an average of roughly $67 per share. This value is a quite high and is due to the
bad market return in the economy, which causes our cost of equity and WACC to
decrease dramatically. With only a 2%-4% increase in the market rate, our estimated
valuations of SBC using these four methods would be greatly improved and very close to
SBC’s actual value per share. On the other hand, the method of comparables seemed to
show that the actual value per share of SBC is slightly overvalued with an average of
56
approximately $23 per share. Although, we feel that using the intrinsic valuations give us
a better assessment of SBC because they factor in future earnings, company growth, as
well as varying cost of equity and WACC. In turn, we are confident that SBC is definitely
undervalued, and we recommend a buy on their stock.
There are also many problems that may arise when doing the types of valuations
in which we implemented. First of all, we are basing all of our intrinsic valuations on the
assumption that our forecast information is correct. This is placing a lot of liability on
future earnings, and it is very possible that the market, as well as the industry may
change. Also, when calculating cost of equity and WACC, we saw the availability for
error. For example, because the market was not performing too well in past data, our
market risk premium was rather low. This is a major weakness in our evaluation because
it may give SBC an inflated estimated price per share. Weaknesses aside, performing the
method of comparables, we believe we got a very accurate evaluation of our firm. This is
because there is a smaller margin for error due to the fact that we are comparing
competitor’s data to our own, instead of using forecasted data. Although when we began
doing the intrinsic valuation methods for SBC we felt that our estimates were way off,
but after performing the “sensitivity analysis” we began to see the actual value of the
firm. In doing the “sensitivity analysis” we were able to factor in growth, as well as
change our cost of equity and WACC. By changing these values we were able to factor in
those possibilities that our estimations were incorrect, as well as give our company
growth aspirations. This gave us a better overview of our company and its performance
and, in the end, we were highly confident in saying that SBC is undervalued by looking at
the intrinsic valuations.
57
SBC Z-Score
Working Capital: -292
Retained Earnings: 27,635
EBIT: 10,142
MV of Equity: 38,248
BV of Liabilities: 61,918
Total Assets: 100,166
1.2(-0.0029)
+
1.4(0.2759)
+
3.3(0.1013)
+
0.6(0.6177)
+
1.0(0.4078)
- 0.0035
+
0.3863
+
0.3343
+
0.3706
+
0.4078
1.495 = Z-Score
After using Altman’s Method for calculating the Z-Score for SBC, we found that
SBC has a Z-Score of 1.495. Even though the model states that a value < 1.8 means that
the company is in danger of bankruptcy and is a high credit risk, we feel that they are
somewhat misrepresented by this model. SBC’s current debt rating is “AA” (with a
negative outlook) and may have such a low Z-Score due to the fact that they have a
negative working capital value. This negative value comes from SBC having more
current liabilities (14,260,000) than current assets (13,968,000) due to the fact that SBC
has a significant amount of assets in the intangible assets (894,000) category and not in
inventory. Even though SBC’s Z-Score is just below 1.5 we feel that they are a stronger
company than indicated by the Z-Score model, not in danger of bankruptcy, and give
them a debt rating in the range of “A” – “BBB” due to a weaker demand for telecom
services.
58
Appendix
A-1: Acquisition of AT&T Wireless
A-2: Cumulative Effect of Accounting Changes (as stated in SBC’s financial
statements)
A-3: Beta Calculation
A-4: Income Statement Forecasting and Common Sized Income Statement
A-5: Balance Sheet Forecasting and Cash Flows Forecasting
A-6: Abnormal Earnings Growth Valuation
A-7: Residual Income Valuation
A-8: Discounted Free Cash Flows Valuation
A-9: Discounted Dividends Valuation
A-10: Works Cited
A-0
Acquisition of AT&T Wireless
As of October 26, 2004 Cingular Wireless, a subsidiary of SBC, was approved by the FCC to
buy and merge with competitor AT&T Wireless for $41 billion. This means that Cingular will now
provide service to 46 million people throughout 49 states. With the acquisition, Cingular has now
become the largest cellular provider in the United States, overtaking Verizon who has 40 million
customers. Cingular laid-off 7,000 employees, or 10% of its workforce, in order to consolidate the two
companies and cut costs to be more cost efficient. Cingular’s new Third Generation Service or 3G will
now be implemented quickly and easily throughout their new areas of service, providing quicker, more
reliable service to all of its customers.
A-1
A-2
Date
Dec-98
Jan-99
Feb-99
Mar-99
Apr-99
May-99
Jun-99
Jul-99
Aug-99
Sep-99
Oct-99
Nov-99
Dec-99
Jan-00
Feb-00
Mar-00
Apr-00
May-00
Jun-00
Jul-00
Aug-00
Sep-00
Oct-00
Nov-00
Dec-00
1-Jan
1-Feb
1-Mar
1-Apr
1-May
1-Jun
1-Jul
1-Aug
1-Sep
1-Oct
1-Nov
1-Dec
2-Jan
2-Feb
2-Mar
2-Apr
2-May
2-Jun
2-Jul
2-Aug
2-Sep
2-Oct
2-Nov
2-Dec
3-Jan
3-Feb
3-Mar
3-Apr
3-May
3-Jun
3-Jul
3-Aug
3-Sep
3-Oct
3-Nov
3-Dec
Treasury-5 yr % Treasury-5 yr
(monthly rate)
4.45
4.6
4.91
5.14
5.08
5.44
5.81
5.68
5.84
5.8
6.03
5.97
6.19
6.58
6.68
6.5
6.26
6.69
6.3
6.18
6.06
5.93
5.78
5.7
5.17
4.86
4.89
4.64
4.76
4.93
4.81
4.76
4.57
4.12
3.91
3.97
4.39
4.34
4.3
4.74
4.65
4.49
4.19
3.81
3.29
2.94
2.95
3.05
3.03
3.05
2.9
2.78
2.93
2.52
2.27
2.87
3.37
3.18
3.19
3.29
3.27
vwretd
sprtrn
0.0445
0.046
0.0491
0.0514
0.0508
0.0544
0.0581
0.0568
0.0584
0.058
0.0603
0.0597
0.0619
0.0658
0.0668
0.065
0.0626
0.0669
0.063
0.0618
0.0606
0.0593
0.0578
0.057
0.0517
0.0486
0.0489
0.0464
0.0476
0.0493
0.0481
0.0476
0.0457
0.0412
0.0391
0.0397
0.0439
0.0434
0.043
0.0474
0.0465
0.0449
0.0419
0.0381
0.0329
0.0294
0.0295
0.0305
0.0303
0.0305
0.029
0.0278
0.0293
0.0252
0.0227
0.0287
0.0337
0.0318
0.0319
0.0329
0.0327
0.0631
0.0385
-0.0381
0.0381
0.0489
-0.0207
0.0511
-0.0305
-0.01
-0.0226
0.0621
0.037
0.084
-0.0396
0.0319
0.0539
-0.0597
-0.039
0.0516
-0.0172
0.0763
-0.0514
-0.0246
-0.1031
0.0196
0.0396
-0.0994
-0.0702
0.0842
0.0106
-0.0173
-0.0182
-0.0596
-0.0916
0.028
0.0788
0.0179
-0.016
-0.0221
0.0446
-0.0497
-0.0109
-0.0705
0.0811
0.0077
-0.0998
0.0745
0.0613
-0.0534
-0.0231
-0.0152
0.0103
0.0825
0.0631
0.0164
0.023
0.0254
-0.0093
0.0602
0.0165
0.0455
0.0564
0.041
-0.0323
0.0388
0.0379
-0.025
0.0544
-0.0321
-0.0063
-0.0286
0.0625
0.0191
0.0578
-0.0509
-0.0201
0.0967
-0.0308
-0.0219
0.0239
-0.0631
0.0607
-0.0535
-0.005
-0.0801
0.0041
0.0346
-0.0923
-0.0642
0.0768
0.0051
-0.025
-0.0108
-0.0641
-0.0817
0.0181
0.0752
0.0076
-0.0156
-0.0208
0.0367
-0.0614
-0.0091
-0.0725
-0.079
0.0049
-0.11
0.0864
0.0571
-0.0603
-0.0274
-0.017
0.0084
0.081
0.0509
0.0113
0.0162
0.0179
-0.0119
0.055
0.0071
0.0508
int
0.0055
R^2
0.0133009
t-test
0.226018
Firm Return Excess Return
0.0114
-0.0173
-0.1206
0.1872
-0.0796
0.1345
-0.0108
-0.1554
0.0678
0.0368
-0.0021
-0.0739
-0.1204
-0.115
0.116
0.0399
0.0019
0.0071
-0.0327
-0.0138
0.1942
0.1566
-0.0487
-0.1309
0.0126
-0.0096
-0.0644
-0.0816
0.0553
-0.0695
0.1241
-0.0869
0.1518
-0.1912
-0.0135
0.0479
-0.0427
0.0155
-0.0106
-0.1704
0.1104
-0.1105
-0.0931
-0.0981
-0.1876
0.2766
0.1187
-0.0488
-0.0985
-0.1407
-0.0356
0.1645
0.1004
0.0035
-0.0857
-0.0264
-0.0093
0.0778
-0.0173
0.1198
-0.0219
0.0119
-0.005
-0.0814
-0.0126
-0.0129
-0.0794
-0.0037
-0.0889
-0.0647
-0.0866
0.0022
-0.0406
-0.0041
-0.1167
-0.0869
0.0317
-0.0934
-0.0888
-0.0391
-0.1249
0.0001
-0.1128
-0.0628
-0.1371
-0.0476
-0.014
-0.1412
-0.1106
0.0292
-0.0442
-0.0731
-0.0584
-0.1098
-0.1229
-0.021
0.0355
-0.0363
-0.059
-0.0638
-0.0107
-0.1079
-0.054
-0.1144
-0.1171
-0.028
-0.1394
0.0569
0.0266
-0.0906
-0.0579
-0.046
-0.0194
0.0517
0.0257
-0.0114
-0.0125
-0.0158
-0.0437
0.0231
-0.0258
0.0181
A-3
Income Statement Forecasting
Dollars in millions except for per share amounts
Historical Values
Operating Revenue
Forecasted Values
1999
2000
2001
2002
2003
49,531.00
51,476.00
45,908.00
43,138.00
40,843.00
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
39,107.17 37,875.30 37,307.17 38,146.58 39,481.71 41,021.50 42,867.46 44,903.67 47,261.11 49,860.47
Cost of Sales
29,380.00
30,985.00
16,940.00
16,362.00
16,653.00
15,067.99 14,593.35 14,374.45 14,697.88 15,212.30 15,805.58 16,516.83 17,301.38 18,209.71 19,211.24
Gross Profit
20,151.00
20,491.00
28,968.00
26,776.00
24,190.00
24,039.18 23,281.94 22,932.72 23,448.70 24,269.41 25,215.91 26,350.63 27,602.28 29,051.40 30,649.23
S, G, and A Expense
*n/a
*n/a
9,383.00
9,575.00
9,851.00
9,603.00
9,603.00
9,603.00
9,647.00
9,661.40
9,623.48
9,627.58
9,632.49
9,638.39
9,636.67
Depreciation and Amortization
8,553.00
9,748.00
9,077.00
8,578.00
7,870.00
8,765.20
8,807.64
8,619.57
8,528.08
8,518.10
8,647.72
8,624.22
8,587.54
8,581.13
8,591.74
Total Operating Expenses
37,933.00
40,733.00
35,400.00 $34,515.00
34,374.00
33,436.19 33,003.99 32,597.02 32,872.96 33,391.80 34,076.78 34,768.63 35,521.41 36,429.23 37,439.65
Operating Income
11,598.00
10,743.00
10,508.00
8,623.00
6,469.00
5,670.98
4,871.30
4,710.15
5,273.62
6,089.91
6,944.72
8,098.83
9,382.26
10,831.88 12,420.82
Nonoperating Expense
1,430.00
1,592.00
1,599.00
1,382.00
1,241.00
1,448.80
1,452.56
1,424.67
1,389.81
1,391.37
1,421.44
1,415.97
1,408.65
1,405.45
1,408.58
Nonoperating Income
685.00
3,737.00
2,041.00
3,216.00
3,673.00
2,670.40
3,067.48
2,933.58
3,112.09
3,091.31
2,974.97
3,035.89
3,029.57
3,048.76
3,036.10
Income Before Taxes
10,853.00
12,888.00
10,950.00
10,457.00
8,901.00
6,892.58
6,486.22
6,219.05
6,995.90
7,789.85
8,498.25
9,718.75
11,003.17 12,475.20 14,048.35
Income Tax
4,280.00
4,921.00
3,942.00
2,984.00
2,930.00
2,413.78
2,271.48
2,177.91
2,449.97
2,728.01
2,976.09
3,403.51
3,853.31
4,368.82
Extraordinary Item
1,379.00
n/a
n/a
n/a
-7.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
207.00
n/a
n/a
-1,820.00
2,541.00
360.50
360.50
360.50
360.50
796.60
447.72
465.16
486.10
511.22
541.36
Cumulative effect of acct. changes
Net Income
4,919.73
8,159.00
7,967.00
7,008.00
5,653.00
8,505.00
4,839.30
4,575.25
4,401.64
4,906.44
5,858.44
5,969.88
6,780.41
7,635.96
8,617.60
9,669.98
EPS (net)
$2.39
$2.35
$2.08
$1.70
$2.56
$1.45
$1.37
$1.32
$1.47
$1.76
$1.79
$2.03
$2.29
$2.59
$2.90
Diluted EPS (net)
$2.36
$2.32
$2.07
$1.69
$2.56
$1.45
$1.37
$1.32
$1.47
$1.76
$1.79
$2.03
$2.29
$2.59
$2.90
2002
2003
2004
2005
2006
2007
2010
2011
2012
2013
Common Sized Income Statement
Historical Values
1999
Revenue Growth
2000
2001
Forecasted Values
2008
2009
% Growth
**7.11%
3.93%
-10.82%
-6.03%
-5.32%
-4.25%
-3.15%
-1.50%
2.25%
3.50%
3.90%
4.50%
4.75%
5.25%
5.50%
Cost of Sales
% Sales
*59.32%
*60.19%
36.90%
37.93%
40.77%
38.53%
38.53%
38.53%
38.53%
38.53%
38.53%
38.53%
38.53%
38.53%
38.53%
Gross Profit Margin
% Sales
40.68%
39.81%
63.10%
62.07%
59.23%
61.47%
61.47%
61.47%
61.47%
61.47%
61.47%
61.47%
61.47%
61.47%
61.47%
S, G, and A Expense
% Sales
n/a
n/a
20.44%
22.20%
24.12%
24.56%
25.35%
25.74%
25.29%
24.47%
23.46%
22.46%
21.45%
20.39%
19.33%
Depreciation and Amortization
% Sales
17.27%
18.94%
19.77%
19.89%
19.27%
22.41%
23.25%
23.10%
22.36%
21.57%
21.08%
20.12%
19.12%
18.16%
17.23%
Total Operating Expenses
% Sales
76.58%
79.13%
77.11%
80.01%
84.16%
85.50%
87.14%
87.37%
86.18%
84.58%
83.07%
81.11%
79.11%
77.08%
75.09%
Operating Margin
% Sales
23.42%
20.87%
22.89%
19.99%
15.84%
14.50%
12.86%
12.63%
13.82%
15.42%
16.93%
18.89%
20.89%
22.92%
24.91%
Nonoperating Expense
% Sales
2.89%
3.09%
3.48%
3.20%
3.04%
3.70%
3.84%
3.82%
3.64%
3.52%
3.47%
3.30%
3.14%
2.97%
2.83%
Nonoperating Income
% Sales
1.38%
7.26%
4.45%
7.46%
8.99%
6.83%
8.10%
7.86%
8.16%
7.83%
7.25%
7.08%
6.75%
6.45%
6.09%
Income Before Taxes
% Sales
21.91%
25.04%
23.85%
24.24%
21.79%
17.62%
17.13%
16.67%
18.34%
19.73%
20.72%
22.67%
24.50%
26.40%
28.18%
% IBT
39.44%
38.18%
36.00%
28.54%
32.92%
35.02%
35.02%
35.02%
35.02%
35.02%
35.02%
35.02%
35.02%
35.02%
35.02%
% Sales
16.47%
15.48%
15.27%
13.10%
20.82%
12.37%
12.08%
11.80%
12.86%
14.84%
14.55%
15.82%
17.01%
18.23%
19.39%
Income Taxes
Net Income
A-4
Balance Sheet Forecasting
Dollars in millions
Historical Values
Assets
Forecasted Values
1999
2000
2001
2002
2003
2004
2005
2006
2007
Current Assets
11,930.00
23,216.00
12,580.00
14,089.00
13,968.00
15,156.60 15,801.92 14,319.10 14,666.92 14,782.51 14,945.41 14,903.17 14,723.42 14,804.29 14,831.76
2008
2009
2010
2011
2012
2013
Long Term Assets
71,285.00
75,435.00
83,742.00
80,968.00
86,198.00
79,525.60 81,173.72 82,321.46 82,037.36 82,251.23 81,461.87 81,849.13 81,984.21 81,916.76 81,892.64
Total Assets
83,215.00
98,651.00
96,322.00
95,057.00
100,166.00 94,682.20 96,975.64 96,640.57 96,704.28 97,033.74 96,407.29 96,752.30 96,707.64 96,721.05 96,724.40
Current Liabilities
19,313.00
30,357.00
23,948.00
14,683.00
14,260.00
20,512.20 20,752.04 18,831.05 17,807.66 18,432.59 19,267.11 19,018.09 18,671.30 18,639.35 18,805.69
Long Term Liabilities***
37,176.00
37,831.00
39,883.00
47,175.00
47,658.00
41,944.60 42,898.32 43,911.78 44,717.54 44,226.05 43,539.66 43,858.67 44,050.74 44,078.53 43,950.73
Total Liabilities
56,489.00
68,188.00
63,831.00
61,858.00
61,918.00
62,456.80 63,650.36 62,742.83 62,525.20 62,658.64 62,806.77 62,876.76 62,722.04 62,717.88 62,756.42
Total Shareholders' Equity
26,726.00
30,463.00
32,491.00
33,199.00
38,248.00
32,225.40 33,325.28 33,897.74 34,179.08 34,375.10 33,600.52 33,875.54 33,985.60 34,003.17 33,967.99
Total Liabilities and Shareholders' Equity
83,215.00
98,651.00
96,322.00
95,057.00
100,166.00 94,682.20 96,975.64 96,640.57 96,704.28 97,033.74 96,407.29 96,752.30 96,707.64 96,721.05 96,724.40
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
8,159.00
7,967.00
7,008.00
5,653.00
8,505.00
4,839.30
4,575.25
4,401.64
4,906.44
5,858.44
5,969.88
6,780.41
7,635.96
8,617.60
9,669.98
7,224.28
7,402.74
7,323.88
6,877.26
7,250.31
7,215.69
7,213.98
7,176.23
7,146.69
Liabilities and Shareholders' Equity
Cash Flows Forecasting
Dollars in millions
Historical Values
Net Income
Forecasted Values
Adjustments to reconcile net income to net
cash provided by operating activities
Total adjustments
8,419.00
6,332.00
7,797.00
9,557.00
5,012.00
7,423.40
Net Cash from Operating Activities
16,578.00
14,299.00
14,805.00
15,210.00
13,517.00
12,262.70 11,799.53 11,804.38 12,230.32 12,735.70 13,220.19 13,996.10 14,849.93 15,793.83 16,816.67
Net Cash from Investing Activities
-10,577.00
-14,403.00
-8,387.00
-3,328.00
-3,105.00
-3,105.00
-3,105.00
-3,105.00
-3,105.00
-3,105.00
-3,105.00
-3,105.00
-3,105.00
-3,105.00
-3,105.00
Net Cash from Financing Activities
-6,105.00
252.00
-6,358.00
-9,018.00
-9,173.00
-8,183.00
-8,183.00
-8,183.00
-8,183.00
-8,183.00
-8,183.00
-8,183.00
-8,183.00
-8,183.00
-8,183.00
-104.00
148.00
60.00
2,864.00
1,239.00
974.70
511.53
516.38
942.32
1,447.70
1,932.19
2,708.10
3,561.93
4,505.83
5,528.67
$1.41
$1.08
$1.03
$1.02
$0.10
$0.93
$0.83
$0.78
$0.73
$0.67
$0.79
$0.76
$0.74
$0.74
$0.74
Free Cash Flow
Dividends Paid (per common share)
A-5
Abnormal Earnings Growth
Ke
Growth
EPS
DPS
DPS invested at 4%
Cum-Dividend Earnings
Normal Earnings
Abnormal Earning Growth (AEG)
Present Value Factor
PV of AEG
Total PV of AEG
Continuing (Terminal) Value
PV of Terminal Value
Capitalization Rate (perpetuity)
Estimated PPS (as of 11/1/04)
Actual Value Per Share
0.04
0.00
0
2004
1.45
0.93
1
2005
1.37
0.83
0.04
1.41
1.51
-0.10
2
2006
1.32
0.78
0.03
1.35
1.42
-0.07
3
2007
1.47
0.73
0.03
1.50
1.37
0.13
4
2008
1.76
0.67
0.03
1.79
1.53
0.26
5
2009
1.79
0.79
0.03
1.82
1.83
-0.01
6
2010
2.03
0.76
0.03
2.06
1.86
0.20
7
2011
2.29
0.74
0.03
2.32
2.11
0.21
8
2012
2.59
0.74
0.03
2.62
2.38
0.24
9
2013
2.90
0.74
0.03
2.93
2.69
0.24
1.00
0.00
0.96
-0.10
0.92
-0.07
0.88
0.11
0.85
0.22
0.82
-0.01
0.79
0.16
0.75
0.16
0.73
0.17
0.70
0.16
0.81
5.90
4.12
102.94
107.87
25.97
A-6
Residual Income
Ke
Growth
Beginning BE(per share)
EPS
DPS
Ending BE (per share)
0.04
0
0
2004
0.80
1.45
0.93
1.32
1
2005
1.32
1.37
0.83
1.86
2
2006
1.86
1.32
0.78
2.40
3
2007
2.40
1.47
0.73
3.14
4
2008
3.14
1.76
0.67
4.23
5
2009
4.23
1.79
0.79
5.23
6
2010
5.23
2.03
0.76
6.50
7
2011
6.50
2.29
0.74
8.05
8
2012
8.05
2.59
0.74
9.90
9
2013
9.90
2.90
0.74
12.06
"Normal Income"
Residual Income
0.03
1.42
0.05
1.32
0.07
1.25
0.10
1.37
0.13
1.63
0.17
1.62
0.21
1.82
0.26
2.03
0.32
2.27
0.40
2.50
Present Value Factor
Present Value of RI
1.00
1.42
0.96
1.26
0.92
1.14
0.88
1.21
0.85
1.39
0.82
1.32
0.79
1.43
0.75
1.53
0.73
1.65
0.70
1.75
t
BV Equity (per share)
Total PV of RI
Continuation Value
PV of Terminal Value
Estimated PPS (as of 11/1/04)
11.15
14.10
62.60
43.69
68.94
Actual Value Per Share
25.97
A-7
Discounted Free Cash Flows
WACC
Growth
Cash Flow from Operations
Cash Provided by Investing Activities
Free Cash Flow (to firm)
Present Value Factor
Present Value of Free Cash Flows
Total PV of Annual Cash Flows
Continuing Value (Assuming no growth)
PV of Continuing Value
Value of Firm
BV of Debt and Preferred Stock
Value of Equity
Shares Outstanding
Estimated PPS (as of 11/1/04)
Actual Price Per Share
0.04
0
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
12262.70 11799.53 11804.38 12230.32 12735.70 13220.19 13996.10 14849.93 15793.83 16816.67
-3105.00 -3105.00 -3105.00 -3105.00 -3105.00 -3105.00 -3105.00 -3105.00 -3105.00 -3105.00
9157.70
8694.53
8699.38
9125.32
9630.70 10115.19 10891.10 11744.93 12688.83 13711.67
1.00
9157.70
0.96
8304.57
0.92
7989.61
0.88
8058.47
86142.39
342791.72
239240.45
325382.83
61918.00
263464.83
3433.00
76.74
25.97
A-8
0.85
8177.66
0.82
8258.70
0.79
8550.20
0.75
8865.87
0.73
9209.99
0.70
9569.62
Discounted Dividends
Ke
Growth
0.04
0
EPS
DPS
BPS
0
2004
0.00
1.45
0.93
0.52
1
2005
0.52
1.37
0.83
1.06
2
2006
1.06
1.32
0.78
1.60
3
2007
1.60
1.47
0.73
2.34
4
2008
2.34
1.76
0.67
3.43
5
2009
3.43
1.79
0.79
4.43
6
2010
4.43
2.03
0.76
5.70
7
2011
5.70
2.29
0.74
7.25
8
2012
7.25
2.59
0.74
9.10
9
2013
9.10
2.90
0.74
11.26
Present Value Factor
PV Dividends
1.00
0.83
0.96
0.82
0.92
0.79
0.88
0.76
0.85
0.93
0.82
0.93
0.79
0.94
0.75
0.98
0.73
1.02
0.70
0.00
Sum of DD
8.00
TV of Dividend
PV of TV
Estimated PPS (as of 11/1/04)
18.50
12.91
20.92
Actual PPS
25.97
A-9
Works Cited
1) AT&T Annual Report, Management Discussion and Analysis, 2003.
2) Bernstein Research Call, The RBOC’s: Defining the Wireline Cost Management
Challenge, 5/28/04.
3) MCI Inc. Annual Report, Management Discussion and Analysis, 2003.
4) SBC Communication Inc. Annual Report, Management Discussion and Analysis,
2003.
5) The San Antonio Business Journal, www.bizjournal.com, 8/16/03.
6) The SBC Website, www.sbc.com, 9/19/04-12/05/04.
7) The Ferrago Website, http://www.ferrago.com/portal/cluster/56585, 12/05/04.
8) Yahoo Finance, http://finance.yahoo.com, 11/03/04.
A-10