Investment Appraisal Tools

Investment seems to be more concerned in the business world nowadays. There are not only entrepreneurs and SMEs searching for investments, but also big firms. They (including investors and investees) seek for investments with a similar principal purpose of enlarging capitals. Naturally, investments come along with risks (may be high or low), which are mostly for investors. The measurement of risk level depends on many elements such as types of projects, time, amount of investment, environment factors and so on. Of them, some can be statistically calculated, while some, mostly considered as unexpected factors, cannot. Then again, high risk investments are those without thorough preparation in advance.

There are many tools investors can use to estimate risks and mainly, to calculate effectiveness and potential returns/rates of return of investments/assets. The investment appraisals techniques, in theory, include Payback period, Accounting Rate of Return (ARR), Net Present Value (NPV), Internal Rate of Return (IRR), Equivalent Annual Cost (EAC), Profitability Index and Discounted Cash Flow (DCF). Of those, NPV and DCF are most mentioned as they show more concerns and effects of elements and factors involved in. These two are also used commonly in practice to assess whether projects are worth investing. This has really contributed to number of successful investments since preparation and planning can help investors to forecast potential risks so as to avoid them, and to produce adequate budgets.

On the other hand, there are existing shortcomings which limit the precision of investors’ estimation. Ritter and Kim (1999) outlined three main inadequacies of DCF identified which are difficulty to estimate future cash flows, to select an appropriate discount rate and to choose suitable and excellent proxy peers group average unlevered beta. These are disadvantages of DCF in term of implementation. In another study, NPV and DCF are believed to restraint strategic decisions and good opportunities (Christensen, Kaufman and Shih, 2008). Investors depends too much on the use of assessment tools, so sometimes, they miss potentially lucrative deals or seriously suffer unexpected risks. For example, investors normally hesitate to place money in poor and developing countries’ projects due to their low rate of return, chance of success and, mayhap, high risks, whereas prefer already successful objects. When unexpected crisis occurs, the later has more possibility to suffer loss due to its wider range of business link. We can take 2008’s crisis as practically representative example. And recently, Japanese’s disasters are considered as unexpected matter leading to sudden losses. It is obvious that we cannot foresee what is going to happen, so all estimations are just relative. Investors, as a result, ought to be flexible rather than dependable on calculations.

Effects of Credit Crunch

It can be said that ‘credit crunch’ has one of the most concerned issue to discuss since it broke out in September 2008 because of its seriousness and impacts on recent business world. The financial crisis started from the failure and bankruptcy of financial institutions in US due to sub-prime mortgage crisis. As domino effect, the crisis spread globally and has caused catastrophes to many economies up until these days.

As a huge number of companies went bankrupt, unemployment has become one of the most serious long-term consequences of 2008’s crisis. This problem, in addition, cannot be solved in short time. That is why after the crisis, the unemployment rates in some countries have not stopped increasing until now. Prominently, according to the Wall Street Journal on 17 March 2011, Spain hits the first place in unemployment rate chart of euro-zone at 20.4% which doubled the euro-zone average.

Unemployment rate of Spain 1988 - Jan 2011 (Source: Eurostat)

One of the reasons, identified on guardian.co.uk, is that Spain has depended too much on housing market, especially bricks, to grow the economy rather than developing different models. When the financial crisis occurred, the drawbacks were clearer and started to leverage.

Another consequence of financial crisis is the monetary problems and threats of rising inflation rate. These two issues were also discussed in previous blog posts. We all recognized that when remarkable financial crunches occur, the production costs will increase because of the growth in demand. In Cost Push theory, by this, inflation rate starts to rise. It does not necessarily mean that credit crunch cause inflation, but its consequences may. Due to recent escalation in costs of oil, gas and electricity, euro-zone is facing the highest level of inflation ever of 2.4% in February since October 2008. In order to lower the inflation rate, it is necessary to reduce the demand of spending. One of the most effective policies which may have immediate influence is setting higher interest rate. This is what Bank of England did to control the inflation when the credit crunch occurred. The policy has also been deeply recognized by European Central Bank (ECB). The interest rate is said to be increased in April (by Jean-Claude Trichet, a President of ECB) from its very low 1% rate which was last from 2009. This can be seen as direct solution for this dilemma, but it might not work proficiently in long-term or when supply still cannot cover demand even in possible increased rate.

Cumulus Media gets the deal to acquire Citadel Broadcasting

Hitting the news in US this week is one of the most prominent M&A activities of Cumulus Media (big radio company) and Citadel Broadcasting which is said to be a “meaningful activity” ever over the last three years by Bishop Cheen (an analyst in Wells Fargo Securities). With the total acquisition cost of roughly US$ 2.4 billion, this agreement could be “the biggest deal in years” (as titled in RadioWorld on 11 March 2011).

After more than 4 months of negotiation, Lew Dickey (Cumulus’s Chairman and CEO) finally had a deal at price of US$37/share which, according to some law firms, is a undervalued offer and unfair for Citadel shareholders. In possibility, easily accepting the offer leads to opinion that whether shareholders are cheated. That is why BODs of Citadel are investigated (by The Law Office of Vincent Wong) for breaches of fiduciary duty and other violations of state law (Business Wire, 2011). On the other hand, let’s take optimistic view, around the time of Cumulus’s announcement (on 23 February) to merge with Citadel, the share price of Citadel fluctuated from US$33.5 to US$34.75 and it has continued to increase from US$33.8 (on 3 March) to US$35.15 (on 11 March). It means that Citadel absolutely gained profits/benefits from the offer of US$37/share. From this point of view, this is really a good and advantageous transaction for Citadel, and Cumulus as well (because it helps to enlarge the size of this giant radio).

Citadel's share price movement on 22 February, 2011 (Source: Bloomberg, 2011)

Citadel's share price movement on 3 March, 2011 (Source: Bloomberg, 2011)

Citadel's share price movement on 11 March, 2011 (Source: Bloomberg, 2011)

After more than 4 months of negotiation, Lew Dickey (Cumulus’s Chairman and CEO) finally had a deal at price of US$37/share which, according to some law firms, is a undervalued offer and unfair for Citadel shareholders. In possibility, easily accepting the offer leads to opinion that whether shareholders are cheated. That is why BODs of Citadel are investigated (by The Law Office of Vincent Wong) for breaches of fiduciary duty and other violations of state law (Business Wire, 2011). On the other hand, let’s take optimistic view, around the time of Cumulus’s announcement (on 23 February) to merge with Citadel, the share price of Citadel fluctuated from US$33.5 to US$34.75 and it has continued to increase from US$33.8 (on 3 March) to US$35.15 (on 11 March). It means that Citadel absolutely gained profits/benefits from the offer of US$37/share. From this point of view, this is really a good and advantageous transaction for Citadel, and Cumulus as well (because it helps to enlarge the size of this giant radio).

As stated by Lew Dickey, the combination between two companies can boost Cumulus’ financial capability and national scope in order to advance the technology and contents. In theory, M&A activities can cause serious problems when it results in monopoly or anti-competitive practices that one firm gain strong market power from M&A activities (Gaughan, 2005). Recalling the case of Yahoo! and Google in 2008, their partnerships agreement covered up to 90% of the internet search advertising market and finally, had to be ended after 4 months. Maybe, this is what many analysts are worrying about in the case of Cumulus and Citadel when they potentially own 572 stations in more or less 120 markets of which 8 are in top 10. The Motley Fool is one of those having uncertain view of this deal, saying that investors should not buy radio stocks as “Radio is dead”, “Cumulus also plans to rearrange the deck chairs on the Titanic” and “terrestrial radio will never be the same” (stated in RadioWorld on 11 March 2011). However, toward the development of technology, the merger is necessary to develop radio broadcasting industry so as to compete against internet, satellite broadcasting and handsets (as Moody’s Investors Service identified in a client note). Despite raising lawsuit notifications, this merger is, up to this point, receiving many backings from two firms’ stockholders and financial institutions leaving the good sign of potential success.