Mba558: Apex Investment Partners Case Project

MBA558: Apex Investment Partners Case Project

Questions & Guidelines

1.        Is AccessLine an attractive investment opportunity for Apex?  Why or Why not?  What are the key risks associated with the investment?

1. How has AccessLine financed itself to date?  Why have they chosen this strategy? Why is Dan Kranzler now considering raising funds from Apex?

1. How attractive are the terms that AccessLine has proposed for the B Series financing?  How does the deal structure address the risks of the investment?  What issues if any should concern Apex?

1. What is an appropriate valuation for AccessLine?  Do analyses using the Venture Capital Method (target discount rate = 60%), the Comparable Companies Method, and the FCFF approach agree with each other?  What do you think of Apex’s analysis?  

1. What does Bolander’s counter-offer look like?  What is different about it? Does this raise still new questions once again?

1. Morgan Stanley’s analysis was based on a Black-Scholes framework, how would you value the warrants using a binomial model?  How does the warrant value change as the prospective date for an IPO changes (the firm could go public as early as 1997, this would make the warrants expire in 2002 rather than 2005)?  How did Morgan Stanley go about assigning a value to the warrant in the B case?  What valuation did they compute?  How might you do it differently?  What valuation do you arrive at? Are Bolander’s criticisms of the Morgan Stanley approach justified?

1. The final agreement called for the terms of Bolander’s proposal except that Apex agreed to pay $16,600,000 for its 2,000,000 shares instead of $16,000,000.  Does this make sense?

Note: Guidelines for warrant calculations on the next page, other hints follow those guidelines.

Guidelines for Calculation of Warrant Values

The purpose of this section is to provide you with some guidance for working through the combined share and warrant valuation.  This will be in the spirit of what I discussed at the end of class on 4/5.

As part of the Apex case analysis you are asked to critique Mr. Bolander’s counter proposal and Morgan Stanley’s criticisms of it.  The proposal on the table involves tacking warrants onto the shares of Accessline (AL) that Apex is considering investing in.  AL’s original proposal asked Apex to pay $16,000,000 for 2 million shares of AL, i.e., $8 per share, while the Series A investors bought in at $7 per share.  Apex is proposing to pay $16,000,000 for 2,000,000 shares PLUS 1,400,000 warrants with X = $10.00/shr (Note: ignore the complications with the exercise price if the warrants are exercised within the next two years). 

Morgan Stanley values the warrants with the Black-Scholes model.  In question (6), I ask you to value the warrants with a binomial model.  Here is how you should proceed:

1. You are trying to value the combination of 1 share + 0.7 warrants and you want the total value of that package to equal $8.  The case suggests that AL might go public in as soon as 2 years, meaning the warrants might expire in as soon as 7 years (or they may run as long as 10 years).  I would like you to construct binomial trees anywhere from 7-10 periods (1 period = 1 year).

1. Since the proposal is for $8 per share and Bolander tries to argue that the warrant value is negligible (you of course know better!), set the initial stock price to $8.  Then construct a tree based on the idea that:

[pic 1]

1. Now value the warrant as a call option on AL shares with X=$10, T = 7, 8, 9, and 10.

1. Next you must account for the fact that each share comes with only 0.7 warrants and you must also account for the fact that these are warrants instead of calls and thus suffer from dilution.  To account for the dilutive effects of the warrants, observe that prior to exercise of the warrants there are 15,229,982 shares of AL outstanding (assuming Apex buys the series B offering).  Ignoring dilution, exercising the 1,400,000 warrants would net you a stake of 1.4/15.229982 = 9.19%.  but in fact, because new shares are issued, your stake will only be 1.4/(15.229982 + 1.4) = 8.42%.  Thus, to adjust for the dilution, multiply you call value by 8.42/9.19 = 0.9162 to account for the dilutive effects of the warrants.

1. Now an example: suppose when you set the AL share price to $8 you estimate a call value of $3 per share.  You need to multiply this by 0.9162 and then by 0.7 to account for the fact that each share comes with 0.7 warrants instead of 1 call option.  This would imply that your estimated value of 0.7 warrants would be $1.924, implying that the combination of 1 share plus 0.7 warrants would be worth $9.924.  You need to adjust the share price until that sum reaches $8.  Then repeat this process for all potential expiration dates of the warrants.  Finally, let me point out to you that the Series A also had warrants tacked on.  You should value those as well.

1. As an additional part of question (6) consider the following: Morgan Stanley valued these warrants as having 10-year maturity and treated them as calls instead of warrants.  Was this simply sloppy or did this work to their advantage to bolster their position as an advocate for AL in this negotiation?

Hints and Other Information for the Apex Case

1. Though the Apex assignment delves into several aspects of the proposed Accessline (AL) transaction, the valuation is by far the most important from our perspective (since this is a valuation class).  Don’t spend a lot of time on peripheral issues unless you are interested in exploring these topics in more detail (e.g., the specifics of the term sheets, etc.)

1. When working through the DCF, relative valuation, and venture capital method portion of the case, the following may be helpful:

1. Though there is a small amount of debt on AL’s balance sheet, you are welcome to assume that AL is 100% equity.
2. Since AL is a privately held company there is no market-based information from which to estimate cost of capital.  In such instances, the norm is to use information from “comparable” companies.  Both 3-COM and BT have data included in the appendix, but I suggest that you use only BT as a comparable.  The 10-yr t-note rate is given in Exhibit 8 (use this for the risk-free rate), and assume a reasonable market risk premium (e.g., 7%).
3. Forecasts of AL’s financials over the next 5 years are given in Footnote #8.  You can fill in any holes with linear interpolation.

1. When working out the warrant valuations, there is information on the volatility of AL in Footnote #3 of the “B” case.  The Appendix of the case assignment details how to deal with the warrant valuation and the sum of the share and warrant.

Christopher Francis

Apex Investment Partners Case Project 

March 17, 2019

AccessLine is attractive due to its service differentiation in a competitive telecommunications industry by pioneering personal communication. AccessLine has proved market penetration and acceptance through strategic partnerships and licenses with major players such as McCaw Cellular and Motorola. The demand for a personal number is also projected to see double digit increases over the next five years. AccessLine has demonstrated its ability to generate positive cash flows and has strong product performance, making it very attractive to investors. The valuation of the firm seems to be at a premium which could pose challenges in the market if participants feel the company is overvalued. Additionally, AccessLine’s competitive advantages are narrow: there is uncertainty surrounding how long the patent will last, most of product volume is from a small customer segment and it is uncertain how long the strategic partnerships will last. Lastly, where AccessLine currently has first mover advantage, competitors have second mover advantage and are not short of funding so threats to AccessLine’s model could increase in the future. Looking at the impact financially, these factors make cash flows very volatile and could limit return or put pressure on the company’s value.