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Iridium Writeup
Iridium Writeup
FINC - 442 Antonio Ascar, Carolina Camargo, Daniel Loureiro, Daniel Medeiros,
Jean Paul Cordahi and Larissa Mattos
Problem Statement
Iridium LLC is a $5.5 billion venture backed by Motorola that offers global phone, fax and paging services via satellite. They
operate in a fairly new and growing segment of telecommunications. Barriers to entry are considerably high, but they are still
facing some competition from both established and upcoming companies. There a number of strategic decisions to be made in
this capital-intensive industry, such as capital structure, technology to be used, distribution and marketing strategy. According to
Iridiums own management, they managed to get everything wrong, from technological glitches and management turnover to
marketing and distribution mishaps. These errors led the company to file for bankruptcy in August of 1999, only one year after
they launched the new service in a $140 million advertising campaign.
1
Financial Decisions Iridium LLC
FINC - 442 Antonio Ascar, Carolina Camargo, Daniel Loureiro, Daniel Medeiros,
Jean Paul Cordahi and Larissa Mattos
Started from the current interest expenses, based on the provided forecasts.
Using a tax rate of 15% we calculated the tax shields and discounted those the same return on debt of 11.3% described
above.
To compute the terminal value of taxes shield we also use growth rate in perpetuity of 5%.
Cost of Financial Distress - COFD: (Exhibit 2)
Probability of default: 55%. Used the probability of a CCC rated company.
Loss given default: 20%. Assumed that the only major loss in case of a default would be the need to sell assets, in which
case a 20% discount should be applied.
COFD = Pr Default * Loss given default * EV
Optimal Leverage Ratio: (Exhibit 3)
We used leverage ratios for each credit rate as on S&P 3-yr medial financial ratios (Exhibit 4).
Probabilities of default for each leverage ratio were estimated based on the equivalent credit rates on Exhibit 4.
Assumed 20% loss given default for all levels of debt/capital ratio. We used APV company valuation to estimate the
enterprise value (EV)
We applied the same D/V ratios used to calculate probability of default and tax rate of 15% in order to compute tax shield
benefits. Tax Shield = EV * D/V * tax rate
We used book enterprise value (EV) of $3.3B for tax shield calculations (EV calculated dividing the total debt $2.85B by
the debt-to-total capital market value 34%)
The cost/benefit trade off of debt was calculated as Tax Shield - COFD, to see where it was maximized.
Analysis
Company valuation:
Iridium has raised substantial debt at different stages, each debt with a different structure, maturity and interest rate. Given the
fluctuations in leverage ratios, we decided to value the firm using the APV method. This will allow us also to better understand
the impact of debt on the companys cash flows.
We started the analysis by computing the free cash flows based on the management estimates described in the case and
additional assumptions presented above. We also calculated the return on equity unlevered in to order to discount those cash
flows and terminal value to present value. The return on equity unlevered used to discount the cash flows was 13.3%. The total
discounted cash flows totalize $23.34B.
Afterwards we calculated companys benefits from debt tax shield. We used managers estimations of interest expenses and its
terminal value to present using return on debt of 11.3%. The total present value of the tax shield benefits is equal to $281M. In
addition to tax shields we calculated the cost of financial distress (COFD) by computing probability of distress (55% for CCC)
and costs on distress (20% of all equity enterprise value). The COFD is equal to $2.57B.
The enterprise value of Iridium as of year-end 1998 assuming the all equity cash flows, the tax shield benefits and cost of
distress is then estimated in $21B.
2
Financial Decisions Iridium LLC
FINC - 442 Antonio Ascar, Carolina Camargo, Daniel Loureiro, Daniel Medeiros,
Jean Paul Cordahi and Larissa Mattos
Recommendation
As we think about Iridiums capital structure we have reasons to believe that it was one of the reasons of companys failure.
Based on our projections, the Cost of Financial distress more than offset the benefits of tax shield, to the point that Iridiums
capital structure was destroying company value at that level. Also, understanding the funding needs of the firm and considering
the advantages and disadvantages of equity issuance, we still believe that managers didnt considered properly the effects of
debt that led the company to bankruptcy. However, Iridiums capital structure was not the only reason for companys failure.
Their overall strategy was based on a number of interdependent deals and variables, and if any of those failed, it would make
the whole business unfeasible. They managed to launch all satellites with a perfect record, but couldnt get through with deals for
service with all targeted local providers across the globe. Their product and services were way off the market average, with big
and expensive phones and exorbitant per minute fees. They made crucial mistakes in their go-to-market strategy, with a huge
advertising campaign, but faulty distribution and customer service. In the end Iridium made mistakes in all aspects of the
business, eventually leading to their bankruptcy.
3
Financial Decisions Iridium LLC
FINC - 442 Antonio Ascar, Carolina Camargo, Daniel Loureiro, Daniel Medeiros,
Jean Paul Cordahi and Larissa Mattos
Exhibits
Exhibit 2: APV
4
Financial Decisions Iridium LLC
FINC - 442 Antonio Ascar, Carolina Camargo, Daniel Loureiro, Daniel Medeiros,
Jean Paul Cordahi and Larissa Mattos
(500)
(1,000)
Tax Shield - COFD
(1,500)
(2,000)
(2,500)
0.0% 20.0% 40.0% 60.0% 80.0% 100.0%