Satellite Truck Rental Company to File Chapter 11

Case Type: operations strategy; new product, new technology.
Consulting Firm: Simon-Kucher & Partners (SKP) first round full time job interview.
Industry Coverage: telecommunications, network.

Case Interview Question #01164: A satellite truck is a mobile communications satellite earth station, typically mounted on a truck chassis as a platform. They are used for remote television broadcasts, to transmit the video signal back to the studio or production facility for editing and broadcast. A satellite truck has a large satellite dish antenna which is pointed at a communications satellite, which relays the signal back down to the studio. Satellite communication allows transmission from any location that the production truck can reach, provided a line of sight (direct view) to the desired satellite is available.

It’s the early 2000′s. Our client is a telecommunication company that operates 46 satellite TV broadcast trucks in the United States. These satellite trucks are rented to broadcasting companies like ESPN, CNN, Fox, ABC, NBC, CBS, etc. Currently all of the trucks broadcast in standard definition (SD). The conversion to High-definition (HD) is coming soon. Should the company build new HD trucks? Why or why not?

Also, the client company owes $120M in debt, coming due in 3 years. The debt must be covered by new cash flows.

Possible Answers:

1. Suggested Framework

* HD market entry strategy
– Upgrading existing trucks/Acquiring new trucks
– Customer base, competition
– Cash flow calculations and NPV.

* SD market possibilities
– Market projections
– Cash flow calculations

* Other options
– Acquisition, merger, filing Chapter 11.

2. Information Gathering

Additional Information: (to give to candidates if asked)

* Customers like ESPN are definitely moving to HD. The conversion to HD will happen quickly.
* SD trucks cannot be converted to HD.
* SD trucks rent for $3,000-$4,000/day, used to be $9,000/day five years ago. Same decrease will happen for HD, and quickly.
* SD trucks will rent for $1,000/day after HD transition.
* HD trucks will rent for $9,000/day.
* HD and SD trucks cost $700/day to operate, nothing when not operating.
* HD trucks cost $7M each, delivery would be in 12 to 18 months.
* The client would need to make as many HD trucks as we already have (46).
* Utilization – lots of idle time (events on weekends, transport time).
* Realistic utilization is 100-120 days/year.
* Trucks last either 6, 7, 8, or 9 years (it is more likely to fail earlier).

3. Detailed Analysis

Note: Assumptions used for calculations here are very liberal. The interviewee can arrive at solution correctly with different numbers, as long as the assumptions are reasonable.

(1) Goals

The client company’s two main concerns are:
* Cover the $120M debt payment in 3 years.
* Operate profitably in the medium to long-term.

We have two possibilities to try to stay afloat – (i) continue operating the SD trucks, or (ii) replace the fleet with HD trucks. Look into the two options. Here we’ll take HD trucks first:

(2) HD Fleet Replacement

We’ll do two calculations – cash flows in the first three years, and long-run profitability.

Let’s start with liberal assumptions – HD rental rates will be $9,000/day near term, similar utilization of 120 days per year. We’ll operate SD trucks for 1 year, then switch completely to HD when the new trucks arrive:

* First three years:
– Year 0: buying 46 HD trucks, -$7M * 46 trucks = -$322M
– Year 1 (SD trucks): ($4,000-$700)/day * 120 days * 46 trucks = $18.2M
– Year 2 and 3 (HD trucks): ($9,000-$700)/day * 120 days * 46 trucks = $45.8M

Therefore in 3 years we’ve earned ($18.2 + $45.8 + $45.8) = $109.8M, but we owe $120M + $322M = $442M. Even with the liberal assumptions we can’t even cover the initial debt. But let’s say we can sell the SD trucks for at least $0.5M each and finance the new HD trucks long term so that we can cover the original debt payment (again, very liberal assumptions).

* Long-term profitability:
Use the information that trucks last 6-9 years to calculate profitability. We’ll assume trucks last 7 years on average, and that HD rental rates drop to $4,000/day. Then, for one HD truck:

Without discounting: Profit = -$7M + ($4,000-$700)/day * 120 days/year * 7 years = -$4.23M

This looks bad, and note that even if the rate stayed at $9,000 you won’t cover the purchase price:
Profit = -$7M + ($9,000-$700)/day * 120 days/year * 7 years = -$0.03M

Conclusion: Operating HD trucks is not profitable in the long-term, even if you can cover the debt payment, which itself is unlikely.

(3) SD Truck Operation

So, if HD trucks can’t cover the debt, can we cover the debt just by continuing operation of our SD trucks?

From the calculation above, each year operating the SD trucks earns $18.2M, so after three years you are still short (-$120 + $18.2 * 3) = -$65.4M

(4) Other Options

Since neither option appears viable, what else can we look at? If the assets cover the debt and the business is cash flow-positive we can look to be acquired or use Chapter 11 to hold off and restructure debt payments. If not, we go out of business.

Do assets cover outstanding debt? We can value the trucks based on remaining operational life. Assume our SD trucks are on average 3.5 years old and the trucks can last 7 years. So, there are 3.5 years remaining.

Value of Truck Fleet = ($4,000-$700)/day * 120 days * 3.5 years * 46 trucks = $64M

So, we can’t cover the debt without buying new trucks. Buying HD trucks is not profitable, and we can assume that buying SD trucks will not be profitable in the future due to declining rental rates. It seems like the only option is to liquidate.

4. Summary of Case Analysis

* HD operation is not profitable in the long-term.
* SD operation can not cover initial debt payment.
* Restructuring the debt won’t be enough, so the only option is to liquidate.