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Analyst Training

Analyst Training

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T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3

Agenda

 Introduction  Trading comparables  Transaction comparables  Discounted cash flow analysis  LBO analysis  Relative value analysis  Merger consequences
– –

Accretion/(dilution) review Pro forma balance sheet analysis review

 Appendix

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T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3

Objectives

 Review the key valuation methodologies and techniques  Review merger consequences / pro-forma analysis including updates due
to recent accounting changes

 Communicate JPMorgan standards  Provide examples and “rules of thumb” to enhance valuation related
intuition and highlight common mistakes

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T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3

Why valuation is important?

Acquisitions How much should we pay to buy the company? Research Should our clients buy, sell or hold positions in a given security?

Divestitures How much should we sell our company/division for? Fairness opinions Is the price offered for our company/division fair (from a financial point of view)?

Valuation
Hostile defense Is our company undervalued/vulnerable to a raider Debt offerings New business presentations Various applications What is the underlying value of the business/assets against which debt is being issued? Public equity offerings For how much should we sell our company/division in the public market?

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T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Valuation methodologies Valuation methodologies Publicly traded comparable companies analysis Comparable transactions analysis Discounted cash flow analysis Leveraged buyout/recap analysis Other • “Public Market Valuation” • Value based on market trading multiples of comparable companies • Applied using historical and prospective multiples • Does not include a control premium • “Private Market Valuation” • Value based on multiples paid for comparable companies in sale transactions • Includes control premium • “Intrinsic” value of business • Present value of projected free cash flows • Incorporates both short-term and long-term expected performance • Risk in cash flows and capital structure captured in discount rate • Value to a financial/LBO buyer • Value based on debt repayment and return on equity investment • Liquidation analysis • Break-up analysis • Historical trading performance • Expected IPO valuation • Discounted future share price • EPS impact • Dividend discount model 4 .

5 . (4) Leveraged Buy Out Used to determine range of potential value for a company based on maximum leverage capacity.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 The valuation process Determining a final valuation recommendation is a process of triangulation using insight from each of the relevant valuation methodologies (1) Discounted Cash Flow Analyzes the present value of a company's free cash flow. (2) Publicly Traded Comparable Companies Utilizes market trading multiples from publicly traded companies to derive value. (3) Comparable Acquisition Transactions Utilizes data from M&A transactions involving similar companies.

0x Public trading comparables Transaction comparables DCF analysis 6 .50 Implied offer = $8.46 $3.0x to 19. the art is using each method to develop a valuation recommendation Price per share $20.0x Street Case 12% to 15% Discount Rate EBIT exit mult.00 $3.00 52-week high/low 15.75 $10.0x to 20.0x 2001E EBIT of $20.00 $15. of 15.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 The valuation summary is the most important slide in a valuation presentation The science is performing each valuation method correctly.75 $15.0x to 20.0x to 25.00 $4.00 $4.7 Mgmt.00 $9.00 $26.0x to 20.5x to 4.6 19.16 15.00 $4.25 2.94 $5.0x 2001E cash EPS of $0.25 $5. of 15.75 $0.0x 2002E cash EPS of $0.00 $3. Case 12% to 15% Discount Rate EBIT exit mult.00 $5.00 $5.00 $10.0x LTM revenue of $185.50 $6.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Agenda  Introduction  Trading comparables  Transaction comparables  Discounted cash flow analysis  LBO analysis  Relative value analysis  Merger consequences – – Accretion/(dilution) review Pro forma balance sheet analysis review  Appendix 7 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Trading comparables analysis as a valuation methodology Valuation methodologies Publicly traded comparable companies analysis Comparable transactions analysis Discounted cash flow analysis Leveraged buyout/recap analysis Other • “Public Market Valuation” • Value based on market trading multiples of comparable companies • Applied using historical and prospective multiples • Does not include a control premium • “Private Market Valuation” • Value based on multiples paid for comparable companies in sale transactions • Includes control premium • “Intrinsic” value of business • Present value of projected free cash flows • Incorporates both short-term and long-term expected performance • Risk in cash flows and capital structure captured in discount rate • Value to a financial/LBO buyer • Value based on debt repayment and return on equity investment • Liquidation analysis • Break-up analysis • Historical trading performance • Expected IPO valuation • Discounted future share price • EPS impact • Dividend discount model 8 .

business risk. lower or the same as the average of the sample May be short term divergences from fundamental value – Stock market may reflect "sentiment” and not the "true picture” Thinly traded. small capitalization and poorly followed stocks may not reflect fundamental value Different accounting standards Different level of information according to national stock market requirements  Market values incorporate perception of all investors reflecting firm prospects. Basic tool for estimating market value Provides check for DCF Values obtained are reliable indicator of the value of firm for minority investment        9 . etc. industry trends. market growth.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Trading multiples analysis is a key technique – based on assumption that current market is right Overview The right comps The right multiple Spreading the comp Deriving value Pros Cons   Difficult to identify 100% comparable companies Must make the difficult decision whether the company being analyzed is valued higher.

equity value Overview The right comps The right multiple Spreading the comp Deriving value Firm value = Market value of all capital invested in (often referred to as “enterprise value” or “asset value”) a business (1) The value of the total enterprise: market value of equity + net debt Equity value = Market value of the shareholders’ equity (often referred to as “offer value”) The market value of a company’s equity (shares outstanding x current stock price) Firm value . It may be appropriate to assume book value of debt approximates the market value as long as the company’s credit profile has not changed significantly since the existing debt was issued.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 A primer: firm value vs. 2 Net debt equals total debt + minority interest + preferred equity + capitalized leases + short-term debt .cash and cash equivalents. 1 10 .net debt (2) Equity value = Assets Liabilities and Shareholders’ Equity Enterprise value Enterprise Value Net debt Equity value The value of debt should be a market value.

al) t m um u i e o e e f l y • Icea vevbfuten n ( rta iaa iofho ld k l .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Firm value should take into consideration all relevant layers of capital Overview Im t e The right comps The right multiple Spreading the comp Deriving value Ce on m m t Eyu q ve ua i l t Coo o nc mt k m s a rticelpl s ft k k en m c es e s u tl as o i • Muoldues oc on n ld ou t • D ice Os p tn i o Crl prdc o t efr sk ni re t * vb eeo e Crl d o te t ni e vb b e * D e b t Pr sk re tc eeo frd D e b t Cles a la p s i e t a Crl prdc o t efr sk ni re t * vb eeo e Crl d o te t ni e vb b e * M itrt ions n e r e i t y C a s h C a s h Mbets aasre rt l ci k eu e i E itrti ats q nsnl e u es fi i e fa t y i eax emltnim nl c f cu fr a e l r l i f l ry u co u • Gl edoaao ve n ( rta iaa iofho ld k l . al) aa fr a e um u i e l l i f l ry e f l o u • Gl icea vevbnctnim a a iaa rt l .a un a r t m nt ic tn t u m r d y • Icer eseeeedormers mfrtnoa e o dnle to s a v ) h a l eu d o t c o r f ho n t o n en m v mhs e s e y • Cro maii ten o t c o r f ho n t o n en m v mhs e s e y • Cro maii ten Note: Asterisk (*) implies you need to decide on placement based on whether the security is in-the-money or not .no ku r e • Mvete Ai tercun D haaa R sect s h l li n o n ic nhs anpenuaser ld e tl a( t t en c sc.do not put it both places! 11 . al) t m um u i e o e e f l y • Icea vevbfuten ean ( rtaiaa i cu o ve nl ld k l .f al ku ie e l • Mve vb a a i hy rt l .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Different multiples apply to equity value and firm value Overview The right comps The right multiple Spreading the comp Deriving value  The defining difference lies in the treatment of debt and its associated cost (interest expense)  A multiple that has debt in the numerator must have a statistic before interest expense in the denominator Equity value • Value for owners of business (after interest expense) • Multiples of: – Net income – After tax cash flow – Book value Firm value • Value available to all providers of capital (before interest expense) • Multiples of: – Sales – EBITDA – EBIT 12 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 The key steps for trading comparables Overview The right comps The right multiple Spreading the comp Deriving value  Identify the right comparable companies  Choose the right multiples for comparison purposes  Spread the comp correctly  Apply the comparable data to derive a value 13 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Key comparables must be in same business as target Overview The right comps The right multiple Spreading the comp Deriving value  Consider the perspective of equity investors (can use equity research as a proxy) – to what would they compare target?  You want to indentify companies that closely resemble the composition and function of the company you are evaluating Operational • Industry • Product • Markets • Distribution channels • Customers • Seasonality • Cyclicality Financial • Growth prospects • Size • Margins • Leverage • Shareholder base (influence of a large shareholder) 14 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Go even further. and identify a limited group as “closest comparables” Overview The right comps The right multiple Example of criteria used Business/ profit mix Market cap/sales Financial margins/growth Comments/ special issues Country Company X Spreading the comp Deriving value Very relevant Company Y Company Z Company A Others Company B Company C 15 .

)  Typical valuation measures include – – Firm value multiples • Firm value/sales • Firm value/EBITDA • Firm value/EBIT Equity value multiples • (Equity value/net income) or (price/EPS (P/E)) • Equity value/after-tax cash flow • Equity value/book equity  Valuation multiple can be calculated on both a latest twelve months (“LTM”) and a forecasted basis  Companies trade most typically off expected future performance (analysts’ estimates) – – EPS estimates are available from I/B/E/S on Bloomberg Other income statement projections are found in equity research reports available from Market Data Services. etc. EBITDA.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Choosing the right multiples Overview The right comps The right multiple Spreading the comp Deriving value It is important to understand what metric the companies in a peer group trade off of (revenue. EPS. Multex and Investext 16 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 The selection/presentation of appropriate multiples is as important as the calculation of the “comps” Overview The right comps The right multiple Spreading the comp Deriving value  Types of multiples used may differ significantly from industry to industry  Use analyst research for choosing comps and multiples  Seek guidance from more senior team members/industry group experts on which multiples to use 17 .

. t l y t i y c • We iv rpu iEe no u r p os iedc rc rfrt pa r of n r i e eo • Ctf deeitn pe os li i c 18 . t a pa cp l r i c i y eo c ih neyam g e i cl ps l s nl c a yt i i i e • Hsiv ccon a itt b e n se e e bo yr e a • C drdlvg o y ono a tl s ns n t a asu h w • Na cesw slbc dalw h euic f o i ldnh u ne s d o a itt b e n se e e bo yr e a • C drdlvg Pcfw r/ s i al ch e o ie dnoalr dubesr a l s y s. t l y t i y c • We iv rpu fwe/ea oryPt t r drE e aa s s i m o s rpvPu n uoc Se s sste f r e i i s • Cnpe Eg ab vl ae i l a C o n s itt bf nctg s d iea i o y rt on r f u • De decn piealrdcn rt sru eit a . t a pa cp l r i c i y eo c ih neyam g e i cl ps l s nl c a yt i i i e • Hsiv ccon a itt b e n se e e bo yr e a • C drdlvg itt bf nx s s d iet ai o y r at n r f • De digre cp o m s Fv/B i aEA r leID m T u oanlau oi y lnt do c i s r i r e • Gticcdis oos nor n o c.om dui nt ne l sn s s r y r a • Weidilcu sr es c t o itt bf nctg s d iea i o y rt on r f u • De decn piealrdcn rt sru eit a . Overview The right comps The right multiple Spreading the comp Deriving value M ue lp tl i Pen r/ r g i as cn ei P r o s ie dnoalr dubesr a l s y s.t m s d ooy a f cr i s • Grrsucpo nenlvg dntf re pe e a • I edoe Pgt /t r h Eo ow oi s ri f r h ra Pt ow m / a ro z o • NleEsgt pe rp oc st s ie d u .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Determine multiples used by investors – there are three commonly used multiples . .

. . m mi ife liia ae r . supplemented by industry-specific ratios and other ratios Overview The right comps The right multiple Industry-specific examples M u l t i p l e F ie rp m v a l u / p o P r o s Tr lnt ee cd or m iy d u s ta ri p ro e f •ee Cw irh teis ich cg ao lua frtn os l ri ao /t h i u t •rlg Ita m o rr to a n tt e li e c m o •p Go ois dt fm ot rr m o ru e a ti u e a n •os Ra fe lrs eh cr tm se c u n t a r k e •et Uh es flc uw lik fl ii oc r h ce yx ch cb ai st t •so s(& ir.n pli o n tm a g b it l s i t y c o m p a n i e s ) C o n s Do po eft nc dm ep ne te ot no nr us m b i n •eri ctt om ua nr ttk rn ye as nh da pr oe e i a l Ato sta uils mm efp so s c a m e p r o i a b l y •sfr Ato sta uils mm efp so s c a m e p r o i a b l y •sfr Dtn fsis iut cg uw liri th ti h ea no g h o u t •ios Fc ipp lte se tdc os c iu ar uo rn et i d f m ei r x •an wb hr iat co hi io m pl ci tf v e ri a ly p t a F ie rb m v a ls u /e s u c r i b r Spreading the comp Deriving value F ie rn m v a l u / t o O t h e r r a t i o s F ie rI m v a lT u / E B Ie na ee p e n d n t o f l e v e r •dg D st td o rr te e d y i f e n •ib dts en pg rc ep co ic ai tu io o n / l a n ic e Ft /ir E B Ie T D A s b t e r a i o •V N tir u s e d b y n v e s t o s •o Ha gr ho ln yf db ei ey d e n tt o n p i t •ipl De ste tae od ru tcs er dc y c o n i n g i f •ibn Nc edh pe rr ok fo ic ts a b ic l i t y •es N tb fy a v o rt e d is n v e s o •or D s t o r t e d y cr yy cP lf/ ic cE a lo iu tt y o n s •ib Ate se us mt em sil cii or m pa sv t le ra a a r •sds Sn m ec ce od uy n tn re y P / E s i l u •ofb d/s oii m im ns at nr ti e c o p a n e s n d u 19 F ie rl m v a ls u / s a e P rl ik c e /u b o o v a e Mt sh te og fw ti r eo nh u s d t h g h •oiw cn otr mn pv ae ne ids ea sn th hi ag ta o o Bn ntm cis hs m an ro ki f o oe r t r a n s a •ec ii n d u s t r e s Uii eis fin ue ltv fl n od rs cu at pr as i e nn t a •sed fn ilt n a n c it a io s t i u i n s Ril f-b ln t ea cto trlo s ik lm oo g ti e p r o t y •efu Cd nte cir o ie ro ef ce tu fn on rg as cc c •an bie en tpu wts efn ee nre cn oc m at nr iio ei s d Co nit sn ef nr sm ua si po r n o s p e c t i v •oe a v a i l a b l e R es lr a t/ ie v e p in c e a r i n g .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Performance measures Overview The right comps The right multiple Spreading the comp Deriving value  Comparing various statistics and performance measures among the companies in your comparable universe can help shed light on why companies may trade the way they do Growth rates Margins / profitability   Gross margin EBITDA margin EBIT margin Net income margin Operating margin Return on total invested capital (industrial companies) Return on equity (financial institutions companies) Capitalization / credit  Sales  Operating income  Net income  Leverage and liquidity ratios Coverage ratios Off-balance sheet debt/operating leases        20 .

EBITDA and EBIT based on analyst research 21 .JPMorgan standards Overview The right comps The right multiple Spreading the comp Deriving value  Use diluted shares using the treasury method  Calendarize forward estimates so that all companies are being compared for the same twelve month time period  Pro forma companies’ financial results for announced transactions (acquisitions and divestitures)  Forward estimates for EPS should be based on IBES or First Call medians. but ensure you understand the components of these estimates – Some analysts included in those mean/median calculations may not have updated their estimates even though there has been a significant change in the company’s prospects  Forward estimates for sales.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Spreading the comps correctly .

not correct for calculating current shares outstanding O u tg s t a n d i n T r a n c h e 1 T r a n c h e 2 T r a n c h e 3 T r a n c h e 4 T o t a l 2 .3 9 2 8 . 9 9 $ Y 3 e 9 s . 7 $ 0 . 5 2 2 . 5 s 6 $ Y 2 e 4 s . 9 7 5 . 0 0 . 2 0 8 .3 1 9 .2 2 3 .2 7 7 2 . 0 0 . 0 7 7 .do not include “Total” line in calculation! Equity value should be calculated using all options and warrants outstanding (not just exercisable) Stock splits Pro forma adjustments Note accounting convention for diluted EPS in financial statements uses average stock price over the prior year . 5  $ Y 8 e . Te(0 osl K tsd/ aoe l hn0 btg) astQ sta i us ca1 a t1 rn i C Ep u r r e xr n ar t m pe lh e C o s a e i c 10 . 0 2 8 7 . 7 8 2 . 0 1 1 0 . 1 6 5 . 1 6 5 . 4 8 . 0 1 7 6 . 3 9 9 . 5 2 2 5 ) 3 3 . 8 9 7 . 0 1 7 6 . 9 7 5 . 9 2 2 . 0 (. 5 15 . 0 1 4 3 . 0 7 . 0 Issues/pitfalls   Break out each tranche of outstanding options and warrants separately Avoid double counting of options . $ 4 0 . 0 9 6 . 8 8 . P rr o c e e d s f o m e x e r c i s e $ 2 5 . 9 7 5 . 8 9 . 0 9 6 . 9 2 2 .9 7 7 2 . 0 5 .9 7 8 7 . 6 7 7 . 4 $ 3 . 7 4 8 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 JPMorgan uses the treasury method to calculate fully diluted shares outstanding Overview The right comps The right multiple Spreading the comp Deriving value E x e r c i s e p r i c e I n t h e m o n e y ? S h a r e s i s s u e d u p o n e x e r c i s e 2 . 0 0 Tuip oes tset ado l iuf s po ho i ano r xn e es sr sc e Tpp rh w e ur a ric sco uhe r ae ysd se s ad r t eh s Ieu ne crn rsd es mi nt to aa l tg hn a s Frn ue lts yo du ihn lag us et dd si t a    22 . 0 T r e a s u r y s h a r e s p u r c h a s e d w i t h p r o c e e d s 6 3 6 . 3 5 . 0 $ 1 . 7 8 2 . 4 6 6 .9 7 4 0 . 0 The treasury method assumes all in-the-money options are exercised and the proceeds used to buy-back shares Example E x a m p lc e C o I n . 0 7 7 . 1 4 3 . 1 3 $ N 5 o 7 . 8 9 4 .

465 { Q1 Q2 Q3 Q4 { Q1 Q2 23 ANNUAL Total Revenue .853 + Six Months 10Q (6/01) $62.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Calculating the LTM (latest twelve months) Overview The right comps The right multiple Spreading the comp Deriving value Fiscal Year QT-1 + Most Recent Period - Period Ending one year prior to most recent QT Annual Example: General Electric LTM = 6/30/01 Annual (12/00) $129.470 Six Months 10Q (6/00) $62.858 = LTM (6/01) $129.

Target FYE 2003E Net Income = $150 Calendarize from 10/31/02 to 12/31/02:  Ideally could use quarterly estimates10 × $120   2 × $150   Target CY2002E Net Income =  +  = $100 + $25 = $125 – However. it is common to employ the technique of calendarization  Calendarization adjusts the financial data of one company to reflect results representative of the period in time corresponding to the latest fiscal year of the client or focus company – This insures that the financial data of both companies is truly comparable by eliminating seasonal or cyclical differences that may arise as a result of dissimilar fiscal year ends  Example: Client/Acquiror has fiscal year end (“FYE”) 12/31 while Target has FYE 10/31 – – Target FYE 2002E Net Income = $120. availability and consistency are an issue 12 12     24 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Calendarizing financial data Overview The right comps The right multiple Spreading the comp Deriving value  When companies in the comparable universe have fiscal years ending at a date other than that of the client or focus company.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Two approaches are widely utilized for developing forward estimates Overview The right comps The right multiple Spreading the comp Deriving value “Bottoms-up” approach   Use IBES median EPS estimate Build-up from EPS to EBIT / EBITDA using analyst estimates for shares outstanding. depreciation & amortization Advantages: – “Automatically” reflects changes in earnings estimates as they are made by IBES – Not tied to one specific equity analyst Disadvantages: – Need to reality-check resulting EBIT and EBITDA – Cannot foot directly to an analyst report “Top-down” approach   Use IBES median EPS estimate Use a specific analyst report (or the average of a group of reports) for EBIT / EBITDA estimates Advantages: – Easy to check – Can cite specific source your estimate came from Disadvantages: – Does not “automatically” update – Will not necessarily reflect consensus     25 . tax rate. interest expense.

EBITDA = $100 – FV / EBITDA = 9.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Dealing with minority interest and equity in unconsolidated affiliates Overview The right comps The right multiple Spreading the comp Deriving value Minority interest  Minority interest represents the portion of a consolidated subsidiary which you do not own Need to make sure the numerator and denominator of a trading multiple are on an apples-to-apples basis – Numerator: Add the minority interest (market value if available or book value) to firm value – Denominator: Consolidated financial results Consider the following example: – Market cap of $500MM – Debt of $500MM – Consolidated EBITDA of $100MM – Minority interest of $50MM Firm Value = $1050.e.5x 26       . treat as cash) – Denominator: Consolidated financial results (do not include equity interest) Consider the following example: – Market cap of $500MM – Debt of $500MM – Consolidated EBITDA of $100MM – Equity interest of $50MM Firm Value = $950.5x Equity interest  Equity interest in unconsolidated affiliates represents a minority stake you hold in another company Need to make sure the numerator and denominator of a trading multiple are on an apples-to-apples basis – Numerator: Subtract the equity interest (market value if available or book value) from firm value (i. EBITDA = $100 – FV / EBITDA = 10.

income before discontinued operations. brokerage report check) – Don’t assume model is always right!    27 . margins. extraordinary charges/income and effect of change in accounting principles) Eliminate non-recurring items – Restructuring charges – Gains/losses on sale of assets – One-time write-offs – Read all footnotes and Management Discussion and Analysis (“MD&A”) sections Tax effect all adjustments.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Other standards when spreading comps Overview The right comps The right multiple Spreading the comp Deriving value  Use income from continuing operations (i. if they relate to an after-tax financial statistic and are tax-deductible – Check MD&A and footnotes for actual tax impact if available – Use marginal rate if tax impact not available Double-check your calculations!!! – “Reality” check on multiples.e. etc. (ruler check.

dividends & repurchases  Differences in fiscal year end (EPS estimate)  Cash (long term investments)  Recent acquisition and divestitures – pro forma #’s  Changes in earnings estimates  Non-recurring items  Recent debt or equity offerings  Take-over activity  Re-statements  Conversion of convertible securities since last reporting period  Differences in international accounting treatment 28 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Typical errors spreading comps Overview The right comps The right multiple Spreading the comp Deriving value  Stock splits.

0 0 (0)0 $12 43 0 0.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Using multiples to derive value Overview  Generally a range of multiples are used to provide a valuation range for your target Multiply the company’s sales. 0 0 $ 5 0 . 0 9 Note: different fullydiluted share count at different prices 29 . 4 million options outstanding with an exercise price of $25. 5 0 $ 2 5 0 $ 4 0 0 $ 5 0 0 $ 2 . 0 x 2 0 . 0 x 1 0 . What equity value per share does each multiple imply? $n m is l.x 0 0 Cea a ql ll ue c iv u tu ay t e $20 200 . book value and other key operating statistics by the respective comparable company multiples – The right comps The right multiple Spreading the comp Deriving value   Subtract net debt from firm values Example: Target company has 98 million shares outstanding.– x = 0 (00 = $x– 222 . 0 x 2 . l i o ep xe cr e p t sa ha a rt e d E P S Ne e to im n c E B I T E B IA T D S a l e s T a r g e t s tt a tc i s i $ 2 . 0 0 Il m p i e d e q u i t y v a l u e $ 5 . 0 0 $ 5 0 . operating cash flow.0 0 0 $ 4 . 0 0 $ 4 8 .xx 5.0)0 5.1 0 = 0 $2 20 .x= 5. operating income.0 0 0 $ 5 . net income.0 8 0 Il m p i e d ea ql ue iv tu y pe e rr s h a $ 5 0 . net debt of $200 million and the following statistics.0 0 0 $ 5 . 0 x 1 3 .– x = 0 (0)0 $12 50 0 0. 0 9 $ 4 8 .0 5 0 Rm eu lall et vi ne tp fs re of m t o ca ol m p a rs b e 2 0 .0 8 0 $ 4 .

9x 10.40 28.0 7.9 8.93 0. except per share data Company LTG 2003 PEG McDonald's YUM Brands Wendy’s Jack in the Box Sonic Corp AFC Enterprises Papa Johns Median Mean $28.4x 9.2 10.4x 18.8x 10.4 13.5 11.0% 13.158 1.0% 20.9 19.0x 19.7 6.78 31.1% 1.3x 8.23 0.3 12.0 13.23 1.9x 9.0% 12.3 19.361 729 11.78x 1.80 0.5 5.9 9.3 19.153 641 $45.3x 15.4 17.99x 1.5% 14.5 10.5x 9.5% 20.3 8.28 29.5x 8. all projections calendarized to 12/31 year-end 30 .4% 14.0% 15.450 9.99 0.285 1.3 12.9x 8.7 23.2x 8.365 1.871 4.1x 17.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 An example: Trading comparables Overview The right comps The right multiple Spreading the comp Deriving value 4/19/02 stock price Market cap Firm value LTM EBITDA Firm value/ 2002E EBITDA 2003E EBITDA Price/ 2002E 2003E EPS EPS $ millions.6 20.9 10.8 6.60 61.8 5.548 1.49 36.11x Note: Projections based on equity analyst research reports.8 16.4 16.06 34.5x 16.98 $37.82 0.8 8.709 1.007 4.1 13.0% 15.5 6.950 12.4 7.2 8.271 1.4 10.8x 15.

3x 5.9x 1 .8x 1 .7x 8.2x 9.4x MCD SONC 8.2x 5.7x 6.2x 7.3x 7.1 x 7.9x 8.6x 8.8x 1 .2x 9.5x 7.4x 1 x 3.0x 7.5x 6.4x 1 0.8x WEN YUM 1999 Q3 1999 Q4 2000 Q1 2000 Q2 2000 Q3 2000 Q4 2001 Q1 2001 Q2 2001 Q3 2001 Q4 JBX 31 .0x 7.7x 1 1 .9x 6.7x 5.8x 8.7x 7.6x 6.2x 1 1 0.9x 6.7x 6.0x 8.1 1x 1 .8x 7.0x 1997 Q1 1997 Q2 1997 Q3 1997 Q4 1998 Q1 1998 Q2 1998 Q3 1998 Q4 1999 Q1 1999 Q2 9.0x 1 0.6x 6.4x 8.1 10.5x 9.5x 8.4x 7.9x 6.0x 8.8x 9.4x 6.0x 8.4x 1 0.6x 7.1 x 7.4x 1 0.0x 9.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Historical LTM EBITDA multiples Overview The right comps The right multiple Spreading the comp Deriving value Firm value/LTM EBITDA 17.5x 7.0x 7.6x 8.8x 1 x 6.4x 6.2x 6.0x 11.2x 7.4x 1 1 4.6x 6.5x 8.6x 8.8x 7.5x 6.3x 6.9x 7.0x 9.9x 1 6.7x 8.0x 1 .8x 7.1 1 5.8x 8.5x 9.0x 15.9x 8. 12.3x 7.0x 1 3.9x 7.2x 7.5x 1 1 .6x 5.7x 8.8x 7.1 x 5.0x 1 3.1 1 3.6x 1 1 0.1 x 8.0x 14.6x 1 .0x 16.3x 7.1 1x 1 x 0.1 x 5.1x 7.9x 8.1 x 8.6x 5.5x 9.0x 8.4x 5.9x 8.0x 12.1 MCD SONC WEN YUM JBX 5-yr avg.3x 9.0x 5.6x 1 1 0.0x 6.2x 8.0x 13.3x 1 x 6.3x 7.

d e 1fsm 5 sm %ea ot y y b ir e ss ids ne t 2 8 % 5 6 % 1 2 1 % Sif i s tna . Mnu ua n l. 0 % 0 . 1 % 4 . 6 % 7 . 1 % 5 .) 5 (% 1 .) 2 (% 0 . ) 1 8 9 % 1 (% 2 . 9 % 8 .n a x d ia p c z n Q S R 8 1 % 0 % 9 4 % B ec rdu o nl a i. 9 % (. 8 % 7 2 . 7 % 5 . 3 % 3 . 0 % Pn oi sn i g t i o C ynte on er mwo pod % a s Ieote ntn r tna % ri l o as Fa ar is % r e h Bo rdio as n tn p i 9 % 2 7 % 8 1 % F-o l eid a re m b l pri lfm a s t o dnr i rto fe .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Champion vs. n t arAn ceW q &d u a id LJS ooie nhv gn r ls Va el rm yl s fnee rc b aes ha i s S tn rg o Cn o ty m m e a r Sb tnn rgd or a r gn ei b ct u oo n t i hs rv at a e sso l h r oe p wd a yu s ee t a f r es taf w oo lke cn pc dr runo osp dao t et xi en c u o Grd lbai o nh a w l b t lrsra attee g os e b s aihU n eV ds. 8 % 8 . c nd ott i nr n ca ee 13as 84rd t yo oe l tnpr hot s am ce i t o 1 7 % 0 % 6 7 % Udi n riuv qie en fm o. rt a Rl ea g in o sg tnn r ti e h S o u t& h M iw d e s t Fieacio rceno n asi c n n f il d hn t a i S tn rg o S tn rg o Fie rce a n h s fa dle i niiu n l f ts cf i i c a it T e nal hc l eo B sm ‘1 y i’0 s n& t 00 e Ss rg u itn c ni c u e n s ad a rnC oKd uF n Pun iz trd z bs aa H . 4 % 1 . 1 % 1 0 . 0 % 5 .d i tr et i ds b et td xe r pdie eo c v tf. l fn p m rc rr ae a ho i g s l i sd i t po m f se e es n x in p a a d n o ice r nso r s ik e cs a.) 3 (% 2 . ht gA Bhre e et lef h l tr wo srs eh ca t o hia d itct e s l rd oy rl a arim tpu a t eo m o tr Q h e S R s . ed la B t u ie i e o bsse eto d b iot e tn -i o p pfm g rto a o ai fr n i g n pa otn p u li o Sc s tnm rgpe oot o r s gh arta lsw e n od inie nt o v a v atig ds vn e. 6 % 1 4 .t g cS ar do gh T rtfm or i w m o Ha os r’ n t d o n inie nt n o e v w a v pc rut os da t W e n d y ’ s hhde aeice vlers e n p a vtnlvo a . 4 % 1 9 . 0 % 8 . f i ea t tda ri n a l t i o cm: ues sr e t b oa ym– o a1 u l( ne gs 8 2 yd 9 rl s o ) Pst o ta oi e rm . ) 1 1 2 % 2 . Seg tnr s rgi oa n n gh rta on w d ss ate m e o r s gh art lsw e o d br rnte ies vy o es n x in p a a d n o icig ns rn e a rat or ya l e t y so ut p p r s pu rim e m vtn a la u i o 1 2 Based on adjusted EBIT Blended growth rate based on Company and Franchised unit comp store sales growth 32 . dn iu si n Asnr p tae p ol e o a d l cm oe n rd sa un w o m e n 2 1 % 3 6 % 5 9 % Lrce ei h . 8 % (.) 8 1 .) 9 1 . ri a f c En xe pc eig rn i sgrtn tneo r itna o al ni ghc rt Ry o el we . 0 % 0 . 1 % 1 . peers Overview G(– rt’ ’) o 01 w0 h 0 Ci ho an m p Mls ca D’ o n d W es n d y ’ Yr s Un M B a d Jit B a hx ce k o n S o n i c The right comps The right multiple Spreading the comp Deriving value Ctesw o ol gh ms rt p ao s e r ’2c ss gh 0 otesw Q ol rt 1p a o m e r Swlsw y ie gh s de t t sr e ao m Uw nt igh tr o Esw a gh rg t nr i o n (% 0 . ank d in ec Maiz e . m n swa ac n nh d de is too aM c r se . rgm o l ni e ced hnp irar l nd e tnk ea ert m e 1 6 % 3 4 % 8 9 % Ioeu nt mh ni ei v n a w v t nctg oo . 4 % 7 . 8 % 0 . r i Cl uy rt r e n edr x ig pnm af no tiWs hea es t r to C bS am s a el . Pm ri h e a ms u n ee a dt r d r u o o w upm ne a dr n eoc rf e r Ipie m rs e s v tnnt ls u u ht rr de ai a on de n e. 2 % 1 0 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Agenda  Introduction  Trading comparables  Transaction comparables  Discounted cash flow analysis  LBO analysis  Relative value analysis  Merger consequences – – Accretion/(dilution) review Pro forma balance sheet analysis review  Appendix 33 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Transaction comparables analysis as a valuation methodology Valuation methodologies Publicly traded comparable companies analysis Comparable transactions analysis Discounted cash flow analysis Leveraged buyout/recap analysis Other • “Public Market Valuation” • Value based on market trading multiples of comparable companies • Applied using historical and prospective multiples • Does not include a control premium • “Private Market Valuation” • Value based on multiples paid for comparable companies in sale transactions • Includes control premium • “Intrinsic” value of business • Present value of projected free cash flows • Incorporates both short-term and long-term expected performance • Risk in cash flows and capital structure captured in discount rate • Value to a financial/LBO buyer • Value based on debt repayment and return on equity investment • Liquidation analysis • Break-up analysis • Historical trading performance • Expected IPO valuation • Discounted future share price • EPS impact • Dividend discount model 34 .

clients. tax benefits) 35 . conditions to closing) Social issues (board seats. earnings or other industry metrics) paid for a target The premium paid to gain control of a target (“control premium”) Business fundamentals of a target (revenue/earnings growth. profitability) Technical transaction elements (deal protection. operating profit. lenders to understand the: – – – Valuation of a company Structuring of a potential transaction Current state of M&A in a specific industry (number and relative value)  Examines a group of transactions to identify a median/range/trend of: – – – – – – The multiple (of cash flow. management) Other value drivers (synergies.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Comparable transaction analysis  Assists investment bankers.

industry – Identifies transactions based on hostile vs. and several other deal – elements The “Comprehensive Summary Report” is very helpful in hand-picking transactions since it includes a synopsis of – the deal in addition to general information regarding both parties and the transaction Available on desktops and through the Business Research Center at (212) 622-4900 – Senior bankers who work in the industry Will be able to point you toward previously used presentations or valuations – Ensures you do not exclude any landmark deals or other deals they would specifically like to include – Merger proxies for similar transactions Fairness opinions of financial advisors disclose the comparable transactions used in their valuation of the target – Other sources include: JPMorgan transaction comps databases – News runs – Equity research reports –    36 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Sources used to locate comparable transactions  Thompson Financial database (SDC) Locates targets based on SIC code. friendly. announcement date. business description. transaction size.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Selecting comparable transactions  When valuing a company. asset vs. divestitures. not be considered as a comparable transaction – Acquisitions of a minority interest (not a change of control transaction) – Rumored or withdrawn transactions  Recent deals are typically a more accurate reflection of the values buyers are willing to pay  Remember that some transactions are more relevant than others when selecting a range of multiples for valuation 37 . stock acquisitions. margins. Morris Trust transactions. key objective is to find the most comparable businesses – – Similar industries with similar products or services Size. generally. reverse mergers. the situation surrounding the acquisition is crucial – Scenarios could include: LBO’s. try to locate transactions in a similar industry as well  Some types of transactions should. form of consideration. and many others – If possible. bankruptcy-related acquisitions. major potential liabilities  When seeking guidance regarding structure. hostile transactions. relative market position.

not extremely accurate but generally close. helpful for business descriptions and summary of transaction Use to spot check your work. and other relevant news Use merger agreement if possible (latest share count available) .click on deal Yahoo!.com/convert/fxhistory) Net debt LTM operating statistics Historical exchange rates Projected financial performance MorganWise. management discussion. and any other possibly relevant sections or exhibits Print out all relevant sections including: cover page. a 10Q. substantial acquisitions. otherwise 10Q or 10K Print out all relevant sections including: cover page. Oanda (www. management discussion.oanda. First Call. or potentially attached to other filings Bloomberg (TICKER <EQUITY> HP) AND Yahoo! unadjusted stock price listing Bloomberg (TICKER <EQUITY> CACS) Bloomberg. warrants. Proxy. exhibits index. and convertible securities Bloomberg (TICKER <EQUITY> HP) Bloomberg (TICKER <EQUITY> CACS) Merger agreement. be careful stock prices aren't already in US dollars Use for premiums analysis. analysts might publish historical or projected estimates for private companies. When necessary. 8K.However Yahoo! Prices are unadjusted for stock splits. a 10K or as an exhibit to other acquirer filings. generally. over period.com/convert/fxhistory) Acquirer Bloomberg "Corporate Action Calendar" Historical exchange rates Target financial and business information Target Bloomberg historical prices Target Bloomberg "Corporate Action Calendar" Basic shares outstanding Options. Bloomberg prices are more reliable. quarterly financial press release. check for stock splits or other relevant news Only for foreign acquirer. not extremely accurate but generally close. check research reports on acquirer Source Comments Closing press release Target & Acquirer business descriptions A few equity research reports Yahoo!.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Comparable transaction multiples analysis document checklist Item General transaction information SDC "Comprehensive Summary Report" Bloomberg transaction description Announcement press release SDC Bloomberg (TICKER <EQUITY> CACS) . the longest was issued first. financial statements and footnotes. financial statements and footnotes. if private.oanda. They can be published in an ammended 8K. provides explanations of complex transaction structures and general street perspective Check both acquirer and target SEC filings during the period. private company financial disclosures* 10K and ALL following 10Q's. Dow Jones. target or acquirer websites Company websites MorganWise. include several days prior and post announcement. Dow Jones. search for target's name in any acquirer filings from announcement through a few months post closing (Use Control + F) to be certain no financial disclosures have been missed. helpful for key transaction dates Be sure it is the ORIGINAL announcement. use avg. use spot rate as of that date Include research reports on target if public. management discussion. so print out BOTH Include if acquirer is paying in stock. target or acquirer websites Use to spot check your work. Multex. private company financial disclosures* Latest 10Q. excerpts are often reproduced throughout the day by other wire services. latest 10Q or 10K. an S4. and any other possibly relevant sections or exhibits Print out all relevant sections including: cover page. financial statements and footnotes. First Call. include LTM period to show 52 week high Check for stock splits. 38 . private company financial disclosures* Bloomberg. INCLUDE ANNOUNCEMENT TIME as well Include only if transaction is closed Include only if necessary due to lack of detail in press release (target website may disappear) Helps gauge the Street reaction to the announcement. may give ball park estimates. VentureSource. VentureSource * Financial information as well as consideration paid for private targets is often overlooked. 10K. exhibits index. Oanda (www. print out the entire document Include if acquirer is paying in stock. private company financial disclosures* Latest 10K and 10Q quarterly financial press release. and any other possibly relevant sections or exhibits Only for foreign target whose financials are in foreign currency. for operating statistics. Multex Offer price* Merger agreement Acquirer historical prices S4. for balance sheet items. exhibits index. include several days prior and post announcement.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Calculating equity and firm value  Definitions of equity value and firm value similar to trading comparables: Equity value + Net debt Firm value Value received by the target / target shareholders (100%) Debt assumed by acquiror minus cash received Total value of business acquired (100%) BE CAREFUL: Transaction value for a change of control transaction will differ from equity and/or firm value when >50% but <100% is acquired  Equity value: – Cash consideration: (fully-diluted target shares @ offer price) x (cash consideration per share) – Stock consideration: (fully-diluted target shares @ offer price) x (exchange ratio) x (price per acquiror share @ the closing price prior to announcement) – Cash and stock consideration: (fully-diluted target shares @ offer price) x (cash consideration per share) plus (fully-diluted target shares @ offer price) x (exchange ratio) x (price per acquiror share @ the closing price prior announcement) Firm value: – In all cases: Add the indebtedness and subtract the cash items that are to be transferred to the acquirer through the transaction to the target equity value • Be careful not to add any convertible debt or preferred securities which were converted into common shares (and already included in the fully-diluted share count) • May be appropriate to include certain other unfunded liabilities in the calculation of firm value for a transaction  39 .

. options. 10-Q. if terms of the transaction change (exchange ratio. should look to valuation on date of – announcement of revised terms Valuing a deal with stock consideration as of the closing date will give a sense for how market reacted to value of two companies together – Transaction fees Typically M&A fees/financing fees are not included in firm value of business acquired as they are not consideration received by seller – However. cash as of most recent publicly disclosed source as of announcement date (i. 8-K) However.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Other equity and firm value issues  Timing (announcement vs. so most interested in valuation based on stock prices as of – announcement date Information regarding shares outstanding. debt.e.e. LBO/recap) it may be instructive to know amount of fees and indicate how they may have impacted – business valuation Asset purchases Note that debt can be transferred with businesses/assets being sold and must be added to the consideration paid by the acquiror – Other liabilities In some instances it may be appropriate to include the assumption of a non-debt other unfunded liability in firm value (such as an existing – restructuring reserve) but never NWI / working capital items Earn-outs/purchase price adjustments     40 . amount of cash consideration). closing) Typically want to assess what buyer was willing to pay for business. or Proxy. – 10-K. in extreme cases (i.

US Dollar)   41 . acquisitions and divestitures) must be considered Currencies – If target is foreign.e. biotech) it is more useful to look at projected financial information as well (typically IBES consensus estimates / median of several analyst reports) • However. when currency has de-valued / re-valued substantially vs.e. technology.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 LTM financial information issues  Time horizon – LTM financial information should reflect what buyer bought the business “off-of” and is generally backward-looking (typically last twelve months of financial information available prior the announcement date) – In certain industry-specific circumstances (i. most-commonly taught method is to apply average exchange rates over LTM period because it is the accounting convention – Is this always appopriate for valuation purposes? Not necessarily – Need to consider carefully / discuss with team-members in extreme cases (i.e. the outlook of equity analysts may be quite different than the outlook of the buyer at the time of acquisition Adjustments – Exclude impact of extraordinary items on a tax-affected basis – Pro forma adjustments (i.

transaction value  Tax benefits – – – – In certain cases (acquisition of assets. amortization period. acquisition of stock with a 338(h)(10) election) a buyer will receive substantial benefits from depreciating / amortizing a write-up and receiving incremental tax deductions An acquiror can often justify a higher purchase price and multiples may be higher in such circumstances Can attempt to estimate the value of tax benefits received by acquiror but depends on a lot of unknown variables (discount rate.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Other general considerations  Synergies – – Synergies are not generally incorporated into the financial information but it may be useful to consider their value when comparing transactions to each other Sometimes will indicate announced synergies as a % of sales. SG&A + COGS. SG&A. tax basis) However. should know which transactions are tax-advantaged and which aren’t 42 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Most common errors  Unaffected stock prices (for premium analyses)  Stock splits  Proper interpretation of exchange ratio – – Target share price / acquiror share price Using the correct acquiror share price  Most recent common shares outstanding (use the merger agreement if available)  Use all outstanding.only tax affect those items that are tax deductible Publicly-available information only. please! 43 . options and warrants and assume that all in-the-money securities are exercised in this analysis        Check for warrants Repriced options New issuances of debt or equity since most recent 10Q or 10K Forgetting debt in an asset transaction Acquisitions or divestitures completed by the target over LTM period Exclude all extraordinary items . not exercisable.

g. update the analysis to incorporate disclosures that were made subsequent to your analysis (e.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 General suggestions  Always check with JPMorgan databases and colleagues to see if work has already been done – Be sure you have carefully double-checked all work before showing to a client!! Have all relevant documentation regarding the deal printed-out – Flag where you got your information from Place all documents as well as a printout of the transaction comp model in a folder or binder If possible. S4. research reports regarding transaction) Be sure to update your list of transactions regularly on active projects to ensure that you do not exclude the most recent. Proxy. transactions      44 . and possibly most relevant. coordinate with M&A research to import your transaction data into our firm database If a transaction is pending or is renegotiated.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Output summary  Show any multiples or transactions that may be helpful for your analysis but don’t be afraid to base your conclusions off the multiples that are the most helpful  Spot check all outputs against your source documents for any obvious errors  Check for consistency regarding units .inputs are in thousands except per share values and outputs are in millions  Be careful of difference between not meaningful (NM) and information that is unavailable (NA)  Try to include any other relevant information 45 .

3 19.7 17.2x 19.383 2.4x EBIT 18.7 11.0 11.8x 2.2 18.9x sales. Unilever presented post tax shield multiples in its public filings for the SlimFast acquisition.019 1.0 19.7 2.1 2.6 17.300 2.4 22.7 19.0x EBITDA and 13.1 3.0 3.6x 2.6 3.985 7.4x 26.4x 17.3x 17. 13.9x EBIT.8 11.6 3. 14.3 0.2x 17.6 25.3 19.9 14.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Transaction multiple analysis .8x  Median overall Median tax benefit transaction Median non-tax benefit transaction Estimated VFO multiples for SlimFast (based on the tax deductibility of the goodwill) were 2.3 17.7x 14.801 906 764 888 1.2x EBIT 1 46 .example $ millions Firm value/ Date Apr-00 Aug-99 Oct-98 Oct-98 Apr-97 Sep-96 Feb-96 Jan-96 Aug-95 Jan-95 Aug-94 Acquirer Unilever Procter & Gamble Newell Clorox Procter & Gamble Gillette Unilever L'Oreal Henkel Colgate-Palmolive Johnson & Johnson Target SlimFast IAMS Rubbermaid First Brands Tambrands Duracell Helene Curtis Maybelline Hans Schwarzkopf Kolynos (AHP) Neutrogena Firm Pre-tax Tax value synergies benefit $2.6 2.300 6.1 15.3 15.6x 3.0 14.0x sales.5 1.8x EBITDA and 16.1 37.1 1.4 14.4x 18.040 906 NA $20 325 90 100 120 NA NA NA NA NA   Sales EBITDA 3.4 16. 2 Estimated VFO multiples for Kolynos were 3.

0 2 5 . 7 6 A n n d a t e 2 / 2 0 / 0 1 1 / 3 1 / 0 1 9 / 2 0 / 0 0 8 / 2 8 / 0 0 B u y e r s A m e r a d a H e s s P u r e R e s o u r c e s E v e r g r e e n P a n C a n a d i a n 7 / 2 0 / 0 0 6 / 1 4 / 0 0 5 / 2 / 0 0 4 / 1 0 / 0 0 1 1 / 1 1 / 9 9 4 / 2 9 / 9 9 8 / 4 / 9 8 A p a c h e C o r p . Inc. 4 5 1 . 0 5 6 . 1 4 0 . 1 3 1 . 1 P r o d u c t i o n ( B c f e ) 7 2 . 0 1 5 . 5 2 1 . 6 4 .example T o t a l tn r a n s a c t i o v a l u e $ M M $ 7 5 0 R e s e r v e v a l u e $ Me MR g i o n s $ G 7 u 5 ls 0 f– C o a t o fn s h o re e / o s h o r 2 6 1 2 G 3 u 1 ls f– C o a t o fn s h o re e / o s h o r 1 7 6 1 R 7 o 6 c k y M o u n t a i n s 4 6 8 3 R 5 o 1 c k y M o u n t a i n s I m p l i e d ru e s e r v e v a l e % R g a s / P r a t i o $ /c M f e 7 0 % 4 . 8 3 6 3 . 5 7 . 0 5 2 6 . 5 1 5 . 0 8 6 9 1 0 0 8 0 6 . 3 1 5 3 . 0 4 . 9 7 6 4 . 2 5 0 . 1 1 0 0 . 8 1 3 9 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Comparable asset transactions . 9 3 7 6 3 3 0 6 2 7 2 1 7 5 0 0 7 4 4 4 7 0 3 G 7 ur 6 ls f– C o a to o f s h e 2 M 9 it 2 d -t C o n i n e n 5 R 4 o 8 c k y M o u n t a i n s 1 G 9 ur 7 ls f– C o a to o f s h e 4 M 3 it 0 d -t C o n i n e n 7 G 3 ur 2 ls f– C o a to o f s h e 4 G 5 ur 0 ls f– C o a to o f s h e 2 9 9 . 9 $ 2 . 2 8 7 . 2 3 5 . 0 7 6 3 . 1 1 . 3 2 1 . 8 1 . 1 5 1 . 9 6 1 . A p a c h e C o r p . 4 2 0 . / K & C L M o n t a n a P o w e r C o m p a n y O c c il d e n t a P e t r o l e u m C o l i n s & W a r e I n c . 8 2 0 . 5 1 0 . 6 6 2 . 0 1 5 2 . V a s t a r R e s o u r c e s S e l e r s L L O G E x p ln o r a t i o Io n ta e r n a t i n l P a p e r K L T G a s I n P c . 4 8 . 0 1 2 . 7 2 1 . 47 . 6 6 7 6 7 9 5 8 1 4 8 4 6 6 0 5 . 1 2 3 . 9 5 0 1 . M c M u r y O i l E q u i t a b l e R e s o u r c e s R e p s o l Y P F S A R o y a l D u t c h / S h e l A t l a n t i c R i c h f i e l d R e s e r v e s ( B c f e ) 3 6 0 . 5 8 0 . 2 4 H i g h M e d i a n M e a n L o w $ 2 . 5 8 Source: John S. A l b e r t a E n e r g y W e s t p o r t B P A m o c o A p a c h e C o r p . 1 5 0 . 0 8 1 . Herold. 0 4 6 0 .

1 % 18.3% 2.9 % 67.1% 80.4% 27.4% T -1 w e ek 28.6% 51.8 % 39 .1 % 49 .5% 44.8% 38.1% 17.3 % 45.1% 22.0% na 33.6% 53.0% 48.6% 28.9% 43.0% 96.7 % T -90 d ay s 44.1% 43.8% 12 0.5 % 38.2 % 46 .7 % 89 .6% 81.2 % 51 .1% 48 .0 % 40.3% 28.9% 67.0% 42.0% 57.1 % 82 .9% 20.0% 46.9% 59.3% 34.7% 51.1% 36.1% 45.4% 27.9 % 32.5 % 48 .6 % 86 .8% 47.6% 53.4% -17.0% 96.9 % 38.6% 10.ne t Inc IX ne t Inc(IP C Inform a tio n) M edscap e In c P S S W orld M e dical Inc A cq u iro r N a m e U S A N etw orks In c B ro adV isio n Inc V A Lin ux S ys tem s Inc G lo bal C ro ssin g Ltd M edicaL ogic Inc/ edsc ape Inc M F isher S cie ntific Intl Inc T -1 d a y 29.6% E x ch an g e ratio prem iu m (d isco u n t) % T -1 d a y 29.2 % 32.9% 67.7 % 20.4% T -1 w ee k 31.8 % T -4 w e ek 18 .3% 33.9% 44.2 % 41 .9% 43.9% 36.5% T -4 w e ek 16.6% 37.3 % 73.7 % 34.6 % 25 .7 % 83.7% 30.5% 35.2% 40.3 % 56.0% 45.3% 33.1% 37.3 % 49.3 % 38.0% 61.8 % -7.3% 9.0% 61.9% 57.5% 55.3% 48.7% C ircle Interna tio nal G ro up IncE G L In c T elx on C orp A X E N T T echn olo gies Inc C yberonics Inc T herm oC ardiosystem s Inc S ym bol T echn olo gies Inc S ym an te c C orp M edtro nic Inc T h oratec L aboratories C orp C oulter P harm aceuticals In c C orixa C orp B lu esto ne S o ftw are Inc A b out.8% 65.1% 46.8% 44.1 % 48.2% 19.1 % T -90 d ay s 29.6 % 10 0.4% 55.9 % 29.3 % 25 .5 % 44 .com Inc A d aptiv e B ro ad ba nd C orp A cc ord N e tw orks Ltd G re at P lains S oftw are Inc K e nt Electronics C orp A uroraB ioscienc es C orp H ew lett-P ackard C o P R IM E D IA Inc W estern M ultiplex C orp P oly com Inc M icrosoft C orp A vne t Inc V ertex P h arm aceuticals Inc M ed ian A verag e 37.8% 78.9 % 46.8% 87.3% 40.1% 1.3 % 52.9% 47.7 % 44.9% 44.5 % 42.8 % 50.1 % 47.4% 65.6% 18.0% 60.2% 43.4 % 40.9% 85.3% 28.5 % 47.9 % 59.8% 12 0.8 % 34 .6% 84.0% 110.4% 14 1.3% 9.2 % 41 .6% 18.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Premiums paid analysis .3% 9.3 % 51 .9% 20.8% 19.example O ffer p ric e p re m iu m (d isco u n t) % A n n .6 % 45.1% 22.6% 22.3% 19 .0 % 28.9 % 37 .6 % 20.8% 42.1 % 10 2.1% 37.0 % 34.6% 34.6 % 16 .3 % 40.5 % 2.0 % 76 . D ate T arg et N am e 1/12/00 1/26/00 2/3/0 0 2/22/00 2/22/00 6/22/00 7/3/0 0 7/26/00 7/27/00 9/8/0 0 10 /3/00 10 /16 /0 0 10 /24 /0 0 10 /27 /0 0 11 /13 /0 0 12 /6/00 12 /21 /0 0 3/22/01 4/30/01 P recisio n R espons e C orp Interlea f Inc A n dover.0% 57.0 % 11 1.7% na 78.6% 18.0% 29.5 % 57.1% 25.0% 29.6 % 75.3 % 13.3% 94.7 % 52.1% 13.2% 43.0% 46.1% 28.3% 40.7% 8.2% 35.9% 24.

collars. devices and products) • Consumer (food. your initial password is comps – Refer to M&A webpage for detailed instructions on entering data 49   .S. tax-elections. wireless. beverage and apparel) How do I access the database? – On everyone’s desktop: Start Menu ⇒ Main Menu ⇒ Information ⇒ MA Comps – If you are prompted to add a password. etc. deals > $1billion since 1998 (excluding FIG) – Smaller deals in certain industries: • Telecom (RBOC.) – Target and acquiror descriptions – Multiples (and underlying data used to calculate) What transactions are contained in the database? – All U. internet & related) • Healthcare (pharmaceuticals.e. LEC. CLEC.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 The JPMorgan M&A database can be used to locate precedent transactions Project implemented by JPMorgan M&A Research Department and M&A Analysts  What information is available from the database? – Transaction descriptions including transaction structure information (i. termination fees. LD-Tier 2. SSIXC. LD-Tier 1.

(D) Player Country: Select the home country of the target and acquiror companies from this list.) (G) SIC Code Lookup: Either enter the appropriate SIC code into this box and hit enter. It could be spread at Announcement.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Transactions in the database may be referenced by several criteria . or a Division/Subsidiary of another company. then use the player as the ultimate parent. It should be taken from a recent company release (10-K. 10-Q. 8-K. (H) Announce Date: This field contains the official announcement date of the transaction (I) Completion Date: This field contains the official completion of the transaction. If the player is a division or subsidiary. Completion. or click the SIC Code Lookup button to navigate the lists to choose the appropriate SIC Code. (J) Status: This field contains the status of the deal (K) Presentation Method: This field indicates the date the deal was spread.(A) Player Name: This field contains the legal name of the player.e. (E) Player Classification: Select whether the player is Public.e. not Bestfoods in this field). when the deal was Revised. or spread based on Private Basis. F (F) Ultimate Parent: Select the ultimate parent of the player. 50 . – Bestfoods is the ultimate parent of Duncan Hines. If the player is the parent organization. Private. only include the division name. (C) Player Industry: Select the most appropriate industry for the target and acquiror companies. (i. – Duncan Hines. Annual Report). A D B G C A B G C H I J K D E E F (B) Player Description: This field contains the player description. (i.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Agenda  Introduction  Trading comparables  Transaction comparables  Discounted cash flow analysis  LBO analysis  Relative value analysis  Merger consequences – – Accretion/(dilution) review Pro forma balance sheet analysis review  Appendix 51 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Discounted cash flow analysis as a valuation methodology Valuation methodologies Publicly traded comparable companies analysis Comparable transactions analysis Discounted cash flow analysis Leveraged buyout/recap analysis Other • “Public Market Valuation” • Value based on market trading multiples of comparable companies • Applied using historical and prospective multiples • Does not include a control premium • “Private Market Valuation” • Value based on multiples paid for comparable companies in sale transactions • Includes control premium • “Intrinsic” value of business • Present value of projected free cash flows • Incorporates both short-term and long-term expected performance • Risk in cash flows and capital structure captured in discount rate • Value to a financial/LBO buyer • Value based on debt repayment and return on equity investment • Liquidation analysis • Break-up analysis • Historical trading performance • Expected IPO valuation • Discounted future share price • EPS impact • Dividend discount model 52 .

corporations and academics • • • • • Corporate clients often use DCF analysis internally Comparable companies analysis Comparable transaction analysis Leveraged buyout analysis Recapitalization analysis. etc.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Overview of DCF analysis Overview Free cash flow Terminal value  Discounted cash flow analysis is based upon the theory that the value of a business is the sum of its expected future free cash flows. discounted at an appropriate rate  DCF analysis is one of the most fundamental and commonly-used valuation techniques WACC – – Widely accepted by bankers. particularly if no comparable publicly-traded companies or precedent transactions are available 53 . liquidation analysis. One of several techniques used in M&A transactions. others include: Other topics – DCF analysis may be the only valuation method utilized.

but certain rules of thumb always apply – Do not simply plug numbers into equations – You must apply judgment in determining each assumption 54 . based on several key projections and assumptions – – – Free cash flows • What is the projected operating and financial performance of the business? Terminal value • What will be the value of the business at the end of the projection period? Discount rate • What is the cost of capital (equity and debt) for the business? Other topics  Depending on practical requirements and availability of data.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Overview of DCF analysis (cont’d) Overview Free cash flow Terminal value WACC  DCF analysis is a forward-looking valuation approach. DCF analysis can be simple or extremely elaborate  There is no single “correct” method of performing DCF analysis.

but can be 5–20 years depending on the profitability horizon) Other topics Terminal value Estimate the exit multiple and/or growth rate in perpetuity of the business at the end of the forecast period Discount rate Estimate the company’s weighted-average cost of capital to determine the appropriate discount rate range Present value Determine a range of values for the enterprise by discounting the projected free cash flows and terminal value to the present Adjustments Adjust the resulting valuation for all assets and liabilities not accounted for in cash flow projections 55 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 The process of DCF analysis Overview Free cash flow Terminal value WACC Projections/FCF Project the operating results and free cash flows of the business over the forecast period (typically 10 years.

discounted using an appropriate weighted-average cost of capital  The cash-flow streams that are discounted include: – – Other topics Unlevered or levered free cash flows over the projection period Terminal value at the end of the projection period  These future free cash flows are discounted to the present at a discount rate commensurate with their risk – If you are using unlevered free cash flows (our preferred approach). the appropriate discount rate is the weighted-average cost of capital for debt and equity capital invested in the enterprise in optimal/targeted proportions – If you are using levered free cash flows. the appropriate discount rate is simply the cost of equity capital (often referred to as flows to shareholders or dividend discount model) 56 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 DCF theory and its application Overview Free cash flow Terminal value WACC DCF theory: The value of a productive asset is equal to the present value of all expected future cash flows that can be removed without affecting the asset’s value (including an estimated terminal value).

assuming no debt or excess cash (“firm value” or “enterprise value”) Debt associated with the business is subtracted (and excess cash balances are added) to determine the present value of the equity (“equity value”) Cash flows are discounted at the weighted-average cost of capital  DCF of levered cash flows (most common in valuation of financial institutions) – – – Projected income and cash-flow streams are after interest expense and net of any interest income Present value obtained is the value of equity Cash flows are discounted at the cost of equity 57 . net of excess cash Present value obtained is the value of assets.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 The two basic DCF approaches must not be confused Overview Free cash flow Terminal value WACC  DCF of unlevered cash flows (the focus of these materials) – – – – Other topics Projected income and cash-flow streams are free of the effects of debt.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Other considerations Overview Free cash flow Terminal value WACC Reliability of projections  DCF results are generally more sensitive to cash flows (and terminal value) than to small changes in the discount rate. Care should be taken that assumptions driving cash flows are reasonable. WACC and exit multiples or perpetuity growth rate 58 . EBITDA margin. Generally. Generally. we try to use estimates provided by analysts from reputable Wall Street firms if the client has not provided projections Sensitivity analysis Other topics  Remember that DCF valuations are based on assumptions and are therefore approximate. the best variables to sensitize are sales. Use several scenarios to bound the target’s value.

discount rates. Overview Free cash flow Terminal value WACC  Three key drivers: – – – Projections and incremental cash flows (unlevered free cash flow) Residual value at end of the projection period (terminal value) Weighted-average cost of capital (discount rate) Other topics  Avoid pitfalls: – – – – – – – – Validate and test projection assumptions Determine appropriate cash flow stream Thoughtfully consider terminal value methodology Use appropriate cost of capital approach Carefully consider all variables in calculation of the discount rate Sensitize appropriately (base projection variables. synergies. .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Always remember .) Footnote assumptions in detail Think about other value enhancers and detractors Always double-check with a calculator! 59 . terminal values. etc. .

balance sheet and statement of cash flows) typically provide all the necessary elements Other topics  Quality of DCF analysis is a function of the quality of projections – – – Often required to “fill in the gaps” Confirm and validate key assumptions underlying projections Sensitize variables that drive projections  Sources of projections include: – – – – Target company’s management Acquiring company’s management Research analysts Bankers 60 ..T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 The first step in DCF analysis is projection of unlevered free cash flows Overview Free cash flow Terminal value WACC  Calculation of unlevered free cash flow begins with financial projections – Comprehensive projections (i.e. fully-integrated income statement.

product-line or location-by-location build-up or simple growth assumptions Operating margins: Evaluate improvement over time. SG&A costs Synergies: Estimate dollars in Year 1 and evaluate margin impact over time Depreciation: Should conform with historic and projected capex Capital expenditures: Consider both maintenance and expansion capex Changes in net working capital: Should correspond to historical patterns and grow as the business grows  Should show historical financial performance and sanity check projections against past results. competitive factors. increased sales growth.g. reasons behind margin improvements. Be prepared to articulate why projections may or may not be similar to past results (e.)  Analyze projections for consistency – – Sales increases usually require working capital increases Capex and depreciation should converge over time 61 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Projecting financial statements Overview Free cash flow Terminal value WACC  Ideally projections should go out as far into the future as can reasonably be estimated to reduce dependence on the terminal value  Most important assumptions: – – – – – – Other topics Sales growth: Use divisional. etc.

you should only include actual cash taxes paid in the DCF. even if those projections include the effects of debt  To do this.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Free cash flow is the cash that remains for creditors and owners after taxes and reinvestment Overview Free cash flow Terminal value WACC  Unlevered free cash flows can be forecast from a firm’s financial projections. The tax footnote in the financial statements will give you a good idea of whether this is a meaningful issue for your analysis 62 . you may want to adjust for the non-cash (or deferred) portion of a firm’s tax provision. simply start your calculation with EBIT (earnings before interest and taxes): EBIT (from the income statement) Other topics Plus: Non-tax-deductible goodwill amortization Less: Taxes (at the marginal tax rate) Equals: Tax-effected EBITA Plus: Deferred taxes1 Plus: Depreciation and any tax-deductible amortization Less: Capital expenditures Plus/(less): Decrease/(increase) in net working investment Equals: Unlevered free cash flow 1 Although beyond the scope of our current discussions. Depending on the firm and industry.

0 27.4 132.1 17.5 36.8 29.3 109.0 $585.6 – 22.5 155.7 21.4 $532.2 128. 2000 2001P 2002P 2003P $484.9 23.3 16.0 68.8 – $53.3) $0.0 – 20.6 99.8 1998 Net sales EBITDA $400.0 12.9 $44.0 88.4 106.0 80.5 43.3 – 26.0 8.4 – $61.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Example: Calculating unlevered free cash flows Overview Free cash flow Terminal value WACC Stand-alone DCF analysis of Company X $ millions Fiscal year ending December 31.8 19.7 17.2 $72.3 21.0 53.8 – $46.6 – $69.5 82.0 90.0 13.5 46.0 96.2 7.8 $59.5 61.0 $79.3 – 24.6 141.5 48.7 19./(decr.4 2005P $779.) in working capital Unlevered free cash flow Adjustment for deal date Unlevered FCF to acquirer Key assumptions: Deal/valuation date = 12/31/01 Marginal tax rate = 40% 63 .6 117.3 (40.8 1999 $440.3 32.5 53.2 $54.9 2004P $708.9 $49.4 – 29.3 120.8 $644.5 23.0 40.6 5.0 69.8 14.2 $40.2 74.8 $65.0 10.6 39.6 Other topics Less: Depreciation EBITA Less: Taxes at marginal rate Tax-effected EBITA Plus: Depreciation Plus: Deferred taxes Less: Capital expenditures Less: Incr.5 16.3 4.

including: – Synergies achievable through the M&A transaction • Revenue • Cost • Capital expenditures – Expansion plans – Cost reductions – Change in sales growth – Margin improvements Other topics  These incremental effects can be valued by discounting them independently (net of taxes) or by adjusting the DCF model and simply measuring the incremental impact 64 . we often need to determine the incremental impact on value of certain events or adjustments to the projections.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Valuing the incremental effects of changes in projected operating results Overview Free cash flow Terminal value WACC  In performing DCF analysis.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3

Once unlevered free cash flows are calculated, they must be discounted to the present
Overview

 The standard present value calculation takes into account the cost of capital by attributing
Free cash flow Terminal value WACC

greater value to cash flows generated earlier in the projection period than later cash flows

Pnle rea= et u sv

F 1 C F (r 1 + )
1

+

F 2 C F (r 1 + )
2

+

F 3 C F (r 1 + )
3

+ .. .

+

F n C F (r 1 + )
n

Other topics

 Since most businesses do not generate all of their free cash flows on the last day of the
year, but rather more-or-less continuously during the year, DCF analyses often use the socalled “mid-year convention,” which takes into account the fact that free cash flows occur during the year

JPMorgan – standard

F 1 C F F 2 C F F 3 C F F n C F Pnle rea= et u sv + + + + This approach moves each cash+ 1 from the+ 2 of the applicable period to the flow end (r 0 1 . + 5 ) (r . 1 5 ) (r . 1 5 ) .. . ( r n5 1 -. + 0 ) middle of the same period (i.e., cash flows are moved closer to the present)

65

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3

It is important to differentiate between the transaction date and the mid-year convention
Transaction date: 01/01

Year

0

0.5

1

1.5

2

2.5

3

3.5

First cash flow, mid-year 1 Discounting = CF1 + (1+r)0.5 (1+r)1.5 CF2

Second cash flow, mid-year 2 CF3 + (1+r)2.5 +

Third cash flow, mid-year 3 ….

Transaction date: 06/30
Period 1 CF to buyer

Year

0

0.5

0.75

1

1.5

2

2.5

3

3.5

First cash flow, mid-period 1 Discounting = CF1 + (1+r)(0.75-0.5)

Second cash flow, mid-year 2 CF2 + (1+r)(1.5-0.5) (1+r)(2.5-0.5) CF3

Third cash flow, mid-year 3 + ….
66

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3

Practice exercise
Transaction date: 09/30

Period 1 CF to buyer

Year

0

0.5

0.75

1

1.5

2

2.5

3

3.5

1st flow, mid-period 1 Discounting = CF1 + (1+r)(0.875-0.75)

2nd cash flow, mid-year 2 CF2 + CF3

3rd cash flow, mid-year 3 + (1+r)(2.5-0.75) ….

(1+r)(1.5-0.75)

67

2 $54.10)3.0 69.5 16.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Example: Discounting free cash flows Overview Free cash flow Terminal value WACC Stand-alone DCF analysis of Company X $ millions 1998 Net sales EBITDA Less: Depreciation EBITA Less: Taxes at marginal rate Tax-effected EBITA Plus: Depreciation Plus: Deferred taxes Less: Capital expenditures Less: Incr.7 21.8 $65.6 39.5 43.5 48.3 16.5 $44.0 53.4 2.5 36.7 19.4 (1+.7 17.6 141.4 132.2 $72.0 27.9 $49.6 99.8 (1+.2 128.5 + $69.0 90.3 (40.0 $79.9 Fiscal year ending December 31.6 – 22.5 46.3 – 24.) in working capital Unlevered free cash flow Adjustment for deal date Unlevered FCF to acquirer Memo: Discounting factor Discounted value of unlevered FCF Discounted value of FCF 2001P–2005P $400.8 29.4 – $61.8 1.8 (1+.0 189.3) $0.8 – $53.5 + $61.5 $48.9 $44.0 13.3 109.9 Other topics Formula Key assumptions: Deal/valuation date = 12/31/01 Marginal tax rate = 40% Discount rate = 10% $189.0 80.6 $585.5 23.8 19.1 17.0 88.0 40.8 14.5 82.0 68.4 106.4 2005P $779.0 0.6 (1+./(decr.5 155.0 $0.6 5.3 – 26.10)0.6 = $46.2 7.8 $59.4 $532.3 32.9 23.6 117.0 10.5 $49.2 74.8 1999 $440.3 21.3 120.0 – 20.0 96.5 61.8 – $46.6 – $69.6 $644.7 2004P $708.4 – 29.0 12. 2000 2001P 2002P 2003P $484.0 8.10)2.3 4.6 3.5 68 .2 $40.10)1.5 53.5 $46.8 0.5 + $53.

the portion of the Free cash flow Terminal value WACC company’s total value attributable to cash flows expected after the projection period  Terminal value is typically based on some measure of the performance of the business in the terminal year of the projection (which should depict the business operating in a steady-state/normalized manner) – Terminal (or “Exit”) multiple method • Assumes that the business is valued/sold at the end of the terminal year at a multiple of some financial metric (typically EBITDA) Growth in perpetuity method • Assumes that the business is held in perpetuity and that free cash flows continue to grow at an assumed rate A terminal multiple will have an implied growth rate and vice versa..T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Terminal value can account for a significant portion of value in a DCF analysis Overview  Terminal value represents the business’s value at the end of the projection period. the terminal value is discounted back to the appropriate date using the relevant rate  Attempt to reduce dependence on the terminal value – – What is appropriate projection time frame? What percentage of total value comes from the terminal value? 69 .e. i. It is essential to review the implied multiple/growth rate for sanity check purposes Other topics – –  Once calculated.

this value is then discounted to the present. as were the interim free cash flows – The terminal value should be an asset (firm) value. EBITDA or EBITDAR.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Terminal multiple method Overview Free cash flow Terminal value WACC  This method assumes that the business will be valued at the end of the last year of the projected period  The terminal value is generally determined as a multiple of EBIT. remember that not all multiples produce an asset value – Note that in the exit multiple method terminal value is always assumed to be calculated at the end of the final projected year. irrespective of whether you are using the mid-year convention Other topics  Should the terminal multiple be an LTM multiple or a forward multiple? – – If the terminal value is based on the last year of your projection then the multiple should be based on an LTM multiple (most common) There are circumstances where you will project an additional year of EBITDA and apply a forward multiple 70 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Most common error: The final year is not normalized Overview Free cash flow Terminal value WACC  Consider adding a year to the projections which represents a normalized year  A steady-state. which can be distorted by contemporaneous industry or economic factors Other topics  Treat the terminal value cash flow as a separate. long-term industry multiple should be used rather than a current multiple. critical forecast – – – – Growth rate • Consistent with long-term economic assumptions Reinvestment rate • Net working investment consistent with projected growth • Capital expenditures needed to fuel estimated growth • Depreciation consistent with capital expenditures Margins • Adjusted to reflect long-term estimated profitability Normalized tax rate 71 .

2 7.2 $40.2 $54.9 7.5 155.1 17.9 * 7.7 19.3 16.4 106.9 $44.5 $49.6 141.5 46.8 $65.3 – 24.6 $155.10)4 72 .0 96.0x 1. 2000 2001P 2002P 2003P $484.3 32.0 40.5 $44.5 23.8 1999 $440.6 99.8 0.8 29.2 74.3) $0.0 13.0 10.2 $72.6 $644.4 $532.3 109.8 14.5 61.3 21.6 3.0 68.8 – $53.0 80.5 53.0x Formula ($155.9 $585.5 $46.0 8.7 21.4 $934.0 – 20.3 120.3 4.9 Fiscal year ending December 31.4 – 29.8 – $46.2 128.0 12.0 27.3 – 26.8 1.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Example: Terminal multiple method Overview Free cash flow Terminal value WACC Stand-alone DCF analysis of Company X $ millions 1998 Net sales EBITDA Less: Depreciation EBITA Less: Taxes at marginal rate Tax-effected EBITA Plus: Depreciation Plus: Deferred taxes Less: Capital expenditures Less: Incr.0x) $745.6 117.6 – 22.5 $48.5 36.0 $79.4 = (1+.0 53.3 745.6 – $69.9 23.7 17.6 39.0 69.4 2.5 82.5 16.6 5.4 132.091.0 90./(decr.5 43.9 $49.4 – $61.0 88.8 19.0 189.0 $0.9 Other topics Key assumptions: Deal/valuation date = 12/31/01 Marginal tax rate = 40% Discount rate = 10% Exit multiple of EBITDA = 7.4 2005P $779.7 2004P $708.8 $59.3 (40.) in working capital Unlevered free cash flow Adjustment for deal date Unlevered FCF to acquirer Memo: Discounting factor Discounted value of unlevered FCF Discounted value of FCF 2001P–2005P EBITDA in 2005P Exit multiple Firm value at exit Discounted terminal value Total present value to acquirer $400.5 48.0 0.

7 728.3 975.0x 8.4 834. except per share data A Discounted FCF 2001–2005 $196.6 = C Firm value at 2005P EBITDA multiple of 6.47 $21.18 $16.0 = Equity value at 2005P EBITDA multiple of 6.2 876.17 $21.0x $19.9 941.6 755.076.6 186.0x $687.80 $20.6 773.2 1.0x $784.4 851.5 $802.5 792.67 $22.7 662.0x 7.0 100.13 calculated using the treasury method Note: DCF value as of 12/31/01 based on mid-year convention 1 73 .2 776.1 182.2 976.0 million options with a weighted exercise price of $8.4 802.0x 7.8 616.0x 7.41 $23.97 $24.0 100.0x 7.97 $21.9 745.9 1.9 907.1 189.39 Discount rate 8% 9% 10% 11% 12% Based on 40.4 702.0 100.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Example: Terminal multiple method (cont’d) Overview Free cash flow Terminal value WACC Discount rate 8% 9% 10% 11% 12% Stand-alone DCF analysis of Company X $ millions.4 $999.0x 8.3 904.3 804.9 1.3 875.87 $17.8 966.0 $1.4 $899.77 $18.1 883.4 934.0x 8.7 + B Discounted terminal value at 2005P EBITDA multiple of 6.007.16 $19.7 828.0x 8.0x $884.6 777.6 855.2 718.6 594.013.17 $23.55 $18.0 $1.3 Other topics - D Net debt 12/31/01 $100.3 E Equity value per share 1 at 2005P EBITDA multiple of 6.0 million basic shares outstanding and 2.0 100.01 $17.6 677.5 638.113.1 $916.041.9 821.8 193.5 693.8 866.

1 this free cash flow is then capitalized at a rate equal to the discount rate minus the growth rate in perpetuity To ensure that the terminal year is normalized.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Growth in perpetuity method Overview Free cash flow Terminal value WACC  This method assumes that the business will be owned in perpetuity and that the business will grow at approximately the long-term macroeconomic growth rate – Few businesses can be expected to have cash flows that truly grow forever. divided by the difference between the discount rate and a perpetual growth rate 74 . and grow it one more year to n+1. JPMorgan models are set up to project one year past the projection year and allow for normalizing adjustments. n. be conservative when estimating growth rates in perpetuity Take free cash flow in the last year of the projection period. this FCFn+1 is then discounted by the perpetuity formula  Other topics  Academic formula JPM recommended method 1 This step is taken because the perpetuity growth formula is based on the principle that the terminal value of a business is the value of its next cash flow.

which in turn affects capex and depreciation – Working capital may also need to be adjusted – Often capex and depreciation are assumed to be equal 75 . EBIT and capital spending.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Growth in perpetuity method (cont’d) Overview Free cash flow Terminal value WACC  Note that when using the mid-year convention. terminal value is discounted as if cash flows occur in the middle of the final projection period – Here the growth-in-perpetuity method differs from the exit-multiple method  Typical adjustments to normalize free cash flow in Year n include revising the Other topics relationship between revenues.

0 40.6 * (1 + .8 $59./(decr..0 $0.5 76 .5 53.2 74.1 17.6 733.5 23.0 12.5 16.6 – 22.4 106.3 21.7 = (.0 90.3 $585.7 17.10 .3 16.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Example: Growth in perpetuity method Overview Free cash flow Terminal value WACC Stand-alone DCF analysis of Company X $ millions 1998 Net sales EBITDA Less: Depreciation EBITA Less: Taxes at marginal rate Tax-effected EBITA Plus: Depreciation Plus: Deferred taxes Less: Capital expenditures Less: Incr.4 – $61.0 27.6 3.0 88.8 29.5 $46.9 $44.7 21.3 4.) in working capital Unlevered free cash flow Adjustment for deal date Unlevered FCF to acquirer Memo: Discounting factor Discounted value of unlevered FCF Discounted value of FCF 2001P–2005P Value 2006PTotal present value to acquirer $400.9 $49.0 96.6 99.5 155.8 $65.6 117.5 48.3 32.5 $49.03)*(1+.8 1.7 2004P $708.0 $79. 2000 2001P 2002P 2003P $484.5 $44.0 189.4 – 29.10)3.0 53.4 2.6 – $69.3 – 24.03) $733.5 43.2 $72.9 Fiscal year ending December 31.5 82.4 2005P $779.3) $0.8 14.6 39.7 $923.0 80.0 69.3 109.8 19.8 – $53.5 46.6 5.8 0.5 36.3 – 26.5 $48.2 $40.0 8.9 23.4 $532.6 141.8 1999 $440.0 13.5 61.0 10.6 $644.0 68.4 132.2 128.8 – $46.2 7.2 $54.7 19.0 – 20.9 Other topics Key assumptions: Deal/valuation date = 12/31/01 Marginal tax rate = 40% Discount rate = 10% Perpetuity growth rate = 3% Formula $69.3 120.3 (40.0 0.

0% 3.5% 3.0 $1.087.077.3 883.8 1.8 $1.5 733.419.13 calculated using the treasury method Note: DCF value as of 12/31/01 based on mid-year convention 1 77 .0 771.8 $1.1 752.6 622.12 $15.0 100.59 $16.062.7 + B Discounted terminal value at perpetuity growth rate of 2.84 $20.1 823. except per share data A Discounted FCF 2001–2005 $196.5% $991.1 = C Firm value at perpetuity growth rate of 2.0 = Equity value at perpetuity growth rate of 2.1 923.0 million options with a weighted exercise price of $8.1 189.162.59 $29.8 193.95 Discount rate 8% 9% 10% 11% 12% Based on 40.7 708.34 $17.5 752.7 794.12 $23.26 $22.5% 3.0 1.14 $32.9 883.7 808.96 $18.0 811.0 100.6 668.6 186.1 182.0 1.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Example: Growth in perpetuity method (cont’d) Overview Free cash flow Terminal value WACC Discount rate 8% 9% 10% 11% 12% Stand-alone DCF analysis of Company X $ millions.8 587.88 $25.0% 3.8 570.187.192.8 Other topics - D Net debt 12/31/01 $100.2 $1.3 983.0 million basic shares outstanding and 2.5% 3.9 618.0 582.005.095.0% 3.0 666.2 $1.1 535.12 $21.8 905.6 768.0% 3.0 977.5 652.9 718.8 968.8 687.5% $1.5% $26.5% 3.0 100.9 681.31 $18.4 $1.40 $14.0 100.37 $15.8 E Equity value per share 1 at perpetuity growth rate of 2.5% $1.7 505.319.0 871.223.292.0 1.1 852.

FCFn] / [FCFn + (terminal value / (1 + WACC)0.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Terminal multiples and perpetuity growth rates are often considered side-by-side Overview Free cash flow Terminal value WACC  Assumptions regarding exit multiples are often checked for reasonableness by calculating the growth rates in perpetuity that they imply (and vice versa)  To go from the exit-multiple approach to an implied perpetuity growth rate: g = [(WACC*terminal value) / (1+WACC)0.g)]  These formulas adjust for the different approaches to discounting terminal value when using the mid-year convention 78 .5 .5] / [EBITDAn * (WACC .5)] Other topics  To go from the growth-in-perpetuity approach to an implied exit multiple: multiple = [FCFn * (1 + g)(1 + WACC)0.

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Terminal multiple method and implied growth rates
Overview Free cash flow Terminal value WACC
Discount rate 8% 9% 10% 11% 12%

Standalone Company X DCF analysis $ in millions
A + B Discounted Discounted terminal value FCF at 2005P EBITDA multiple of 2001–2005 6.0x 7.0x 8.0x $196.8 $687.5 $802.1 $916.7 193.1 662.6 773.1 883.5 189.6 638.9 745.4 851.8 186.1 616.2 718.9 821.6 182.7 594.5 693.5 792.6 = C Firm value at 2005P EBITDA multiple of 6.0x 7.0x 8.0x $884.4 $999.0 $1,113.6 855.8 966.2 1,076.7 828.4 934.9 1,041.4 802.3 904.9 1,007.6 777.2 876.3 975.3

Other topics

Terminal value as percent of total firm value 6.0x 7.0x 8.0x 78% 80% 82% 77% 80% 82% 77% 80% 82% 77% 79% 82% 76% 79% 81%

Discount rate 8% 9% 10% 11% 12%

D Net debt 12/31/01 $100.0 100.0 100.0 100.0 100.0

= Equity value at 2005P EBITDA multiple of 6.0x 7.0x 8.0x $784.4 $899.0 $1,013.6 755.8 866.2 976.7 728.4 834.9 941.4 702.3 804.9 907.6 677.2 776.3 875.3

E Equity value per share 1 at 2005P EBITDA multiple of 6.0x 7.0x 8.0x $19.17 $21.97 $24.77 $18.47 $21.17 $23.87 $17.80 $20.41 $23.01 $17.16 $19.67 $22.18 $16.55 $18.97 $21.39 Implied perpetuity growth rate at 2005P EBITDA multiple of 6.0x 7.0x 8.0x 0.2% 1.3% 2.1% 1.1% 2.2% 3.0% 2.0% 3.1% 3.9% 2.9% 4.0% 4.8% 3.8% 4.9% 5.8%

At a 9% discount rate and an 8.0x exit multiple the price is $23.87 and the implied terminal growth rate is 3.0%
Based on 40.0 million basic shares outstanding and 2.0 million options with a weighted exercise price of $8.13 calculated using the treasury method Note: DCF value as of 12/31/01 based on mid-year convention
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Perpetuity growth rate and implied terminal multiples
Overview Free cash flow Terminal value WACC
Discount rate 8% 9% 10% 11% 12%

Standalone Company X DCF analysis $ in millions
A + Discounted FCF 2001–2005 $196.8 193.1 189.6 186.1 182.7 B Discounted terminal value at perpetuity growth rate of 2.5% 3.0% 3.5% $991.0 $1,095.4 $1,223.0 811.9 883.8 968.9 681.5 733.7 794.0 582.6 622.0 666.7 505.1 535.8 570.1 = C Firm value at perpetuity growth rate of 2.5% 3.0% 3.5% $1,187.8 $1,292.2 $1,419.8 1,005.0 1,077.0 1,162.0 871.1 923.3 983.6 768.7 808.1 852.8 687.9 718.5 752.8

Other topics

Terminal value as percent of total firm value 2.5% 3.0% 3.5% 83% 85% 86% 81% 82% 83% 78% 79% 81% 76% 77% 78% 73% 75% 76%

Discount rate 8% 9% 10% 11% 12%

D Net debt 12/31/01 $100.0 100.0 100.0 100.0 100.0

= Equity value at perpetuity growth rate of 2.5% 3.0% 3.5% $1,087.8 $1,192.2 $1,319.8 905.0 977.0 1,062.0 771.1 823.3 883.6 668.7 708.1 752.8 587.9 618.5 652.8

E Equity value per share 1 at perpetuity growth rate of 2.5% 3.0% 3.5% $26.59 $29.14 $32.26 $22.12 $23.88 $25.96 $18.84 $20.12 $21.59 $16.34 $17.31 $18.40 $14.37 $15.12 $15.95 Implied EBITDA exit multiple at perpetuity growth rate of 2.5% 3.0% 3.5% 8.6x 9.6x 10.7x 7.4 8.0 8.8 6.4 6.9 7.5 5.7 6.1 6.5 5.1 5.4 5.8

At a 9% discount rate and a terminal growth rate of 3.0%, the price is $23.88 and the implied exit multiple is 8.0x
Based on 40.0 million basic shares outstanding and 2.0 million options with a weighted exercise price of $8.13 calculated using the treasury method Note: DCF value as of 12/31/01 based on mid-year convention
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Choosing the discount rate is a critical step in DCF analysis
Overview Free cash flow Terminal value WACC

 The discount rate represents the required rate of return given the risks inherent in the
business, its industry, and thus the uncertainty regarding its future cash flows, as well as its optimal capital structure

 Typically the weighted average cost of capital (WACC) will be used as a foundation for setting
the discount rate

Other topics

 The WACC is always forward-looking and is predicted based on the expectations of an
investment's future performance; an investor contributes capital with the expectation that the riskiness of cash flows will be offset by an appropriate return

 The WACC is typically estimated by studying capital costs for existing investment opportunities
that are similar in nature and risk to the one being analyzed

 The WACC is related to the risk of the investment, not the risk or creditworthiness of the
investor¹

1

In valuing a company, always use the riskiness of its cash flows or comparable companies in estimating a weighted average cost of capital. Never use the acquirer’s cost capital unless, by some chance, it is engaged in an extremely similar line of business. However, if a business is small relative to an acquiror’s, sometimes ti may be appropriate to consider the use of the acquiror’s WACC in performing the valuation. The additional value created by using the acquiror’s WACC can be viewed as a synergy to the acquiror in the context of the transaction.

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9 7 % 9 .t r ee r m rfrt) an tr(= eb oe ea t 0 u = Af do jm ur s tt e n cn ot rio r e l a t o + sr tm ot c k a k e rs e t u r n + Pt re ea ds id c te b + 1 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 The cost of equity is the major component of the WACC Overview Free cash flow Terminal value WACC JPMorgan estimates the market cost of equity at approximately 10%  The cost of equity reflects the long-term return expected by the market (dividend yield plus share appreciation) JPMorgan estimates the cost of equity using the capital asset pricing model – Risk-free rate based on the 10 year bond yield – Incorporates the undiversifiable risk of an investment (beta) – Equity risk premium reflects expectations of today’s market Ct oi sy tq o f e u = Re ir st k fa e e r + B e t a xEp qr ue ii m tkm yi r u s A“” pe px rt t or pa r i a e ra f eve t br ur e ro ni e s k x r a t e x x Es su tt i ie m a d n g ve ah rtn isu oie us c q 5 . 0 0 = 1o 0n -b yd ey ai re l d (a) ae nr ng ue la a v Fa ov rkg m aa re ee tr = = 4 . 0 0 %  Other topics L ro oe nt n gu .r t n e r m ee qs utt in i tv n ye im n tye or dk at ’a s m L re oif ns gk . 9 7 % 82 .

7 3 . 4 4 . 2 6 .0% Overview Free cash flow Terminal value WACC Equity risk premiums is estimated based on expected returns and recent historical returns Equity premiums Rolling average over 10-year bond 14% Equity returns less 10-year bond yield Arithmetic average 12% Rolling 30 years 3n 0d yi en ag r s e 1 9 9 4 Rolling 50 years E q u is tk y r i p% r( e) m i u m 2 . 0 Other topics 10% Percent 8% 1 9 9 5 1 9 9 6 6% Rolling 40 years 1 9 9 7 1 9 9 8 1 9 9 9 4% 2% 19 55 19 58 19 61 19 64 19 67 19 70 19 73 19 76 19 79 19 82 19 85 19 88 19 91 19 94 19 97 20 00 2 0 0 0 2 0 0 1 Year 83 . 4 4 . 2 5 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 JPMorgan estimates the equity risk premium at 5. 7 5 . 8 5 .

0 # of companies 800 600 Predicted betas Supermarkets 0.0 0.0 0 (0.6 Predicted betas 400 200 Historical betas 3.5 3.9 2.0 1. and leverage – Predicted betas are more consistent and less volatile than historical betas  Historical betas only measure the past relationship between a firm’s return and Other topics market returns and are often distorted Distribution of predicted and historical betas for 5. incorporating firms’ earnings volatility.0) (0.5 4.2 1.0 2.09 0.0 1.43 Cellular 1.5) (1.5) Beta Beta 84 .52 Utilities 0.600 publicly-traded companies # of companies 800 600 400 200 0 (1.62 Internet 2. industry exposure.78 Food 0.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 JPMorgan uses predicted betas to calculate the cost of equity Overview Free cash flow Terminal value WACC  Predicted betas are constructed to adjust for many risk factors.5 2.5) 0. size.5 1.

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JPMorgan uses the long-term cost of debt in estimating WACC
Overview Free cash flow Terminal value WACC

 The long-term cost of debt is used because the cost of capital is normally
applied to long-term cash flows

 Using the long-term cost of debt removes any refinancing costs/risks
from the valuation analysis – To the extent a company can fund its investments at a lower cost of debt (with the same risk), this value should be attributed to the finance staff

Other topics

 JPMorgan uses the company’s normalized cash tax rate

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The cost of equity and debt are blended together based on a target capital structure
Overview


Free cash flow Terminal value WACC

The target capital structure reflects the company’s rating objective – Firms generally try to minimize the cost of capital through the appropriate use of leverage The percentage weighting of debt and equity is usually based on the market value of a firm’s equity and debt position – Most firms are at their target capital structure – Adjustments should be made for seasonal or cyclical swings, as well as for firms moving toward a target Using a weighted average cost of capital assumes that all investments are funded with the same mix of equity and debt as the target capital structure


Other topics

WACC formula

Illustrative SYSCO Weighted Average Cost of Capital calculation
Cost of equity
C ol s tp o ft c a i a 1o 0n --( yd e a r T b Mm ae rk km ei tp ru ir s (ard xre )(ti) Bd ep tr c ct ue e n Ae dkm jdm uti sp ta er m re u C o s tu o ft e q i y = A v g ) 4 . 9 7 % 5 . 0 0 % 0 . 6 2 3 . 1 0 % 8 . 0 7 %

Cost of debt
C o s t o f d e b t (d ) T a x s h i e l
1

6 . 2 5 % 2 . 1 9 % 4 . 0 6 %

Target capital structure
(Assumes current = optimal)

A fs tt e rd -e tf a x c o o b t

Debt/total capital2 = 6.1%

Nominal WACC = 7. 82%
Assumes 35% marginal tax rate 2 Total capital = debt + market value of equity
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The cost of a firm’s equity should be adjusted for size
Overview Free cash flow Terminal value WACC

Investors typically expect higher returns when investing in smaller companies – Increased risk – Lower liquidity Betas vary very little by size

Size premium by market cap
Based on historical returns analysis
5.2% 3.1% 2.5% 1.9% 1.7% 1.4% 1.1% 0.8% 0.0%

Other topics

 

$0–100

$100–250 $250–500 $500–700

$700– 1,000

$1,000– 1,500

$1,500– 2,500

$2,500– 5,000

$5,000+

Historical equity returns suggest higher return required by investors in smaller companies P/E growth ratios (PEG) tend to decline with size Empirical data combined with judgement should be applied when estimating the cost of equity for smaller firms

Market cap ($MM)

Size premium by market cap
Based on PE/growth (PEG)
2.2% 1.6% 1.1% 0.8%

0.0% $100–500 $500–1,000 $1,000–2,500 $2,500–5,000 $5,000+

Market cap ($MM)

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Predicted betas declined substantially in several industries, although food distribution has been increasing over the last few years

Overview Free cash flow Terminal value WACC

 Predicted betas are declining in
industries whose fundamentals do not appear to have changed

Predicted betas for various industries1
1.20 1.10 1.00

Other topics

 JPMorgan believes that current
predicted betas do not fully represent the equity risk of investments in these sectors

0.90 0.80 0.70 0.60
Food retail Pharma Food dist.

 Using a predicted beta adjusted to
reflect historical levels over a longer time frame (up to 5–10 years) is appropriate

0.50 0.40

Packaged food

0.30 Jan-95

Oct-96

Jul-98

Apr-00

Jan-02

Typically between three and five large-cap companies were used to develop these “industry” predicted betas Source: Barra
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66 10 yr.46 0.40 5 yr avg.57 1.82 1992– 1997 0.69 0.27 0.36 0.50 0.79 0.91 0.64 0.54 0.09) 0.62 0.63 0.58 0.60 0.63 0. 1992– avg. 0.53 0.52 0.9% 0.46 0.66 0.54 0.39 0.59 0.35 0.7% 96.0% 78.43 0.64 5 yr avg.46 0.62 0.77 0.8% 69.4% 107.23 0.30 0.52 0. 1997 0.55 0.66 0.4% 31.47 0.75 0.60 Current hist.48 0.19 0.70 0.73 0.276 $696 18. 0.66 1.30 0.31 0.9% 97.39 Predicted beta (levered) Market cap $17.903 Debt/ equity 6. beta 0.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Historical analysis suggests current predicted betas may understate cost of equity in food distribution Overview Free cash flow Terminal value Company WACC SYSCO Ahold Other topics Other food distributors Performance Food Group International Multifoods United Natural Foods Fleming Companies Nash Finch SuperValu Median $1.43 0. 0.97 Predicted beta (unlevered) Current 0.33 0.482 5102 352 825 391 3.15 0.68 0.73 0.56 0.26 0.54 0.1% 298.67 0.47 0.23 0.61 0.35 0.39 0. avg.19 (0. 2002 89 .78 0.61 0.82 0.43 0.56 0.76 $ millions Note: Share prices as of July 3.24 0.26 0.37 0.62 0.84 0.41 10 yr.87 0.64 0. 2002 Source: Barra as of May 30.358 14.02 0.87 0.76 0.8% Current 0.

1 % Other topics $ 2 0 M t a r g e t SYSCO WACC sensitivity 10% 0. 5 %.65 Levered beta 0.0% 10.5% 90 .0% 10. 8.2% 9. 0 %0 7 . 8.1% 8.1% Note: Assumes 35% marginal tax rate 1 Assuming an equity risk premium of 6.1% 9.7% 8. 6 % 6 .3% 40% 8. 0 4 % 9 . 7 0 5 . 2 5 % .7% 8. 3 % 9 . 7 % 2 0 % 09 .8% 10.3% 7.5% 7.7% 10.4% 40% 8.6% 7.4% 7.2% 8. 0 % 6 .4% 8.8% 8.1% 9.7% 7.85 0.0% 40% 7.4% 8. 5 %. 7 0 5 .80 0.5% 10.9% 8.4% 9.75 0.4% 9.8% Debt/equity 20% 30% 7.70 Levered beta 0.9% 9.0% 7.9% 9. 0 % 6 .7% 9. 0 % 0 .2% Debt/equity 20% 30% 9.4% 9.3% 8.5% 7. 0%0 0 1 . 5 %.0% 9.7% 7.4% 9.90 9. 8. 0 %.75 0. 2 5 % 8 7 . 8 0 C o m p a n y S Y S C O $ 1 B N t a r g e t $ 5 0 M t a r g e t W A C 9 .8% 8. 3 % 2 0 % 09 .7% 10.4% 7.4% 10.0% $1BN target WACC sensitivity1 10% 0.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 The appropriate cost of capital will depend on the entity which is being valued Overview Free cash flow Terminal value WACC For illustrative purposes R i sU O kn l e v e r e d pR C C t i m a e l l e v e r e d o s t o f o s t o f p r e mad i u m bb ee t t / e q u i t y b e e q t a u f i t y i n a n c i n g 5 .80 0. 4 % 1 0 . 0 %0 7 . 0 %0 6 .1% 9.70 Levered beta 0.75 0.85 0. 3 % 6 .2% 7. 2 % 2 0 % 09 . 8 . 5 %. 2 5 %8 8 .8% 8. 7 0 5 .80 0. 0%% 8 0 1 0 . 2 5 %8 .6% 9.2% $200MM target WACC sensitivity2 10% 0.8% 8.90 9.8% 11.5% 8.7% 10.1% 10. 7 0 2 0 % 0 .5% 2 Assuming an equity risk premium of 7.3% 9.70 0.8% 10.85 7.1% 10.3% Debt/equity 20% 30% 8. 0%0 0 1 0 .7% 9.9% 9.

g. not market expectations Other topics Target capital structure • • The actual.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Most common errors in calculating WACC Overview Free cash flow Terminal value WACC Cost of equity • • • • • • Equity risk premium based on very long time frame (post 1926: Ibbotson data) Substitute hurdle rate (goal) for cost of capital Use of historical (or predicted) betas that are clearly wrong Investment specific risk not fully incorporated (e. not target.. capital structure is used WACC calculated based on book weights 91 . country risk premiums) Incorrect releveraging of the cost of equity Cost of equity based on book returns.

the term “synergies” refers to the changes in their aggregate operating and/or financial results attributable to their being operated as a combined enterprise. Synergies can take many forms: – Revenue enhancements – Raw material discounts/purchasing power – Sales and marketing overlap – Corporate overhead reductions – Distribution cost reductions – Facilities consolidation – Tax savings  The value of achievable synergies is often a key element in whether to proceed with a proposed transaction – Calculate synergies for both the acquiring company and the target – Remember incremental cash flow  Synergies are generally valued by toggling pre-tax changes to various financial statement line items into a DCF model of the combined enterprise and simply measuring the incremental impact 92 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Valuing synergies Overview Free cash flow Terminal value WACC Other topics  When two businesses are combined.

e.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Sensitivity analysis is vital when presenting the results of DCF analysis Overview Free cash flow Terminal value WACC Other topics  Recall that DCF valuation is highly sensitive to projections and assumptions  So-called “sensitivity tables” chart the output based on ranges of input variables – It is common to use a 3x3 table (i. DCF analyses using exit multiples and perpetuity growth rates generally show sensitivities for the method used to calculate terminal value and a range of discount rates – Sensitivities can be shown for any variable in the model (including financial projections) – Judge which sensitivities would be useful to decision makers 93 .. depicting sensitivity tables enables users of DCF output to assess the degree of “fuzziness” in the results  As shown in our previous examples. showing three different values for each of two input variables) to enable the reader to “triangulate” to the appropriate inferences  Since DCF results are by their nature approximate.

EBITDA and/or net income).) 94 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Companies with multiple businesses are often valued on a sum-of-the-parts basis Overview Free cash flow Terminal value WACC Other topics  This approach is sometimes referred-to as a “break-up” valuation – – Particularly common when the company is believed to be undervalued by the public Better accounts for discrepancies in market conditions facing the businesses  The methodology requires estimating financial results for each business (EBIT. which can then be used with appropriate multiples or growth rates in order to arrive at a firm value for each part before the results are summed  Completing a sum-of-the-parts valuation can be more challenging than a straightforward (single-business/consolidated) DCF analysis – Typically less detailed financial data is publicly-available for segments – Often assumptions must be made about how to allocate expenses. especially those that are clearly shared across businesses (like corporate-level SG&A) – Need to consider different characteristics of each business segment (discount rate. terminal value assumptions. etc.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Agenda  Introduction  Trading comparables  Transaction comparables  Discounted cash flow analysis  LBO analysis  Relative value analysis  Merger consequences – – Accretion/(dilution) review Pro forma balance sheet analysis review  Appendix 95 .

the exit and the period between the acquisition and the exit are critical to determining an appropriate capital structure and potential returns to equity 96 . as cash flows generated during the investment period are used to pay down debt  Financial sponsors profit by exiting three to five years after the transaction – – – Sell the target to another buyer Take the target public Recapitalize the target  Assumptions regarding the investment transaction.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 LBO analysis provides another perspective on M&A transactions Overview Example  A leveraged buyout is an acquisition transaction in which much of the purchase price is funded with debt  This type of capital structure enables financial sponsors to “leverage” returns on their relatively small equity investment.

comparable companies/transactions analyses thereafter)  LBO analysis provides another data point for strategic players that may chiefly rely on DCF analysis  LBO valuation may be useful from a competitive point of view.. acquiring with the expectation of selling in several years)  Financial sponsors generally analyze a transaction using LBO methodologies in the first instance (and DCF.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 LBO analysis can play an important role in many M&A engagements Overview Example  M&A clients include both financial sponsors and strategic players – – Financial sponsors typically pursue M&A transactions with different perspectives and objectives (e. as strategic players vie with financial sponsors for the same assets 97 .. a shorter investment horizon) Strategic buyers sometimes behave like financial investors (i.e.g.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 The process of LBO analysis Overview Example Projections Develop an integrated model of the business that projects EBITDA and cash available for debt repayment over the investment horizon (typically 3–5 years) Terminal value Estimate the multiple at which the sponsor can be expected to exit the investment at the end of the investment period Pro forma capitalization Determine a transaction structure and a pro forma capital structure that result in realistic financial coverage IRR Calculate returns (IRR) to the equity sponsor Adjustments Tweak the transaction/capital structure as needed to achieve harmony (if possible) between IRR. leverage and valuation 98 .

with positive flows to equity typically coming at exit – Amount and predictability of free cash flows dictate whether a company is an attractive or viable LBO target  Cash flows are not discounted  Terminal value drives valuation.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 The initial steps in an LBO analysis are identical to those in a DCF analysis Overview Example  The same financial projections developed for a DCF analysis can be used to build a basic LBO model  Free cash flows are expected to be used to service debt. and is calculated on the basis of multiples – Multiple of exit-year EBITDA is generally used to bound the valuation of the enterprise in any possible exit scenario 99 .

as well as transaction-related leakage: – Refinancing existing debt – Transaction expenses – Equity purchase price – Debt and equity to be rolled-over  Sources must equal uses – – Any debt or equity that is rolled-over shows up under both sources and uses Always depict every part of the capitalization. including: – – – New debt New equity Rolled-over debt and equity  Uses of funds should address all parts of the target’s existing capital structure.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Pro forma capitalization and transaction structure are set forth in “sources and uses” Overview Example  Sources should show the entire pro forma capitalization of the company. whether it changes pro forma or not 100 .

PIK securities and warrants Expected IRR in the 15%– 20% range Typically supplied by a financial sponsor Highest risk / cost of capital Sometimes “stapled” to high-yield paper to attract broader investor group Minimum annual returns >20% Mezzanine securities • • • • Sample inputs Sub.to 8-year tenor First in line at liquidation Lowest coupon Subordinated debt Sample inputs • Senior/sub notes • 25%–35% of total • Discount notes capital • T + 350–650 • 7–10 years Typically supplied by an investment or commercial bank or a mezzanine fund Riskier debt / typically unsecured Primarily bullet structures Typical tenor is 10-year High coupon Typically supplied by an investment or commercial bank or a mezzanine fund (often sponsor-affiliated) Multiple forms: Convertible debt. convertible preferred stock. debt (conv.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 LBO models are driven by the characteristics of the sources of capital for the transaction Overview Components of capital Example Senior debt • Revolving • Term Sample inputs • 30%–50% of total capital • LIBOR + 200-400 • 5–8 years                  Typically supplied by an investment or commercial bank Usually secured / most restrictive covenants Amortizing 5. exchangeable debt.) • 0%–35% total capital • High teens/low 20s Preferred stock • 7–10+ years PIK Warrants Common equity Sample inputs • 20%–40% of total capital • 20%-30% IRR • 5–7 year horizon 101 .

g.. initial investment) are always negative. exit proceeds) are always positive  Keep in mind that there may be cash flows to the sponsor prior to exit – These flows must be factored into the calculation of IRR in the period in which they are received  Remember that equity sits at the bottom of the capital structure – Debt must be paid-off or refinanced for holders of equity to receive any return on their investment  IRR is also driven by the investor’s pro forma equity ownership percentage 102 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Internal rate of return (IRR) is the key return benchmark utilized by financial investors Overview Example  IRR represents the implied discount rate at which the net present value of cash flows equals zero – The math underlying IRR is highly complex – Excel and financial calculators effectively back into IRR by narrowing a series of guesses at the appropriate rate – When calculating IRR. cash outflows (e.. and cash inflows (e.g.

IRR and credit ratios serve as gauges of the transaction structure’s viability Overview Example  Key credit ratios include: – – – – Total debt to EBITDA Senior debt to EBITDA EBITDA to total interest EBITDA less capital expenditures to total interest  Both providers of debt and equity have minimum requirements for participating in a transaction – Debt covenants typically require periodic certification of financial ratios – Equity sponsors generally will not invest without comfort as to likely returns 103 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Together.

for example: – – – – – – – – EBITDA coverage (EBITDA/total interest expense) of not less than 2.0–4.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Structural benchmarks vary across industries and reflect current market conditions Overview Example  M&A professionals require input from colleagues actively involved in debt capital markets in order to develop reasonable assumptions regarding capital structures in LBO analyses  Guidance received from debt-market participants could include.2x Total debt/EBITDA of not more than 4.5–5.5x Senior debt/EBITDA of not more than 3.0x EBITDA – capital expenditures coverage [(EBITDA ‑ CAPEX)/interest expense] of not less than 1.0x Senior bank term loan completely repaid in 5–7 years Bank debt not to exceed 60% of the initial capitalization Pure equity of not less than 25% Ability to convey “growth” prospects to banks and high-yield investors  Always remember that markets are dynamic 104 .

024 125 899 35.0x $100 $700 500 200 Operating improvement and arbitrage Example EBITDA Exit multiple EBITDA at Exit Firm value at Exit Debt (after paydown of $75 per yr) Equity value at exit IRR (5-Year exit) 7.0x $128 1.1% 105 .0x $100 700 125 575 23.0x $128 896 125 771 31.5% 7.0% 8.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 IRR drivers Overview Three important factors drive IRRs: 1) De-levering 2) Operating improvement and 3) Multiple expansion (arbitrage) No operating Operating At improvement/ improvement/ purchase No arbitrage No arbitrage EBITDA Purchase multiple EBITDA on Purchase date Firm value at Purchase date Debt at purchase (5x EBITDA) Equity value invested 7.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Sample LBO valuation analysis Overview $ millions Example Assumes management promote of 5% Valuation as at 12/31/01 3 Leverage based on bank/bond case 1 2 106 .

3 2 6% . 8 2. 0 0% $ . 4 21 7. 0 0 $ 72 2. et w z N euy e qit w R oeeuy o vr qit llTt lsu e o or s a c 20 . 1 2% . 0 2 % 0 1. 0 9 . 0 7 . 0 5. x 2 07 . % 0 1. 0 I t rs n et e rt a e 90 . 3 4% . 1 3. 8 2. % 7 7 0% . 0 8% . 3 22 9. % 0 107 . 8 10 % 0. 5 0 9% . 7 2. 2 0% . x 4 Tr e m ( er) ya s 7 . % 5 3 1% . 8 $ %ft t l oo a 0% . 8 10 % 0. et llRinne x t g ezdb e ac eis m . 0 0 3. % 4 0 5. 7 3. % 0 90 . et llz E it pr hs p e q y u ae r u c ic T nat nes r sc f e a io R oeeuy o vr qit llTt lue o ss a Su e of ns or s f ud c Fne udd C me o it d mt Aon m t u %ft t l oo a Aon m t u %ft t l oo a $ 6 . 0 0 2% . 0 7 . 0 20 0. et llN mzdb e e . 8 4. 0 2 % 0 1. 1 3. x 5 00 . 0 0 2% . % 2 00 . % 6 7 2. 0 Example E t g ah a ne x in cs blac is R oe e lvr v S iot r lon e r e as n m N sbdb e u. 9 9 6% . 8 10 % $ 0. 9 9 6% . 0 0 40 0. et w R oesbdb o vr u. x 7 25 . 4 5. 0 EI D B A T cvr g oe e a 00 . 0 7. 3 2 7% . 0 0% . 2 3. x 5 08 . et f in z R oemzdb o vr e . % 0 5 22 9. 0 77 9. 0 0 4% . % 0 20 . 6 4. 0 6. 0 8 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Stand-alone LBO analysis of Company X Overview $ millions U s ff ns s o ud e Mim cs blac in u ah a ne m Rinne x t g eiodb e ac eis sn r et f in R oesn rdb o vr eio et llRinne x t g u.db e ac eis sb et f in R oesbdb o vr u. 0 0% . 0 0 3% . 9 4. 5 $ 72 2. 8 0% . 0 6 % 0 Wrn a at r s ( d ss %i h) l C he a fe s ( ot) pi s n Aon m t u 5 . 6 3. 8 6 . % 7 5 21 7. % 5 15 . 0 9 .

0 40 5 .2 32 4 .2 $ 22 4 .9 7 % 2 .0 21 9 .0 2 .1 4 % 8 x .8 9 % 2 .0 $ 4 0 .4 2 % 3 .0 6 x .6 3 % 2 .0 45 2 .2 1 % 1 .9 5 % 2 .1 2 % Example $ Eu q ity p rc a e u hs p e ric 2 .0 3 .5 5 % 2 .8 35 4 .2 x 4 0 .2 22 9 .0 26 6 .8 4 5 .0 2 % 2 .5 22 9 $ 30 5 .7 x 26 1 .8 35 9 .9 7 % 2 .8 5 % 2 .0 40 0 .0 2 .6 5 % 2 .0 45 2 .4 24 6 .4 4 % 3 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Stand-alone LBO analysis of Company X (cont’d) Overview $ millions 5 e r le e dre rn toe u a v rio sp e -y a v re tu s q ity t a u ric s E it m ltip o E IT A x u le f B D 6 x .5 7 x .4 29 3 .4 108 .0 x 19 8 .0 40 0 .2 27 6 .5 3 .5 x 29 6 .4 24 1 .0 x 25 9 .9 7 % 3 .9 9 % 2 .6 $ 24 9 .6 39 1 .2 0 % 2 .7 % 5 8 30 5 .0 36 1 .6 Eu q ity p rc a e u hs p e ric $ 9 .0 0 % 2 .4 29 8 .2 3 % 2 .6 39 6 .8 30 7 .0 35 7 .0 40 5 .9 3 % 1 .3 9 % 1 .8 $ 30 2 .6 34 4 .7 1 % 2 .0 35 7 .0 5 0 .6 7 % 7 x .0 6 % N we u re u du d r v rio ss c re e q ity q ire n e a u tru tu s T ta in l le e g o l itia v ra e 4 5 .8 7 % 2 .2 37 1 .0 $ 21 4 .

0x 819.0% Example Acquirer/new equity investors New mezz. Maximum senior leverage Maximum total leverage EBITDA exit multiple Interest on cash balances Terminal equity value EBITDA Exit multiple of EBITDA Firm value Less: Debt Plus: Cash Less: Refinancing fees Plus: Dividends Equity value $ $ 40.6% 0.6 198. exp.0 685.4% 1.0x 7.0% 106.4% 100.1 $ 7.5 5.3 $ 1.0 555.0 5.0x 901.9 $ 351.25x 4.091.0 442.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Stand-alone LBO analysis of Company X (cont’d) Overview $ millions Equity ownership summary % basic shares 93.0 3.0% % diluted shares 92.0% 6.0% $ $ $ 2002P 117.7 $ 835.5 $ 2004P 2005P 2006P 141.50x 7.3% 6.0x 5.1 $ 1.0 7.0 5.0 311.0x 992.5 109 .9 $ 2003P 128.8 $ 7.0 5.4 5.7 $ 155.9 $ 170.7 $ 996.5 1.3% 100.190. lenders Roll-over equity holders Other assumptions Tax rate LTM (2001) EBITDA Non-financing trans.4 260.0x 7.9 $ 382.

7 6 4x .8 3 5x . 0 25 0P 0 6 8 .8 3 1x . 0 8 .8 6 24 0P 0 1x . 3 8 $ . 7 2 4 26 0P 0 IR R 2% 9 . 0 8 .0 3 2x .6 2 2x . 9 $ 22 0P 0 8 $ .3 7 3x . 9 1% 9 . 2 6 (9 ) 2. 2 1 1 7 0 . 0 23 0P 0 8 $ . 8 Example $ 9.5 5 3x .3 8 2x . 3 110 . 0 8 . 4 $ 21 0P 0 (9 ) 2.6 2 2x .0 3 23 0P 0 1x .2 8 1x . 4 8 $ . 2 6 22 0P 0 23 0P 0 $ 24 0P 0 6.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Stand-alone LBO analysis of Company X (cont’d) Overview $ millions Rrs n eiy enow t t t eq u u Ea2 /4 x t1 1 i / 0 t 3 Ea2 /5 x t1 1 i / 0 t 3 Ea2 /6 x t1 1 i / 0 t 3 Rrs mn lnr enoea e d t t z i ee u zn s Ea2 /4 x t1 1 i / 0 t 3 Ea2 /5 x t1 1 i / 0 t 3 Ea2 /6 x t1 1 i / 0 t 3 Cisits rdtt i e ac t s Soe/ BA er bED n dt I i T Tldt ED o e/ B A t b I a T EDttlitrs BA a e t I /o ne T (BAaxttlitrs EDce/o ne I . 0 24 0P 0 6 6 .1 2 25 0P 0 0x .7 1 6x . 9 (9 4) .0 8 N A N A 22 0P 0 2x . 0 8 .p) a e t T Aog t ls ci n 2x . 0 26 0P 0 IR R 2% 0 . 0 8 . 5 2% 5 . 2 6 (9 ) 2.1 9 3x . 7 1% 9 .9 6 2x .6 9 3x .9 9 26 0P 0 0x . 9 (9 4) . 3 3 8 25 0P 0 $ 7.0 2 3x .5 2 $ 21 0P 0 (9 4) .3 1 3x . 4 2% 7 .

2 3 8 .7 $ 1 .3 1 1 8 .7 2 3 2 . ) in w o r k in g c a p it a l C a s h a v a ila b le f o r d e b t s e r v ic e M e m o : P e r io d R e v o lv e r B a la n c e a t b e g in n in g o f p e r io d P lu s : B o r r o w in g s ( r e p a y m e n t s ) B a la n c e a t e n d o f p e r io d In te r e s t S e n io r t e r m lo a n s B a la n c e a t b e g in n in g o f p e r io d P lu s : B o r r o w in g s L e s s : M a n d a to ry p a y m e n ts L e s s : O p t io n a l p a y m e n t s B a la n c e a t e n d o f p e r io d In te r e s t $ 2002P 1 1 7 .3 4 .3 1 0 9 .7 $ 0 2 3 2 .0 4 .3 7 0 .2 2 5 .9 $ 1 5 .5 3 1 .6 $ 3 8 .4 $ 0 1 9 3 .2 7 .7 $ 4 6 0 .4 $ 0 1 5 4 .6 1 6 .2 $ 1 2 .9 2 1 .4 0 .9 $ 2 4 .5 6 5 .4 7 1 .4 $ 1 .0 0 .3 4 2 .0 5 0 .6 5 .7 1 5 4 .7 0 .7 $ 3 8 0 .5 $ $ $ 2 7 1 .6 $ 2 2004P 1 4 1 .5 4 0 . 0 = n o ) 111 .9 1 3 1 .3 $ 2 2 .4 (1 1 .8 2 8 .6 2 3 .3 1 2 0 .0 3 0 .0 6 2 .0 8 .4 8 .9 $ 2 3 .0 3 0 .c a s h in te r e s t L e s s : C a p it a l e x p e n d itu r e s L e s s : I n c r .1 $ 3 2005P 1 5 5 .5 1 9 .3 2 0 0 .1 $ 1 7 .5 3 7 9 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Stand-alone LBO analysis of Company X (cont’d) Overview $ millions S u m m a r y fin a n c in g s c h e d u le E B IT D A D e p r e c ia t io n & a m o r t iz a t io n N o r m a liz e d E B IT In te r e s t e x p e n s e I n t e r e s t in c o m e T a x a b le in c o m e L e s s : In c o m e ta x e s In c o m e a fte r ta x e s P lu s : D e p r e c ia tio n P lu s : P I K n o n .4 6 0 .5 3 5 .4 2 9 .7 $ 2 1 8 .3 1 0 1 . D iff e r e n c e $ R e c a p y e a r? (1 = y e s .7 $ 1 2 7 .6 $ 1 7 8 .6 9 9 .5 2 2 .3 2 6 .0 5 0 .5 3 9 .7 $ 1 6 .2 $ 5 0 6 . / ( d e c r .4 ) 0 .0 4 0 .1 $ 0 1 1 6 .1 0 M a x im u m s e n io r le v e r a g e $ R e v o lv e r + s e n io r d e b t b a la n c e a t e n d o f p d .1 2 4 .4 3 5 .1 6 5 .6 4 1 .0 2 6 .3 8 4 .7 $ 2 1 .9 $ 3 8 .7 1 2 .7 1 9 3 .7 $ 4 2006P 1 7 0 .6 2 2 .0 ) 1 1 .3 5 8 .2 $ 4 1 8 .4 4 8 7 .7 $ 2 4 8 .6 0 .4 1 3 2 .3 2 4 .2 5 Example $ $ $ $ $ 1 6 .7 $ (1 .4 ) 2 3 .1 $ 3 8 .6 $ 0 .6 $ 1 9 .2 5 5 2 .4 $ ( 1 2 .6 4 7 .9 3 4 .6 $ 1 1 .3 2 8 2 .1 1 7 .8 0 .1 $ 1 2003P 1 2 8 .2 $ 2 3 .4 $ 2 .3 $ 3 8 .7 1 1 6 .0 1 4 5 .8 $ 1 9 .6 $ 8 .4 2 3 .0 2 5 .

4 $ 2005P 5 3 .0 4 0 .0 $ 4 9 .9 8 . c a s h S u m m a ry B e g in n in g D e b t B a la n c e E n d in g D e b t B a la n c e $ 2002P 5 3 .0 $ 3 .0 $ 3 0 .0 5 .7 1 2 .2 $ 5 3 .9 $ 8 .0 $ 3 .0 $ 3 0 .0 $ 0 .6 $ 3 0 .4 $ 3 1 1 .0 0 .3 $ $ $ $ 5 .9 $ 4 9 .0 $ $ $ $ 5 .o v e r s u b .0 3 .0 $ 4 9 .0 $ 3 0 .0 0 .6 $ 3 0 .3 $ $ $ $ 5 .2 5 3 .4 3 1 1 .3 $ 5 .9 $ 8 .1 5 .0 3 8 .7 ( 8 .7 5 .0 3 0 .0 5 0 .0 3 8 .9 $ 4 9 .6 $ 3 0 .4 5 .2 $ 6 .4 Example $ $ $ $ $ 3 0 .5 112 .3 $ 4 0 4 .0 3 0 .4 $ 2003P 5 3 .7 ( 1 6 .0 3 8 .9 $ 8 . debt B a la n c e a t b e g i n n i n g o f p e r i o d P lu s : B o r r o w in g s L e s s : M a n d a to r y p a y m e n ts L e s s : O p tio n a l p a y m e n t s B a la n c e a t e n d o f p e r i o d In te r e s t C ash B a la n c e a t b e g i n n i n g o f p e r i o d P lu s : F r e e c a s h flo w L e s s : M in im u m c a s h b a la n c e L e s s : M a n d a to r y d e b t re p a y m e n ts C a s h a v a ila b le ( n e e d t o f in a n c e ) N e t c h a n g e in c a s h C a s h a t e n d o f p e r io d I n te r e s t in c o m e o n a v g .4 $ 2004P 5 3 .6 1 9 8 .3 $ $ $ $ 5 .0 6 2 .0 $ 4 9 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Stand-alone LBO analysis of Company X (cont’d) Overview $ millions N ew sub.0 $ 4 9 .2 $ 6 .4 $ 2 6 0 .0 3 8 .9 $ 8 .6 2 6 0 .9 $ 4 9 .6 $ $ $ 4 9 .6 $ 3 0 .6 5 .0 0 .1 5 .0 $ 2 2 .9 4 9 .0 0 .0 $ 3 5 1 .6 )$ 5 .1 ) 5 .2 $ 6 .0 $ 3 0 .2 5 .4 5 .9 $ 4 9 .2 $ 3 8 2 .0 $ 3 .2 $ 5 3 .0 3 8 .2 $ 5 3 .2 $ 5 3 . debt B a la n c e a t b e g i n n i n g o f p e r i o d P lu s : B o r r o w in g s L e s s : M a n d a to r y p a y m e n ts L e s s : O p tio n a l p a y m e n t s B a la n c e a t e n d o f p e r i o d In te r e s t R o ll . d e b t B a la n c e a t b e g i n n i n g o f p e r i o d P lu s : B o r r o w in g s L e s s : M a n d a to r y p a y m e n ts L e s s : O p tio n a l p a y m e n t s B a la n c e a t e n d o f p e r i o d In te r e s t N ew m ezz.7 1 .4 $ 2006P 5 3 .0 3 8 2 .7 2 3 .0 $ 3 .4 3 5 1 .2 6 .2 $ 6 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Agenda  Introduction  Trading comparables  Transaction comparables  Discounted cash flow analysis  LBO analysis  Relative value analysis  Merger consequences – – Accretion/(dilution) review Pro forma balance sheet analysis review  Appendix 113 .

relative valuation analysis is utilized in the context of stock-for-stock exchanges to determine the appropriate exchange ratio offered to shareholders in a transaction  The exchange ratio reflects the number of acquiror shares offered for each target share – So if you are a target shareholder and you are offered an exchange ratio of 0.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Introduction to relative valuation  Relative valuation is utilized to illustrate how the value of one company compares to another company  Typically. you are being offer 1/2 of an acquiror share for each share of the target you own  Several relative valuation approaches exist – – – – Historical trading and exchange ratio analysis Contribution analysis Relative multiple and discounted cash flow analysis Valuation of synergies 114 .500x.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Historical trading and exchange ratio analysis  Historical exchange ratio analysis Illustrates the relative movement in stock prices (and implied exchange ratios. large cap) Relative market attention / analyst coverage Multiple expansion of one of the company’s peer group versus the other over the selected time horizon 115 . aka “natural exchange ratios”) looking back over a certain timeframe  Calculated simply as the target share price on a given date divided by the acquiror share price on the same date – Does not include any premium to the target  Provides a historical benchmark to justify the contemplated exchange ratio  Issues to consider when analyzing data include – – – Liquidity of shares / trading volume (small vs.

60 per share 1 2 116 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Illustrative historical trading and exchange ratio analysis Historical exchange ratio # of acquiror shares per target share More favorable to Target C u r e n t s t o c k p r i c e A c q u i r o r $ 3 4 . 8 2 T a r g e t $ 8 9 . 6 0 2 T a r g e t $ 6 .347x Less favorable to Target Current = 0. 7 0 C u r e n t m a r k e t c a p i t a l i z a t i o n A c q u i r o r $ 2 7 4 .194x Represents average exchange ratio over the trailing period ended June 27. 2002 Closing prices as of June 27. 7 At $12 per share = 0. 2002 3 Assumes Acquiror’s current price of $34.

)  Typical equity value metrics would include – – Net income Levered free cash flow measures  Cautionary note: contribution analysis does not measure the growth and risk profile of the two companies’ financial performance and differing multiples may be justifiablie when assessing relative value 117 .e. customers.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Contribution analysis  Compares the relative equity valuation of two parties to their respective “contribution” to a combined company’s financial performance  Typical firm value metrics would include – – – – – Revenues EBITDA EBIT Unlevered free cash flow measures Industry-specific (i. etc. reserves.

803 $3.803 $14.9% $8.4340x ACQUIROR Market value % contribution Firm value1 % contribution EBITDA 2001E % contribution 2002E % contribution Net income 2002E % contribution 2003E % contribution $1.3% $1. other estimates based on JPMorgan Equity Research 3 Based on I/B/E/S consensus estimates.6956x $3.8046x $8.4% $5.3% $7.1% $18.320 62.790 59.087 39.322 43.398 $15.7036x As of 2/6/02.592 33.450 66.573 $15.6606x $1.3% $10.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Relative contribution analysis $ millions Implied equity value ACQUIROR TARGET $18.2% TARGET $7.253 37.4340x Implied exchange ratio 0.8% Total $25.3% $58.042 $18.018 59.9% $5.1% 0. TARGET EPS estimates based on I/B/E/S consensus estimates post 1/29/02 1 2 118 .477 40.7% $19.6% 0.1% $11. ACQUIROR 2002E EPS based on company guidance.275 59.3% $38.653 29.653 29.1% $3. based on company press release.380 40. net debt for ACQUIROR as of 12/31/01 (per press release) and for TARGET as of 9/30/01 (per 10-Q).7% $10.9% $10.326 59.4% 0.150 70.150 70.7% 0.210 40.150 70.7% $2.6% $3.406 40. pro forma for acquisitions 2001A for ACQUIROR.653 29.528 40.716 60.7% $7.9% 0.397 59.000 $15.482 56.

6% Offer = 35.7% 39.573 $3.803 $8.7% 59.398 Relative ownership Exchange ratio 0.0% Acquiror 65.1% 40.4340x .8046x .3% 40.1% 70.0% 56.308 Acquiror $58.4% 43.4340x .6606x .7% 29.000 $3.9% 29.5385x Target 35.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Sample contribution analysis Target $25.0% Market value Firm value 2002E EBITDA 2003E EBITDA 2002E Net Income 2003E Net Income Implied ER .6956x .042 $8.3% 60.7036x 119 .3% 70.9% 59.

8 3 .6 5 x $4 2 3 .2 51 3 1 .2 ) 0 96 .7 o n rs ip 9 % we h Imlie s a sis u dtota e p d h re s e rg t C rre t ta e s a so ts n in u n rg t h re u ta d g a q iro cu r 5 .3 0 00 52 .9 9 13 35 .7 9% 50 3 88 8 38 5 55 1 Implied exchange ratio (equity value metrics) 0 30 .3 0 19 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Calculating the implied exchange ratio Company statistics A q ir r cuo C rre t s a p e u n h re ric F lly ilu ds a c u t u -d te h re o n F lly ilu dmrk t c p u -d te a e a Ntd b e et E IT A BD N t in o e e cm Tr e ag t C rre t s a p e u n h re ric F lly ilu ds a c u t u -d te h re o n F lly ilu dmrk t c p u -d te a e a Ntd b e et E IT A BD N t in o e e cm $4 5 1 .6 3 1 .8 55 1 75 .7 0 % f n t in o ec n u db o e c m o trib te y F lly ilu d a q iro s a s u -d te c u r h re P fo as a so ts n in toy ld ro rm h re u ta d g ie 5 .4 4 x 120 .2 0 Imlie e c a g ra b s do n t p d x h n e tio a e n e in o e(3 8/ 5 5 cm 5 1) N tu l e c a g ra b s do c rre t a ra x h n e tio a e n u n s a p e ($ 4 5/ $ 4 2 h re ric s 1 .2 3 11 .1 0 85 2 .

3 0 00 52 .9 9 13 35 .6 0 x Implied exchange ratio (firm value metrics) F lly ilu d a q iro s a c u t u -d te c u r h re o n P fo as a so ts n in toy ld ro rm h re u ta d g ie 6 .3 0 19 .0 2 84 2 .7 4 54 6 .0 4 64 1 .7 0 C m in dfirmv lu obe ae C m in de u v lu o b e q ity a e % B D c n u db E IT A o trib te y F v lu b s do E IT A irm a e a e n B D cn u n o trib tio Im lie e u v lu p d q ity a e A a% f to l e u v lu s o ta q ity a e a q iro cu r 5 .8 55 1 75 .2 ) 0 30 .8 3 50 6 .2 0 $4 2 3 .6 3 1 .0 1% 51 3 89 6 38 3 55 1 0 66 .8 3 .0 a q iro o n rs ip 1 % c u r we h Im lie s a sis u dtota e p d h re s e rg t F lly ilu dta e s a c u t u -d te rg t h re o n Im lie e c a g ra b s do p d x h n e tio a e n E IT A(3 8/ 5 5 B D 3 1) N tu l e c a g ra b s do c rre t a ra x h n e tio a e n u n s a p e ($ 4 5/ $ 4 2 h re ric s 1 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Calculating the implied exchange ratio (cont’d) Company statistics A q ir r cuo C rre t s a p e u n h re ric F lly ilu ds a c u t u -d te h re o n F lly ilu dmrk t c p u -d te a e a Ntd b e et E IT A BD N t in o e e cm Tr e ag t C rre t s a p e u n h re ric F lly ilu ds a c u t u -d te h re o n F lly ilu dmrk t c p u -d te a e a Ntd b e et E IT A BD N t in o e e cm $4 5 1 .1 0 85 2 .2 51 3 1 .2 3 11 .1 2% 3 .4 4 x 121 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Relative multiple and discounted cash flow valuation  Compares the ranges suggested by stand-alone valuations of two companies on a multiples or discounted cash flow basis – Step 1: Valuation the acquiror and the target separately – Step 2: create a relative value summary  Need to consider which ends of the range it is appropriate to compare when determing an appropriate exchange ratio / ownership percentage – High/Low and Low/High – High/High and Low/Low 122 .

00 $5.0x to 20.0x LTM revenue of $185.75 Lowest public comp price 52-week high/low 15.00 $3.25 $10.0x to 20.00 $15.94 $5.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Sample relative value football field: Target valuation Price per share $20.25 2.75 $10.75 $15. of 15.0x 2001E cash EPS of $0.50 Implied offer1 = $8.50 $6.00 $5. (see p.19 as of 7/12/01 Certain of the multiples implied by precedent transactions have been adjusted by indexing them to the movement in an index of stock prices of companies comparable to Pablo.6 19.16 15.46 Highest public comp price $0.0x to 20. 22 for additional detail) 3 Based on IBES EPS growth estimate and average margin estimates of brokerage reports 1 2 123 .7 Mgmt.00 $4.311x and Pedro’s closing price $27.0x 2001E EBIT of $20.00 $26.5x to 4.00 $3.0x Street Case3 12% to 15% Discount Rate EBIT exit mult.0x Public trading comparables Transaction comparables2 DCF analysis Based on the offer exchange ratio of 0.0x 2002E cash EPS of $0.00 $5.00 $3.0x to 19.00 $4.00 Street case DCF $9.0x to 25.00 $4. of 15. Case 12% to 15% Discount Rate EBIT exit mult.

00 $43.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Sample relative value football field: Acquiror valuation Price per share $60.0x to 15.0x Comparable diversified company analysis Public company analysis DCF analysis2 1 2 Comparable diversified company analysis and public company analysis are based on brokerage report estimates Based on management projections 124 .00 $22.50 $29.00 52-week high/low 10.18 Sum-of-the-parts Discount rate 9% to 13% EBITDA with exit multiple of 11.0x to 25.50 $30.0x to 12.00 $21.25 DCF $40.50 $20.0x 2001E EPS of $1.60 $50.00 Highest public comp price $33.00 $29.0x to 13.00 $26.00 Current = $27.00 $28.75 $20.0x 2001E EBIT of $239 19.50 Lowest public comp price $10.25 $30.19 $0.28 $21.0x 2001E EBITDA of $346 12.

00 High/Low $5.311x 0.50/$30.313x 0.081x 0.182x 0.244x 0.000x 0.250x 0.179x 0.488x 0.073x Contribution analysis 0.500x 0.311x 0.476x Offer: 0. Mgmt. case case/Mgmt.00/$33.000x 0. comparables to case/Mgmt.217x 0. case Public with $40 mm of with $40 mm of comparables synergies synergies (Sum of Parts & Diversified) Discounted Cash Flow Analysis 1 Exchange ratio ranges computed by taking the high/low equity value per share of Target using various valuation methodologies over the low/high valuation of the acquiror using various valuation methodologies 125 . case case/Mgmt.00/$20.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Relative valuation summary Less favorable to Acquiror Exchange ratio1 1.25 0.237x 0.75 Low/High $3.50 Low/High $3.750x High/Low $5.219x 0.50/$43.441x 0.074x More favorable to Acquiror Transaction Street Street Mgmt.162x 0.091x Natural exchange Public ratio comparables to Public comparables (Sum of Parts & Diversified) 0. case case/Mgmt.

example $ in millions Acquiror pro forma ownership 58.3% 9.2%) (2.0% 47.0% 58.000 Premium1 20.188 11.918 60.040 40.0% 66.7% 38. Norwich Union PLC SmithKline Beecham Pharmacia & Upjohn VIAG AG Banca Commerciale Italiana SpA Hoechst AirTouch Communications Banco Central Hispanoamericano Astra AB Synthelabo SA Amoco Chrysler Corp General Accident Swiss Bank Guinness PLC Ciba-Geigy AG Acquiror BHP Ltd Vivendi Granada group PLC Terra Networks (Telefonica SA) CGU PLC Glaxo Wellcome Monsanto VEBA AG Banca Intesa Spa Rhone Poulenc Vodafone group PLC Banco de Santander SA Zeneca Group plc Sanofi SA British Petroleum Daimler-Benz AG Commercial Union Union Bank of Switzerland Grand Metropolitan Sandoz AG Transaction value $11.0% 59.2%) 0.234 55.0% Acquiror/ target Board Split 9/9 14/6 8/8 11/3 9/8 8/8 9/9 7/3 NA 5/5 7/7 13/12/2 7/7 4/3/5 13/9 6/6 7/7 4/4/1 5/5 8/8 Ann.8% 5.6%) 9.8% 51. SEC filings.8% 55.486 13.3% 1.961 26.199 11.858 75.0% 53.970 29.6% 60.1% 60.0% 67.0% (4.089 6.940 21.5% (9.287 11.152 22.467 11.0% 58.3%) (7.0% 57.3% 63.8% 8.3% (12.320 32.8% 53.1%) 6.5% 64.9%) 40.6% (3.7% 22.153 15. date 3/19/01 6/20/00 5/17/00 5/16/00 2/21/00 1/17/00 12/21/99 9/27/99 6/30/99 5/17/99 1/5/99 1/15/99 12/9/98 12/2/98 8/11/98 5/7/98 2/25/98 12/8/97 5/12/97 3/7/96 Target Billiton PLC Seagram Compass Group PLC Lycos Inc.0% 50.8% 3.511 40.0% 52. SDC 1 Premium to target share price one day prior to announcement 126 .5% NewCo Chairman Acquiror Acquiror Acquiror Acquiror Acquiror Acquiror Acquiror Acquiror Acquiror Target Target Joint Target Acquiror Joint Joint Acquiror Acquiror Joint Target CEO Accounting regime United Kingdom France United Kingdom Spain United Kingdom United Kingdom United States United States Italy France United Kingdom Spain United Kingdom France United Kingdom United States United Kingdom IAS United Kingdom IAS Acquiror Acquiror Joint Target Target Target Target Joint Joint Target Acquiror Target Acquiror Joint Acquiror Joint Target Target Acquiror Acquiror Source: Press releases.4% 58.765 15.5% 58.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 MoE transactions .9% 22.0% 63.428 8.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Agenda  Introduction  Trading comparables  Transaction comparables  Discounted cash flow analysis  LBO analysis  Relative value analysis  Merger consequences – – Accretion/(dilution) review Pro forma balance sheet analysis review  Appendix 127 .

EBITDA or earnings impact – Capitalization.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Introduction  Pro forma analysis provides both acquirers and targets insight into the income statement and balance sheet impact of a transaction – Revenue. leverage and credit capacity impact  Valuable tool for both acquirer and target – – – – Indicates buyer’s ability to pay Suggests most appropriate form of consideration to offer Allows buyer to predict or manage market reaction to announcement Demonstrates landscape of competing buyers  Balance sheet and income statement impact go hand-in-hand – Both driven by form and amount of consideration 128 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Agenda  Introduction  Trading comparables  Transaction comparables  Discounted cash flow analysis  LBO analysis  Relative value analysis  Merger consequences – – Accretion/(dilution) review Pro forma balance sheet analysis review  Appendix 129 .

Radio may focus on ATCF while wireless telecom companies may prefer to show EBITDA) Two methods exist for calculating accretion/(dilution) – “Top down”: integrated merger model – “Bottom up”: transaction-adjusted.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Overview of accretion/(dilution) analysis  Accretion/(dilution) primarily measures the impact of a merger or acquisition on the income statement of a potential buyer Accretion/(dilution) analysis can be based on revenue. and dividends per share – EPS is most commonly used form of accretion/(dilution) analysis – Industry will typically dictate which are the most relevant metrics (for example. estimate-based model Key measures for accretion/(dilution) – Dollar and percent change of acquirer earnings per share – Pre-tax synergies required for break-even impact to EPS – Pro forma ownership when stock is used as an acquisition currency – Pro forma leverage/capitalization¹    1 Note that capitalization will change when stock is used and net debt leverage levels will change when cash is used 130 . after-tax cash flow. earnings. EBITDA.

other securities. sellers also evaluate their break-even sale price and required currency  Typically. combination)  Used by both buyers and sellers – – – – Buyers identify highest price they can afford to pay and what currency to offer Buyers evaluate how much competing bidders can afford to pay Sellers evaluate what price potential buyers can afford to pay and in what currency In the context of a divestiture.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Purpose of accretion/(dilution) analysis  Accretion/(dilution) analysis can be used to determine – – The capacity of the acquirer (or potential acquirers) to pay a premium for a target Optimal form of consideration (cash. stock. JPMorgan performs sensitivity analyses to find break-even points where the offer price for a target results in no incremental earnings or losses to acquirer’s earnings per share 131 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Two primary methods exist to compute accretion/ (dilution) To ow pn d Iedgoi pt nt m dt rc tr emhe g rr e od a e l je e w bcedhsm a stnsw e ln e cf tet a h a an ea l t o ftgce t cie oeqaeb rrt un o d aa rd m . teod s a bt f t s r • Mcm ad jites otno o n atr sn nted r as vr ne c u h t ai 132 . h a • Rn ah lo murlojc obasbo ro.ii oa o fn s • Rvipgfm aiavrda ns ooetg a neu.r s ipou mae a cr cq t i t r ai pre d yno oe b par a e rit • Mapfal whq’cttg h eu rirn e aee i i r cr d s e is a t r ipdhno mb t sn a yr a c t at t ec e i u uie s e s szoel.i lsdr ntn y . i h n r ca on m p y Bu op tm t o Etasnst Pmeat S tb ai h e e dlsa si a y cie ung o s irde mce t t ba ar nq a r ptnjsfipf rcsu oa o .a lt c t d n e t po d s o • R ipfey n ocfwa tn trs ipo e h h mn t e l l ts a ii o oc itep ae m ntxsdic ee en o r e nt e sn n lanceoa e d rlssa r aahbc l u y le • Cactywn st p pr sts hm ro tii e a oas e c fm c i t i n a t unudno ik itteot o c n es f a i t r a • Qdivmin ate ci o c r rv e dea it ip li m u c v t lxaitta e ns c il a hn by • Felsa icr muo no ubs ot lpy r ra tl e p ie r e tg a rt e s Considerations iiu fi ti ot f loeno f t f l ra c i yp c e • Dtencr mceder ua rngo lpqs t tf tl uars ie i a r ceai otva m ns pels i y t i e e t w tu ls s eih g i ot sc h e i m .dgm j i ai r c e t o n t o icetnoa n natnt r t rs .e s t es au t rt e utnqin nitosa c yu b e re l r a t e o ap s tn sis uo m ike lypr s rm ro s .e ea a r d m ce l i l esno x edm ps ic ea e n n Description Benefits rie tctpe o mu it o vor c d aa u • Pssce rf ciem o dps mon bca n i e e mdaw fc a b.

2 Acquirer Cae u ri rsr rh ee np t c Stn h sg a ti run ea sd o Ma api rcz kilt ei o t ta an N// e( 0 tb 2 d3 e0 t ) 6 Fe iv ra m l u Epe a e: rsh nrr i s na g 2 0 0 2 E 2 0 0 3 E 2 0 0 4 E De(u iesa vpea inhn drrn da l ) : Il gv pnM m dsa$ psei(u ) i r i n nM e i d a: d da l o d. 5 6 1 . s $ 2 0 . 0 $ 1 .. 0 $ 1 . 4 5 0 0 . 2 5 4 1 . 2 0 0 . 5 0 0 $ 5 0 8 . 8 0 $ 0 . 4 8 $ 1 9 . 6 133 . 0 3 5 8 . 9 2 5 1 $ 1 . s $ 1 2 . 6 8 1 .8 0 0 .0% on debt issued (amortized as deferred financing fees over 7 years) Interest rates assumptions • Tranche I ($300MM maximum senior debt): 7.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Sample transaction assumptions Transaction description  Acquirer buying target with the following transaction assumptions: – – – – Transaction closes 12/31/02 Advisory fees of 0.5% – – – – – Interest rate earned on existing cash: 3. 4 5 $ 0 ..25% of transaction value Financing fees of 1.0% • Tranche II (subordinated debt): 12. 9 5 1 . 6 6 9 $ 1 . 1 7 5 1 7 5 0 .0% Tax rate on incremental earnings and expenses (including net interest expense): 35% Dividend policy of acquirer remains unchanged 50% of excess purchase price allocated to goodwill (approximately $70 million) • Remaining 50% of excess purchase price allocated to asset write-up and depreciated over 20 years Target's existing debt not refinanced Target Cae uh rsr r ri ee np t c Stn hun asg r td ea s i o Ma api rcz kilt ei o t ta an N/0 e6 tb/ d3 e0 t 2 ( ) Fe iv ra m l u Epe a e: rsh nrr i s na g 2 0 0 2 E 2 0 0 3 E 2 0 0 4 E De(u iesa: vpea inhn drrn da l ) Il gv pnM m ds(u ) pseia$ i r i n nM e i d a: d da l o d. 8 5 $ 4 4 . 4 $ 1 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Key adjustments to pro forma income statement The applicability of most income statement adjustments depends on the consideration issued to the seller and the way the acquiror funds an acquisition Ct oi no sn ia d e r At dn jm u s t e Ainez f-f c at tt nf m eaeti r i on a n ro xg i a Nt afat ocdeti ni v ez -u ir m dl s on ee y ro d o i b a AntDsiu f-irnAse tt ca f atp e eD e r mr ta e& w x l o r m Anncb f-iroae tt tsan eetsd r en t a tr t x i o Ane f ce f-irdnad tt tscm eedr s r e t ou a tu h x i o s Anlsoer f-ir()ninf tt ts gdsl ees nd r e ai h at i v o x o dt a Ays f-se tt n ee r r ag xi Tigia raom ani pt n o ie s dr c wn t l m o Cpaies h rrfdh a ou d n.ll s gf y a eo ur i m e n t X X X X X X X X X X X X X X X X X X X S t o c k C a s h X M i x X 134 .

with little discretion applied to mean and median calculations – – – Quality of estimates and analysts varies dramatically across consensus samples Modeling conventions are often not explained or apparent Analysts may be assuming different projected share counts. rather than net income  Some estimates included in consensus numbers are out-dated – – – May not reflect updated company guidance or recent financial results May not reflect abrupt changes to underlying industry economics May not reflect recent M&A transactions or securities offerings  Items embedded in consensus estimates are not always clearly explained or uniform across samples – – – – – Fully diluted share assumptions and treatment of options and convertibles may vary Interest expense Tax rates Accounting policies Stock-based compensation and amortization of intangibles other than goodwill 135 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 What is in a “consensus” estimate? While First Call or I/B/E/S estimates may provide a perceived “Street” consensus. they introduce some degree of uncertainty  First Call and I/B/E/S consensus estimates are based on an aggregation of research analysts’ estimates.

shareholder votes.) – Timing of regulatory requirements for closing (HSR review.) – Seasonality of industry economics and impact on estimates or calendarization Capital structures should best reflect current circumstances – Equity currency should be reviewed in context of recent share price and larger equity market performance – Cash deals should reflect reasonable interest rates and lending market capacity – Pro forma leverage and interest coverage levels should be consistent with acquirer’s desired credit rating Both advisory and financing fees have a meaningful impact on pro forma financials – Although equity analysts tend to “look through” some extraordinary charges.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Transaction assumptions are the foundation of all sound analysis  Choose an appropriate closing date reflecting available information and transaction structure – Timing of process requirements for closing (share registration. advisory and other one-time fees will impact the cash balance used in the transaction and subsequent annual interest expense – Amortization of financing fees will impact EPS over the immediate future of the combined entity Tax rate on incremental earnings and expenses should reflect acquiror’s and target’s combined tax efficiencies and adjustments should be made to post-transaction tax expenses for potential NOLs assumed by an acquirer    ALWAYS CLEARLY DESCRIBE TRANSACTION ASSUMPTIONS 136 . etc. etc.

) 0 0 (. 7 (0) $1 . 9 3 9 . 0 (.4 8 2 6 0 6x .9 million 1 137 . 2 u ² s e d $5 1 1 . 0 0 . 0 (.) 0 3 0 . 1 (1 ) 1% . 1 $9 1 .2 1 .3 4 . 6 9 8 .) 2 5 $5 1. 5 23 0 0 $8 1 .) 0 1 (. 1 $8 1 . 0 0 . 4 (0) $9 .7 4 3 . 4 24 0 0 $0 1 . se a AieP crr S q E u Aieec e crr tn q ni o u m TeP at S r E g Teec e at tn r ni o g m At e dm js n u t s A-xanema f ranc fe o tn t t f ng arzo e i i t i i N ecl as fe oa o di evr em tn n u do arzo .) 0 1 (. 3 2 93 15 . 0 5 7 $5 1 .4 Earnings impact Fr i msxp rh d iu nlo eep a a gs iin cte r t e l .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Sample transaction – 100% stock consideration Earnings impact Assumptions A q ire s a p e c u r h re ric : 20 P 0 3 /E 20 P 0 4 /E A q ire s a so ts n in c u r h re u ta d g T rg t s a p e a e h re ric : 20 P 0 3 /E 20 P 0 4 /E T n a tio a s m g2 %p m m ra s c n s u in 5 re iu O r p e(a u in 2 %p m m ffe ric ss m g 5 re iu ) S a sa q ire ¹ h re c u d Im lie e c a g ra (T ) p d x h n e tio /A S a sis e h re su d T xra o in re e ta e p n e : a te n c m n l x e s s $0 3 2 .n (0 $) .0 1 . 0 (. 0 0 .0 2 x 1 . (0 $) .9 2 x 8 .% 0) 6 $ 1 .6 9 8 6 $2 5 1 . 0 0 . 4 6 0 . 3 $5 0 .0 5 % Should be calculated using the offer price not current target price ² Used to fund transaction expenses and advisory fees of $2. 0 (. 6 2 93 15 .) 2 3 (. 8 1.) 0 0 (. 0 (.) 2 7 $3 1. 0 0 . 0 0 . 5 $9 2 6 .t i y d b t i i A-xDf mer -p f ra &oa t ie t t D r s wu e A s t A-xtrsnn tnb f ra et t si d tti e r a e e n oa c t o A-xtrsecnmh f ra et di f c tti e u r a e n dt os o A-xtrso g oiiesra f ra etls a n ddol t t i e s i d nhf l e n ( )n v t A-xnis f rayre t t se e g Tstnoilarzoo pm rn i gd ma (rm e a c ow o tn i a n a o l t i i i t r ) Ordin te u s hec r t o Tlase t nic e o dt notn t j m eo au t s m Poatn e rfr nic om o e m Poaa otng rfr srs t an om eu d h si Poa S rfr E om P A tniu )$ c i / ltn) c odi ( r ( o e A tniu )% c i / ltn ) c odi ( r ( o e Payris bk e r-xn e rav e se t ee t go .1 1 5 .) 2 3 (.4 6 2 6 3 .) 0 2 0 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Considerations for a stock transaction  P/Es and relative valuations play a meaningful role in accretion/(dilution) analysis – High P/E of an acquirer may imply stock may be “cheap” acquisition currency. attitudes and receptivity of principals and investors in a transaction – Exchange ratios should not be grossly inconsistent with historical relative trading performance of acquirer and target – Purchase price and pro forma ownership should take into account contribution analysis Flow back and sell-off of acquirer stock could meaningfully affect acquirer’s share prices on announcement/closing – Cross-shareholder analysis – Whether acquirer and target are included in the same indexes. if any – Fund limitations on owning international stocks and/or stocks not listed on local exchanges – Dividend policy implications of receiving acquirer stock   138 . relative to lower P/E stock or the “implied debt P/E” A number of issues will play an important role in the optics.

5 N M 1 Should be calculated using the offer price not current target price 139 .xtrsn ncn b f raneor st dt t t i e t taao e e i A. 2 1% 2 . 9 0 . 0 0 . 1 9 56 89 . 6 $7 1 . 3 $5 0 . 0 (. ct r a t e l ea A ieP c rr S q E u A iee c e c rr tnm q ni o u TeP at S r E g Teec e a t ti o r nnm g Ase dt n j m u t s A. 6 $3 2 .% 6) 1 $ 9 . 0 $3 0 . 1 (0 $) .0 3 . 6 0 . 6 9 8 . 0 (.8 7% .seeoe. 0 (7 4) .i s t o i A.) 2 3 (4 4) .0 30 39 5 .6 (0 ) .8 69 $ 0 . 0 0 . 0 0 .0 1 . 9 2 4 56 89 .xtrsecn mh e f raneduor c ud t t i e t dt fo a s e i s A. 8 0 . 4 6 0 .4 8 26 Earnings impact F rs mneepsrd iu i ii sxpeh a g nlo.3 51 4 . 0 5 7 $5 1 . 8 1. 0 0 .2 1 .0 $ 5 . 4 0 .5 2% 3% . 8 0 .xDfoaere f ra &rm tw-p t t DA s i u e s t A.0 5% (0 $) .x aige o an f rai n f a rzi t t f c em t e nn t o i Ndubaiofe o an o ecl d r e m t n dt e v y a rzi .xtrslsg o iie sra f rane( sa nv nhfl t t i e t o) i dddo l e n t A.) 2 3 (2 4) . 0 (5 4) . 2 $ 5 .x n is f rayre t t se e g Tst n oila rzi nrmm rnc gdl ma ( i p e aao ow o t o a n i t o i i t r ) O rdt n teec s h uo r i Tlase t nic e o dt n o tnm t j m eo au t s Poa tic e rfr nnm om o e Poaa otng rfr srsuai om e t d h s n PoaP rfr E om S Aeniun$ c t /dt ) ) c i (l i ( ro o Aeniun% c t /dt ) ) c i (l i ( ro o Ptx n i s b kv r. 0 0 . 6 0 . 5 (0 ) $0 . 4 24 0 0 $0 1 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Sample transaction – 100% cash consideration Earnings impact Assumptions T rg t s a p e a e h re ric : O r p e(a s m g2 % re iu ) ffe ric s u in 5 p m m S a sa q ire ¹ h re c u d D b is u dtofu da q is n et s e n c u itio : E u p rc a e w c s q ity u h s d ith a h T n a tio fe s ra s c n e F a c gfe s in n in e C s b la c u e intra s c n ah a ne s d n a tio T ta d b ra e o l e t is d D b a c tio : e t llo a n T nh I ra c e T n h II ra c e In re t R te : te s a s T nh I ra c e T n h II ra c e In re t ra o fo g n c s b la c te s te n re o e a h a n e T xra o in re e ta e rn g a te n c m n l a in s $2 5 1 .9 6 . 9 3 9 .3 60 2 . 0 0 . 0 $8 1.e e yr t ra n a g e 23 0 0 $8 1 . 1 (. 4 $.

stock may be more or less appropriate as an acquisition currency – Financing assumptions should reflect both acquirer’s stand-alone and combined debt capacity and ratings circumstances Debt coverage and capitalization statistics should be included to highlight potential ratings issues and support interest – rate assumptions Current and recent ratings history of acquirer should be reviewed to confirm ability to issue debt securities – Covenants of existing acquirer debt should be considered – Review transaction and pro forma financials with ratings advisory and DCM teams to determine appropriate rates – Use existing acquirer cash sparingly. if at all Existing cash is likely used to meet working capital funding requirements – Minimum cash balance may be required for debt covenants – Opportunity cost of using cash on hand should always be contemplated and reflected in interest expense – Restricted cash considerations –   140 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Considerations for a cash transaction  Use multiple tranches of debt where appropriate Reflects capital structure and market capacity limitations for larger deals – Varying interest rate on debt tranches will impact interest expense on offer price increases or decreases – Note that depending on debt mix.

ne o) i v n o l t n f Arasei s fe xy r e t .1 2. 8% . 0 (8) 17 .i n e r to t n t i Ndui l ai o/oee o ec ed r t r e n dtb v y hf s AraDA m e rep fe xD foa twt . 0 0 .ng t T stogdl aozi nrmm) rnc nowm a ( i p e aa o il r too a n i t i i t r Orec n te dto hr u s i T la s es ni c e o d t nt enm t j m ot o a u t Pfr aenm r o ni c e omt o Pfr aheosnn r o s rsut dg o m a t ai Pfr aP ro E om S Arto(iun$ cen l to() c i /d i ) Arto(iun% cen l to( ) c i /d i ) Ptxy ri s baen r.0) $331. 1.ne dtor a e t Arai trsl s g odddhta fe x e t( s a ni i e s r l t . 0 0 . 34 9 . 0 (.0% 141 . $9 05 .233 Earnings impact F rs mnee psr d iu i ilo.3 (0) $3 .0% 35.) 2 3 (6) 12 . $325.9 3. 62 0 . 0 .% 5) 1 $9 9 .seet r kv e ng oe.) (. (09 $0 .3 (0.&r s i u t s t Arai trs naaodt fe x e tot ncne t . $9 1. 0 (9) 13 .ne r s t b t i Arai trs ecnochs fe x e tdui f msud t .25 15.2 $5 19 . 0 . 11 79 40 . 0 .) 2 3 (6) 19 .5% 3. 1 0 . $1 06 . 2 0 . 0 0 . 93 8 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Sample transaction – 50% cash / 50% stock consideration Earnings impact Mixed consideration assumptions Target share price: Offer price (assuming 25% premium) Shares acquired Shares issued Debt issued to fund acquisition: Equity purchased with cash Transaction fees Financing fees Cash balance used in transaction Total debt raised Debt allocation: Tranche I Tranche II Interest Rates: Tranche I Tranche II Interest rate foregone on cash balance Tax rate on incremental earnings $12.e a 23 0 0 $6 18 . xpe hea gen li s ct r a t a Aur P c ie S qr E Aur enm c ie ti c e qr n o T eP a tE r S g T eenm a tni c e r t o g As es dt n j m u t Arafncgemzi n fe x ai f ao a t .3 $300.0 31. 24 0 0 $8 10 . 0 (. 46 79 40 .0% 12. 0 . (0) $3 . 0 0 . 07 5 $4 15 .468 16. 0 0 . 0 0 . $6 1. 6 N M 7.2 $9 16 .31 42.

accretion or dilution potential will usually be evident by simply comparing the P/E multiples of the acquirer and the target – If the acquirer has a higher P/E than the target. the deal will be dilutive because the acquirer is buying less EPS than the target shareholders are accepting as consideration – Remember to take the premium into account when calculating the target’s P/E – Utility of comparison will also depend on transaction assumptions regarding goodwill impairment or other asset amortization For 100% cash transactions. the cost of debt (interest payments) and cost of acquiring the target’s earnings will determine the accretive or dilutive impact of a transaction – Where the inverse cost of debt (1/(after-tax cost of debt)) is greater than the P/E of the target.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 The role of P/E valuations in accretion/(dilution)  For stock-for-stock deals. the deal will be accretive because the acquirer is buying more EPS than the target shareholders are accepting as consideration – If the acquirer has a lower P/E than the target. the deal will be accretive – Where the inverse cost of debt is lower than the P/E of the target. the deal will be dilutive  142 .

6%) (8.8 15.0% 10.1%) (20.0% 30.6 87.5% $10.8%) (13.9%) (16.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Presenting accretion/(dilution) with sensitivities  Sensitivities provide the total picture of a transaction’s potential impact.0% $14.4 22.3 17.0% (3.8 41.0 28.3%) (11.0% 50.0% $6.2 9.0% 40.1 45. relevant sensitivities to demonstrate may include – Premium (discount) – Consideration offered (% of stock/% of cash)  Acquirer’s stock price  Earnings per share  Synergies – Interest rate(s) on debt issued Sensitivities should reflect consideration specifics – Purchase price and ownership (stock) 2003 synergies to break-even – ($MM) Stock consideration 100.7 62.8%) (8.1%) (4.0% 50.2%) (19.0% (6.3 58.4%) 10.4 18.0%) (7.3 13.0% 40.0% (3.5%) (10.2 41.2%) (15.3%) Premium Premium 20.4%) (18.9%) 87.0% 1.0%) (6.0% 143 .3 46.4%) (13.5% (1.0% 50.9 75.5%) 20.1%) (22.2%) 62.8%) (21.7%) (14.0%) 75.9 52.2 39.3 28.9  2003 accretion / (dilution) – (% per share) Stock consideration 50.5% (4.0% 30.5% $2.0% (9.3 34.8 22.8 100.8 32.5%) (19.0% NM 5.3 27.

4%) $20.0% 50.00 (2.4%) (9.5%) $21.9%) (8.0% 2.5% (1.0% 40.4%) (9.5% 10.1%) (20.1%) (12.9%) $22.3%) (12.9%) 8.0 10.4%) (18.0%) (8.3%) $23.1%) (18.3%) (16.1% (4.0% 30.0% (4.0% (5.0% (2.00 10.0%) (5.1%) (13.9%) 8.1% (3.4%) (20.8%) (13.1%) (28.3%) (10.2% (3.9%) (13.7% 1.8%) (16.2%) (15.0% 40.2%) (20.7%) $15.1%) (16.6%) (20.0% 40.1%) (27.9%) 2003 accretion / (dilution) – (% per share) Blended interest rate (%) 11.3%) (11.1%) (13.0% Premium 20.9%) 9.5%) (17.4% 1.0% 30.0%) (10.0% 50.6%) Premium Premium 20.8%) (22.0% 144 .7%) 9.03 (6.00 (3.0% 10.4%) (17.0% Cash deals 2003 accretion / (dilution) – (% per share) Interest rate on senior debt (Tranche I) 6.2%) (5.9%) 7.7%) (11.4%) (18.5%) (31.0% (6.2%) (14.0 0.1%) (5.7%) (22.0% 50.5%) (11.3%) 10.2% (1.0 2.2%) (5.1%) (25.1% (2.8%) $20.0% 50.0 (2.9%) $25.5% 4.3%) (15.0%) (24.0% 0.0% 30.9%) 20.5%) (9.8%) (10.1%) (26.4%) (9.0% (2.3%) (29.0% 2.0% 40.1% (5.1%) (11.1%) 10.5%) (6.1%) (22.4%) (21.1%) (26.0% 3.4%) (8.3%) (7.8%) 2003 accretion / (dilution) – (% per share) Pre-tax synergies realized 2003 $5.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Relevant sample transaction sensitivities Stock deals 2003 accretion / (dilution) – (% per share) Acquirer stock price $19.6%) (15.0% 6.3%) (7.0%) (19.3%) (11.0 4.4%) (19.5% 1.7%) (13.5% (0.5% (0.0% (8.00 (5.0%) Premium 20.2%) (7.5%) (8.9%) 7.4%) (18.0% 30.2%) (7.1%) (29.1%) (14.1% (3.6%) $10.9%) (24.5%) (20.

g variable margins on incremental revenues) • Equity markets heavily discount or. integration costs) – Consider the cash flow impact of synergies One-time charges and expenses – Acquiring companies will incur one-time merger-related costs due to reorganization. the Street “looks through” one-time charges • Include the net interest impact of cash changes  145 .. assume synergies come from cost-savings unless told otherwise – Revenue synergies • Incremental revenues may have costs associated with them that need to be reflected in any synergy calculations (e.e. in many cases. severance packages • One-time charges are disclosed in SEC filings • From a valuation perspective.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Synergies and transaction related costs  Synergies – For top-down modeling simplicity. as they are typically difficult to quantify and accurately project – Synergies are typically realized gradually over time and should be phased in accordingly – It may be prudent to “risk-adjust” any expected synergies to account for ability to realize them and/or for negative synergies (i. disregard revenue synergies.

they will increase annual depreciation expenses based on the incremental increase in depreciable assets – Limiting asset write-ups will reduce negative impact of increased depreciation expenses – In some cases. an acquirer will incur future interest and amortization payments that may require additional borrowing – AccretionOne calculation method Asset write-ups and additional depreciation expenses – While asset write-ups will reduce goodwill generated in a transaction.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Additional items to consider  Tax benefits – In assuming additional options are exercised under premium scenarios a tax shield will be generated based on the implied deductible compensation expense generated from the vesting / exercise of options at a discount to the acquisition price – Asset write-ups have tax implications1 Acquirers may be forced to pay “interest on interest” – In using cash and thereby raising debt. asset write-downs may impact EPS accretion / dilution Impact of dividends paid by acquirer – Additional cash will be necessary to fund new dividends paid and should be reflected in incremental expenses – Dividend accretion/(dilution) analysis may be relevant to determine appropriate premium    1 Write-ups create a deferred tax liability (equal to the write-up multiplied by the tax rate) 146 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Summary considerations for EPS accretion/(dilution) analysis  EPS-based accretion/(dilution) is only a back-of-the-envelope exercise and is not a substitute for an integrated merger model – Does not necessarily reflect cash flow implications and debt pay-down capabilities of combined company EPS estimates should be used with caution – First Call and I/B/E/S estimates are consensus numbers that do not always reflect consistent underlying assumptions – Small differences in EPS figures can have dramatic impact on net income ($0.05 per share on 200 million shares reflects a $10 million variance in net income) Share count of target must be a dynamic number – Share count should increase (decrease) with offer price to reflect additional (reduced) shares underlying in-the-money options Negative net income targets CANNOT create meaningful accretion Accretion/(dilution) should always be sanity-checked – Relative P/Es – Acquirer’s cost of debt vs. cost of target’s earnings Accretion/(dilution) should always be checked with your calculator      147 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Agenda  Introduction  Trading comparables  Transaction comparables  Discounted cash flow analysis  LBO analysis  Relative value analysis  Merger consequences – – Accretion/(dilution) review Pro forma balance sheet analysis review  Appendix 148 .

market access.and post-acquisition credit metrics  Key credit metrics include: – – – – – – Pretax Interest Coverage EBITDA Interest Coverage Funds from Operations to Interest Funds from Operations to Debt Debt to EBITDA Debt to Book Capitalization 149 . balance sheet and cash flow statement (preferred) “Bottom up”: transaction-adjusted.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Overview of pro forma balance sheet analysis  Pro forma balance sheet analysis provides a means of assessing the impact of a potential transaction on an acquirer’s cost of borrowing. LTM-based model  Pro forma balance sheet analysis relies primarily upon a comparison of an acquirer’s pre. and financial flexibility  Two methods exist for demonstrating balance sheet impact: – – “Top down”: integrated merger model with income statement.

the pro forma credit rating of the seller and the minimum level of cash consideration needed Buyers identify highest price they can afford to pay and how much cash can be offered Buyers evaluate how much other competitive bidders can afford to pay Sellers evaluate how much potential buyers can afford to pay and how much cash to demand  Used by both buyers and sellers – – –  Typically.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Significance of pro forma balance sheet analysis  Pro forma balance sheet analysis is critical in determining – – – – The debt-financed acquisition capacity of an acquirer (or competing bidders) Required equity component of an offer to ensure a particular rating outcome Financing implications of a particular transaction structure (cost of capital and market access) In a divestiture. JPMorgan performs sensitivity analyses to address relevant inflection points where the offer price for a target results in meaningful changes to a combined capital structure 150 .

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Credit ratings as a key financing decision driver  A company’s corporate credit rating determines its – – – Cost of borrowing Breadth and depth of access to the capital markets Financial flexibility (liquidity/covenant constraints)  Pro forma balance sheet analysis allows potential acquirers to assess leverage breakpoints and their associated ratings outcomes in order to develop a comprehensive financing plan  Significant debt-financed transactions can erode credit profile and can lead to a ratings downgrade  The determination of potential financing structures is often bound by the trade-offs between maximizing EPS subject to limiting ratings pressure 151 .

3% 214.2% 3.1 3.0 40.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Sample transaction – 100% cash consideration Acquirer Balance sheet: Total debt Shareholders’ equity value Minority interest Income statement: LTM EBITDA LTM EBIT LTM interest expense Capitalization: Debt/equity Debt/total capitalization1 Coverage ratios: Debt/LTM EBITDA Debt/LTM EBIT LTM EBITDA/interest LTM EBIT/interest $800.2% 45.1 3.5 2.5% 52.5 2.7% 109.2% 68.0 2.8x 6.0 $119.0 Pro forma $2.0 137.8 (525.0 42.0 176.0 Adjustments $659.0 950.0 270.0 525.034.0 94.0) 0.6 $345.9x 7.8 950.0 0.5x 4.0 Note: excludes lease-related leverage and hybrid securities 1 Includes minority interest 152 .0 55.0 Target $575.0 $226.4 5.0 0.5 4.6 84.2 4.0 0.

0 Target $575.9% 46.3 0.0 95.0 Adjustments $0.375.0 0.6 2.0 $226.2% 45.5 4.600.8x 6.1 3.3 0.0x 5.5x 4.0 125.0 950.8 Note: excludes lease-related leverage and hybrid securities 1 Includes minority interest 153 .0 84.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Sample transaction – 100% stock consideration Acquirer Balance sheet: Total debt Shareholders’ equity value Minority interest Income statement: LTM EBITDA LTM EBIT LTM interest expense Capitalization: Debt/equity Debt/total capitalization1 Coverage ratios: Debt/LTM EBITDA Debt/LTM EBIT LTM EBITDA/interest LTM EBIT/interest $800.2 4.0 $119.0 40.0 2.0 270.4 4.0 $345.0 55.2% 3.7% 109.0 1.0 Pro forma $1.0 0.1 3.1 3.0 0.0 525.3% 85.5% 52.0 94.0 176.

49 5.91 4.0% 47.0% 30.0% 56.88 75.0% 30.0% 2.63x 3.35 3.0% 52.3% 57.3% 67.5% 69.25 6.99 EBITDA / interest Stock consideration 0.0% Premium 20.36 5.19x 3.0% 10.00 6.0% 40.88 50.0% 3.63x 2.81 2.) Premium 20.6% 62.3% – – – Consideration (stock vs.0% 4.0% 3.99 3.0% 57.5% 50.2% 63.0% 50.12 5.62 2.24x 5.6% 45.99 3.8% 75.0% 51.56 4.0% 40.23 25.8% 63.83x 4.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Pro forma balance sheet sensitivities  Similar to EPS analysis.89x 2.73 2.5% 46.0% 40.0% 3.9% 68.4% 57.82 6.0% 2.97 2.0% 25. etc.50 25.7% 44.41x 4.0% 3.25 75.49 4.4% 43.0% 5.0% 4.32 3.0% Debt / EBITDA Stock consideration 0.63 3.4% 62.0% 100.62 100.5% 50.45 2.0% 3.06 2.63 3.0% 62.39x 3.0% 50.66x 5.45 4.0% 67.5% 52. cash) Estimates (EBITDA) Assumptions (premium.0% 154 .4% 70.63 Premium 30.34 2.99x 3.2% 10. sensitivities provide the “whole picture”  Sensitivities should demonstrate the impact of changes to relevant metrics Debt / total capitalization Stock consideration 0.99 20.0% 10.13 3.51 50.99 5.63 3.2% 57.0% 5. interest rates.0% 50.29 100.37 3.68 5.54 2.7% 50.

T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Agenda  Introduction  Trading comparables  Transaction comparables  Discounted cash flow analysis  LBO analysis  Relative value analysis  Merger consequences – – Accretion/(dilution) review Pro forma balance sheet analysis review  Appendix 155 .

Unsystematic risk is that portion of risk that can be diversified away. which is an expected return above and beyond the risk-free rate. Therefore.rf) – There is also an error term in the CAPM formula. but this is usually omitted Where re = rf = rm = ß= the required market return on the equity of the company the risk-free rate the return on the market the company’s projected (leveraged) beta 156 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 JPMorgan estimates the cost of equity using the capital asset pricing model  The Capital Asset Pricing Model (CAPM) classifies risk as systematic and unsystematic. the CAPM defines the cost of equity as equaling the risk-free rate plus the amount of systematic risk an investor assumes  The CAPM formula follows: Cost of equity = Risk-free rate + (beta * market risk premium) re = rf + ß * (rm . The size of the risk premium is linearly proportional to the amount of risk taken. Systematic risk is unavoidable. and thus will not be paid for by investors  The CAPM concludes that the assumption of systematic risk is rewarded with a risk premium.

a company with an equity beta of 2. the beta value should be an expected value as well Although the CAPM analysis. the beta determines how much of the market risk premium will be added to or subtracted from the risk-free rate Since the cost of capital is an expected value. divided by the variance of expected returns on the stock market A company whose equity has a beta of 1. other capital asset pricing models exist. such as multi-factor models like the Arbitrage Pricing Theory     157 . including the use of beta. is the overwhelming favorite for DCF analysis.0 is “as risky” as the overall stock market and should therefore be expected to provide returns to investors that rise and fall as fast as the stock market.0 should see returns on its equity rise twice as fast or drop twice as fast as the overall market Returning to our CAPM formula.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Beta   Beta provides a method to estimate an asset's systematic (non-diversifiable) risk Beta equals the covariance between expected returns on the asset and on the stock market.

S. select “more”. then “Financial Database Services”. IDD) – – – Barra predicted betas can be found through the Investment Bank Home Web page1 Note that Bloomberg betas are based on historic prices and are therefore not forward-looking Impute unlevered beta for private company from public comparables  The market risk premium (rm . Treasury note is generally used to approximate the risk-free rate – – Long-term cost of debt is used. because the cost of capital is normally applied to long-term cash flows Obtain from Bloomberg or a similar source  Projected betas can be obtained from Barra or an online database (e. the spread of market return over the risk-free rate) is periodically estimated by M&A research based on analysis of historical data – The current MRP assumption is 4..rf.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Using the capital asset pricing model  The yield-to-maturity on the 10-year U.0% 1 In the “Investment Banking” menu.. then “Barra Betas” 158 . i.e.g.

which looks at different target capitalizations.e.. a similar argument exists for betas. includes the effects of leverage. i. or unlevered. the equity beta must be delevered to get an asset. beta. The predicted equity beta. In the course of performing a variance analysis. This asset beta is then used in the CAPM formula to determine the appropriate cost of capital for various debt levels  The formula follows:  To relever the beta at a target capital structure: 159 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Delevering and relevering beta  Recalling our previous discussion regarding the difference between asset values and equity values. the observed beta.

tau. T – Tau. in place of the marginal tax rate. represents the average blended benefit a shareholder gets from a company borrowing (reflects many factors) – The value of tau is derived by researchers using complicated statistical analyses  Although the delevering/relevering methodology is standard for WACC analyses. the formula does not produce a highly accurate result  Remember the fundamentals: the market charges more for equity of companies that are financially risky 160 .T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Delevering and relevering beta (cont’d)  Note that JPMorgan M&A sometimes uses a factor. currently equal to 0.26.

70 5 2. 00 0 Cn oty ur rkrm i p im s eu 00 . 2 11 .% 50 0 2.% 33 3 Se t 1y pa o -r rd 0 Ta rs p r si ( ) eu b e 1.% 00 0 1. 6 04 . 00 0 4. 6 7% . 1 7% . 6 9% . 50 0% . 12 7% .% 0 00 . 10 8% .% 0 00 .Auebafdteazo n ede=er ba 1( t e a tvu fei ) 1tx e s m eoe ql e. Tg ae rt n ia A onW ml C C 7% . 1 Ct f oo s uerd u n e e iy lve qt 9% .aryf1y r . 9 3 Ndt e e/ t b mc. 0 9% . 67 6% . 4 00 . 00 0 5.T\TRAINING\TRAINING MAR2002\Pitches\ CF M&A Bootcamp Materials v3 Example: Calculating WACC based on comparable companies Target WACC analysis as of 1/1/01 Mooms m n a e n i aup s c c oc s t r i o R-ert ik e e sf a r 1 2 50 . 8 04 . 1 17 . 4 9% . 0 9% . 4 8% . 6 20 1% . 60 0% . 8 15 0% . 7 7% . 0 PeeTgmi aaa rj cdae antx t ot r t r l re g 40 0% .% 4 4% . 43 0% . 8 8% . T rt aa xe 00 . 8 09 . Ledeaui g er basm ve t s n uerdeo ne b f lve t a 09 . 7 01 . 9 09 . 4 14 0% . 00 0 3. 0 11 .Tar bdsf1/1 oc Bmg i k e eyl . 4 00 .% 0 00 . l r t ve t e t a b r le u * k t a) s s t b u r s 161 . 7 Ct f oo s lvee iy erd u e qt 9% . 1 8% . 70 0% . 11 0% . 6 TgW cca n ae A aui r t C l lt C o Om pa t l i dt ae e/ r t b k m ciaa n atlzi pi t o 30 0% . 10 3% . 4 00 .% 0 Ptx re a l ntr oe gm ct f e oo b s dt 7% . 4 Uve n ed l r e ba 4 e t 03 . 8 8% . 7 10 . 9 09 . 9 Ct f oo s lvee iy erd u e qt 9% . 14 1% . 4 00 . Ns o: t e 1 2 3 4 Om pa t l i dt e/ b e iy qt u 49 2% . 40 0% . 22 2% .a S eu n r o u 1 Sr : o e r SrePraMrs rh oc JM n&ea u: o g A ec Sre a pdeba oc Bar i tdes u: r e r c t UvebaLede/( +oldt/mea oqy ( -art). 5 11 . 33 3% . Ta e/ oldt t b me iy k qt t u . ka t p . 4 9% . 0 9% . 8 8% . 0 00 . 9 00 .% 0 00 . Emdaeqyspm s a m tei rkr i m t t r u i eu i e k t I dtyea ls ns ban i ur t a s y Pjcd r ee ot Cpaeopy o abc a m l m r n Cpy oaA m n Cpy oaB m n Cpy oaC m n Cpy oaD m n Aa vg ee r lveba erde e t 16 . 0 8% . 3 R-ert =et. 74 8% .mi o0eU r syo ao/ 0( ue l ob ) sf a i d t t . . 8% . 25 2% . 1. 9 7% .

August 2002 Confidential Internal use only Corporate Finance M&A Bootcamp Materials .

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