Deutsche Bank Securities: Financing the Acquisition of Consolidated Supply S.A.

Case Questions
Question 1
What is the problem in the case?
The Vice President of the Deutsche Bank Securities, Maria Ober had received a loan
request for financing of one of the bid related to a large hospital supply distributor on November
20, 2003. The offer price for the proposed acquisition and the financial commitment indications
were both due in about 2 weeks time.
This transaction was based upon a very significant level of the debt; therefore, it was a highly
leveraged acquisition for Deutsche Bank Securities.
The problem facing Deutsche Bank Securities is now to analyze the deal, place a valuation
on the firm, identify the valuation of the future possible synergies and then make a final decision.
Deutsche Bank Securities has also contributed in such financings in the past also and the reason
for this was the profitability of the transaction which was quite huge.
Moreover, the core problem underlining this case is not make a yes or a no decision for
this proposed financing request but it focuses more on changing the design structure of the
transaction in order to make it more fruitful for some of the related parties to this transaction. Apart
from this a detailed credit analysis also needs to be performed for the target company in order to
determine the significance of risk inherent in this proposed deal for Deutsche Bank Securities and
all other related parties.
Question 2
What is the CSSA worth?
The actual worth of CSSA could be determined through a number of approaches. Initially
beginning with identifying the true worth of CSSA the internal rate of return for this transaction
as provide in case exhibit 10 of 21.3% could be compared to an appropriate benchmark and if it
exceeds that benchmark then CSSA could be considered as worthy for investment. The internal
rate of return of 21.3% reflects the return which would be earned by the target equity holders
therefore; the most appropriate benchmark to compare this equity holder’s return would be the
target company’s cost of equity.
In order to identify the cost of equity, the capital asset pricing model has been used in order
to estimate the target firm’s cost of equity. The excel spreadsheet shows the calculations for the
cost of equity. The beta has been unlevered and then re-levered to reflect the leverage of the target
firm and the same level of risk. The cost of equity thus ranges from 9.4% to 12.6% and the internal
rate of return is 21.3%, therefore, based upon this approach CSSA seems to be worthy and the
valuation for CSSA also looks attractive.
However, there are a lot of studies which show that default risk is not captured by the
levered beta and as a result of this the return which is required by the equity holders is understated
and it might result in wrong decisions being taken. The private equity investors usually demand a
rate of return in the range of 25%-35%. The case also states a target required rate of return for the
private equity investors of 30%. If the return generated by this deal of 21.3# is compared with the
required rate of return of 30%, then the valuation of CSSA and its worth seems quite weak.
Apart from these approaches, the valuation of the firm could be performed on the basis of
the projected cash flows and growth assumptions. Through this approach the worth of the firm
could be evaluated in more depth based on economic view. The bid which has been placed upon
CSSA is $ 1.513 billion. A detailed discounted cash flow model has been created for the firm based
upon the projected free cash flow calculations.
The discount rate calculations have also been performed based upon the new weights and
the costs associated with debt and equity for CSSA. The terminal growth rate has been stated to
be 4-5% therefore, 4% has been used in this case in order to compute the terminal value beyond
2013. The total valuation for CSSA has been found to be $ 3.148 billion based upon the discounted
cash flow method. This valuation is $ 1.635 billion in excess of the purchase price as provided in
exhibit 6.
Apart from this the valuations have also been computed for CSSA based on other multiples
approaches which could be seen in the excel spreadsheet. Each of the valuation approach shows
that excess value would be generated as compared to the purchase price of $ 1.513 billion.
The graph could also be seen for the range of the valuations based upon different approaches for
CSSA. All of these valuations suggest that ICL is paying an adequate purchase price and it is not
overpaying in this deal. This deal is going to generate a plenty of value for the firm along with the
total of $ 979 million of funded debt..........

Deutsche Bank Securities: Financing the Acquisition of Consolidated Supply S.A. – Case
Solution

The vice president of Deutsche Bank Securities was approached by a private equity fund named

Intercontinental Capital. Ltd (ICL) offering to help finance the acquisition of a large hospital-

supply distributor. It was a good deal for DB who could work with a private equity firm with a

good reputation. As an independent advisor, would you recommend ICL and DB Securities to go
ahead with this deal? Would you propose any changes to the capital structure?
Case questions answered:

1. Please conduct your evaluation of CSSA, using the information available on the case. Is
the buyer paying too much?
2. How sensitive is your previous analysis of the buyer’s assumptions on:
a. Future growth;
b. Ebitda margin improvements:
c. Working capital improvements;
d. All the above
3. Consider the proposed financing structure and terms. Additionally, assume the following
binding covenants to be imposed:
a. Interest coverage ratio (Ebitda / Interest Expense) > 2.0×
b. Leverage Ratio (Total Debt / Ebitda) < 6.75×
Is this company taking excessive leverage? What factors (strategic, operational, economic)
should we take in consideration to answer this question?
4. Why is Deutsche Bank structuring the financing of this deal as a combination of Senior
Secured and High Yield Debt? What determines the maximum amount of senior secured
debt that a company may take? Considering its relatively high cost, why is ICL
considering such a large issuance of high yield debt to finance the deal (instead of equity)?
5. Analyse the CSSA’s ability to repay the loans according with the schedule proposed in
Case Exhibit 7. How sensitive is your analysis of the buyers’ assumptions on future
operating performance?
6. Analyze the CSSA’s ability to comply with the proposed covenants. How sensitive is your
analysis of the buyers’ assumptions on future operating performance?
7. As an independent advisor, would you recommend ICL and DB Securities to go ahead
with this deal? Would you propose any changes to the capital structure?

NOT THE QUESTIONS YOU WERE LOOKING FOR? CLICK HERE .

Case answers for Deutsche Bank Securities: Financing the Acquisition of Consolidated Supply
S.A.

This case solution includes an Excel file with calculations.

Executive Summary

 In 2003, the Hospital supply industry was fragmented in both the supply and demand side.
Europe and the US represented most of the market. A private equity fund named
Intercontinental Capital. Ltd (ICL) approached Deutsche Bank (DB) to help them finance
 an LBO of Consolidated Supply SA (CSSA). It was a good deal for DB who could work
with a private equity firm with a good reputation.
 The DB believed in the ICL’s assumptions for the forecasting period. The APV method
was used to account for changes in the cost of debt and in the debt to equity ratios each
year. For the discounted rate it was assumed that MRP was 7,1% and that through the
comparables it led to an unlevered cost of capital of 9.743%. The DCF valuation based on
the stated assumptions yields an Enterprise Value of about $1.974 billion, resulting in an
Equity value of $995 million. According to multiple valuations, CSSA‘s Enterprise Value
is about 1.974 billion dollars. Since ICL placed a bid of $1.435 billion (solely the
Enterprise Value), the fund is rather underpaying than overpaying as the intrinsic value of
CSSA is assessed to be 30% higher.
 Four scenarios were created for a sensitivity analysis using from -30% to 30% of the
expectations over the following captions: Growth Rate of Revenue, EBITDA margin, and
NWC. Revenue growth’s assumption is important once computing the valuation of the
company, as less 30% of expected growth per year will lead to a decrease in EV by 14%.
EBITDA margin will be crucial once calculating the valuation of the company, an
improvement of 30% will cause about 32% of the increase in the final EV of the company.
Working Capital improvements of 30% per year will lead to a change of approximately
6,5% of the Enterprise Value. NWC is the less sensible variable when compared to the
previous ones. Once computed together, these three variables have a huge sensibility in the
Enterprise value, with these scenarios it can go up to 71% more than expected or decrease
by 50% of the expected/originally forecasted one.
 For the purpose of maximum value creation and return to the PE fund, the deal will be
financed mainly with senior secured debt and high yield debt, being covenants’
compliance what restricts the different use of debt securities. Given the forecast assumed
by ICL, the target company conveniently complies with all imposed covenants.
Operational, economic and strategic factors are important indicators for covenants
compliance, but it is important to take them into consideration further after, on CSSA’s
Repayment Schedule. With a sensitivity analysis we can conclude that only with high
percentage changes in the EBITDA margin (between 15% and 20%), it will lead to the non
compliance of many covenants; when these are not complied with, the bank is allowed to
ask for immediate repayment of all the debt, leading to the bankruptcy of CSSA.
Regarding the repayments, CSSA is currently able to fulfill its obligations regarding Debt
and Interest payments. Therefore the group believes it could leverage a little bit more, but
always considering the costs inherent to debt borrowing.
 Taking into account the valuations calculated, the size of the deal for Deutsche Bank and
the risks involved for CSSA if it incurred in more debt, the independent advisory suggests
an unchanged capital structure.

Industry Overview

Hospital Supply Industry Overview

 Diversified market across regions, products and end markets

 North America and Europe represent 41% and 32% of the market respectively
 Thanks to increases in surgical procedures and medical advances, projected industry
growth was of 4% to 5%
 Increases in investments in R&D also indicated market growth
 Supply and demand are highly fragmented
 Customers ranged in fields like Hospitals, Surgery centers, outpatient medical facilities,
and medical offices
 The market was lead by 3 main distributors (holding 28% of the market):
 Medical and Scientific Supply (MASS)
 Spa and Hospital Distribution
 CSSA