M&A: CONCEPTS AND THEORIES

NEW YORK INSTITUTE OF FINANCE

Comparable acquisitions

Acquisitions is, as you know, it's very similar to a public company. We have data
services that provide a lot of the comparable data. Not perfect. So it's the same
situation where you've got companies in the industry you pick out and try to see if
your company is better or worse and try to make adjustments to whatever the
multiples are.

So let's look at this little simple chart here. Ad here's a few M&A deals that we're
able to get some information on. Here's our EV to EBITDA, OK. It's-- the median is
7.2. Here's the price earnings ratio. So we only got three of them. We only got three
comparables. And they may be old. They may be-- usually in my line of work, we
don't-- if they're older than 12 months, we can't use them. So we got these two
numbers.

So if you're negotiating for your client, if you let's say in investment banking and
you're trying to sell the company, what's your-- trying to sell an IT company-- what's
your minimum asking price? You've got at least ask for this, right. That's-- everybody
else is getting this. Why shouldn't you? That's where you start

OK, the fourth and final method of valuation in this line of work is leveraged buyout
or private equity valuation. So most the times leveraged buyout's going to have 70%
to 80% debt in its capital structure. So that means that the investors, the private
equity fund is only putting up 20% or 30% of the money. So it's much higher
leverage than a typical publicly traded company or most-- certainly most private
companies I've encountered.

So knowing that and knowing what the requirements are to be a buyout type
company low tech, solid earnings history, low debt, if you have a subject business
that fits those attributes, what's a good, what we'd say, ballpark number for its
value as a leveraged buyout candidate? So there are many ratios that one could
apply. I think for our purposes a simple ratio. Let's look at the-- an interest coverage
ratio for a deal. It's financed with 75% debt.

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So now in today's market 1.4 is not out of the question. In other words, the lender is
saying I'm going to lend you all this money to buy the company leveraged buyout
fund, but the company has to cover with its pre-tax income. It has to cover the
interest charge at least 1.4 times. It's, kind of, common.

Now you remember, the leveraged buyout fund does not guarantee the debt. It's
what's called non-recourse debt. So if the leveraged buyout company has problems,
the lenders can't run to the buyout fund and say, hell, you helped, pay us back. The
leveraged buyout fund will say, no, you're on your own.

OK, so let's look at an example of a company with $100 million of pre-tax, pre-
interest income, right. So the lenders are saying, look, we'll do the deal. You're low
tech. You're low debt. You've got steady results. We'll let you cover that 1.4 time. So
how much interest does that mean it can cover?

71.

71. That means 71 is the maximum interest expense per year. Now, what's the US
treasury today? It's about-- treasury bond's about 3% 10 years, right, give or take.
So for a leveraged buyout, the lenders are probably going to say we want a 4.5%
premium for the risk, which means they might lend you the money that's 7 and 1/2%
on a good day.

So divide the 71 by-- see how I did that. That's the maximum debt you can get. So if
that's the debt I can afford and my debt to equity is 75/25, how much equity do I
need? See. If I know that's a maximum that I can get is that, the lenders are going
to say we want 25% equity. That means the business total value is 1269, and it's
going to have this much equity.

So from an M&A point of view, if I'm using the various approaches we've discussed,
the enterprise value in this business $81.26 billion. So this is just, kind of, a rough
estimate, right. Not saying it's-- that's a good ballpark, if you're talking. And they
might say, well, how's that translate into EBITDA, right.

So if this is EBIT, maybe an EBITDA in a typical business might be-- a relationship

might be 40. So the EBITDA might be 140, and therefore-- we're just fooling around.
This is not exact. What did I say the average rate today was for deals? About 10
times, so about nine. That's roughly translated. It makes sense.

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If you looked at-- which I have looked at the last five or six big buyout deals. It's
8/9/10 times is, sort of, what they've been trading for. So that's the example there.
Now here's, sort of-- this next table wraps up what we've been talking about.

We've got four approaches, and if you were to hire someone like me or someone like
Focus where I work and you said I'm trying to buy a company or let's say I'm trying
to sell a company. I want to know what I can get for-- what can I get for it? What
do think-- what's your best estimate Focus? We might produce a table like this. So
we look at comparable transactions. We look at comparable public companies. We
look at discounted cash flow, and then if it's appropriate, we look at the buyout.

Then you come up with a range, and then you look at, sort of, the middle of the
ranges to come up with a tighter range. So in this particular example it looks like
the targets worth between $360 and $420 million dollars. Now that table is-- might
be several weeks’ worth of work. You saw the numbers that had to be generated
and the financial models and everything. So that's an expensive task, a lot of effort
for such an undertaking.

And if you were to ask a valuation firm to do this kind of work, they might charge
you $20,000 or $30,000 or $40,000 depending on how complex your company
was.

So if you have a range, would you actually bid for the company?

First, you have to respect that the seller probably has been given some advice
along the same lines. If you're in a competition with other firms, they would have
similar logic and similar statistics as you. All right, so your first bid would probably
be between the two numbers, and your final bid would probably be a little and
around $420 unless you had some special synergies that no one else had. Maybe
you might get a little higher.

I mean generally when we're auctioning a company and we think it's going to be
between these ranges, assuming the company's due diligence checks out, the value
tends to be a little on the high side. Because there might be-- if you're selling a
company approach 100 bidders-- this we'll talk about tomorrow-- you mean, you
might get three or four or five offers.

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And usually one or two offers will be low balls. That's a slang expression for
unrealistic low number. Two or three will, kind of, be in the middle. And you might
have one that's going to be at the top or near the top. That's-- they're going to be a
winner, or depending on what your optimistic view is, they could be the loser. The
winner could be the loser.

So your offer is going to be somewhat reflective of these simply, because

everybody in the business is knows how it works and knows the various valuation
techniques and so on. And so they're going to come up with somewhat similar
numbers.

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