LBO and MA Exchange Ratio

LBO General Discussion
Merger and Acquisition Modelling October 28, 2023

1
Leveraged Finance - Introduction
• Leveraged Finance simply means funding a company or business

unit with more debt than would be considered normal for that
company or industry.
• Higher-than-normal debt implies that the funding may be riskier,
and therefore more costly, than normal borrowing -- higher credit
spreads and fees. It is often also more complex with covenants
and waterfalls.
• Hence leveraged finance is commonly employed to achieve a
specific, often temporary, objective: to make an acquisition, to
effect a buy-out, to repurchase shares or fund a one-time
dividend, or to invest in a self sustaining, cash-generating asset.

2
Leveraged Buyout Process
• A group takes over control of a company (sometimes with hostile

takeovers).
• Use high level of leverage and multiple debt layers to take control
• Once in control, improve operations – increase EBITDA, divest
unrelated businesses to generate cash for transaction, re-sell the
new company for a profit.
• High amortization assures self-restraint on behalf of the borrower.
• In a typical LBO, capital expenditures do not exceed depreciation
by much.
• By changing the relative participation of debt and equity in the
capital structure, an LBO redistributes returns and risks among
providers of capital.

3
Typical LBO Structure – Earlier Data
Divide by EBITDA in Computing EV/EBITDA and Debt/EBITDA
4-6 Incremental
Debt to
EBITDA
ratio
This totals 7-8 x

EBITDA

4
PRINCIPAL LBO FINANCING TIERS
Type Comments
Commercial • 1st lien against real estate
mortgage • 70 – 90% of property value
Revolving line of • Interest-only loan secured primarily by accounts receivable and inventory (prime collateral)
credit
Mezzanine debt • “Cash-flow” loans, with possible deferrals in early years

• Zero-coupon bonds
• May include “equity kickers”
Seller note • Unsecured interest-bearing note typically repaid within 3 – 7 years
Contingent payments • Additional payments due only if revenues or earnings milestones are met
Senior equity • Special class of common or preferred stock issued to LBO sponsor with liquidation preference
and possible preferred return
Common stock • Typically issued to management and possible minority interest retained by seller
• Purchase of management equity may be financed, in part, by nonrecourse note
Bridge loan • Temporary loan to be repaid within 6 – 12 months from permanent financing

5
5
6
Leveraged Buyout Modeling 6
Use of Mezzanine Debt to Meet Objectives and Restrictions of
Equity and Senior Debt LBO General Points
• An LBO is a transaction in which an investor group acquires a company by taking on

an extraordinary amount of debt, with plans to repay the debt with funds generated
from the company or with revenue earned by selling off the newly acquired
company's assets
• Leveraged buy-out seeks to force realization of the firm’s potential value by
taking control (also done by proxy fights)
• Leveraging-up the purchase of the company is a "temporary“ structure
pending realization of the value
• Leveraging method of financing the purchase permits "democracy“ in
purchase of ownership and control--you don't have to be a billionaire to do it;
management can buy their company.
• Raise money to pay for buyout premium
• Get as much as possible from the senior lenders
• Get as little as possible from the equity investors
• Tailor the terms of the mezzanine to be serviced from the expected cash flow.

7
Leveraged Buyout General Characteristics
• Leverage ranges from 6:1 to 12:1. Debt to EBITDA ranges from 3.5 times
to 6 times or even more.
• Investors seek equity returns of 20 percent or more – focus is on equity
IRR rather than free cash flow.
• Average life of 6.7 years, after which investors take the firm public. Bank
amortizes senior debt over 3-7 years.
• Characteristics
• Strong and stable cash flows
• Low level of capital expenditures
• Strong market position
• Low rate of technological change
• Relatively low market valuation

8
J-Curve or Hockey Stick and LBO’s
• The return depends on the holding period:

• If the LBO would be sold early on, the LBO would have a low
rate of return because of the premium used in the acquisition
and the fact that EBITDA has not increased
• Eventually, the return increases as the EBITDA grows and
cash flow is used to pay of debt
• Evaluate the optimal holding period for the LBO with
alternative possible EBITDA scenarios.

9
Some General LBO Statistics

10
Return on Alternative Investments

11
Equity Returns for Tollroads
• The following slide shows returns

12
Private Equity Returns
PI IRR
VC Buyouts VC Buyouts
25th percentile 0.37 0.51 0.21% 1.29%
50th percentile 0.64 0.81 6.34% 9.60%
75th percentile 0.99 1.09 14.95% 18.31%

Source: Phlippou and Zollo (2006).
The authors conclude that the returns earned from PE raised between
1980 and 1996 lags the S&P 500 by around 3.3% per annum.
Manager selection is absolutely critical, but comparisons are difficult since

evidence on returns is opaque

13
EV/EBITDA Multiples in LBO’s

14
EV/EBITDA by Size and Type

15
EV/EBITDA by Industry

16
Private Companies Sell At A Small Discount
Median P/E Multiples: Public vs. Private Deals

30
25
24 25 24
25 23
21
20 20 21 21
20 19 19
18 17
18 17
Multiples
17 16 17
16
15 15
13
10
0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Public Private

17
Source: Mergerstat (U.S. Only)

Disclaimer: Data is continually updated and is subject to change
Liquidity Determines Valuation Premium
Median Transaction Multiples by Deal Size
14
12.8
11.6 11.8 11.8 11.4
12 11.4 11.1 11.3 11.3
10.9 11.1
10.0 10.3 9.9 9.9
10 9.6 9.2 9.3 9.3 9.4 9.4 9.1
8.8 8.3 8.6 8.8
8.2 8.4 7.8 8.5
7.7
Multiples
8 6.9 7.0
0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Under $250 Million $250 to $500 Million Over $500 Million

18
Source: Mergerstat (U.S. Only)

Disclaimer: Data is continually updated and is subject to change
Debt to EBITDA

19
20
Highly Leveraged Loans
Top 20% most aggressive loans
Total Leverage Total Leverage (All Deals)

Senior Leverage
8.0x First-Lien Leverage
7.0x 7.1x
6.0x
6.0x 5.7x
5.0x
4.6x 4.8x
4.0x
2.0x
0.0x
2000 2001 2002 2003 2004 2005 2006

21
Source: S&P LCD; issuers with pro forma adjusted EBITDA of more than $50mm; as of 12/31/06
Note: Includes each year, the top 20% leveraged loans by initial Debt/EBITDA
Average Equity Contribution to LBOs
Equity as a Percent of Total Sources
40.6% 40.0% 39.5%

37.8%
35.3%
33.4%
32.1%
35.0% 37.3% 34.8%

33.9% 32.6% 31.1%
29.8%
3.9% 5.5% 4.7%

2.7% 2.7% 2.3% 2.3%
2000 2001 2002 2003 2004 2005 2006
Rollover Equity Contributed Equity

22
Source: S&P LCD

23
Illustration of Some Multiples
• Multiples for a couple companies are shown below
Which multiple best reflects value for the various

companies – note the EV/EBITDA is most stable

24
Example of Computation of Multiples from Comparative
Data
• JPMorgan also calculated an implied range of terminal values for Exelon

at the end of 2009 by applying a range of multiples of 8.0x to 9.0x to
Exelon's 2009 EBITDA assumption.
Note that the

median is
presented before
the mean

25
Investment Banker Analysis of Multiples

26
Premiums in Private Equity versus M&A

27
Private Equity Market
• global fundraising from since 1998 estimated at more than $1,000 billion
• US represents about two-thirds
• Europe represents about one-quarter; not much left for the rest of the world, but
some signs that the focus is spreading East
• about two-thirds of the equity raised for private equity is devoted to buy-outs (in both
Europe and US)
• but these are highly leveraged – often with only 30% equity in capital structure; so
the value of transactions is much larger than the equity figures suggest
• money is pouring into buy-out funds: $96 billion was committed to US funds alone in
the first half of 2006
• funds are getting bigger: Blackstone recently raised a $15.6 billion fund; TPG raised
$15 billion; Permira raised €11 billion …
• secondary deals are on the rise: in 2005, 28% of all buy-out deals were between PE
houses, amounting to over $100 billion (Dealogic)

28
Debt Capacity

29
Computation of Debt Capacity
• Computation of debt capacity cannot be reduced to a simple formula:

• Re-calculate the debt capacity under many scenarios.
• Stress tests should include price and volume pressure resulting from unfavorable
competitive or macro-economic pressures.
• Need assurance on cash flows in the first couple of years.
• The debt is an important signal along with the equity investment of managers.
• LBO financing is expressed in terms of debt to EBITDA
• Secured financing
•3 x EBITDA
• High yield
•2.5 to 3.5 x EBITDA Incremental
• Equity
•1.5 to 2 x EBITDA
• Total Transaction Value
•7 to 8 x EBITDA

30
Debt Capacity Method
• Balance sheet approach

• Market value of debt as percentage of market value of the
firm
• Compare with industry average
• Free cash flow approach
• Is there enough cash flow to pay more interest comfortably?
• How much more interest?
• How much more debt?
• Debt/EDITDA, EBIT/Interest, other measures

31
Debt Capacity and Interest Cover
• Despite theory of
probability of default
and loss given
default, the basic
technique to establish
bond ratings
continues to be cover
ratios,\.

32
Changing LBO Structure from 1980’s to 2000’s
Note the reduction in

senior debt and the
increase in High
Yield and Mezzanine
Debt

33
Credit Rating Standards and Business Risk
About 5 x EBITDA for BBB

with Business Risk of 4

34
Bond Ratings and Yield Spread

35
Example of Rating System
Map of Internal Ratings to Public Rating Agencies

Internal
Credit Corresponding
Ratings Code Meaning Moody's
1 A Exceptional Aaa
2 B Excellent Aa1
3 C Strong Aa2/Aa3
4 D Good A1/A2/A3
5 E Satisfactory Baa1/Baa2/Baa3
6 F Adequate Ba1
7 G Watch List Ba2/Ba3
8 H Weak B1
9 I Substandard B2/B3
10 L Doubtful Caa - O
N In Elimination
S In Consolidation
Z Pending Classification
36
Credit Spread on Debt Facilities
• The spread on a loan is directly related to the probability of

default and the loss, given default.
S
The Credit Triangle
S = P (1-R)
P R
 The credit spread (s) can be characterized as the default probability (P)
times the loss in the event of a default (R).
37
Expected Loss Can Be Broken Down Into Three
Components
Borrower Risk Facility Risk Related
EXPECTED Probability of Loss Severity Loan Equivalent

LOSS Default Given Default Exposure
= x x
(PD) (Severity) (Exposure)
$$ % % $$
What is the probability If default occurs, how If default occurs, how

of the counterparty much of this do we much exposure do we
defaulting? expect to lose? expect to have?
The focus of grading tools is on modeling PD

38
Moody’s Forecast of Default Rates
Defaults versus Long-term Average
Moody's Speculative Grade Trailing 12-Month Default Rates

Actual Jan. 2000 to Aug. 2002 / Forecasted Sept. 2002 to Feb. 2003
12.0%
10.7%
11.0% 10.5% 10.5%
10.3% 10.3%
10.5%
10.3%
10.1% 10.0% 10.0% 10.0% 10.0% 9.8%
9.8% 9.3%
10.0% 9.6%
9.0% 8.8%
8.8%
9.0% 8.5%
7.9%
7.7% 7.7%
8.0%
7.1%
6.7%
7.0% 6.2%
% 6.0%
5.0%
4.0% 3.77%*
3.0%
2.0%
1.0%
0.0%
May-01
May-02
Feb-01
Mar-01
Feb-02
Mar-02
Feb-03
Jul-01
Jul-02
Jan-01
Jun-01
Jan-02
Jun-02
Jan-03
Sep-01
Nov-01
Dec-01
Sep-02
Nov-02
Dec-02
Oct-01
Oct-02
Aug-01
Aug-02
Apr-01
Apr-02

39
Months
Note: *Long run annual default rate is 3.77%
Probability of Default
• This chart shows rating migrations and the probability of default

for alternative loans. Note the increase in default probability with
longer loans.

40
Recovery rates
• Estimating recovery rates

• There is no market or highly illiquid market
• Immediately upon announcement of default, after some reasonable period for information
to become available, or after a full settlement has been reached
• Recovery rates of bond
• Subordinated classes are appreciably different from one another in recovery realization
• Difference between secured vs. unsecured senior is not statistically significant
• Recovery rates of bank facilities
• Bank facilities( loans, commitments, letter of credit) are senior to all public senior bonds
• Bankruptcy law and practices differs from jurisdiction to jurisdiction
• Distribution of recovery rates
• Consistently wide uncertainty
• Beta distribution

41
Default Rates on Alternative Types of Debt
• Project Finance recovery rate estimated to be 75%
Average Historical Recovery Rates per $100
$80 $75
$71
$70
$56
$60 $51
$50 $41 $38
$40 $33
$30
$20
$10
$-
F o reig n C cy All S r S ec'd B ank S r S ec'd Deb t S r. Uns ec'd S r. S ub Deb t S ub . Deb t
S o v B o nd s C o rp o rat es Lo ans Deb t

42
Recovery Rates

43
LBO Exit

44
Discussion of LBO Exit
• Once increase the EBITDA through increasing efficiency, exit

through selling the company
• J-curve or hockey stick – pay a premium and the return goes
down before EBITDA increases
• Exit often measured with EV/EBITDA multiples
• If increased EBITDA, the multiple should be lower than the
acquisition multiple in theory
• Increased stability may imply higher multiples
• Mezzanine debt equity kickers come when the company is sold

45
LBO Exit Possibilities

46
Splitting Terminal Value
• Provide Incentives to management

• Hurdle rate of return
• Sharing of Excess Return
• Use future value factors
• Complex when multiple cash inflows rather than a single
cash inflow

47
Subordinated Debt

48
Alternative Types of Financing for LBO’s

49
Waterfall Example
Operating Expenses
Capital Expenditure
Agency Fee and TIFIA Service Fee
Senior Debt Interest and Hedging Costs
Deposit to Extraordinary Maintenance and Repair

Reserve (requirement of the ARCA)
TIFIA Interest Payments
Scheduled Repayment of Bank Loan
TIFIA Scheduled Amortization
Repayment of Bank Loan (through cash sweep)
Interest Payment on Affiliate Subordinated Note (“ASN”)
Amortization of ASN
Equity Distributions

50
Payment in Kind Notes
• PIK notes are fixed-income securities that pay interest in the form of
additional bonds rather than cash. Like zero-coupon bonds, they give a
company breathing room before having to make cash outlays, offering in
return rich yields.
• Example: In 2005, Wornick Co., a Cincinnati supplier of packaged meals
controlled by Veritas Capital Fund, raised $26 million in 13.875% senior
PIK notes through CIBC World Markets. Some deals are floaters:
Innophos's 10-year, noncaii-2 notes were priced to yield 800 bp over
LIBOR.
• Some PIKs have the added risk of being issued at the holding company
level, meaning they are subordinated and rely on a stream of cash from
the operating company to pay them down.
• PIK notes tend to receive ratings at the lower tier of the junk spectrum.
Examples: the Norcross deal was rated Caal/B-; Warner Music and K&F
were rated Caa2/B-; and Innophos came at B3/B-.

51
Mezzanine Debt
• Mezzanine debt is issued with a cash pay interest rate of 12 to 12

1/2 percent and a maturity ranging from five to seven years.
• The remainder of the required 18 to 20 percent all-in-return
consists of warrants to buy common stock, which the investor
values based on the outlook of the company, or incremental
interest paid on a "pay-in-kind" or PIK basis.
• The fee for raising the money runs between two and three
percent of the transaction.
• Deal sizes typically range from three million to $25 million but can
go as high as $150 million.
• Source: Bank of America

52
Mezzanine Debt
• High-yield or “junk” bonds

• 5- to 15-year maturity (although may be a demand loan)
• Prepayment
• May be prohibited during lockout period
• May require a penalty during years immediately following lockout period
• Interest
• Generally fixed at a substantial premium over Treasuries, although may
be floating rate
• Payment-in-kind (PIK) provision allows issuer to pay interest to
bondholders by issuing more bonds
• Zero-coupon bonds don’t pay a cash coupon, but are issued at discount
and accrete to par value at maturity

53
Issuers of High Yield Bonds
• "Fallen angels" are the classic issuer of junk bonds. These are former investment-
grade companies that are experiencing hard times, which cause their credit to drop
from investment-grade to lower ratings.
• "Rising stars" are emerging companies that have not yet achieved the operational
history, the size or the capital strength required to receive an investment-grade
rating. These companies may turn to the bond market to obtain seed capital. A start-
up company that qualifies for a single-B rating should have about the same risk level
as a going concern with the same rating.
• High-debt companies (which may be blue chip in size and revenues) leveraged with
above-average debt loads that may cause concern among rating agencies.
Leveraged buyouts (LB0s) create a special type of company that typically uses
high-yield bonds to buy a public corporation from its shareholders.
• Capital-intensive companies turn to the high-yield market when they are not able to
finance all their capital needs through earnings or bank borrowings. For example,
cable TV companies require large amounts of capital to acquire, expand or upgrade
their systems.
• Foreign governments and foreign corporations, often less familiar to domestic
investors, may rely on high-yield bonds to attract capital.

54
Covenants and Events of Default for High Yield Debt
• High yield bonds have a "standard" covenant package intended to maintain the
credit quality of the issuer and its group and the unencumbered movement of cash
up the issuer's group and ensure that the issuer deals on an arm's length basis with
its group companies. The covenants will include limitations on the ability of the
issuer and other group companies from
• incurring further indebtedness,
• making certain "restricted payments" (such as dividends and other
distributions to shareholders, intra-group loan repayments and investments)
• asset transfers
• granting liens over its property and assets
• entering into non-arm's length transactions with group companies.
• "Events of default" include any default in the payment of principal or interest (usually
following a specified grace period), any breach of covenant and the instigation of
insolvency or other related proceedings against the issuer or the group.

55
Spreads on High Yield Bonds
Promised Yields on Treasuries and High Yield Bonds
20.00
Spread
18.00 10-Year Treasury Bond
High Yield
16.00
14.00
12.00
10.50
10.06
10.00 9.44
8.56
8.24
8.00 7.27
5.86 5.97
6.00 5.46 5.39
5.04
4.51 4.55
4.18
3.89 3.98 3.75 3.67 3.74
4.00 3.28 3.45
3.10 3.16 3.14
2.81 2.94
2.00
1.23
-
1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

56
High Yield Defaults and Economic Indicators

57
Buyouts and Real Estate
• CI Buyout shops like The Blackstone Group, Permira, Apollo and

CVC Capital Partners have long coveted real estate because they
can use the buildings as guarantees against hefty bank loans.
• Rich property assets were one of the main drivers behind the
leveraged acquisition of U.S.-based toy retailer Toys R Us
Valuable real estate has also driven most of Europe's big retail
deals in the past two years, with department stores Selfridges,
Debenhams, Harvey Nichols, Bhs and Arcadia all taken private.
• Another factor luring private financiers to property is the expected
introduction of real estate investment trusts, or REITs. REITs are
listed property funds which can carry out their investment
activities tax free provided they pay out a high proportion of their
profits in the form of taxable dividends.

58
Buyout Examples

59
LBO Example – MediMedia – 1980’s
• Revolver and senior debt

• Amount $32 million
• Term 7 years
• Rate LIBOR + 2.25%
• Mezzanine Debt
• Amount $15 million
• Term 8 years
• Rate LIBOR + 3.25%
• Vendor Note
• Amount $11 Million
• Equity
• Amount $11 Million

60
LBO Example – Revco Late 1986
Sources
• Bank Term Loans 455,000
• Senior Subordinated 400,000
Common equity to total financing –
• Subordinated 210,000 2.41%
• Junior Subordinated 91,145
• Common Stock 93,750
• Exchangable Preferred 130,200 Cash Flow/Cash Interest 87%
• Convertible Preferred 85,000
• Junior Preferred 30,098 Required Asset Sales $255 million
• Investor Common 34,276
• Cash of Revco 10,655
•Total Sources1,448,799 First three years of principal
• payments -- $305 million
Uses
• Purchase of Common Stock 1,253,315
• Repayment of Debt 117,484
• Fees and Expenses 78,000
•Total Uses 1,448,799

61
LBO Example – Revco Drug Stores
• Poor stock performance before the LBO

• Taken private at $1.4 billion in 1986 – one of the largest LBO’s
• Premium of 48% compared to year earlier stock price
• Complex capital structure with 9 layers of debt and preferred
stock
• Collapsed 19 months after going private
• Maintained capital expenditures

62
LBO of Ashell
• Tranche 1: US$288.478 Term Loan A

• 05 Oct 2005-04 Oct I 2012 AIS: 225 bps/NA
• Tranche 2: US$180.299m Term Loan B
• 05 Oct 2005-04 Oct 2013 AIS: 275 bps/NA
• Tranche 3: US$180.299m Term Loan C
• 05 Oct 2005-04 Oct 2014 AIS: 325 bps/NA
• Tranche 4: US$64.392m Revolver/Late >= 1 Yr.
• 05 Oct 2005¬04 Oct 2012 AIS: 225 bps/NA
• Tranche 5: US$193.177m
• Revolver/Line >= 1 Yr. 05 Oct 2005-04 Oct 2012 AIS: 225 bps/NA
• Tranche 6: US$80.49m Term Loan
• 05 Oct 2005 AIS:500 bps/NA
• Tranche 7: US$159.693m
• Other Loan 05 Oct 2005 HIS:1025 bps/NA

63
TRW Payment in Kind Note Example
• In March 2003, Blackstone Group acquired TRW Automotive from

Northrop Grumman for $4.7 billion.
• Part of the debt financing was a 600 million, 8% pay-in-kind note
payable to a subsidiary of Northrop Grumman Corporation
• Valued at $348 million on a 15-year life using a 12% discount
rate
• As of September, 2004, the accreted book value totaled $417
million, and accreted face-value was $678 million
• That month TRW Automotive repurchased the Seller Note and
settled various contractual issues stemming from the acquisition,
for a net amount of $493.5 million.

64
Woodstream
• Brockway Moran & Partners purchased Woodstream Corp., a maker of

wild animal cage traps, rodent control devices and pesticides, from Friend
Skoler Co. LLC.
• The $100 million purchase price is equivalent to between 6.5 and 7x
EBITDA.
• Of the equity, Brockway contributed 85% of the total, with management
chipping in 10%. Lenders Antares Capital Corp. and Allied Capital Corp.
fill in the remaining 5%. Total equity represents approximately 40% of the
purchase price.
• On the debt side, Antares led a $58 million senior facility, along with
Merrill Lynch and GE Capital Corp. The senior debt component also
contains a revolver to be used in the future as working capital (and not
included in the $100 million purchase price).
• CIT Private Equity and Denali Advisors LLC provided a subordinated note
in the amount of $17 million.

65
Woodstream Debt
• Senior debt: Libor + 3.50%, 4 year amortization

• Subordinated notes:
• 7% cash interest
• 7% pay-in-kind interest
• Warrants to purchase 5% of the company's equity at $0.05
per share
• Repayment after 5 years or at exit event
• Fees 1.5%
• Equity
• 27% required return

66
Equity Office Properties
• Blackhawk Parent will cause an aggregate of approximately $19.3 billion to be paid to our
common shareholders.
• In addition, our operating partnership will use commercially reasonable efforts to commence
tender offers to purchase up to all of the senior notes and it will use reasonable best efforts to
redeem all of the redemption notes. there were approximately $8.4 billion aggregate principal
amount of senior notes, $51.5 million aggregate principal amount of redemption notes and
$1.5 billion aggregate principal amount of exchangeable notes outstanding. Our revolving credit
facility will also be repaid and our mortgage loan agreements and secured debt will be repaid or
remain outstanding. an aggregate principal amount of approximately $5.4 billion of consolidated
indebtedness under our revolving credit facility, mortgage loan agreements and secured debt.
• In connection with the execution and delivery of the merger agreement, Blackhawk Parent
obtained a debt commitment letter from Goldman Sachs Mortgage Company, Bear Stearns
Commercial Mortgage, Inc. and Bank of America, N.A. providing for debt financing in an aggregate
principal amount of up to the lesser of (a) $29.6 billion
• Blackhawk Parent obtained an equity bridge commitment letter from Goldman, Sachs & Co., Bear
Stearns Commercial Mortgage, Inc. and BAS Capital Funding Corporation for an equity
investment in an aggregate amount of up to $3.5 billion.
• It is expected that in connection with the mergers, affiliates of The Blackstone Group will contribute
up to approximately $3.2 billion of equity to Blackhawk Parent, which amount will be used to fund
the remainder of the acquisition costs that are not covered by the debt and equity bridge financing.
Common equity was 16.6% of the total

transaction value

67
LBO History

68
Finance Theory and LBO’s
• Desirable to adopt high leverage during a transition period

• Leveraged buyouts – acquisitions financed mainly by borrowing
• Leveraged recapitalizations – companies borrow to retire most of
their equity
• Workouts – companies with excessive debt that have to be
recapitalized in order to meet debt capacity.
• Jensen’s free cash-flow hypothesis.
• Managers spend excess cash at their discretion rather than in the
interest of the firm.
• Debt reduces the agency cost and restores the valuation to the
enterprise value
• Sponsor’s incentive from the equity investment that does not get
paid until the debt is repaid.

69
General Concept
• New Owners
• Improve Operations
• Divest Unrelated Business
• Re-sell the Newly Made Company at a Profit
• Early Successes with High Yield Bonds
• 1981 – 99 LBO’s
• 1988 – 381 LBO’s
• Discipline declined with increased deals
• Made assumptions that growth and margins could reach levels
never before achieved

70
LBO Bubble
• In 1981, 99 LBO deals took place in the US; by 1988, the number was
381.Early on, LBO players grounded their deal activity in solid analysis and
realistic economics.
• Yet as the number of participants in the hot market increased, discipline
declined. The swelling ranks of LBO firms bid up prices for takeover prospects
encouraged by investment bankers, who stood to reap large advisory
fees, as well as with the help of commercial bankers, who were willing to
support aggressive financing plans.

71
LBO Bubble - Continued
• We have reviewed some financial projections that underpinned several high-profile

LBO bankruptcies in the late 1980s. Many of these transactions were based on
assumptions that the companies could achieve levels of performance,
revenue growth, operating margins, and capital utilization never before
achieved in their industry. The buyers of these companies typically had no
concrete plans for executing the financial performance necessary to meet their
obligations. In many such transactions, the buyers simply assumed that they could
resell pieces of the acquired companies for a higher price to someone else.
• Why wouldn't investors see through such shoddy analyses?
• In many of these transactions, bankers and loan committees felt great pressure to
keep up with their peers and generate high up-front fees, so they approved highly
questionable loans. In other cases, each participant assumed someone else had
carefully done the homework.
• Buyers assumed that if they could get financing, the deal must be good.
• High-yield bond investors figured that the commercial bankers providing the
senior debt must surely have worked their numbers properly. After all, the
bankers selling the bonds had their reputations at stake, and the buyers had
some capital in the game as well.
• Whatever the assumption, however, the immutable laws of economics and value
creation prevailed. Many deals went under.

72
LBO’s in the U.S.
• In the early 1980s inflation became under control. Investors

rediscovered the confidence to innovate.
• A market for corporate control emerged, in which companies and
private investors (corporate raiders) demonstrated their ability to
successfully complete hostile takeovers of poorly performing
companies.
• Once in control, the new owners often improve operations, divest
unrelated businesses, and then resell the newly made-over
company for a substantial profit.
• The emergence of high-yield bond financing opened the door for
smaller investors, known as leveraged-buyout (LBO) firms, to
take a leading role in the hostile-takeover game.

73
LBO Statistics
• 3% to 6% of M&A activity in number of transactions

• Peak in 1980’s
• Significant increases in efficiency
• Late 1980’s, 27 percent of LBO’s defaulted
• Opportunities to transfer wealth between groups

74
The Deal Decade, 1981-1989 (the fourth movement)
• Motivating forces
• Surge in the economy and stock market beginning in mid-1982
• Impact of international competition on mature industries such as steel and
auto
• Unwinding diversified firms
• New industries as a result of new technologies and managerial innovations
Decade of big deals
• Ten largest transactions
•Exceeded $6 billion each
•Summed to $126.1 billion
• Top 10 deals reflected changes in the industry
•Five involved oil companies — increased price instability resulting from OPEC
actions
•Two involved drug mergers — increased pressure to reduce drug prices
•Two involved tobacco companies — diversified into food industry

75
1980s LBO Wave
Non Investment Grade Bond Volume
As a % of Average Total Stock Market Capitalization
• Prior to 1980 managers were 1977 - 1999
loyal to the firm, not
shareholders
• Little managerial share
ownership, stock
compensation
• Little external threat of
takeover
Going Private Volume
• Characteristics As Percent of Average Total Stock Market Value
1979 - 1999
• Highly levered deals: cash
payment funded by
borrowing
• Hostile
• Industry clusters

76
The Deal Decade, 1981-1989 (Continued)
• Financial innovations
• High yield bonds provided financing for aggressive acquisitions by
raiders
• Financial buyers
•Arranged going private transactions
•Bought segments of diversified firms
• "Bustup acquisitions"
•Buyers would seek firms whose parts as separate entities were worth
more than the whole
•After acquisitions, segments would be divested
•Proceeds of sales were used to reduce the debt incurred to finance the
transaction
• Rise of wide range of defensive measures as a result of increased hostile
takeovers

77
LBO Greed or Efficiency Gains
• LBOs shifted corporate governance

• Managers had high equity stakes
• Debt disciplined manager decision making
• Close monitoring from LBO investors, stong
boards
• First half of 1980s
• Improved operating profits Contested Tender Offers as % of Total
• Few defaults 1974 - 1999
• Last half of 1980s
• 1/3 defaulted
• But, operating profits improved from pre-LBO
levels, just not enough
• Prices paid in LBO deals were too high
• By the end of the 1980s corporate raiders
and LBOs were despised
• Securities fraud
• Junk bond market collapsed

78
Lasting Results from 1980s Takeovers
• Managers are more shareholder focused

• Hostile takeovers not as necessary
• More shares are owned by institutional investors (1980 <30 % to 2000
>50%)
• More monitoring and activism from shareholders
• Management stock ownership and stock compensation has increased
• More interested in creating stockholder value
• CEO option grants increased x7 from 1980 – 1994
• Equity compensation = 50% in 1994, <20% in 1980
• Boards are more active

79
Value Created by LBO’s

80
Productivity Study of LBO’s

81
Productivity Study and LBO’s

82
LBO Modelling Issues
• Perspective of Alternative Parties

• Cash Flow Waterfall
• Model the default points on alternative instruments
• Model the IRR on cash flows received by different
instruments
• Complex Interest Structures with Payment in Kind and multiple
interest rates
• Sources and Uses of Funds
• Pro-Forma Analysis
• IRR on Alternative Financial Instruments

83
Jordan Cement Case
• The owner of Jordan Cement wants to sell his family's company

for $19 million. He is prepared to offer a vendor note at 10% p.a.
for up to $2 million of the financing.
• A preliminary agreement for the sale has been reached between
the Biriqadar family and the sponsors of the acquisition, Orascom
and a European development bank. Together with management,
the sponsors can contribute equity capital of $5.5million, and
banks can provide a further $12 million.
• Create model with mezzanine debt

84
Fundamental Events of Default
• Fundamental events of default include

• the failure of the borrower to pay debt service;
• failure to comply with insurance requirements;
• entry of a final court judgment in excess of a significant
dollar amount which is not paid or stayed after a certain
period;
• abandonment of the project;
• bankruptcy of the borrower;
• failure of the sponsor to maintain ownership of the project (if
the sponsor's ownership is a critical component of the
evaluation of the project's credit risk).

85
Other Events of Default
• Other Events of Default Include:

• operational covenants,
• a merger or sale of assets
• failure to deliver notices
• failure to obtain or comply with governmental permits.
• Depends on Materiality
• Negotiated ad hoc.
• Agreements should provide for a clear and adequately described
mechanism for allowing the parties to deal with the defaulted
project.

86
Exchange Ratios and M&A Modeling of Public Companies

87
Introduction
• A key question for management is how an acquisition will effect

earnings per share. While there are flaws with the logic of
earnings accretion and dilution, consolidation analysis is often
central to the M&A process.
• This section reviews issues associated with dilution and
accretion effects of acquisitions.
• Translation of exchange ratios into implicit prices and
premiums
• Combined and standalone earnings per share with different
growth estimates
• Problems with momentum strategy.

88
Earnings and Financial Evaluation versus Standalone
Valuation
• Valuation analysis determines the value of the target on a

standalone basis
• Financial evaluation projects earnings and financial ratios for the
combined company after acquisition using different purchase
price and financing assumptions
• Effects of issuing shares with dilution
• Effects of debt and equity financing
• Effects of paying different premiums

89
Investment Banker Presentation on Merger Activity

90
Exchange Ratio Examples
• Examples of Share Exchanges

• If the merger is completed, holders of Mobil common
stock will receive, for each Mobil share, 1.32015 shares
of Exxon Mobil common stock. Exxon Mobil will issue
approximately 1.03 billion shares of Exxon Mobil common
stock to Mobil shareholders.
• The exchange ratio of the business combination is 0.77
shares of Chevron Texaco common stock for each share
of Texaco common stock.

91
Exchange Ratio
• Using a share exchange is equivalent to issuing shares rather than using debt.
• To evaluate exchange ratios, begin with stock prices before the merger or
acquisition, to determine the number of shares of the new company that the existing
shareholders will receive.
• Exchange Ratio = Target Share Price/Acquirer Share Price
• For example, if the target has a share price of 10 and the acquirer has a
share price of 20, the exchange ratio is .5
• In this case, the target receives .5 shares of the new company for each share
of the acquiring company.
• If a premium is part of a transaction, the target shareholders receive a higher
exchange ratio.
• For example, if the premium is 25% in the above example, the target
shareholders receive
• Exchange Ratio = Exchange Ratio x (1.25) = .625
• By receiving 25% more shares, the premium is realized.

92
Formula for Share Exchange
• The actual achieved premium should reflect the fact that the new
company has a different value than the acquiring company:
• P = Value combined/(new shares)
• P = Value of acquirer + Value of target + Synergies/(new shares)
• Then the premium is evaluated against the new price
• Can do something similar when a combination of shares and cash
is used.

93
Example of Contribution Analysis in Share Exchange
• Lehman Brothers and Evercore analyzed the respective

contributions of AT&T and BellSouth to the estimated calendar
years 2006, 2007 and 2008 EBITDA and Net Income of the
combined company based on estimates provided by AT&T
management, and excluding the effect of expected synergies.
This analysis indicated the following relative contributions of AT&T
and BellSouth and the following implied exchange ratios:
Should the exchange ratio

correspond to EBITDA or
Net Income

94
Stock Offer
• Fixed exchange ratio

• # of acquirer shares to be exchanged for each target share is set at
the time of the offer
• Floating exchange ratio
• Value to be paid is agreed upon at the time of offer, ratio floats until
closing
• Collar
• Upper and lower limits on shares to be offered (floating)
• Upper and lower limits on price to be paid (fixed)
• Walk-away
• Target can walk from fixed if acquirer’s stock falls too low
• Acquirer can walk from floating if it’s stock falls too low

95
Premiums

96
Premiums and Valuation
• While DCF valuation and other methods are important, there are
expected premiums in the market. An alternative way to analyze
a merger is to estimate market premiums and then see if the
merger works.
• Some of the next slides illustrate how premiums are estimated
from market data.
• The first slide show academic studies of price increases for target
companies using event studies.

97
Premium Analysis in Mergers by Investment Banks
• Lehman Brothers reviewed the premiums paid to stockholders in

selected precedent transactions with an equity value greater than
$1 billion for (1) all industries announced from 1998 to
December 13, 2005 (691 transactions in total) and (2) comparable
transactions in the utility sector

98
Empirical Evidence
• Target firms in a takeover receive an average premium of 30%.

• Note that once cannot precisely measure the date for computing
the premium
Selling
companies
ABNORMAL RETURN (%)
CUMULATIVE AVERAGE
+
Buying
companies
Announcement date
TIME AROUND ANNOUNCEMENT

(days) October 28, 2023
99
Merger and Acquisition Modelling
Upward Trends in Control Premiums
• The following chart shows trends in control premiums. For the

US the premium was 31% from 1996 to 2002 and for Europe it
was 34% according to Anrzac.

100
Review of Other Transactions in the Industry

101
Investment Banker Analysis of Premiums

102
Investment Banker Analysis of Premiums

103
Example of Premium in Oil company Mergers
•J.P. Morgan's analysis showed that for transactions involving smaller companies
with a relative market capitalization comparable to that of Mobil pre-announcement,
a premium of 15% to 25% matched market precedent. The analysis indicated
that, based on the closing share prices on November 30, 1998, the day prior to
announcement of the merger, the implied premium paid to Mobil shareholders would
be approximately 10%. The analysis also indicated that, based on closing share
prices on November 24, 1998, two trading days before Exxon and Mobil issued a
joint press release confirming that they were in discussions concerning a possible
merger, the implied premium paid to Mobil shareholders would be approximately
20%.
•Morgan Stanley reviewed eleven selected comparable merger transactions
and compared the implied premium to the relative market capitalization of the
smaller entity. This analysis evidenced premiums in a range from 5.0% to 15.0%
based on closing share prices on the day before the announcement of the
transaction. The implied premium received by Amoco Shareholders upon receiving
40.0% ownership of the combined entity is 13.3%, also based on closing share
prices on the day before announcement of the transaction. The premium received
by Amoco Shareholders when measured over different time periods similarly
matched the premiums indicated by comparable transactions when measured over
the same time period.

104
Example of Premium in Oil Company Mergers
•The 17.7% premium represented by the exchange ratio on October 13 was

somewhat below, but the 25.3% premium represented by the exchange ratio over
the 30-day average relative trading price of Chevron and Texaco was in line with,
premiums paid in comparable transactions reviewed by the board, which ranged
from 23% to 33% based on the last closing share price of the applicable companies
before the announcement or rumor of a transaction. For the Chevron/Texaco
merger, the board considered the last-day premium and the 30-day premium (as
well as premiums calculated over longer periods of time, as described above)
because of the possibility that the one-day premium had been affected by leaks or
market rumors concerning the possibility of a transaction between Chevron and
Texaco;
•The current and historical market prices of Pennzoil-Quaker State common stock
relative to the merger consideration, including (a) the fact that Pennzoil-Quaker
State common stock had never traded over $16.50 per share, (b) the fact that the
$22.00 per share merger consideration represented a 55.5% premium over the
closing price of Pennzoil-Quaker State common stock four weeks earlier and a 42%
premium over the closing price of Pennzoil-Quaker State common stock of $15.49
per share on March 22, 2002, the last trading day before the board's approval of the
merger agreement and (c) the fact that the weighted average acquisition cost for
holders of Pennzoil-Quaker State common stock since January 2001 was $12.88
per share;

105
Example of Premium Analysis

106
Example of Premium in Telecom
• Precedent Transactions Premiums Analysis. Citigroup and Goldman

Sachs reviewed certain publicly available information relating to certain
selected precedent transactions since 1998 with transaction values in
excess of $20 billion that Citigroup and Goldman Sachs deemed relevant.
For each of the selected transactions, Citigroup and Goldman Sachs
calculated the percentage premium or discount per share received by the
target’s shareholders based on the closing price per share of the target’s
common stock on the day before and the month before the announcement
of the transaction and compared it to the premium to be paid to BellSouth
shareholders based on the exchange ratio in the merger agreement of
1.325x and the closing stock prices of AT&T and BellSouth on March 3,
2006. The following table summarizes the results of this analysis:
• 1 Day 1 Month As transaction is
closer, the target
• Median for Precedent Transactions 15% 21% share price
• BellSouth/ AT&T increases.
16% 29%
Exchange ratio
premium
depends on
measurement

107
Exercise: Compute Premiums in Oil Mergers
• On November 25, 1998, the last full trading day before Exxon and
Mobil issued a joint release confirming that they were in
discussions concerning a possible combination, Exxon common
stock closed at $72 11/16 and Mobil common stock closed at $78
3/8. On April 1, 1999, Exxon closed at $70 1/8 and Mobil closed
at $87 3/8.

108
Example of Premium Analysis
• Premiums Paid Analysis

• To assess the premium to be paid by Exelon to PSEG shareholders, Lehman Brothers reviewed
selected historical transactions for the premiums paid to shareholders in such transactions.
Lehman Brothers selected transactions with an equity value greater than $1 billion for (1) all
industries announced from 1998 to December 16, 2004 (507 transactions in total), and
(2) comparable transactions in the power and utility sector. The selected comparable historical
transactions in the power and utility sector were the following:
• Proposed acquisition of UniSource Energy Corporation by Saguaro Acquisition Corp., a
corporation whose indirect owners include investment funds affiliated with J.P. Morgan
Partners, LLC, Kohlberg, Kravis, Roberts & Co., L.P., and Wachovia Capital Partners
(announced November 2003)
• Energy East Corporation's acquisition of RGS Energy Group, Inc. (announced
February 2001)
• Potomac Electric Power Company's merger with Conectiv (announced February 2001)
FirstEnergy Corp.'s acquisition of GPU, Inc. (announced August 2000)
• PECO Energy Company's merger with Unicom Corporation (announced September 1999)
Northern States Power Company's merger with New Century Energies, Inc. (announced
March 1999)
• American Electric Power Company, Inc.'s merger with Central and South West Corporation
(announced December 1997)

109
Premium Example
• The premiums were calculated over the share price one-day prior, one-
week prior and four-weeks prior to the selected historical transactions'
respective announcement date. These premiums were then compared to
the implied premium to be paid to PSEG shareholders over the price one-
day prior to, one-week prior to, and for the four-weeks prior to
December 16, 2004. The following table reflects the results of the analysis:

110
Synergies versus the Premiums
• Total potential cost savings and other synergies identified by the

management of Exelon have been estimated at approximately
$400 million in the first full year of operations following completion of the
merger and approximately $500 million in the second full year of
operations following completion of the merger.
• The management of PSEG estimated similar levels of synergies, giving
effect to all expected improvements in the operating performance of
nuclear generating units, including improvements reflected in PSEG's
forward-looking financial information for 2005-2009.
• Related costs-to-achieve these synergies are currently estimated at
approximately $450 million in the first full year of operations following
completion of the merger and approximately $700 million over a period of
four years following the merger.
• Identified plans for stand-alone cost reduction initiatives have also been
recognized and deducted from the estimated potential cost savings in the
amount of $5 million in the first full year of operations and $9 million in the
second full year of operations. The impact of these planned initiatives will
continue into the future and reduce identified merger synergies each year.

111
Share Exchange Model

112
Share Exchange Analysis
• The next few slide illustrate the process of computing accretion

and dilution from a few market and earnings data items.
• This is a technique actually used in share exchange transactions
as illustrated by the investment banker excerpts.

113
Example of Accretion and Dilution
• Lehman Brothers and Evercore estimated that, based on the

assumptions described above, the pro forma impact of the
transaction on the earnings per share of AT&T, excluding the
amortization of intangibles and integration costs would be
approximately 1% dilutive in 2007, and then approximately 3%,
5% and 5% accretive in 2008, 2009 and 2010, respectively.

114
P/E Analysis with Synergies
• Pro Forma Merger Analysis. Goldman Sachs prepared a pro forma

analysis of the financial impact of the merger. Using I/B/E/S International
Inc. earnings estimates for 1999 and 2000, Goldman Sachs compared
the earnings per share of Mobil common stock on a stand-alone
basis and Exxon common stock on a stand-alone basis, to the
earnings per share of the common stock of the pro forma combined
company. Goldman Sachs performed this analysis based on the
exchange ratio of 1.32015 and under three scenarios reflecting cost
savings and operating synergies projected by the management of Mobil
and Exxon to result from the merger:
• assuming Scenario I, the merger would be dilutive - that is, would
represent a reduction - to both 1999 and 2000 earnings per share of
Exxon common stock on a stand-alone basis and would be accretive-that
is, would represent an addition - to 1999 and 2000 earnings per share of
Mobil common stock on a stand-alone basis; and
• assuming Scenario II or Scenario III, the merger would be accretive in
1999 and 2000 to the earnings per share of Exxon common stock on a
stand-alone basis and the earnings per share of Mobil common stock on a
stand-alone basis.

115
P/E with Synergies
•Morgan Stanley analyzed the pro forma Amoco EPS for fiscal years
1999 and 2000 based on IBES estimates as of August 10, 1998. The
analysis showed, assuming $2 billion in synergies phased in over three
years, on an equivalent share basis, that the Merger would be
significantly accretive to Amoco Shareholders.
•J.P. Morgan performed an analysis comparing BP's and Amoco's price to
earnings multiples ("P/E multiple") to those of Exxon and The Shell
Transport & Trading Company plc ("Shell T&T") for the past five years.
The source for these P/E multiples was the one year prospective P/E
multiple estimates by IBES. Such analysis indicated that BP and Amoco
had been trading in the recent past at a 20% to 25% discount to both
Exxon and Shell T&T. J.P. Morgan's analysis indicated that if BP and
Amoco were to be valued at P/E multiples comparable to those of Exxon
and Shell T&T there would be significant enhancement of value to
shareholders of BP and Amoco. J.P. Morgan pointed out that there could
be no assurance that this value would be realized.

116
Discussion of P/E Analysis
•J.P. Morgan performed an analysis comparing Exxon's price to earnings

multiples with Mobil's price to earnings multiples for the past five years.
The source for these price to earnings multiples was the one and two
year prospective price to earnings multiple estimates by I/B/E/S
International Inc. and First Call, organizations which compile brokers'
earnings estimates on public companies. Such analysis indicated that
Mobil has been trading in the recent past at an 8% to 15% discount to
Exxon. J.P. Morgan's analysis indicated that if Mobil were to be valued at
price to earnings multiples comparable to those of Exxon, there would be
an enhancement of value to its shareholders of approximately $11 billion.
Finally, this analysis suggested that the combined company might enjoy
an overall increase in its price to earnings multiple due to the potential for
improved capital productivity and the expected strategic benefits of the
merger. According to J.P. Morgan's analysis, a price to earnings multiple
increase of 1 for Exxon Mobil would result in an enhancement of value to
shareholders of approximately $10 billion.

117
Investment Banker Share Exchange Analysis

118
Investment Banker Earnings Combination Analysis

119
Investment Banker Earnings Analysis

120
P/E and Size
• Higher trading multiples accorded to the equity of the "super-

majors" in the securities markets (BP Amoco, ExxonMobil, and
Royal Dutch/Shell), such as price-to-2001 estimated
earnings multiples, as of October 13, 2000, of 17.0 for BP
Amoco, 21.7 for ExxonMobil and 18.8 for Royal Dutch/Shell as
compared to 13.7 for Chevron;

121
Tyco Example
• Founded in 1960 as a scientific research boutique

• Transformed in late 1960’s to a mini-conglomerate by acquiring
24 companies.
• Dennis Kozlowski, began as an auditor and became CEO in
1992.
• Acquisitions beginning in 1994:
• Kendall International – disposable medical supplies
• ADT Security services ($ 11.3 billion)
• CIT Group ($9.2 billion) Financial Services

122
Tyco Excerpts
• December 1999
• We aim for sustained earnings growth of 20 percent,
powered by increased revenues and earnings expansion…
We spend hundreds of hours assessing the benefits and
risks of each transaction we consider. We always ask:
What’s the worst case scenario? We perform thorough due
diligence every time, and we walk away from nine out of ten
transactions we evaluate….We think we can double our
earnings over the next three years.

123
Relative P/E Ratios – Tyco Example
• Tyco’s sales soared from $19 billion to $36 billion. But most of the growth
has come from acquisitions. The Company’s sales grew by 3% excluding
acquisitions.
• Tyco Excerpts:
• Focus on steady percentage growth in EPS. To sustain a constant
percentage rate of growth in EPS requires larger and larger absolute
increases. This is called “momentum”
• Increasing number and dollar value of acquisitions.
• Avoidance of EPS dilution; focus on accretive acquisitions.
• Heavy reliance on accounting conventions that produce favorable
results such as pooling of interests.
• Non-disclosure of $8 billion in acquisitions.

124
Momentum Acquiring
• At the core of Tyco’s acquisition-growth story is a buoyant stock market

that created a high priced acquisition currency and a feedback effect that
together create a perceived momentum in the financial performance of the
firm. The observed rate of growth in EPS influences investors to value the
firm more highly. This increases the price/earning multiple. The firm
issues new (higher priced) shares in an acquisition. If the acquisition is
accretive, the EPS grows faster. The faster growth promotes a higher P/E
ratio and the cycle continues.
• What is remarkable about the momentum story is that for a time it may
mask an economic growth rate that is rather mundane. Tyco’s growth rate
was probably in line with the manufacturing sector of the United States –
2 percent to 4 percent in real terms per year. But with momentum, low
organic growth is offset by rapid growth from acquisition strategies that
create a toxic exposure to unexpected trouble. The outcome is generally
sudden and painful to investors.
• Robert Bruner

125
Leveraged Buyout Case Study

126
• Company Profile
• $91 million North Carolina based manufacturer and distributor of specialty dyestuffs
for the textile, floorcovering and paper industries
• Economically source dye crudes over seas; quality test, mix, repackage and sell dye
crudes to end user
• Largest independent distribution and processor of specialty dyes in U.S.
• Customer list included Fruit of Loom, Mohawk, International Paper, Sara Lee,
Russel Mills
• The current management team was previously employed by a specialty chemical

company which passed on the opportunity to acquire the dyestuff manufacturer

127
Company Profile
$100
History of Strong Sales Growth and Stable Cash Flow
$80
$60
$40
$20
$0
FY1992 FY1993 FY1994 FY1995 FY1996 FY1997
Sales (millions)
$10
$5
$0
FY1992 FY1993 FY1994 FY1995 FY1996 FY1997
Adj. EBITDA (millions)

128
Key Investment Considerations:
Superior Consolidation Platform
Technical Marketing Strategy
Strategically Positioned for Continued Growth
Strong Management Team
Diversified Customer and Supplier Base

129
Original Buyout Structure

The total purchase price of $61.6 million represented a 5.5
multiple of cash flow.
XYZ advised the mgmt team on the structure and financing

of the acquisition.
The following table contains sources and uses:

Sources (in millions of $) Uses (in millions of $)
Working Capital Revolver

(13 mm Facility) 3.7 Cash Purchase Price 40.0
Senior Term Debt 28.0 Non Compete Cov. 10.0
Subordinated Debt 17.4 Existing Debt 11.6
Equity 15.0 Trans. Fees 2.5
Total 64.1 64.1

130
The following table depicts the pro forma capital structure:
Pro forma Capital Structure
Working Capital Revolver 3.7 5.8%

Senior Term Debt 28.0 43.7%
Total Senior 31.7 49.5%
Subordinated Debt 17.4 27.1%

Equity 15.0 23.4%
Total 64.1 100.0%

131
Senior Debt Terms:

Working Capital line interest rate 9.7%
Senior Term Debt interest rate 10.2%
Senior Debt as a multiple of EBITDA: 2.8X
Sub Debt Terms:

12.5% current pay
Attachable warrants
Total Debt as a multiple of EBITDA: 4.3X

132
Management’s Interest
Purchased interest of 7% of common equity
Received carried interest of 23%
Based on management projections and a 5X EBITDA exit

multiple in 5 years, management anticipated:
$27.4 mm in cash proceeds

94% IRR

133
• Case Study Epilogue
• Industry Shift
• Dye industry severely impacted by declining textile mill output and increased paper mill raw
material costs
• Mill production decline consequences of retail shake out in 1995
• Industry experienced 8%-10% price compression
• Company unable to meet projections and debt amortization
• Needed additional liquidity to buy companies through the contraction and trough of the business
cycle
• Refinancing
• XYZ recently completed a refinancing / acquisition financing which consisted of $40mm in senior
debt and $5mm in equity
• Highly leveraged transaction total debt to EBITDA ratio of 6.7
• Senior debt multiple 3.2 times EBITDA

134
Project Dye
Fees
Initial Leveraged Buyout and financing
$1,300,000
Refinancing 800,000
Total Fees $2,100,000
XYZ retained to advise on additional equity private

placements and buyside advisory in order to fund the
company’s future growth strategy.

135

LBO and MA Exchange Ratio

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LBO General Discussion

Merger and Acquisition Modelling October 28, 2023

• Leveraged Finance simply means funding a company or business

Merger and Acquisition Modelling October 28, 2023

• A group takes over control of a company (sometimes with hostile

Merger and Acquisition Modelling October 28, 2023

This totals 7-8 x

Merger and Acquisition Modelling October 28, 2023

Mezzanine debt • “Cash-flow” loans, with possible deferrals in early years

Seller note • Unsecured interest-bearing note typically repaid within 3 – 7 years

Merger and Acquisition Modelling October 28, 2023

• An LBO is a transaction in which an investor group acquires a company by taking on

Merger and Acquisition Modelling October 28, 2023

Merger and Acquisition Modelling October 28, 2023

• The return depends on the holding period:

Merger and Acquisition Modelling October 28, 2023

Merger and Acquisition Modelling October 28, 2023

Merger and Acquisition Modelling October 28, 2023

• The following slide shows returns

Merger and Acquisition Modelling October 28, 2023

25th percentile 0.37 0.51 0.21% 1.29%

50th percentile 0.64 0.81 6.34% 9.60%

75th percentile 0.99 1.09 14.95% 18.31%

Manager selection is absolutely critical, but comparisons are difficult since

Merger and Acquisition Modelling October 28, 2023

Merger and Acquisition Modelling October 28, 2023

Merger and Acquisition Modelling October 28, 2023

Merger and Acquisition Modelling October 28, 2023

Median P/E Multiples: Public vs. Private Deals

Merger and Acquisition Modelling October 28, 2023

Source: Mergerstat (U.S. Only)

Median Transaction Multiples by Deal Size

Under $250 Million $250 to $500 Million Over $500 Million

Merger and Acquisition Modelling October 28, 2023

Source: Mergerstat (U.S. Only)

Merger and Acquisition Modelling October 28, 2023

Top 20% most aggressive loans

Total Leverage Total Leverage (All Deals)

Merger and Acquisition Modelling October 28, 2023

Equity as a Percent of Total Sources

40.6% 40.0% 39.5%

35.0% 37.3% 34.8%

3.9% 5.5% 4.7%

Rollover Equity Contributed Equity

Merger and Acquisition Modelling October 28, 2023

Source: S&P LCD

• Multiples for a couple companies are shown below

Which multiple best reflects value for the various

Merger and Acquisition Modelling October 28, 2023

• JPMorgan also calculated an implied range of terminal values for Exelon

Note that the

Merger and Acquisition Modelling October 28, 2023

Merger and Acquisition Modelling October 28, 2023

Merger and Acquisition Modelling October 28, 2023

Merger and Acquisition Modelling October 28, 2023

Merger and Acquisition Modelling October 28, 2023

• Computation of debt capacity cannot be reduced to a simple formula:

Merger and Acquisition Modelling October 28, 2023

• Balance sheet approach

Merger and Acquisition Modelling October 28, 2023

Merger and Acquisition Modelling October 28, 2023

Note the reduction in

Merger and Acquisition Modelling October 28, 2023