Investment Banking – SEO Intern Hard Skills Training

MATERIALS FOR DISCUSSION

Anand Shah - OzCap CONFIDENTIAL | June 2006
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Table of Contents
1. Typical Responsibilities of a Summer Analyst

2. Valuation Analysis – The Core Methodologies of Investment Banks

A. Introduction to Valuation
B. Comparable Company Analysis
C. Comparable Acquisition Analysis
D. Discounted Cash Flow Analysis
E. Leveraged Buyout Analysis
F. Interpreting and Presenting Valuation Results

3. Other Important Analyses – Merger Consequences & Credit Comps

Appendix
A. What is Enterprise Value?
B. What is WACC?
C. How to Build Projections
D. Choosing the Right Range – Comps and CompAcqs

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1. Typical Responsibilities of a Summer Analyst

Anand Shah OzCap

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What Are the Typical Responsibilities of a

Summer Analyst?

Make the life of the associates or analysts you are working with easier

Let them know you are there to help

Earn their trust and gain responsibility

The major items you can anticipate you will be expected to prepare are

Company Profiles
– Company Overview
– Product Overview
– Financial Overview
– Stock Price Performance
– Recent Events
– Research Analyst Views
– Ownership Structure & Management and Board of Directors Biographies

Research for Companies and Industries

Compiling / Creating PIBs

Formatting Information / Processing comments from your deal teams

Comps/CompAcqs

BE A GREAT LISTENER AND LEARNER!

ALWAYS DOUBLE CHECK YOUR WORK!

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Preparing Company Profiles BE RESOURCEFUL!!

You will likely prepare many Company Profiles as a summer analyst. Each bank and each
group may have a different standard format for doing profiles. Ask others for examples
The resources to use are FactSet, Bloomberg, Thomson Research, Company Website, Yahoo!
Finance, Public Filings (10-Ks, 10-Qs, S-1s, Registrations, Prospectuses, Proxies, Annual
Reports, 20Fs, Interim Reports and press releases/news), and Google
Here are some specific items you may expect to include in a Company Profile

A quick overview of the Company’s operations:

What is their business? What do they do? Who do they serve?

State where the company is headquartered and the number of employees

What is their market position – leading, second, third, etc.?

Products and services: What are they?

If your team wants product illustration, create a separate page or box with pictures and brief
descriptions

List the Company’s major brands

Target customers and markets: How big are the markets they are in? Who are the key
customers?

Look at the segment results in the 10-K and Research

Manufacturing capabilities and facilities: Number, location and type of facilities

LTM or historical/projected financials: Revenues, EBIT and EBITDA with growth and margins

Section for recent news, including important situations, acquisitions, etc.

Ownership and Management/Board – Breakdown of Ownership / Senior Management/Board

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Sample Company Profile

Business Description Operating Summary
The Company is a manufacturer of electronic instruments and electric
motors with operations in North America, Europe, Asia and South ($ in millions, except per share data)
America. The Company is organized into two operating groups: FYE 12/31, 2000 2001 2002 2003E 2004E
Sales $1,024.6 $1,019.3 $1,040.5 $1,055.5 $1,140.6

Electronic Instruments Group (“EIG”) (52% of Total Sales and EBIT)
% Growth 10.8% (0.5%) 2.1% 1.4% 8.1%

Produces advanced monitoring, testing, calibrating, measurement, EBITDA $179.1 $178.0 $181.7 $192.0 $208.2
and display instruments sold to the process, aerospace, power and % Margin 17.5% 17.5% 17.5% 18.2% 18.3%
industrial markets EBIT $135.9 $132.8 $148.7 $157.2 $171.7
% Margin 13.3% 13.0% 14.3% 14.9% 15.1%

Electromechanical Group (“EMG”) (48% of Total Sales and EBIT)
Capex $29.5 $29.4 $17.4 $20.5 $28.0

Manufacturer of air-moving electric motors for vacuum cleaners and % Margin 2.9% 2.9% 1.7% 1.9% 2.5%
other floor care products. Other products include brushless DC EPS $2.11 $2.12 $2.49 $2.60 $2.95
motors, motor-blowers and specialty metal products % Growth 14.1% 0.5% 17.5% 4.4% 13.5%
Source: Company filings.

Products manufactured are small vacuum motors with fans that
rotate at high speeds and require advanced technology

Key end-markets include:
– Floor care markets (39% of sales) - EMG has the leading share, Business Mix
through its sales of air-moving electric motors to most of the (% of sales)
world's major floor care OEMs
– Technical motors - Used in aerospace applications, business Sales Mix Geography
machines and computer equipment, military and mass transit
ROW
vehicles, and medical equipment
13%
– Specialty motor markets (22% of sales) - EMG manufactures a Electromechanical
Group Asia
specialty motors for outdoor power equipment, such as electric
48% 10%
chain saws, leaf blowers and power washers; household
appliances; fitness equipment, and sewing machines
– Power and Switch Markets - The switch business produces Europe
12%
solenoids, and other electromechanical devices for the motive and United States
stationary power markets Electronic 66%
Instruments

EMG holds a leading market share in North America and Western 52%
Europe and is focused on expanding to Asia
Source: Company filings.

Employs approximately 7,700 people

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Sample Company Profile (Cont’d)

LTM Stock Price Performance Management and Directors
$53 1,540
NAME AGE POSITION
Frank Hermance 53 CEO/Chairman of the Board
1,320 John Molinelli 55 Executive VP/CFO
$48 Albert Neupaver 51 President Electromechanical Group
1,100 Robert Chlebek 58 President Electronic Instruments Group
Thomas Mangold, Jr. 56 President Electronic Instruments Group
$43
880 Robert Mandos, Jr. 43 VP/Comptroller
Sheldon Gordon 66 Director; Chairman of Union Bancaire Private Holding
660 David Steinmann 60 Director; Managing Director of American Securities LLP
$38
Helmut Friedlaendar 88 Director; Private Investor
440
James Malone 59 Director; Founder of Bridge Associates LLC
$33
220
Elizabeth Varet 58 Director; Managing Director of American Securities LLP
Lewis Cole 71 Director; Partner, Stroock & Stroock & Lavan LLP
$28 0 Charles Klein 63 Director; Managing Director of American Securities LLP
Nov-02 Jan-03 Mar-03 May-03 Jul-03 Sep-03 Nov-03 Source: Company filings.

Market Valuation Ownership

($ in millions, except per share data)
NAME SHARES % HELD
Current Stock Price: $46.05 Gabelli Asset Management 3,198,276 9.6%
52-Week High/Low: $48.41 / $29.49 J. L. Kaplan Associates LLC 1,837,364 5.5%
2003 YTD Price Change: 19.6% Columbia Wanger Asset Management LP 1,456,000 4.4%
% Discount to 52-Week High: (4.9%) Wellington Management Co. LLP 1,045,700 3.1%
Equity Value: $1,559.3 Barclays Global Investors, N.A. 1,002,024 3.0%
Enterprise Value: $2,005.5 Janus Capital Management LLC 947,990 2.8%
Enterprise Value / EBITDA: Dalton, Greiner, Hartman, Maher & Co. 840,910 2.5%
2003E 10.4x Franklin Advisers, Inc. 567,518 1.7%
2004E 9.6x Cramer Rosenthal McGlynn LLC 566,821 1.7%
P/E J. & W. Seligman & Co., Inc. 530,539 1.6%
2003E 17.7x Top 10 Total 11,993,142 35.9%
2004E 15.6x Source: Shareworld.

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Sample Company Profile (Cont’d)

Current Capitalization and Maturity Profile
Capitalization Summary Maturity Profile

Capitalization Summary Maturity Profile as of 6/30/2003

($ in million) ($ in millions)
Actual Estimated
(1) $329
6/30/2003 12/31/2003
Cash $1.3 $4.8
Debt: Rate:
Unsecured Revolving Credit Lines 2.08% $14.0 –
Fixed Rate Secured Term Loans 8.81% 3.6 –
Fixed Rate Unsecured Term Loans 7.67% 273.8 258.7
Capitalized Leases 8.00% 1.8 1.8
Synthetic Leases 124.4 124.4
Total Debt $417.6 $384.9
Shareholder's Equity 452.4 474.6
Total Capitalization $870.0 $859.5

Summary Statistics:
Total Debt / Total Capitalization 48.0% 44.8% $33 $28
Total Debt / 2003A EBITDA 4.5x 4.2x $9 $14
$5
Total Debt / 2004E EBITDA 4.2x 3.8x
Source: Based on 10-K and 10Q.
(1) Assumes $33 million pay down of unsecured revolving credit lines, fixed rate 2004 2005 2006 2007 2008 Thereafter
secured term loans and fixed rate unsecured term loans since 6/30/2003. Source: Based on 10-K.
Note: Maturities after 2008 include $124 million of synthetic leases.

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Sample Company Profile (Cont’d)

Equity Analyst Commentary
Wachovia Deutsche Prudential Banc of America
Securities Bank Financial Securities

Analyst Jonathan Feeney Marc Greenberg Jeffrey G. Kanter Bryan Spillane

Latest Report 2/5/04 2/2/04 1/30/04 1/29/04
Price $35.41 $36.20 $36.74 $36.74
2004 EPS, P/E $1.95, 18.2x $2.08, 17.4x $1.97, 18.6x $2.00, 18.4x
2005 EPS, P/E $2.18, 16.2x NA $2.30, 16.0x $2.20, 16.7x
12-month Price Target $33 - $36 $36 $36 $35
Rating Market Perform Hold Neutral Weight Neutral
Comments “For FQ2…both case volume “Pricing of (0.6%) came in “Looking at consolidated “We are pleased with
and revenue grew, but better than our expectation of a results, sales improved 4% on management’s commitment to
California wine sales lagged 2.6% decline, largely due to a 3% improvement in volumes, improve [ ]’s returns, as
due to grocery strikes.” the mix benefits associated implying a 1% price/mix evidenced by the recent sale of
“ [ ]’s core business, [ ], with the shift of Opus sales into benefit…this better mix was an its Chilean assets.”
continues to see declines in Q2 and Q3 and stronger than improvement in [ ]’s higher “We believe management is
wholesale depletion and expected sales on RM Private end wines, perhaps a true taking the right actions to
shipments. We expect [ ] to Selection.” indication that on premise improve the company’s
invest strongly in the brand and “Both [ ] volume and pricing trends continue to improve.” margins, competitive position
grow [ ] shipments.” were much lower than we “The risks to our price target and return on capital…industry
“Starting in FQ4, [ ] should be expected.” are that volumes continue to as whole is better positioned,
able to realize lower grape “Continued grocery strikes in accelerate and management’s especially relative to the past
costs as wine produced at the Southern California (about 5% attempt to improve mix will three years.”
beginning of the grape glut of total [ ] business) are more than offset potential “ [ ], [ ]’s largest brand, faced
comes to market. This should continuing to weigh on core [ ] pricing pressures.” an aggressive industry pricing
benefit [ ] as its competitors volumes.” “Although we continue to environment and represented a
likely will not be able to “We worry that [ ]’s focus on assert that the wine industry drag on the company’s
compete in price as grape line extensions into an already has some terrific growth growth.”
prices increase.” saturated and highly prospects ahead, if [ ] has
competitive market is causing another weak quarter, [ ]’s
a key equity ( [ ]) to be stock may sit a bit.”
somewhat diluted…In short,
challenges remain.”
“
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2. Valuation Analysis – The Methodologies of Investment Banks

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A. Introduction to Valuation

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Why Does Valuation Matter?

Valuation is at the core of our job. It is used for:

Buy-side advisory mandates

Sell-side advisory mandates

Hostile / defense mandates

Valuation / fairness opinions

Comparison of market prices to values obtained from appropriate valuation techniques

Merger valuations

IPO pricing / valuation

Financing decisions

Correct valuation is critical for a number of reasons

Clients base their decisions on our advice

Sets precedent and is used as a datapoint for future valuation in specific industry

Delivering valuation advice exposes an investment bank to legal risks
– The best way to mitigate such risk is to deliver flawless, reasonable, well-justified and
thought through valuations

Ever seen a MD in a meeting when it turns out the numbers are wrong? Ever had one on the
line following such a meeting?
– Senior members of your various firms are asked to put their careers on the line based on
the analysis analysts and associates create

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What Is Value and Why Is Value Difficult to Judge?

Value of an asset may differ substantially for different holders and under different scenarios

Value to seller vs. value to buyer or competitors

Going concern value vs. liquidation value or replacement value

Synergies / benefits of investment

Positive: e.g., revenue and cost benefits of owning an asset

Negative: e.g., strategic “cost” of holding the asset, management distraction, integration
required etc.

Tax position

Value of tax loss carry-forwards dependent on buyer’s ability to utilize

Value of control, i.e., value of operational influence on cash flows vs. value of passive dividend
stream: minority vs. majority stakes

“Strategic value”: unlocking development opportunities beyond the asset itself

Perceived “strategic” value may be proportional to desire to own

“It is optimism that is the enemy of the rational buyer.” – Warren Buffett

“Price is what you pay, value is what you get.” – Warren Buffett

Value is in the eye of the beholder.

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How Do You Calculate the Value of a Company?

Answer = Enterprise Value
Enterprise Value = Market Value of Operating Assets
Equity Value = Market Value of Shareholders’ Equity
Equity Value = Enterprise Value – Net Debt(1)

Liabilities and
Net Assets Shareholders’ Equity
Net Debt = Total Debt
Net Debt + Minority Interest -
Cash

Enterprise Equity Value or Market

Enterprise Value Capitalization =
Value
Equity Value Shares Outstanding *
Trading Price

(1) For simplicity sake, Net Debt (Corporate Adjustments) is generally defined as total debt + minority interest + preferred stock + capitalized leases – excess cash and cash equivalents.

You will generally use the valuation techniques in this presentation to calculate the
enterprise value of the firm, which then allows you to calculate its equity value.

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Valuation Analysis – Four Main Methodologies

Investment banks have developed four main methodologies that are commonly used to
generate the theoretical value of a company
Comparable Company Analysis

Used to understand the value of a company by reference to current market trading multiples of
other publicly-traded companies with similar operating, financial and business characteristics
Comparable Acquisition Analysis

Used to understand the value of a company in an acquisition scenario, including premiums paid,
by reference to other transactions of similar businesses
Discounted Cash Flow Analysis

Used to determine the intrinsic value of a company based on a given financial plan excluding
the impact of the capital structure of the company
Leveraged Buyout Analysis

Used to determine the intrinsic value of a company based on a financial plan including the
impact of the capital structure of the company
Today we will give you an overview of these analyses and discuss typical problems
analysts have preparing each of them.

For a valuation analysis, investment banks will typically produce each of these analyses
and develop a comprehensive range of values which will be shown to a client.

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B. Comparable Company Analysis

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Introduction to Comparable Company Analysis

Comparable Company Analysis is used to understand the value of a company by reference
to market trading multiples of other publicly-traded companies with similar operating,
financial and business characteristics

Theory – Investors will attribute similar value to similar assets and will therefore value one unit
of EBITDA, earnings, assets, accounts, etc. similarly; thus, comparability is key

Also known as Compco Analysis, CSCs – Comparison of Selected Companies, Comps
Analysis, Public Market Comps Analysis, etc.

Most industry groups in corporate finance keep a standard set of comps for each given
sector/industry

Industrial Groups – Capital Goods Comps, Automotive Supplier Comps, Paper and Forest
Products Comps, Metals and Mining Comps, Industrial Conglomerate Comps, etc.

Media & Telecom Groups – Wireless Telecom Comps, Entertainment Comps, Newspaper
Comps, Radio and Broadcasting Comps, Publishing Comps, Cable Comps, etc.

Financial Institutions Groups – Regional Bank Comps, Investment Bank Comps, Mutual
Funds Comps, Insurance Comps

Energy Groups – Power & Utilities Comps, Oil & Natural Gas Comps, Chemicals Comps,
Energy Distribution Comps

When you join your specific group, you should ask an analyst in your group if there is a list of
the “Standard Comps”

This list should also delegate who is responsible for maintaining them

Comps are usually updated on a quarterly basis when new public financial statements are
available (i.e., 10-K, 10-Q, press release) and equity research is fresh

Unless a major corporate event has occurred which requires an immediate update
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Comparable Company Analysis (Conceptual Overview)

Doing a compco analysis is a lot like shopping for cereals

A simple comparison of prices does not work

Cereals, just like companies, have different attributes. Some attributes include:

Weight / Size
Fat Content
Price
Caloric Content

Sugar Content
Brand Name
Nutritional Value

$3.00 per box How can you $2.00 per box

20 ounces
compare? 25 ounces

15¢ per ounce
8¢ per ounce

Other We can utilize Other

Brand name ratios to compare
Generic name

300 calories per serving different sized /
350 calories per serving

10 grams of sugar per serving priced objects
12 grams of sugar per serving

90% daily vitamins per serving on a like basis
70% daily vitamins per serving

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Comparable Company Analysis (Sample Output)

Similar to comparing the cereals, Comp analysis utilizes ratios to understand the relative
value of various companies

Enterprise Value / Sales, Enterprise Value / EBITDA, Equity Value / Net Income, Price / EPS

Higher ratios generally imply a more positive outlook for the company relative to peers

Cannot compare Enterprise Value / Net Income, Equity Value to EBITDA

EBITDA and EBIT provide value to the entire Enterprise; Net Income provides value to
Equity Holders only
Shows multiples
Sample Compco Output for multiple years
($ in millions)
to reflect growth
ENTERPRISE VALUE AS A MULTIPLE OF:
SHARE EQUITY ENTERPRISE 2004E 2005E P/E 2004E % MARGIN % GROWTH
COMPANY PRICE(1) VALUE VALUE SALES EBITDA EBIT SALES EBITDA EBIT 2004E 2005E EBITDA EBIT LT EPS

TL
JB Hunt Transport $31.20 $2,522 $2,633 1.0x 6.9x 11.7x 0.9x 6.0x 9.5x 20.4x 16.0x 14.7% 8.7% 19.8%
(2)
Swift Transportation 15.26 1,281 1,681 0.6 4.6 8.5 0.6 3.5 5.7 11.7 8.7 13.3% 7.3% 17.6%
Werner Enterprises 18.50 1,494 1,392 0.9 5.0 10.3 0.8 4.3 8.2 17.5 14.2 17.6% 8.7% 14.6%
Heartland Express 23.16 1,158 956 2.1 8.2 10.6 1.8 7.0 9.4 19.3 17.2 25.1% 19.5% 13.0%
Knight Transportation 23.59 891 850 2.1 7.9 12.1 1.8 4.9 6.6 21.3 17.7 27.1% 17.7% 17.6%
Covenant Transportation 15.60 230 290 0.5 3.6 8.2 NA NA NA 13.0 11.3 13.1% 5.9% 13.2%
Mean 1.2x 6.1x 10.2x 1.2x 5.1x 7.9x 17.2x 14.2x 18.5% 11.3% 16.0%
Median 1.0x 6.0x 10.4x 0.9x 4.9x 8.2x 18.4x 15.1x 16.2% 8.7% 16.1%
LTL
Yellow Roadway Corp $33.07 $1,597 $2,532 0.4x 5.3x 8.8x 0.3x 4.7x 7.6x 10.7x 8.3x 7.1% 4.2% 13.0%
CNF Inc 36.35 1,842 2,326 0.4 5.8 9.4 0.4 5.5 8.7 16.2 14.6 6.7% 4.1% 12.8%
US Freightways 31.33 870 999 0.4 4.4 8.3 0.4 3.9 6.9 14.6 11.4 9.3% 5.0% 9.9%
Overnite 23.70 664 781 0.5 5.4 9.6 0.4 4.6 8.0 15.1 12.7 9.2% 5.2% 12.7%
Arkansas Best 27.61 708 714 0.4 4.7 7.7 0.4 4.4 7.2 12.8 11.7 9.5% 5.9% 11.7%
Old Dominion 37.25 599 695 0.9 6.7 11.3 0.8 5.9 9.8 18.2 15.9 13.6% 8.1% 15.7%
SCS Transportation
#REF! 20.92
#REF! 323
#REF! 447
#REF! 0.5
NM 4.7
NM 10.2
NM 0.5
NM 4.4
NM 8.9
NM 16.6
#REF! 13.7
#REF! 10.2% 4.7% 18.8%
Mean 0.5x 5.3x 9.3x 0.5x 4.8x 8.1x 14.9x 12.6x 9.4% 5.3% 13.5%
Median 0.4x 5.3x 9.4x 0.4x 4.6x 8.0x 15.1x 12.7x 9.3% 5.0% 12.8%

Source: Wall Street Equity Research and Company Filings.

Note: Companies in bold and italics were used in the Dresdner document in 2002.
(1) As of 5/14/04.
(2)
(3)
Pro forma for the acquisition of Merit from Wal-Mart.
Reflects 5.75% convertible notes due 2005.
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How to do a Comparable Company Analysis

If an analyst or associate asks you to do Comps for them, here is a general strategy to
apply:
1. First, ask if there are any precedent Comps?
2a. If you receive precedent Comps,

Supposing the Comps are outdated, use them as an example as to how to update the Comps

Supposing the Comps are current, ask the analyst/associate what you should update

Update with the correct information and make sure to check the Comps
2b. If there are no precedent Comps, ask the associate if he knows which companies should be
included in the analysis

If you are asked to determine what the Comps should be

Find the 10-K of the Company and search for names of competitors
– Search any competitors 10-K’s to find more peers

Find research for the company/industry and see if there is a Comp analysis shown

Use SIC codes and search for companies with a similar size (revenues/equity value)

Always read a business description of the companies you are considering to include in the
analysis – select companies with similar products/customers/method of distribution

Prepare a proposed list of companies you think should be included in the Comp analysis
including a reasoning for each company; Ask the associate/analyst whether the list you have
selected is appropriate  Always prepare a list of questions for
3. Check the comps your associate/analyst and address
anything weird you picked up when

Compare against the previous version of the comps
doing you Comps analysis

Check against research  Please Ask Questions!!! If they are

Check against the other companies in your comps – is it way off? good questions, you will give people
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Typical Issues/Problems with Comparable

Company Analysis
Here are some typical issues/problems experienced by analysts when preparing Comps:

Output sheet is mis-linked to the input sheet

Wrong calculation of Enterprise Value

Did not use most recent financial information available (10-K vs. 10-Q vs. Press Release)

Shares do not include in-the-money convertible debt, options and/or newly issued equity

Double count convertible debt (convert and include in debt calculation)

Improper adjustment for equity investments (on balance sheet – financing subsidiaries, off
balance sheet – under 50% of shares) and minority interest

Forget to include contingent liabilities (asbestos, lawsuits, pension, etc.)
 Please note that there are several ways to calculate Enterprise Value – as a result various firms, groups and
even individuals have a specific method of treating contingent liabilities and equity investments

Excluded proper adjustments to income statement historicals/projections for non-recurring items

Need to back-out gains/losses, special charges, restructuring, discontinued ops – anything
that cannot be expected in continuing operations

Lack of consistency of historical and forward results

Make sure to understand how the research analysts are calculating forward operating results
– your projections should use the same method used to calculate historical results

Improper adjustments for acquisitions/divestitures

Where appropriate, one must adjust both Enterprise Value and Income Statement metrics on
an annualized basis

Improperly match ratios

Calculated EV/Net Income, Equity Value/EBITDA

Include equity investments in Enterprise Value, but do not adjust income statement

Calendarization not done or done inaccurately

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C. Comparable Acquisition Analysis

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Introduction to Comparable Acquisition Analysis

Used to understand the value of a company in an acquisition scenario, including premiums
paid, by reference to other transactions of similar businesses

Also known as CompAcq, Deal Comps, Merger Comps, Transaction Comps, etc.

Comparable acquisition analysis is very similar to Comps Analysis and uses ratios to show
relative valuations in various announced acquisitions

Generally, more specific criteria in determining comparability than in a Comps Analysis
– If you are acquiring a door company, a Comps Analysis may show building materials
companies; whereas, a CompAcq Analysis will show acquisitions of previous door
companies
– In the best case scenario, you will find one or more recent CompAcqs of company with
very similar products/customers and growth/margins

Most industry groups in corporate finance keep a standard set of CompAcqs for a given
industry/country/acquisition scenario

Because different acquisition scenarios can provide significantly different valuations for a
given company, sometimes it is more important to match the acquisition scenario rather than
the industry or country
– Minority Stake Purchase, Controlling Stake Purchase, 100% Purchase, Buyout of public
shareholders in a previously spun out company, etc.

CompAcq multiples are typically higher than Comp multiples as they include the control
premium required in an acquisition scenario

Acquiring companies are expected to pay a premium above the public market value because
their shareholders benefit from synergies that the existing company’s shareholders might not
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Comparable Acquisition Analysis

When a company acquires another company, the acquiring company is typically required to
pay a higher value, control premium, than the public market pays for the target

In order to calculate the multiples implied in an acquisition scenario, you should look at the deal
terms (i.e., tender price) and apply them

Determines the purchase price

As you can see in the press release below, any acquisition with a stock component will
generally have a total value that changes until the transaction is closed
– As a result, you should ask your analyst/associate whether to do CompAcqs on
announcement terms or closing terms

Also, make sure to include the net debt of the target in the purchase price

Sample July 8, 2003 -- Yellow Corporation and Roadway Corporation, two of the most widely
Press Release – recognized brand names in the transportation industry…have entered into a definitive
On an agreement under which Yellow Corporation will acquire Roadway Corporation for
announcement approximately $966 million, or $48 per share (based on a fixed exchange ratio and a
basis you would use
$48 for a per share 60-day average price per share of $24.95 for Yellow common stock in a half cash, half
target price, stock transaction). This represents a 49 percent premium for Roadway shares based on
then you would the 60-day average closing price of Roadway stock. Yellow Corporation will also assume
include the assumed an expected $140 million in net Roadway indebtedness, bringing the enterprise value of
net debt of
$140 million. the acquisition to approximately $1.1 billion.
In general, upon the closing of the acquisition, each share of Roadway stock will be
converted into 1.924 shares of Yellow common stock. However, there is a cash
election option and a collar of plus or minus 15 % from $24.95 per Yellow share.

24
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Comparable Acquisition Analysis (Sample Output)

Typically shows value as a multiple of most recently available or LTM (last twelve months)
results. Some industries will show value as a multiple of 1-year forward expected results

Enterprise Value (Transaction Value, Purchase Price) as a multiple of Revenues, EBITDA and
EBIT

Sometimes includes industry specific metrics, i.e. EV as a multiple of Reserves, Subscribers,
Access Lines, etc.

Due to limited public disclosure of announced deals, not all data will be available; thus, do not
worry if there are NAs (not applicable)
Sample CompAcq Output
($ in millions, except per access line amounts)
TRANSACTION VALUE/
DATE ACQUIRED TRANSACTION TRAILING YEAR 1 TRAILING YEAR 1 ACCESS
ANNOUNCED TARGET NAME ACQUIRER NAME ACCESS LINES VALUE EBITDA EBITDA EBITDA EBITDA LINES
01/15/04 TXU Communications Ventures Co. Consolidated Communications, Inc. 170,000 $527 NA NA NA NA 3,100
07/17/02 (1) Illinois Consolidated Telecom. Co. Homebase Acquisition Corp. 90,333 $271 $40.5 - 6.7x - 3,000
02/14/02 Telecom Systems of NH Telephone & Data Systems 7,500 - - - - - -
11/21/01 Conestoga Enterprises D&E Communications 84,000 273 $21.3 - 12.8x - 3,250
11/16/01 MCT Telecom Telephone & Data Systems 18,800 - - - - - -
09/21/01 Kerrville Communications VALOR Telecommunications 26,936 135 17 - 8.0 - 5,019
11/27/00 Chorus Communications Telephone & Data Systems 45,000 226 13 - 18.1 - 5,022
09/01/00 (2) GTE (AK) Alaska Power & Telephone (AP&T) 20,564 - 6 6 - - -
07/31/00 (2) GTE (WI) Century/Telephone USA 126,000 365 - 44 - 8.3 2,897
07/31/00 (2) GTE (AR) Century Telephone 214,000 843 - 93 - 9.1 3,941
07/12/00 Global Crossing Citizens Communications 1,100,000 3,500 387 - 9.0 - 3,182
06/30/00 GTE (IA) Iowa Telecom 288,000 965 - 110 - 8.8 3,351
04/01/00 Peoples Mutual Telephone - VA FairPoint Communications Inc. 7,879 35 4 4 9.8 9.1 4,480
04/01/00 GT Com FairPoint Communications Inc. 52,018 211 18 19 11.5 11.4 4,056
01/03/00 FairPoint Communications Inc. (3) Thomas H. Lee / Kelso 147,800 880 - 74 - 12.0 5,954
07/07/99 Aliant Communications Inc. ALLTEL 285,000 942 110 - 8.6 - 3,304
05/27/99 GTE (AZ, CA, MN) Citizens Communications 186,839 664 - - - - 3,554
03/01/98 Taconic Telephone Co. FairPoint Communications Inc. 24,832 77 9 11 9.1 7.1 3,113
06/01/00 Matanuska Telephone Assoc. Alaska Communications Systems 57,500 188 - - - - 3,261
High 1,100,000 3,500 18.1x 12.0x 5,954
Low 7,500 35 6.7 7.1 2,897
Median 70,750 273 9.1 9.1 3,351
Mean 154,611 638 10.4 9.4 3,826

(1) ILEC values are not adjusted for the value of non-ILEC operations.
(2) Access Lines exclude CLEC lines form 8-K dated 7/25/2001. Trailing EBITDA based on management presentation dated 9/19/01 and adjusted for the sale of its wireless
business for $60 million to VoiceStream. (wireless EBITDA assumed to be zero). The transaction value is adjusted for the sale of its wireless business, CLEC/LD business,
cable/paging/fiber assets, and the value of the tower agreement. 25
(3) Date Closed.
CONFIDENTIAL NYDOCS1 - #664830v18 - Nov 22 2004 - 18:45 /26

How to do a Comparable Acquisition Analysis

If an associate asks you to do CompAcqs for them, here is a general strategy to apply:
1. Ask if there is an existing CompAcq Analysis/Database for the sector?

If there is, ask if there are specific acquisitions you should add to the existing database

Typically the Managing Director/Director/Vice President will know what acquisitions should
be added to the existing analysis

Otherwise, search recent industry news or SDC to see if there are any substantial deals to
add
2. If there is no existing CompAcq Analysis and you are starting from scratch

Do an SDC run to find recent (2-5 years) acquisitions within your sector (by SIC code) where
the target company has financials available and is of similar size

For each potential CompAcq, make sure to read the description of the target company before
you do the analysis

Make sure the acquisition structure is similar (full purchase vs. minority stake purchase)
3. Calculate the acquisition multiples

Ask what the standard methodology for doing CompAcqs is (i.e., deal terms at announcement
or deal terms at closing)

Make sure to understand what metrics are required for a full analysis
4. Check the CompAcqs – Very difficult

Sometimes research will show acquisition multiples

Are the multiples reasonable?

Ask yourself, how do your multiples compare to previous transactions?
26
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Typical Issues/Problems with Comparable

Acquisition Analysis
Here are some typical issues/problems experienced by analysts when preparing CompAcqs:

The deal terms for an acquisition are not specified to the public

Often deal terms are not specified for small acquisitions or private to private acquisitions

See if SDC or Research has an acquisition value and/or multiples

Transactions involving private companies are very difficult to get acquisition multiples for

The deal terms are available, but public financials are not available

Private to private – Financials are generally only available if the target Company has public
debt outstanding
– If the transaction value of the deal is greater that $300MM, typically there is or will be
public financials when the debt financing is sold to the public
– Otherwise, transactions above $100MM typically have some bank loans and your firm’s
corporate lending desk may have an Information Memorandum

Public – Sometimes a company will sell a business unit/subsidiary and if that business unit is
small (not classified as a segment), financials will be unavailable; check press releases,
investor presentations and research for this specific information
 Please note that sometimes the answer is, “that CompAcq cannot be done”

Improper calculation purchase price

Do not take the purchase price directly from SDC or press release
– Sometimes SDC rank value does not include debt and uses wrong deal terms
– You should check multiple sources

Does not properly incorporate contingent liabilities

Does not include value of investments/minority interest

Does not incorporate change of control
– Should use outstanding rather than exercisable options and in-the-money convertible debt

Excluded proper adjustments to income statement historicals/projections for non-recurring items 27
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D. Discounted Cash Flow Analysis

28
CONFIDENTIAL NYDOCS1 - #664830v18 - Nov 22 2004 - 18:45 /29

Introduction to Discontinued Cash Flow Analysis

Used to determine the intrinsic value of a company based on a given financial plan
excluding the impact from the capital structure of the company

Theory – The intrinsic value of any productive asset is the present value of its cash flows

Typical analysis includes 5 years of Free Cash Flow and includes a terminal value to account
for the remaining cash flows in perpetuity

Discounted Cash Flow Analysis is also known as DCF analysis

Why do a cash flow analysis? Theoretically, discounted cash flows and discounted earnings
produce identical valuation results; however

Over the short to medium term, cash flow can differ substantially from accounting earnings
due to:
– Capex vs. depreciation
– Various non-cash items included in earnings
– Goodwill amortization and write-downs

Earnings are more easily manipulated than cash flow
– Provisions / accruals
– Accounting for capital expenditures: capitalized vs. expensed
– Revenue recognition policies
– Inventory accounting (LIFO vs. FIFO)
– Off-balance sheet financing and special purpose vehicles

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Introduction to Discontinued Cash Flow Analysis (cont’d)

DCF analysis typically builds off after-tax EBIT to get to free cash flow

($ in millions)
YEAR ENDED DECEMBER 31, Terminal Value Calculation:
2004E 2005E 2006E 2007E 2008E 2009E
2009E EBITDA $186.4
Revenue $481.3 $507.8 $535.7 $565.2 $596.3 $629.1
% Margin 5.5% 5.5% 5.5% 5.5% 5.5%
Exit Multiple Assumed 10.0x
Implied Terminal Value $1,864.3
EBIT $73.1 $99.8 $109.2 $121.1 $133.2 $152.6
% Growth 36.6% 9.4% 10.9% 10.0% 14.6% Equity Value Calculation:
% Margin 15.2% 19.6% 20.4% 21.4% 22.3% 24.3%
PV of Unlevered Free Cash Flow $397.6
Cash Tax Calculation
PV of Terminal Value 1,052.4
EBIT $73.1 $99.8 $109.2 $121.1 $133.2 $152.6
Cash Tax Rate 36.5% 36.5% 36.5% 36.5% 36.5% 36.5% Implied Ent. Value $1,450.0
Cash Taxes $26.7 $36.4 $39.9 $44.2 $48.6 $55.7 Net Debt @ 12/31/03A 380.1
Unlevered Free Cash Flow Implied Equity Value $1,069.9
Tax Adjusted EBIT $46.4 $63.4 $69.3 $76.9 $84.6 $96.9 FD Shares Outstanding 15.9
Plus: Depreciation & Amortization 27.2 27.5 28.9 30.4 32.1 33.8 Implied Price Share $67.32
Less: Capital Expenditures (25.0) (25.0) (25.0) (25.0) (25.0) (25.0)
Plus: Asset Disposals – – – – – –
Plus: Change in Working Capital 18.5 34.9 6.4 1.3 14.3 19.5 Terminal multiple
Unlevered Free Cash Flow $67.1 $100.8 $79.7 $83.5 $106.0 $125.2
Discount Period 1.0 2.0 3.0 4.0 5.0 6.0 and WACC is based
Discount Rate (WACC)
Discounted Unlevered Free Cash Flow
10.0%
$61.0
10.0%
$83.3
10.0%
$59.9
10.0%
$57.1
10.0%
$65.8
10.0%
$70.7
on the Comps

Present value of cash flow stream = Sum of present values of individual cash flows
∞
CFn CF1 CF2 CF3
∑
n =1 (1 + r )
n
= + +
(1 + r ) (1 + r ) (1 + r )3
1 2
+ ...

In the formula and analysis above (based on the NPV formula in Excel), assume that cash flows
are received on the last day of each forecast year (“end-year cash flows”)

In reality, cash flows are typically spread out across the year and you may come across
similar analysis done using mid-year cash flows

30
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Discontinued Cash Flow Analysis (Sample Output)

DCF outputs typically show a range of values to offer the viewer a better understanding of
how much value is impacted by the Terminal Value and WACC

DCF Matrix Same as previous page

($ in millions)
2009E TERMINAL VALUE EBITDA MULTIPLE
DISCOUNT RATE 8.5x 9.0x 9.5x 10.0x
10.0% $397.6 $397.6 $397.6 $397.6 Present Value of Free Cash Flow
894.5 947.1 999.7 1,052.4 Present Value of Terminal Value
$1,292.1 $1,344.8 $1,397.4 $1,450.0 Enterprise Value
(380.1) (380.1) (380.1) (380.1) Net Debt as 12/31/2003
$912.0 $964.7 $1,017.3 $1,069.9 Equity Value Used to test the
1.9% 2.4% 2.7% 3.1% Implied Perpetuity Growth Rate whether the
11.0% $385.3 $385.3 $385.3 $385.3 Present Value of Free Cash Flow terminal multiple
847.2 897.1 946.9 996.7 Present Value of Terminal Value is reasonable
$1,232.5 $1,282.4 $1,332.2 $1,382.1 Enterprise Value
(380.1) (380.1) (380.1) (380.1) Net Debt as 12/31/2003
$852.4 $902.3 $952.1 $1,002.0 Equity Value
2.9% 3.3% 3.7% 4.0% Implied Perpetuity Growth Rate
12.0% $373.6 $373.6 $373.6 $373.6 Present Value of Free Cash Flow
802.8 850.1 897.3 944.5 Present Value of Terminal Value
$1,176.4 $1,223.6 $1,270.9 $1,318.1 Enterprise Value
(380.1) (380.1) (380.1) (380.1) Net Debt as 12/31/2003
$796.3 $843.5 $890.8 $938.0 Equity Value
3.8% 4.2% 4.6% 5.0% Implied Perpetuity Growth Rate

31
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How to do a Discounted Cash Flow Analysis

If an associate asks you to do a DCF for them, here is a general strategy to apply:
1. Are there projections available from Management?

Typically the target company will issue the investment bank a financial summary that offers a
long range plan

Sometimes this plan will be less than five years. You should make some basic assumptions
and stretch the plan into a long range plan
2. If there are no projections available from Management, you should build a model

You start with equity research which will typically give you a 2-3 year outlook for the company.
You should make some basic assumptions and stretch the plan into a long range plan

Forward growth, margins and working capital should be consistent with historical changes
3. Select a terminal multiple based on the comps

Create your basic DCF model down to Unlevered Free Cash Flow
4. How flexible does the model need to be?

You should ask your team whether it makes sense to build a model that is extremely flexible

General Sales Level – Your model should allow you to change the overall sales growth,
gross margin, EBITDA margin, Capex levels, and working capital changes

Segment/Product/Customer – Sometimes it is necessary that your model be able to run at a
deeper level to discriminate between the growth and margins of various products or
customers; this is not necessary for the typical DCF Analysis
5. Check your DCF – Use a calculator to make sure your formulas are correct

Do you match management and/or research for the available years?

Do the projections make sense relative to historical results? Is the valuation reasonable?

Write-up a summary of the assumptions you used to create the projections, your team will ask

32
CONFIDENTIAL NYDOCS1 - #664830v18 - Nov 22 2004 - 18:45 /33

Typical Issues/Problems with DCF Analysis

Here are some typical issues/problems experienced by analysts when preparing a DCF:

Miscalculation of Unlevered Free Cash Flow

Income Statement Items – should not include interest, discontinued operations, extraordinary
charges; tax rate should be based on some statutory rate and taken on EBIT

Other Cash flow items – an increase in working capital is a decrease in free cash flow; all
non-cash equity income and minority interest should be excluded from calculation

Bad representation of financials

Growth and margin improvement is too high

D&A significantly eclipses Capex (not realistic/practical as D&A should trend towards Capex)
– Cannot have long term growth without asset growth – working capital and Capex generate
sales growth

Incorrect derivation of the discount rate/WACC

Use the target’s WACC (not acquirer), understand all cash flows are not equally risky, realize
that inflation impacts cost of capital

Miscalculation of net debt and corporate adjustments

Net debt and/or corporate adjustments should include minority interest and reflect any equity
investments where the value of these investments is not captured in free cash flow

Improper matching of free cash flow and net debt

If net debt is as of 9/30/2004 (FYE 12/31/04), the cash flow for the initial period should only
reflect 3 months to properly match against the net debt when calculating Equity Value

Calculation of equity value per share

Equity value per share should reflect any dilution from exercisable options as dependent on
the share price (circular calculation)

Terminal value is too-high and reflects unrealistic growth assumptions
33
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E. Leveraged Buyout Analysis

34
CONFIDENTIAL NYDOCS1 - #664830v18 - Nov 22 2004 - 18:45 /35

Introduction to Leveraged Buyout Analysis Overview

Used to determine the intrinsic value of a company based on a given financial plan
including the impact of the capital structure of the company

Also known as LBO analysis

Similar to the DCF analysis, the intrinsic value of any productive asset is the present value
of its cash flows

The LBO analysis is conceptually different from the DCF analysis

Different companies can handle different levels of debt; thus, the value of a company
should incorporate the capital structure of a company and the implied levels of interest paid
– The ability to take on leverage (debt) will greatly impact value to an investor

The value of a company should be based on the required return of investors, generally
20% -25%

The LBO analysis takes an investment by a 3rd party (usually at a premium to the current
market value) and calculates the implied return if the 3rd party sold that investment after a
given time period (paying down debt in the interim)

An increase in equity value over time is generated by debt paydown, multiple expansion
and EBITDA growth

The LBO analysis is often used to show a company what their base valuation is. This method
generates a base valuation because the return concept limits the amount the company can be
acquired for

35
CONFIDENTIAL NYDOCS1 - #664830v18 - Nov 22 2004 - 18:45 /36

Leveraged Buyout Analysis (Sample Analysis)

The analysis below shows a simple LBO where a Sponsor has invested $150 million in
equity and raised $400 million of debt to purchase a Company at 5.5x EBITDA of $100
million

By year 2008, the Company has paid down $220 million of debt and has seen EBITDA grow to
$120 million

As long as the company can enter into the deal at less than 6.0x EBITDA it will generate a
return to investors of around 20% or more (provided there is no major multiple contraction)

LBO Analysis Sources and Uses

($ in millions) ($ in millions)
Free Cash Flow 2003A 2004E 2005E 2006E 2007E 2008E Sources Cum. Mult. of
EBITDA $100 $105 $110 $116 $122 Amount LTM EBITDA
- Interest (23) (21) (18) (15) (13) Debt Raised (8.0%) $400.0 4.0x
Equity Investment $150.0 5.5x
- Taxes (22) (24) (26) (29) (32)
Total Sources $550.0 5.5x
- Change in WC – (5) (5) (6) (6)
Cash from Ops. $55 $55 $60 $66 $71 Uses Cum. Mult. of
- CAPEX (17) (17) (18) (19) (20)
Amount LTM EBITDA

Cash to Pay Debt $39 $38 $42 $47 $51 Total Purchase Price $550.0 5.5x
Total Uses $550.0 5.5x
Debt Balance $400 $361 $323 $281 $234 $183

Sale Value IRR Analysis Entry Multiple Purchase Price Calculation

2008 EBITDA $122 4.5x 5.0x 5.5x 6.0x LTM EBITDA $100.0
Exit Multiple

Multiple 5.5x 4.5x 49% 30% 19% 13% Purchase Multiple 5.5x
Sale Price $669 5.0x 53% 34% 23% 16% Total Purchase Price $550.0
2008E Debt (183) 5.5x 58% 37% 26% 19%
2008E Equity $486 6.0x 61% 40% 30% 22%
Returns Calculation
Equity Investment $150 12/31/2003
Closing Equity $486 12/31/2008
IRR over 5 years 26.5% 36
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How to do an LBO Analysis

If an associate asks you to do a LBO Analysis for them, here is a general strategy to apply:
1. Find out if there are projections available from Management, otherwise use research?

Your plan should extend to the proposed exit date for the target company

Build your operating model that forecasts operating income and the relevant balance sheet
accounts
2. What is the expected purchase price price and leverage that can be put on the target company?

The purchase price should be at a premium to the existing share price in the case of a public
LBO and mirror previous comparable acquisitions in the case of a private to private transaction

Leverage should be based on previous deals or guidance from capital markets

Standard Leverage is 2.0-3.0x bank debt and 1.0-2.0x bond (bank is generally preferred over
bond)
3. After you determine a proposed capital structure for the company, figure out the interest rate on
the various tranches of debt

How should you treat the target’s old tranches of debt – is it a full refinancing or will old debt
stay in place?
4. Build your LBO or input these items into your firm’s standard LBO/M&A shell

You should ask your team whether it makes sense for the operating model to be extremely
flexible

Income Statement Assumptions – Ability to run various cases

Capital Structure Assumptions – Do you already have a set capital structure?
5. Check your LBO

Does the balance sheet in your model balance?

Does your income statement match management and/or research for the available years?

Is your debt paydown reasonable? 37
CONFIDENTIAL NYDOCS1 - #664830v18 - Nov 22 2004 - 18:45 /38

Typical Issues/Problems with LBO Analysis

Here are some typical issues/problems experienced by analysts when preparing an LBO:

Balance sheet does not balance

Go through each balance sheet account, make sure that there is a corresponding entry on
the cash flow statement

If the equity is purchased above book value, the assets must increase (either asset write-up
or goodwill)

No negative assets – you cannot amortize PP&E greater than its book value (D&A too high)

Bad representation of financials

Growth and margin improvement is too high

Including non-cash items in cash flow (income from equity investments)

D&A significantly eclipses Capex (not realistic/practical as D&A should trend towards Capex)
– Cannot have long term growth without asset growth – working capital and Capex generate
sales growth

Miscalculation of equity purchase price/exit value

Should reflect any equity investments where the value of these investments is not captured in
free cash flow, include minority interest

Equity value should reflect change of control (outstanding options; in-the-money convertible
debt)

Improper matching of free cash flow and net debt

If net debt is as of 9/30/2004 (FYE 12/31/04), the cash flow for the initial period should only
reflect 3 months to properly match against the net debt when calculating Equity Value 38
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E. Interpreting and Presenting Valuation Results

39
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Valuation Methodologies –Strengths/Weaknesses

Strengths Weaknesses

Main Valuation Methods

Comparable Company Analysis
Reflects current public market view of company/sector
Public market does not have full info

Market environment and business cyclicality

Quality of Comparables

Consistency of accounting

Comparable Acquisition Analysis
Incorporates acquisition/change of control premium
Quality of comparables

Takes out some of the reliance on current market – Availability of information
conditions
Consistency of accounting

Deal specific issues – synergies / market conditions /
cyclicality

Historical analysis

Discounted Cash Flow Analysis
Incorporates target company full financial plan
Quality of financial forecasts

Developing meaningful sensitivities

Discount rate

Terminal value assumptions

Leveraged Buyout Analysis
Incorporates target company full financial plan
Quality of financial forecasts

Takes into account ability to leverage business
High yield market appetite

Floor value of business
Timing of purchase relative to target Company’s business
cycle
– Debt based on LTM EBITDA
Other Valuation Methods

Research Price Targets
Takes into account short-term expectations of public
Public market does not have full info
market
Short-term value

Relative Contribution
Takes into account comparison recent historical and
Does not include long-term prospects
projected results
Relative timing in cycle

Applies same multiple to businesses

Sum-of-the-Parts / Break-Up
Takes into account relative value of a Company with
Availability of business unit level information (how deep?)
multiple businesses
Same as Comps/CompAcq/DCF

Specific Asset/Replacement
Takes into account current replacement value
Availability of information

Too low relative to going concern value (re-investment)

Dividend Discount
Takes in account actual cash flows to investors from
Return on capital reinvested
going concern corporation
Theoretically, same as DCF value

40
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Presenting Valuation Results

Cross check results of different valuation methods

Typically, Comp Analysis values are below CompAcq Analysis values due to the control
premia inherent in CompAcq multiples

DCF Analysis values can be argued to imply control premium since modeling of cash flows
typically implies access to such cash flows; therefore, DCF Analysis values are typically
closer to CompAcq Analysis values

Cross check results against other sources of value insight

Trading range, if listed company

Broker valuations

Company statements

Select valuation range based on reasoning, not on average

Graphically present results of all valuation methods

Implied EV/ 2002E Implied EqV/

Valuation Ranges EBITDA 2002E Cash NI

Current Trading / + Premium (30%) 8.8 11.4 12.2x - 14.6x 21.2x - 27.6x
Note: 30% premium used for
Trading Range (last 3 months) 7.2 10.6 10.7x - 13.9x 17.3x - 25.6x
illustrative purposes only.
Broker Target Prices 7.0 10.2 10.6x - 13.5x 16.9x - 24.6x
Premium applied needs to be
CompCo (Mgmt) / + Premium (30%) 8.1 17.3 11.6x - 19.8x 19.6x - 41.7x
based on premia paid in
CompCo (Broker) / + Premium (30%) 5.1 9.2 8.9x - 12.6x 12.2x - 22.3x
comparable transactions.
DCF (Mgmt) 13.1 16.6 16.1x - 19.2x 31.7x - 40.1x

LBO Analysis 5.8 7.9 9.6x - 11.4x 14.1x - 19.0x

Selected Range 9.0 14.0

0 2 4 6 8 10 12 14 16 18 20
Note: Multiples are based on Management Case
Equity Value per Share (€)
2002E EBITDA and Cash NI
41
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3. Other Important Analyses – Merger Consequences & Credit Comps

42
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Preparing Merger Consequences

You may be asked to prepare merger consequences for two or more companies.
Here is a quick overview of merger consequences analysis:

A merger consequences (aka mergercon) analysis determines the value of various pro forma
metrics when a Company buys another by Company

Inputs: Generally, a standard mergercon analysis will be built off two companies forward EPS

Forward EPS * Existing Fully Diluted Shares = Forward Net Income

Share price for Acquirer and Share Price for Target

Target Enterprise Value and Target Book Value

Proportion of acquisition financing in stock vs. cash

Estimate of tax rate, interest rate on acquisition financing, portion of asset write-up and years
to depreciate asset write-up, estimate of fees, synergies

For credit statistics, you would also need acquirer total debt and target total debt

Quick and Dirty Merger Consequences ($ in millions)

Pro forma Company A 2005 Full Income Statement Calculations
50% Cash / 50% Stock Deal
Comp. A Comp. B Adjustments PF Comp. A
Company A Net Income $1,240 Revenues $28,788 $16,111 $44,899
Company B Net Income $4,010 EBITDA 6,671 2,668 400 9,739
Synergies After-Tax 282 D&A (1,257) (521) (226) (2,004)
Depreciation (on Asset Write-up) After-Tax (159) EBIT $5,414 $2,147 $174 $7,735
Interest on Acquisition Financing After-Tax (499) Interest Exp. (112) (77) (707) (896)
Financing Fees Amortization After-Tax (19) Other 386 – (27) 359
EBT $5,688 $2,071 ($560) $7,199
PF Net Income $4,855
Taxes (1,678) (648) 165 (2,160)
PF Shares (Includes Share Increase) 2,002 Tax Rate 29.5% 31.3% 29.5% 30.0%
PF EPS $2.43 NI before Min $4,010 $1,423 ($395) $5,038
Old EPS $2.30 Min. Interest – (183) (183)
Accretion / (Dilution) 5.6% NI $4,010 $1,240 ($395) $4,855
Shares 1,746.5 127.0 255.6 2,002.1
EPS $2.30 $9.77 ($1.54) $2.43
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Preparing Merger Consequences (cont’d)

Sample Output
Here is a sample output page for Merger Consequences.
Company A Acquires Company B – Analysis at Various Prices
50% Stock \ 50% Cash
(US$ in millions, unless otherwise stated)
Premium 0.0% 20.0% 30.0% 40.0% 50.0%
Acquisition of Company B at Various Premia(1)
Share Price € €141.00 €169.20 €183.30 €197.40 €211.50
Share Price US$ $168.56 $202.27 $219.13 $235.98 $252.84
(2)
Fully Diluted Shares 127.1 127.7 128.0 131.4 131.6
Equity Value US$ $21,429 $25,839 $28,047 $31,002 $33,263
(2)
Total Debt 6,020 6,020 6,020 5,274 5,274
Minority Interest 842 842 842 842 842
(3)
Cash (2,647) (2,647) (2,647) (2,647) (2,647)
(4)
Investments (998) (998) (998) (998) (998)
Enterprise Value $24,646 $29,056 $31,264 $33,473 $35,734
Implied Multiples:
EV / 2004E EBITDA 9.24x 10.89x 11.72x 12.55x 13.39x
EV / 2005E EBITDA 8.56x 10.09x 10.86x 11.62x 12.41x

Company A (includes $400 million of synergies)

2004E Standalone EPS $2.30
(5)
2004E PF EPS $2.60 $2.48 $2.43 $2.35 $2.29
Accretion / (Dilution) $ $0.31 $0.19 $0.13 $0.05 ($0.00)
Accretion / (Dilution) % 13.3% 8.1% 5.6% 2.3% (0.1%)
2005E Standalone EPS $2.53
(5)
2005E PF EPS $2.86 $2.74 $2.68 $2.60 $2.54
Accretion / (Dilution) $ $0.34 $0.21 $0.15 $0.07 $0.01
Accretion / (Dilution) % 13.3% 8.4% 6.0% 2.9% 0.6%
PF Ownership 89.9% 88.1% 87.2% 86.1% 85.2%
(6)
PF Net Debt / 2004E EBITDA 1.43x 1.65x 1.76x 1.91x 2.03x
Note: Share prices and exchange rate as of [ ]. US$ / EUR exchange rate of 1.195 used for Company B share price and financials.
(1) Company B balance sheet information based on 20-F converted to US$ at current exchange rates.
(2) If necessary, diluted shares and total debt adjusted for in-money-convertible debt.
(3) Includes marketable securities, cash and cash equivalents. Excludes short-term loan assets of $155 million.
(4) Includes market value of investments in unconsolidated affiliates.
(5) Acquisition assumptions include:
Company B results adjusted for US GAAP to exclude amortization of goodwill and non-recurring items.
Assumes writeup of 25% of excess of equity purchase price over book value depreciated over 25 years.
Assumes acquisition fees based on 85 bps of the total purchase price.
Assumes acquisition financing raised at pre-tax cost of 6.0%.
Assumes Company A uses cash on Company B's balance to acquire Company B’s outstanding shares.
Assumes acquisition financing fees based on 115 bps, amortized over 5 years.
(6) Includes synergies of $400 million. 44
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Preparing Credit Comps

You may be asked to prepare Credit Comparable Companies Analysis (Credit Comps).
Credit comps are very similar to general equity Comps

The major differences are:

Breakout of debt – Typically you will breakout debt to show bank debt, senior secured debt,
senior debt and subordinated debt

Inclusion of capitalized operating leases and back out of rent – Typically for a credit comp,
you will capitalize operating leases and back out rent for comparability purposes

Inclusion of credit ratings and credit ratios on output sheet
Owens- Ball Berry Crown Cork Constar
($ in millions) Illinois Corporation Plastics & Seal Co. International
Issue Sr. Sec. Notes Senior Notes Sr. Sub. Notes Senior Notes Sr. Sub. Notes
(1)
Amount $625 $300 $250 $300 $175
Issue Date 11/5/02 12/5/02 7/17/02 1/18/95 11/15/02
Maturity 11/15/12 12/15/02 7/15/12 1/15/05 12/1/12
Coupon 8.750% 6.875% 10.750% 8.375% 11.000%
Rating (Moody's/S&P) B2/BB Ba3/BB B3/B- Ca/CCC B3/B-
Price (1/9/03) 103.750 101.750 107.500 94.000 100.000
Yield to Worst 8.09% 6.59% 9.34% 11.83% 10.99%
Spread (bps) 434 319 566 996 723
LTM Data
(3)
LTM Date 9/30/02 9/30/02 9/30/02 9/30/02 9/30/02
Revenues $5,733.6 $4,826.9 $478.4 $6,914.0 $711.1
(2) (2) (2)
EBITDA 1,338.8 628.3 113.6 842.0 82.9
Margin 23.4% 13.0% 23.7% 12.2% 11.7%
Capital Expenditures $531.0 $139.8 $31.7 $123.0 $24.6

Balance Sheet Data

Cash $177.1 $58.2 $13.2 $246.0 $2.9
Total Debt 5,417.6 1,978.3 608.8 4,584.0 365.1
Total Interest 363.2 136.1 49.4 367.0 29.2

LTM Credit Statistics

Debt/EBITDA 4.0x 3.1x 5.4x 5.4x 4.4x
Net Debt/EBITDA 3.9x 3.1x 5.2x 5.2x 4.4x

EBITDA/Interest 3.7x 4.6x 2.3x 2.3x 2.8x

(EBITDA-Capex)/Interest 2.2x 3.6x 1.7x 2.0x 2.0x
Source: CSFB Research and prospectus filings.
(1) Includes $175 million tack-on priced at 100.549% on 12/11/02.
(2) Represents adjusted EBITDA, excluding unusual gains, losses and charges.
(3) Financials are not yet adjusted to exclude Constar spinoff.
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Appendix

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A. What is Enterprise Value?

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Simple Answer:
Enterprise Value Versus Equity Value
Enterprise Value = market value of operating assets
Equity Value = market value of shareholders’ equity
Equity Value = Enterprise Value – Net Debt(1)

Liabilities and
Net Assets Shareholders’ Equity

Net Debt

Enterprise
Enterprise Value
Value
Equity Value

(1) For simplicity sake, Net Debt (Corporate Adjustments) is generally defined as total debt + minority interest + preferred stock + capitalized leases – excess cash and cash equivalents.

You will generally use the valuation techniques previously spoken about to calculate the
enterprise value of the firm, which then allows you to calculate its equity value.

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Less Simple Answer:

Enterprise Value Versus Equity Value
Un-
consolidated/ Net
LT Financial Financial
Assets Debt

Enterprise Other
Value Corporate
(Core Adjustments
Business) Equity
Value

Value of the firm’s
Value of unconsolidated
Financial debt (market
Minority interests (market
Value of shareholders’
operations investments and other value) value) equity
long-term financial

Cash and cash
Any other value
assets
equivalents components not reflected

EV of Disposal Assets in the previous blocks,

Capitalized leases
e.g.,

Market value, where

Preferred stock (though
Long-term provisions
available
not all jurisdictions, e.g (pensions, etc.)
Germany)

Contingent liabilities

UFCF
Income from associates
Financial interest result
Interest cost of LT
Net Income
and participations provisions

EBITDA
Net book assets

Certain interest income
Cash flow impact of

EBIT
payout of provisions

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Thinking about Corporate Adjustments?

Core Business Enterprise Value needs to be adjusted for all value components not captured
in the Unlevered Free Cash Flow (DCF Analysis) or EBITDA (Comps Analysis). If possible,
such adjustments should be made at market values:
Assets

Unconsolidated equity investments and other participations

Note that investment income is typically post-tax income (applying an EBITDA or EBIT
multiple to such income for purposes of the TV calculation would be conceptually flawed)

Other long-term financial assets

Non-operating real estate and other non-operating assets

Cash and securities

Value of tax loss carry-forwards

Can be valued implicitly via the cash flows by inclusion in the financial model

Separate valuation appropriate if income of (prospective) holder of an asset can be offset
against tax loss carry forwards at the level of the target asset (i.e., more rapid utilization)
Liabilities

Financial debt

Financial debt is typically interest bearing

Overriding consideration however is whether a liability has operating or financing nature

Minority Interests

On-balance sheet pension liabilities (exclude interest cost component from UFCF)

Certain other (long-term) provisions, e.g., nuclear decommissioning, mining and other
environmental clean-up, large-scale restructuring, asbestos, etc. (again, exclude interest
component from UFCF)

Check cash flow impact (“ever-green” vs. cash-drain)
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B. What is WACC?

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WACC – Discount Rate Overview

The WACC should be thought of as the opportunity cost of capital, the long-term return an
investor expects to earn in an alternative investment of equivalent risk

The WACC to be used in a DCF analysis is specific to the business or asset being valued. It
does not necessarily depend on the buyer’s or seller’s overall cost of capital

WACC is used by firms as the hurdle rate for a project or division, as a performance benchmark
for return on capital calculations, to determine desirability of stock repurchases or issuance, or
for valuation purposes

Mathematically, WACC is expressed as:

After-tax Proportion of Debt Cost of Proportion of Equity

WACC(1) = Cost of Debt x in Capital Structure + Equity x in Capital Structure ;
Cost of
Equity(2)
= Risk-Free
Rate + Levered
Beta
x Equity Market Risk Premium +; [ Size Premium ]
Levered Unlevered
x 1 + (1 - Tax Rate) x (Debt/Equity Ratio)
Beta(3)
= Beta

(1) Assumes capital structure is only debt and equity. Other sources of capital, such as preferred stock, would need to be included if present.
(2) Based on the Capital Asset Pricing Model.
(3) Assumes company’s debt is risk-free. In certain limited situations, an adjustment can be made to this formula to account for the riskiness of the company’s debt.

The Weighted Average Cost Capital (“WACC”) is the recommended discount rate to be
used in the unlevered discounted cash flow valuation of an asset.

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WACC – Cost of Capital Build-Up

Small Cap Foreign
Stocks Stocks

Foreign Stock
Size Premium
Premium
Large Cap
Stocks
Corporate
Bonds

Long-Term Default
Premium
Treasury Equity Equity Equity
Bonds Risk Risk Risk
Premium Premium Premium

Long Horizon Long Horizon

Premium Premium
Treasury
Bills

Inflation Inflation Inflation Inflation Inflation Inflation

Real Riskless Real Riskless Real Riskless Real Riskless Real Riskless Real Riskless
Rate Rate Rate Rate Rate Rate

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C. How to Build Projections

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Building Projections – Key Considerations

General Principle

Projections should be based on:

Analysis of historical performance

Company projections

Equity research analyst estimates

Industry data: benchmark growth and margin development against comparables

Should reflect company’s continuing operating results free and clear of extraordinary items,
discontinued operations, etc.
– For a DCF, it will also exclude the effects of financial leverage

Scenarios / sensitivity analyses for key variables

Specifics

Planning Horizon: forecast period should be long enough to capture time required for business
to reach “steady state”, i.e., achieve normalization of annual growth, margins and reinvestment

Most banks will typically use 5 years, however individual case may suggest otherwise
(e.g., finite asset life, non-normalizing cash flow patterns)

Nominal vs. Real: Projections are typically prepared in nominal terms, not real terms

Managers think in nominal terms

Interest rates quoted in nominal terms

Financial statements typically stated in nominal terms (particularly relevant for depreciation)

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Building Projections – Helpful Framework

Corporate – Indicative Structure for Unlevered Free Cash Flow Calculation
Unlevered Free Cash Flows
1. Revenue Price and volume
Model forecast

+ Revenues COGS: Price and

- Variable Costs volumes
= Gross Profit Other variable costs
2. Cost
Model Semi Variable / Fixed
Costs
- Fixed Costs
= EBITDA Labour and headcount
S,G & A
3. Tax Other fixed costs
Schedule - Depreciation and Amortisation
= EBIT
Planned Investments
Average useful life of
4. Deprec. and existing and new fixed
Capex Matrix - Corporate Tax (on EBIT) assets
= Unlevered Net Income
Effective tax rate
Existing tax relief's
+ Depreciation and Amortisation
- Net Capital Expenditures
5. Working +/- Change in Net Working Capital
Trade Receivables
Trade Payables
Cap. Sched. = Unlevered Free Cash-Flow Product and Materials
Stock

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Building Projections – Think About Your Work

General

Understand the industry / understand the business

Start with a sound analysis of historical financials (3 years is good, 5 years better)

Growth rates
Cost reduction programs

Margin development
Working capital development

One-off items
Sanity Checks

Check margin development and growth rates vs. benchmarking of peers

Try to drive projections on EBITDA margin, not EBIT margin

Unusual changes in margins and growth rates must have specific explanations (no hockey
sticks!)

Ratio of capital expenditures / depreciation should converge to approx. 1 in the long term

Make sure asset growth is in line with projected revenue growth (look at e.g., fixed asset turn)

Consider supply and demand dynamics and the implications of your assumptions for the supply
and end markets

Consider the implied market share of your projections

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D. Choosing the Right Range – Comps and CompAcqs

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Comparability / Reliability is Critical

General

Quality of comparables definitely outweighs quantity of comparables

Check for comparability of business / operations, e.g.,

Product mix
Size

Revenue / operating income split
Geography

Check for financial standing: (perceived) bankruptcy risk impacts meaning of multiples

Check for comparability of accounting

Comparable Traded Companies

Check for comparability of trading characteristics

Quality of exchange
– Small stock exchanges often trade at discounts to their international peers
– Adjustment for systematic market P/E differential may be required

Free float / liquidity / size
– Prices of illiquid stock are often more volatile and often trade at discounts to their peers
– Market prices may even systematically deviate from rational valuation

Absence of extraordinary influences: take-over speculation, transaction rumours, creative
accounting worries, etc.

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Comparability / Reliability (cont’d)

Comparable Acquisitions

Check for comparability of transaction characteristics

Stake sold: minority vs. majority

Premium transaction vs. MoE

Circumstances of sale: forced sale vs. truly competitive auction

Transaction timing: typically more recent transactions are better comparables
– Time in the cycle
– Market constitution

Any other transaction-specific factors

Check for other (non-monetary) price/value components, e.g.,

Put / call options

Long-term procurement or supply contracts

Earn-outs

Check for non-commercial value influences

(Political) pressure / sweetheart deals

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Comparability / Reliability (cont’d)

Exercise: What is a good vs. bad comp?
* Please consider the make-up of the below company’s businesses prior to making your choice
Example 1: Valuing Schindler (Elevator and Escalator company)

Which is the better Comp?

United Technologies (Otis Elevators)

York International (Air conditioning, heating, refrigeration ventilation)

Example 2: Valuing Varta (Consumer and automotive battery manufacturer)

Which is the better Comp?

Gillette (Duracell)

WD-40 Company (multi-purpose lubricants, cleaning products, etc.)

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Understand the Factors that Drive Differences in Multiples

What makes one Company or Transaction more comparable than another?

Market position / Scale Are they of a similar size and position relative to peers?

Competitive Position – Are their competitive positions similar based on the following criteria?

Geography – Are their major operations and markets similar?

Products – Are their products of a similar level of technology, brand recognition, and are there
a lot of substitutes?

Customer base – Are they at similar stage of the value chain?

Cyclicality – Are they subject to a similar business cycle? Are they at the same point in the
cycle

EBITDA Margin – Do they have similar cost and pricing leverage with customers?

ROA, Capital Turns – Do they have similar levels of working capital and Capex requirements?

Earnings Sustainability / Long-Term Prospects – Do they have a similar growth projected?
Do their target markets exhibit similar rates of growth?

Reputation – Do they have similar recognition for quality and performance?

Management – Does their management team have a similar reputation?

Earnings stability / predictability

Risk – An increase in cost of capital leads to lower multiples?

Accounting and Tax environment
Sanity check the results: Is the multiple not representative

Negligible margins – High EBITDA multiple; Low Sales Multiple

Large equity income (not picked up in EBITDA or Sales) – Is this adjusted for in Enterprise Value?

Non-debt contingent liability (asbestos) – Is this adjusted for in Enterprise Value? 62
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USE THIS AS A GUIDE!!!

THANKS FOR YOUR

ATTENTION!!
WE WISH YOU GOOD LUCK IN
THE COMING WEEKS!!

63