DECEMBER 2004 TVILNIGIINOD GNY JLVAl¥S ATLDIVISAND MERGE oc [For any pitchbook or presentation including advisory, equity or debt security or loan product of combinations thereof NOT for use in fairness/valuation or Commercial Hank presentations.) ‘Thi prezentaton was prepared exclusively for the bene anc internal ue af the JPergan client to wham ie drecti aciesed ane deere nlcing such lens subsites, the “Compan In erer to ss the Campa in evaluating, en a preliminary bos, the fealty ofa possible wansaction or {temacton ond des rat any en it f puso or acta, ele ein part, ary eter pty ‘Ths preston sor don proces ‘on and incomplete witout reterencef, an shoul be viewed salelyincangaction wth, the orang provided by PNorgsn. Neier ths retentation nor ry of corents maybe ciclsecor wed fr any ater supose without their written carsrt of JPrSa ‘The tfermatio inthis presenation s base upen any management forecasts supplied to us and reflects prevaling contin: an our views as of ths date allot vei are sccachaly sujet t change _PHagansapians and estimotes constitute JPMorgarsjuderet an sau be regrdea a neste, fretiinary an for tustratve purposes oy. In prepares presentation, we have relied pon and assured, witout independent verfeatior, ie [Sceuracy and conpletnes of all ifermatio avaiable far publi soarces or which was provided tos by of on Beal ofthe Company which Was ‘erie rerewed by us. In aon, or analyses ae not and dont purport tobe appr ofthe ast, stock, or busines of the Company or any (tier entity sPergan makes no representations a to Ue stl Ylue whieh ay be recived conection with a arscton rr he eal, at oF ‘accountng eects of earsummating 3 ansaction. Unies expressiy contemplated here, the Information nts prsertaton does notte into account the effect of 2 possible trasaction or transactions vena an actual er potential change of conta, which may have syficant valuation and ether tects ‘Notethtandig anything herein tothe contrary, the Company anc each fs employees, representative ot cther ments my an any ad ll ‘eran, wit ination of yn te US. feerl and sate Income tax rete and the US, federal ana sate came tae trate the LWansacton cantatas hereby and all materi of any kind (nl inion or aher tax analyses) that are provide to the Coan relating to sich tax treatment and tax structure infra sch tentment and/or structure relates to U.S. federal or state come tax strategy prvded tothe Company Pers Pore’ polices pri enplyees rom offering, rectly or nde, avrabe research rating or specie price are, o offering to change 3 ‘ating r price target, oa sujec company as corederation or néaceren for he Yeebt of busines o for compensation. JPMorgan als prohibits Rs ‘esearch analysts rom beng compensted for Iwalvemert ivestent banking Wansactons excopt tothe exter that uch patirpatin intend _Plorgan sa marketing name fr krvesrent banking bsnestes of Plorgan Chase & Co. ants bss worlwide, Securities, syélate oan arangg, Finacial ascry and other iestment banking acts are performed by acambiraton of P. Nrgan Series I, .P. Megan, “TP. morgan Secures La and the appropriately ceneadaubldaries of Pergan Crate Co, n Asa Pactc, and lending, derivates and eter ‘ammercial bang activites ate performed by JPlergan Chae ane, WA. .Phorgan seal tear members maybe evpojec: an of he freeing nutes ‘This presentation does ot consteut a commitment by ary JPMorgan entity to underwrite, sbserbe foro place any securities orto extend or arange creditor to provide anyother sence, SsemorganANALYSIS eR MERG oc ae Agenda Ssermorgan tern Discounted cash flow analysis 6 Relative value analysis 56 Merger consequences nINTRODUCTION Valuation methodologies ly traded So Pee analysis = "Public Market Valuation” 1 Value based on ‘market trading rmltiples of comparable companies 1 Apple using historical and prospective multiples 1 Does not include a control premium Ssemorgan 1 "Private Market Valuation” 1 Value based on multiples patd for comparable ‘companies in sale transactions 1 Includes contrat premium Intrinsic” value of business 1 Present value of projected free cash flows 1 Incorporates bath short-term and long-term ‘expected performance 1 Risk in cashflows and capital structure captured in discount rate 1 Value toa finaneial/LBO buyer 1 Value based on debt repayment and return on equity investment 1 Liquidation analysis 1 Break-up analysis, f= Historical trading performance = Expected PO valuation 1 Discounted future share price = EPS impact 1 Dividend discount ‘modelINTRODUCTION The valuation process Determining a final valuation recommendation is a process of triangulation using insight from each of the relevant valuation methodologies (1) Discounted (2) Publicly Traded (3) Comparable ) Leveraged Cash Flow Comparable Acquisition Bay Out Analyzes the Companies Transactions Used to determine present value of Urilizes market Utilizes data from range of patential a companys free trading multiples M@A transactions, value for a ‘cash flow, from publicly involving similar ‘company based on traded companies companies. ‘maximum leverage to derive value. ‘capacity. SyemorganThe valuation summary is the most important slide in a valuation presentation The science is performing each valuation method correctly, the art is using each method to develop a valuation recommendation sso noted sia wen sy Nit = is pee) 0 = a iain Wem ae SRE yeas GE SURSLC aa eae ES “ae CERT aoe mee Tiss ee, em) CST) ES pian bic tdi pa, Spee or NTRODUCTION =| SypraoeganINTRODUCTION Aprimer: firm value vs. equity value = Market value of all capital invested in a business" (often referred to as “enterprise value” or “firm value” or “asset value”) ‘The value of the total enterprise: market value of equity + (total debt + Capitalized Leases - Cash and Cash equivalents) + Minority Interest + Preferred Equity Total debt includes all Long term debt, Current portion of Long term debt, short term debt and overdrafts = Market value of the shareholders’ equity (often referred to as “offer value") The market value of a company’s equity (shares outstanding x current stock price) Assets Liab Net debt, ete Pen Enterprise value Value Pres | The value of debt should bea market value. it may be appropriate to assume book value of debt approximates the market value 2 long asthe company's credit profile has nt charged significantly since the existing debe was issued. ies and Shareholders’ Equity SsemorganANALYSIS MERGER wer Agenda Ssermorgan Introduction ee Relative value analysis Merger consequences Page 56 nvsis DISCOUNTED CASH FLOW ANA Discounted cash flow analysis as a valuation methodology er So analysis = "Public Market Valuation” 1 Value based on ‘market trading rmltiples of comparable companies 1 Apple using historical and prospective multiples 1 Does not include a control premium Ssemorgan 1 "Private Market Valuation” 1 Value based on multiples patd for comparable ‘companies in sale transactions 1 Includes contrat premium Ea Ea Intrinsic” value Value toa Liquidation of business financial LB0 analysis buyer 1 Present value of # Break-up analysis projected free 1 Value based on cash flows debt repayment ™ Historical trading and return on peirormaice * Incorporates both ity Savestment incopstaie to equity 1 xpected IPO long-term valuation expected 1 biscounted future performance share price 1 Rise in cashflows 685 im and capital aL structure captured 1 Dividend discount in discount rate aOverview of DCF analysis = = Discounted cash flow analysis is based upon the theory that the value of a business is the sum of its expected future free cash flows, discounted at an appropriate rate = DCF analysis is one of the most fundamental and commonly-used valuation techniques Widely accepted by bankers, corporations and academics Corporate clients often use DCF analysis internally One of several techniques used in M&A transactions; others include: Comparable companies analysis Comparable transaction analysis Leveraged buyout analysis Recapitalization analysis, liquidation analysis, etc. DCF analysis may be the only valuation method utilized, particularly if no comparable publicly-traded companies or precedent transactions are available SsermorganOverview of DCF analysis = = DCF analysis is a forward-looking valuation approach, based on several key Projections and assumptions Free cash flows What is the projected operating and financial performance of the business? Terminal value = What will be the value of the business at the end of the projection period? Discount rate What is the cost of capital (equity and debt) for the business? = Depending on practical requirements and availability of data, DCF analysis can be simple or extremely elaborate 1m There is no single “correct” method of performing DCF analysis, but certain rules of thumb always apply Do not simply plug numbers into equations You must apply judgment in determining each assumption SsermorganThe process of DCF analysis == Projections /FCF > Terminal value Discount rate > Present value > Adjustments > Ssermorgan Project the operating results and free cash flows of the business over the forecast period (typically 10 years, but can be 5-20 years depending on the profitability horizon) Estimate the exit multiple and/or growth rate in perpetuity of the business at the end of the forecast period Estimate the company’s weighted-average cost of capital to determine the appropriate discount rate range Determine a range of values for the enterprise by discou projected free cash flows and terminal value to the present Adjust the resulting valuation for all assets and li accounted for in cash flow projectionsDCF theory and its application == Ssermorgan DCF theory: The value of a productive asset is equal to the present value of all expected future © (including an estimated terminal value), discounted using an appropriate weighted- average cost of capital fh flows that can be removed without affecting the asset’s value 1 The cash-flow streams that are discounted include Unlevered or levered free cash flows over the projection period Terminal value at the end of the projection period = These future free cash flows are discounted to the present at a discount rate commensurate with their risk If you are using untevered free cash flows (our preferred approach), the appropriate discount rate is the weighted-average cost of capital for debt and equity capital invested in the enterprise in optimal /targeted proportions If you are using levered free cash flows, the appropriate discount rate is simply the cost of equity capital (often referred to as flows to shareholders or dividend discount model)The two basic DCF approaches must not be confused == = DCF of cash flows (the focus of these materials) Projected income and cash-flow streams are free of the effects of debt, net of excess cash Present value obtained is the value of assets, assuming no debt or excess cash (“firm value” or “enterprise value”) Debt associated with the business is subtracted (and excess cash balances are added) to determine the present value of the equity (“equity value”) Cash flows are discounted at the weighted-average cost of capital CF of cash flows (most common in valuation of financial institutions) a Projected income and cash-flow streams are after interest expense and net of any interest income Present value obtained is the value of equity Cash flows are discounted at the cost of equity Ssermorganvsis ISCOUNTED CASH FLOW ANA Other considerations Berea Reliability of projections = DCF results are generally more sensitive to cash flows (and terminal value) than to small changes in the discount rate. Care should be taken that assumptions driving cash flows are reasonable. Generally, we try to use estimates provided by analysts from reputable Wall Street firms if the client has not provided projections Sensitivity analysis = Remember that DCF valuations are based on assumptions and are therefore approximate. Use several scenarios to bound the target's value. Generally, the best variables to sensitize are sales, EBITDA margin, WACC and exit multiples or perpetuity growth rate Hence, alw. ea ae Ssermorganvsis OUNTED CASH FLOW ANA Always remember... 1 Three key drivers Projections and incremental cash flows (unlevered free cash flow) Residual value at end of the projection period (terminal value) Weighted-average cost of capital (discount rate) 1 Avoid pitfalls Validate and test projection assumptions Determine appropriate cash flow stream Thoughtfully consider terminal value methodology Use appropriate cost of capital approach Carefully consider all variables in calculation of the discount rate Sensitize appropriately (base projection variables, synergies, discount rates, terminal values, etc.) Footnote assumptions in detail Think about other value enhancers and detractors eee) SsermorganThe first step in DCF analysis is projection of unlevered free cash flows = Calculation of unlevered free cash flow begins with financial projections Comprehensive projections (i.e., fully-integrated income statement, balance sheet and statement of cash flows) typically provide all the necessary elements = Quality of DCF analysis is a function of the quality of projections Often required to “fill in the gaps” Confirm and validate key assumptions underlying projections Sensitize variables that drive projections = Sources of projections include ‘Target company’s management ‘Acquiring company’s management Research analysts Bankers SsermorganProjecting financial statements Tor 1 Ideally projections should go out as far into the future as can reasonably be estimated to reduce dependence on the terminal value = Most important assumptions Sales growth: Use divisional, product-line or location-by-location build-up or simple growth assumptions Operating margins: Evaluate improvement over time, competitive factors, SGEA costs, Synergies: Estimate dollars in Year 1 and evaluate margin impact over time Depreciation: Should conform with historic and projected capex Capital expenditures: Consider both maintenance and expansion capex a Changes in net working capital: Should correspond to historical patterns and grow as the business grows = Should show historical financial performance and sanity check projections against past results. Be prepared to articulate why projections may or may not be similar to past results (e.g. reasons behind margin improvements, increased sales growth, etc.) = Analyze projections for consistency Sales increases usually require working capital increases CAPEX and depreciation should converge over time SsermorganFree cash flow is the cash that remains for creditors and owners after taxes and reinvestment = ™ Unlevered free cash flows can be forecast from a firm’s financial projections, even if those projections include the effects of debt = To do this, simply start your calculation with EBIT (earnings before interest and taxes) EBIT (from the income statement) Plus: Non-tax-deductible goodwill amortization Less: Taxes (at the marginal tax rate) Equals: Tax-effected EBITA Plus: Deferred taxes! Plus: Depreciation and any tax-deductible amortization Less: Capital expenditures Plus/(less): Decrease/(increase) in net working investment. Equals: Unlevered free cash flow + Ato bond the zope of eu cet dus, ou shod oie acl ates pin the CF. Depend onthe fm and indy, you may wat ta fer tron sno ctered) prions fim poison. The taxa nthe Srl ates wl om ys nd ea tw rs men ak Ssermorgans urs Flow ISCOUNTED CASH Example: Calculating unlevered free cash flows a ee a nets ano 300 GR) SHA $58.6 Soak 57088 S793 ears 0 48~*w3S~S~C«OSSCSC SOS tes Tees maa ate mime a2 Tocetfected ETA wos bus «84 aS Pls Depreciation ome 3 BA mis Dtered teres : tan Copal epectures wo oe es eee. woking capt mo aso 83a Urtevered ees ow 03 48 ~C«SC aw juste for alte 03) Unleered CF to acaurer 900 a8 Key sssumptions: Deavaluation date = 12/31/04 argnal tax rate = 40% | SsermorganValuing the incremental effects of changes in projected operating results & In performing DCF analysis, we often need to determine the incremental impact on value of certain events or adjustments to the projections, including: Synergies achievable through the M&A transaction Revenue Cost Capital expenditures Expansion plans Cost reductions Change in sales growth ‘Margin improvements 2 = These incremental effects can be valued by discounting them independently (net of taxes) or by adjusting the OCF model and simply measuring the incremental impact SsermorganOnce unlevered free cash flows are calculated, they must be discounted to the present = The standard present value calculation takes into account the cost of capital by attributing greater value to cash flows generated earlier in the projection period than later cash flows FCF, FCF, FCF, FCF, Present value = (sn! (1407 (tary ARS (ry? '™ Since most businesses do not generate all of their free cash flows on the last day of the year, but rather more-or-less continuously during the year, DCF analyses often use the so- called “mid-year convention,” which takes into account the fact that free cash flows occur - during the year FCF, FCF; FCF; FCF, JPMorgan > Present value = gd +— sone (tor? (tary'® (tay = (terre? '= This approach moves each cash flow from the end of the applicable period to the middle of the same period (i.e., cash flows are moved closer to the present) Ssermorganvsis OUNTED CASH FLOW ANA It is important to differentiate between the transaction date and the mid-year convention Yer 0. 0.5 1 15 2 25 3 35 La La La First cash flow, Second cash flow, Third cash flow, mid-year 1 mid-year 2 mid-year 3 cr, cr, cr, (ions (ys (1975 Period 4 CF to buyer i i i | t tT T : T t Year 0. 07 1 15 2 28 3 35 First cash flow, Second cash flow, Third cash flow, ‘mid-period 1 mid-year 2 mid-year 3 cr, cry cr, (ner0 (1ry0509) (reneevsis ISCOUNTED CASH FLOW ANA Practice exercise Poriod 1 OF to buyer — i L 1 1 t mT T y Tr t Year 0 05, 1 18 2 25 3 35 aL ty La, tstflow, 2nd cash flow, ‘Sd cash flow, mid-period 1 mid-year 2 mid-year 3 cr, CF CF, Discounting= 5 ——*_ 5 —_ (taneasor, ——(4e)15075) (taneso7s ‘spmorganISCOUNTED CASH Example: Discounting free cash flows 20012002 Net sales $400.0 $440.0 aITDA, 0 88.0 Les: Depreciation mo Be iT 03.0 Les: Taxes at marginal ate 7. 98 Tacetfected EBITA 540.8 Plus: Depreciation Plus: Deferred taxes Les: Capital expenditures Less: Incr (cr. in working capital Unlevere free cath flow Adjustment for deal date Unlevered FCF to acquirer Memo: Discounting factor Discounted value of unievered FCF Discounted value of FF 2005 2008P Formula sm ey assumptions: Deal/valuation date = 12/31/04 Marginal tx rate = 40% Discount rate = 10% $189.6 = S468 Syemorgan (1+.10)%5 Fiscal year ending December 31, 700s 100s 2005 200 20072008 HBO «GIA «505.6 SAD —«T0RG «779.5 8 1065 IA RAUNT 158.9 Ms 607893 Bs 56S mo 42 8k 2. 4 $543 S97 S05.7— SS STBS 0 7689 mo 20 M2 GW wo 85704 3 68 BA 8G oa) - - = = 500 468 $53.8 Seid 569.6 oo st as soo S46 67 SHB 99 199.6 $53.8 $61.4 $69.6 (1+. 10)'5 (14.105 "(14.105Terminal value can account for a significant portion of value in a DCF analysis = Terminal value represents the business’s value at the end of the projection period; e., the portion of the company's total value attributable to cash flows expected after the projection period = Terminal value is typically based on some measure of the performance of the business in the terminal year of the projection (which should depict the business operating in a steady-state/normalized manner) Terminal (or “Exit”) multiple method Assumes that the business is valued/sold at the end of the terminal year at a multiple of some financial metric (typically EBITDA) Growth in perpetuity method * ‘Assumes that the business is held in perpetuity and that free cash flows : continue to grow at an assumed rate A terminal multiple will have an implied growth rate and vice versa. It is essential to review the implied multiple/growth rate for sanity check purposes ™ Once calculated, the terminal value is discounted back to the appropriate date using the relevant rate = Attempt to reduce dependence on the terminal value ‘What is appropriate projection time frame? What percentage of total value comes from the terminal value? Ssermorgan EbTerminal multiple method = This method assumes that the business will be valued at the end of the last year of the projected period 1 The terminal value is generally determined as a multiple of EBIT, EBITDA or EBITDAR; this value is then discounted to the present, as were the interim free cash flows The terminal value should be an asset (firm) value; remember that not all multiples produce an asset value Note that in the exit multiple method terminal value is always assumed to be calculated at the end of the final projected year, irrespective of whether you are using the mid-year convention . = Should the terminal multiple be an LTM multiple or a forward multiple? If the terminal value is based on the last year of your projection then the multiple should be based on an LTM multiple (most common) There are circumstances where you will project an additional year of EBITDA and apply a forward muttiple SsermorganMost common error: The final year is not normalized = Consider adding a year to the projections which represents a normalized year & Asteady-state, long-term industry multiple should be used rather than a current multiple, which can be distorted by contemporaneous industry or economic factors © Treat the terminal value cash flow as a separate, critical forecast Growth rate Consistent with long-term economic assumptions Reinvestment rate Net working investment consistent with projected growth Capital expenditures needed to fuel estimated growth Depreciation consistent with capital expenditures & Margins Adjusted to reflect long-term estimated profitability Normalized tax rate SsermorganExample: Terminal multiple method cal year ending Deceiver 3, Ee ee a Ne ae Sond So. HOA0 Sse SS Souaz SOR $7795 trroa oo 88D 389, ma wo 8S OS Tacefteced EDTA wos bas Sa STD Ps Deprecton oH es: apt expences mo moka es ere) woking anal oo 8808s a sje ter eal te 3) = 7 “ _ a Uevered FCF to sear S00 ssa 88H S| amo: sent ator ao 05S : Dtcnted vale of wieveed FEF foo us eT an S89 z Diconted vale fF 2052080 188 & {D170 20080 sis a Ext ritole 708 | —_Teal presen vaue to acquirer sees ©) Rebate ate» 273704 ($155.9 * 7.0%) e valuation date = 9 * 7.0% =| Marana tc rate = 400 mm eras gla 2) Dhacount ate = s08 s 7 S| exemuttipieo ETD = 7.05 (1+.10) SsermorganExample: Terminal multiple method (cont’d) a Decured Diced eile Female 1 21200 TDA mast ge Eon mie ot Dicomtrte 208208 to 7a aa 6001 Be * 368 soars Senter caus 90 sR om ma sae mi me e207 108 ws ons mse mae su ipa ite tes tea ast ora ons pore be m7 mss mama 93, © GSR). SS . Equity value Equity value per share’ ec dot 200 TOA mae of 208 TDA mate of Ducomtrate 2/1704 bo 7 Be 600 Be z 18 $100.0 sea $098.0 $1,013.68 30917 97 gaa 2 oe 00 mee tua am Siar anarSanar woe von ma mus aaa sir sina : tte woo ma toes tre Sis ngr ae é 126 100.0 ona 63 875.3 $16.55, $18.97 $21.39 =| maetr ae maaan mein ‘spmorganGrowth in perpetuity method = This method assumes that the business will be owned in perpetuity and that the business will grow at approximately the long-term macroeconomic growth rate Few businesses can be expected to have cash flows that truly grow forever; be conservative when estimating growth rates in perpetuity = Take free cash flow in the last year of the projection period, n, and grow it one more year to n+1;" this free cash flow is then capitalized at a rate equal to the discount rate minus the growth rate in perpetuity = To ensure that the terminal year is normalized, JPMorgan models are set up to project one year past the projection year and allow for normalizing adjustments; this FCFn+1 is then discounted by the perpetuity formula Terminal value = (FCF, * (1+ g))/(WACC ~ 8) Terminal value = (FCF,.s)/(WACC ~ 8) o where FCF, = FCF in final projected period where FCF, = FCF in year after projections & = growth rate in perpetuity 8 ‘growth rate in perpetuity WAC = weighted-avg. cost of capital WAC = weighted-avg. cost of capital PV of terminal value = terminal value/(1+WACC)"°* PV of terminal value = terminal value/(1+WACC)"°> ‘Tp then bec the pretty sowthfrmls son the price ta the ein alas net al af test ca flow, dee ye Syemorgan asGrowth in perpetuity method (cont’d) = Note that when using the mid-year convention, terminal value is discounted as if cash flows occur in the middle of the final projection period Here the growth-in-perpetuity method differs from the exit-multiple method © Typical adjustments to normalize free cash flow in Year n include revising the relationship between revenues, EBIT and capital spending, which in turn affects, CAPEX and depreciation Working capital may also need to be adjusted Often CAPEX and depreciation are assumed to be equal Ssermorgan 0Example: Growth in perpetuity method a Fiscal year ending December 31, 001 mon moms mowers ose 20008 Net aes 00.0 $00 = ¢733,.6 =| ———_____ S (10 - .03)*(1+.10)29 SyemorganExample: Growth in perpetuity method (cont’d) a + [faeeseeeee\Cneeeeenen Discounted terminal value Firm value at perpetuity growth rate of at pespetuty growth rate of Discount rte 2005-2008 2.5% 30% 3.5% 2.56 3.08 136 co $196.8 $10 $1,095.4 $1,228.09 Sirs $12R2 — s1ai98 3s, 1931 ang a8 968.9, 10050 “1077.0 4.162.0 10% 189.6 gus jira 7940 ona an 503 % 186.1 se OT 7687 808.1 3528 De 4927 05.1 se S704 79S 7828 a quit value Equity value per share! 5 Net debt st perpetuity growth rate of, at perpetuity growth rate of z Discount rate 12/31/04 25% 3.0% 3.5% 258 3.08 358 z om $100.0 Sioa78 $1,122 S388 26.59 Sai «S326 98 100.0 ‘oso 'g7ra 1,062.0 Sam S388 5.96 = 10% 100.0 ma 33 3836 sie 2012 2159 8 1% 100.0 87 708.1 7528 Sie S731 Sta. P 28 100.0 579 tas az S437 S52 515.95, ‘spmorganTerminal multiples and perpetuity growth rates are often considered side-by-side a = Assumptions regarding exit multiples are often checked for reasonableness by calculating the growth rates in perpetuity that they imply (and vice versa) '§ To go from the exit-multiple approach to an implied perpetuity growth rate: = [WACC"terminal value) / (1+WACC)®9 - FCF, / [FCF,, + (terminal value / (1 + WACC)°2)] '= To go from the growth-in-perpetuity approach to an implied exit multiple: multiple = [FCF, * (1 + 9)(1 + WACC)®5] / [EBITDA, * (WACC - g)] = These formulas adjust for the different approaches to discounting terminal value when using the mid-year convention SsermorganTerminal multiple method and implied growth rates SEs x Discounted scouted terminal valve Firm vaue Terminal value as percent Discount FCF SC 1DHPEBTDA multiple of at 20HP EBITDA multiple of of oa rm vale rte 1005-2008 6.0x TK ox 70 Be 6m 1080 ek rr 78 ak % wa 26 7A a3 255.8 906.2 1/0767 ™ wea 10 1966189 HSA as m4 9349 tea ™ wh S ie ‘64 662 7189 aa 602.3 9049 10078 ™ 7% Bw 1% W755 35m m2 81639783 1 BIN | 2 aut value culty value pe stare! Implied perpetaty growth rate : Dicourt Net debt at 20P EBITDA multiple of at 20DHP EBITDA mltiple of _—|_—at 2008P EBTIDA matic of mi rate 12/30/04 6x7. BOx 6k 7B 60x 10x z &% s000—«— Sena SOOO SONS «=I RN SAT | ame aw % 10.0 7558 8662 977 © SBA S217 823.87 his 228 30% 7 10 joo 8 784 BMD Sets $1780 S041 S201 20s 31a 398 S 8 foo 723 way sore © Site Si967 Sz.8 “] | 29m Soe ae 2 i joo 72763 asi Stes Siao7_ sau | | san 49m Sa Ne reece eked aa naa) Ren AU eC EROPerpetuity growth rate and implied terminal multiples Discounted Discounted terminal value Firm value Terminal value 3 percent Discount FF at perpatulty growth rate of at perpetuity growth rate of (of ttal firm value rate 2005-2008 255 30n 3.5 25% 308 3.5% 25% 3.0% am 5196.8 $991.0 §1095.4 $9,230 $4,187.8 $1,2922 $1,410.86 ‘ax 85 % 19341 On9 6638 89 © 1,005.0 1,077.0 1,162.0, nd we 109.6 Ges RT 7940 arnt "92.3986 mm 18 06.1 526 622.0 666.7 7687 SOBA 8828 eT 12% 1827 50.1 5358.8 570.1 679837528 TK 7% s Emit valve uty value per share! np ERTDA exit mukiple : Discount Het debt_ at pepetty growth ateof at perpetuity growth ateot | at perpetuity growth rale of ; rate m7pstoe m 35K 2K 3K ak 2s 08 1.56 : Be $1000“ Figere Sima? gy3I98 © Go.se SIGIR Ze Box 9x 10.7 o8 tooo "5050 9770 “1002.0 © SRI sa888 525.96, 74 50-4) 88 7 vos joo 8 77tm33 eae © St8ae St. [srt oa 69 | 75 S ie joo 8 7 a1 Te Sto i731 [S100 57 | 6s a ae joo 5079 iss ase Saar Sis2_|s1595, si sa | sa S Re eee eee ene e Gee eae eaeRcs ‘spmorganChoosing the discount rate is a critical step in DCF analysis ® The discount rate represents the required rate of return given the risks inherent in the business, its industry, and thus the uncertainty regarding its future cash flows, as well as its optimal capital structure © Typically the weighted average cost of capital (WACC) will be used as a foundation for setting the discount rate = The WACC is always forward-looking and is predicted based on the expectations of an investment's future performance; an investor contributes capital with the expectation that the riskiness of cash flows will be offset by an appropriate return 1m The WACC is typically estimated by studying capital costs for existing investment * opportunities that are similar in nature and risk to the one being analyzed 1 The WACC is related to the risk of the investment, not the risk or creditworthiness of the investor? ‘pratries by soe che, tt paged inanestemey sericea, Nowcrey a umes anal rive toanaeurors oneness my ee Sorat tocereer the of he gus WAC pertering te aiaton, The ade ae ested y uns sega WAC cone od a SsermorganJPMorgan estimates the cost of equity using the capital coe asset pricing model = The Capital Asset Pricing Model (CAPM) classifies risk as systematic and Uunsystematic. Systematic risk is unavoidable. Unsystematic risk is that portion of risk that can be diversified away, and thus will not be paid for by investors, m= The CAPM concludes that the assumption of systematic risk is rewarded with a risk premium, which is an expected return above and beyond the risk-free rate. The size of the risk premium is linearly proportional to the amount of risk taken. Therefore, the CAPM defines the cost of equity as equaling the risk-free rate plus the amount of systematic risk an investor assumes = The CAPM formula follows: ot = + ) : FAB got) Where f= the required market return on the equity of the company the risk-free rate T= the return on the market 8 = the company's projected (leveraged) beta " There fs also an error term in the CAPM formula, but this is usually omitted SsermorganLOW ANALYSIS ISCOUNTED CASH The cost of equity is the major component of the WACC = The cost of equity reflects the long-term return expected by the market (dividend yield plus share appreciation) '® Risk-free rate based on the 10 year bond yield & Incorporates the undiversifiable risk of an investment (beta) ‘= Equity risk premium reflects expectations of today’s market = The market risk premium (r,t . ., the spread of market return over the risk-free rate) is periodically estimated by MEA research based on analysis of historical data Cost ofequity = Risk free rate + Beta x Equity risk premium eee ahd Peromin en cay eee esc cee eee) etch return above risk free Cee METI (beta-0) stock market ees fed = 10-year bond yield + Predicted betas x Estimated using (annual average) various techniques For market average 4.97% + 1.00 x 5.00% = 9.97% Syemorgan 8vsis OUNTED CASH FLOW ANA JPMorgan estimates the equity risk premium at 5.0% Equity risk premiums is estimated based on expected returns and recent historical returns 186 30 years ending nuit is premium) —Foting 30 years — Rotng 0 years —Roling 30 years 1994 27 1995, 34 1996 44 ia 1997 47 1998 52 1999 62 10% 2000 58 2001 50 % * ; 1955 1959 1962 1968 1972 1976 1980 1984 1988 1992 1997 2001, ‘spmorganBeta Ssermorgan Beta provides a method to estimate an asset's systematic (non-diversifiable) risk Beta equals the covariance between expected returns on the asset and on the stock market, divided by the variance of expected returns on the stock market A company whose equity has a beta of 1.0 is “as risky” as the overall stock market and should therefore be expected to provide returns to investors that rise and fall as fast as the stock market; a company with an equity beta of 2.0 should see returns on. its equity rise twice as fast or drop twice as fast as the overall market Returning to our CAPM formula, the beta determines how much of the market risk premium will be added to or subtracted from the risk-free rate Since the cost of capital is an expected value, the beta value should be an expected value as well Although the CAPM analysis, including the use of beta, is the overwhelming favorite for DCF analysis, other capital asset pricing models exist, such as multi-factor models like the Arbitrage Pricing TheoryJPMorgan uses predicted betas to calculate the cost of equity 1 Predicted betas are constructed to adjust for many risk factors, incorporating firms’ earnings volatility, size, industry exposure, and leverage Predicted betas are more consistent and less volatile than historical betas = Historical betas only measure the past relationship between a firm’s return and market returns and are often distorted @ Projected betas can be obtained from Barra or an online database ( . ., IDD) Barra predicted betas can be found through the Investment Bank Home Web page’ Note that Bloomberg betas are based on historic prices and are therefore not forward-looking Impute unlevered beta for private company from public comparables : kao —Matrcat tata —Predeeabate Ferree] ‘ete be 7 (eur (15) 6.005) 00 05 10,15 20 25 30 35 40 os oz 1 19 Py SsermorganDelevering and relevering beta ® Recalling our previous discussion regarding the difference between asset values and equity values, a similar argument exists for betas. The predicted equity beta, i.e., the observed beta, included the effects of leverage. In the course of performing a variance analysis, which looks at different target capitalizations, the equity beta must be delevered to get an asset, or unlevered, beta. This asset beta fs then used in the CAPM formula to determine the appropriate cost of capital for various debt levels 1 The formula follows: By= B/E = ((1 -T) * (Debt/Equity))] f Where: BU = unlevered (asset) beta BL = leveraged beta T = marginal tax rate = To relever the beta at a target capital structure: = By" Tt + ((1 -T) * (Debt/Equity))] SsermorganDele vering and rele vering beta (cont’d) = Note that JPMorgan M&A sometimes uses a factor, tau, in place of the marginal tax rate, T Tau, currently equal to 0.26, represents the average blended benefit a shareholder gets from a company borrowing (reflects many factors) The value of Tau is derived by researchers using complicated statistical analyses = Although the delevering/relevering methodology is standard for WACC analyses, the formula does not produce a highly accurate result = Remember the fundamentals: the market charges more for equity of companies that are financially risky m Exercise 1, Levered Beta = 1.25, T = 40%, D/ 2. Find the levered Beta at a D/E = 1.0 1.75; What is the Beta Unlevered? Ssermorgan= Investors typically expect higher returns et ep am when investing in smaller companies oat Increased risk Lower liquidity a ee * om m Betas vary very little by size I I Eigeaa™ ™ Historical equity returns suggest higher oo 250 "300 708 : return required by investors in smaller eieale EE 2 1 P/E growth ratios (PEG) tend to decline with : size 2 z ‘= Empirical data combined with judgement should be applied when estimating the cost ue of equity for smaller firms B oO ISCOUNTED CASH FLOW A Ssermorgan The cost of a firm’s equity should be adjusted for size Si00si0 Ss00.0m Sr.o002s00 s25005,000 $5.00 “JPMorgan uses the long-term cost of debt in estimating WACC '& The long-term cost of debt is used because the cost of capital is normally applied to long-term cash flows 1 Using the long-term cost of debt removes any refinancing costs/risks from the valuation analysis To the extent a company can fund its investments at a lower cost of debt (with the same risk), this value should be attributed to the finance staff ‘= JPMorgan uses the company’s normalized cash tax rate SsermorganThe cost of equity and debt are blended together based on a target capital structure = The target capital structure reflects the company's rating objective Firms generally try to minimize the cost of capital through the appropriate use of leverage = The percentage weighting of debt and equity is usually based on the market value of a firm’s equity and debt position Most firms are at their target capital structure ‘Adjustments should be made for seasonal or cyctical swings, as well as for firms moving toward a target 1 Using a weighted average cost of capital assumes that all investments are funded with the same mix of equity and debt as the target capital structure WACC=ro * [DUNT + te * E Where: T= Marginal tax rate D+E Die E=Market value of equity re = Return on equity D=Market value of debt r= Return on debt Cost of eculty Cost of debt Costor capita cost of ett one {ovyearT-bone (Avg) 49% (0 Taxstietd! 2.19% Maret es premium s.008 (Beta (current predictea) rt ened ‘tiene ens debt 406% Sqotdactecciaar Se (ee {EEE Cest oF equity ‘spmorganLysis Flow ISCOUNTED CASH Example: Calculating WACC based on comparable companies Bek free rte! 5.0% Projected Target marginal tax rate 0.0% {stimated market equty rk premium, 4.0% Net Total Costot—_Contot comparable Projected dettimit: debit. Ueveed levered unlevered company levered bet? a oe Cempany 406 ~STaR 00 OSCR cemmpany 8 om = 0k a ry) as Cempany€ a 037 oo ost 78 cemmpany a 86 101 a ee) aa average 0942.08 sae ogo ot Boe SES Sprensto vere beta mina ‘oye Prevactorg “suring Cortof Target deomaret trench Coty ek tnrmeosot smlevered tered tia Ceptalzaten optimal de/equy (op) “premium "bt tetnarory —equty Wace 2008 a9 SD COOK 10 oak. 00 “7 200m aa tm 88 a 00 1000 209 a 1a tos za ‘oo 100 400 ow oa ttn 20 700 ma smo om aa tor a0 a2 “tree ated omar of 10 year US, Tay bod aro 1/1/01 Sore: aonb) 2Sarce sigan Ma esereh ‘Utero bettered at ta nae sl egy xa) Asians bel of et eas 0 Ssermorganvsis ISCOUNTED CASH FLOW ANA The appropriate cost of capital will depend on the entity which is being valued Rsk Unievered Optimal —_—Re-evered Cost of Costot Company premium bbeta__debU/eauity beta equity financing wace Sysco. 3.0% 0.70 20% 0.80 9.0% 6.23% 828 S10 target 5.06.56 0.70 20% 080 908-1035 6.25750 | BIK-9.38 580mm target 5.07.08 070 20% 0.80 9.081065 6.25%-20m | Bae-97% 200mm target 5.087.56 0.70 20% 0.80 9.081105 6.2K-A50 | 8ae-10.1% SS | Tea =o =< ee ae a ee n° rr a ee Beli rm rox cat ER nm om om cm fax oa anion Balas rm rau re SGA om on mn a fee taaeettariis 0.80] 8.5% 8.2% 7.8% 7.6% £085 100k 9.6% 9.2% 8.9% 10.8% 10.4% 10.08 9.7% 0.85 8.8% 8.4% 8.0% 7.8% 7 0.90 10.3% 9.8% 9.4% 9.1% 11.2% 10.7% 10.3% 10.06 Levered beta eeeees | Levered beta "Assmingon ety ak erwin 8 8% *ASziing on omy st premnot 735. SsermorganOUNTED CASH DCF in-class exercise Ssermorgan = The Forecasted EBITDA and FCF for the next three years (2005, 2006, 2007) are EBITDA (US Smm): 450, 500, 550 FCF (US $mm): 250, 261, 277 = Other assumptions: Perpetuity growth rate of 3.0% Terminal exit multiple of 7.5x Unlevered beta of 0.80 Risk free rate= 4.6% ‘Market risk premium= 6% Cost of debt: 6.2% ‘Marginal tax rate: 35% ‘Market value of equity-US $4,541mm Net debt= US $2,524mm,DCF in-class exercise (cont'd) = Calculate The cost of equity WACC PV of FCF NPV of company Perpetual growth method PV of Exit multiple method What if we use end period discounting in: Perpetual growth method Exit multiple method What is the valuation if we need to value the company as on March 31, 2005? Use Exit/Perpetual growth methods using mid year conventions Use Exit/Perpetual growth methods using end year conventions SsermorganMost common errors in calculating WACC Ssermorgan Cost of equity = Equity risk premium based on very long time frame (post 1926: Ibbotson data) Substitute hurdle rate (goal) for _of capital Use of historical (or predicted) betas that are clearly wrong Investment specific risk not fully incorporated (e.g., country risk premiums) Incorrect releveraging of the cost of equity Cost of equity based on book returns, not market expectations arget capital structure = The actual, not target, capital structure is used = WAC calculated based on book weightsValuing synergies Ssermorgan = When two businesses are combined, the term “synergies” refers to the changes in their aggregate operating and/or financial results attributable to their being operated as a combined enterprise. Synergies can take many forms Revenue enhancements Cost savings Raw material discounts/purchasing power Sales and marketing overlap, Corporate overhead reductions Distribution cost reductions, Facilities consolidation Tax savings ‘Merger related expenses (restructuring, additional CAPEX, integration expenses) = The value of achievable synergies is often a key element in whether to proceed with a proposed transaction Calculate synergies for both the acquiring company and the target Remember incremental cash flow i Synergies are generally valued by toggling pre-tax changes to various financial statement line items into a DCF model of the combined enterprise and simply measuring the incremental impactValuing synergies 1 Sources of synergy projections ‘Management Research Estimates from comparable transaction (% of sales, increase in EBITDA margin etc.) © DCF with synergies Valued separately from standalone DCF Run sensitivity on synergy valuations © Other considerations Timeline for achieving synergies Run as sensitivity various cases of realization e.g., 25%, 50%, 75%, 100% realization Tax impact Costs incurred to achieve synergies OUNTED CASH SsermorganSensitivity analysis is vital when presenting the results of DCF analysis = Recall that DCF valuation is highly sensitive to projections and assumptions 1 So-called “sensitivity tables” chart the output based on ranges of input variables It is common to use a 3x3 table (i.e., showing three different values for each of two input variables) to enable the reader to “triangulate” to the appropriate inferences Since DCF results are by their nature approximate, depicting sensitivity tables enables users of DCF output to assess the degree of “fuzziness” in the results 1@ As shown in our previous examples, DCF analyses using exit multiples and perpetuity growth rates generally show sensitivities for the method used to calculate terminal value and a range of discount rates Sensitivities can be shown for any variable in the model (including financial projections) Judge which sensitivities would be useful to decision makers Ssermorgan PmCompanies with multiple businesses are often valued on a) === sum-of-the-parts basis Ssermorgan = This approach {s sometimes referred-to as a “break-up” valuation Particularly common when the company is believed to be undervalued by the public Better accounts for discrepancies in market conditions facing the businesses = The methodology requires estimating financial results for each business (EBIT, EBITDA and/or net income), which can then be used with appropriate multiples or growth rates in order to arrive at a firm value for each part before the results are summed = Completing a sum-of-the-parts valuation can be more challenging than a straightforward (single-business/consolidated) DCF analysts Typically less detailed financial data is publicly-available for segments Often assumptions must be made about how to allocate expenses, especially those that are clearly shared across businesses (like corporate- level SG&A) Need to consider different characteristics of each business segment (discount rate, terminal value assumptions, etc.)ANALYSIS eR MERG oc wer Agenda Ssermorgan ace Introduction 1 Discounted cash flow analysis 6 Iue analysis a Merger consequences nIntroduction to relative valuation & Relative valuation is utilized to illustrate how the value of one company compares to another company & Typically, relative valuation analysis is utilized in the context of stock-for-stock exchanges to determine the appropriate exchange ratio offered to shareholders in a transaction = The exchange ratio reflects the number of acquiror shares offered for each target share So if you are a target shareholder and you are offered an exchange ratio of 0.500x, you are being offer 1/2 of an acquiror share for each share of the target you own = Several relative valuation approaches exist Historical trading and exchange ratio analysis Contribution analysis Relative multiple and discounted cash flow analysis, Valuation of synergiesHistorical trading and exchange ratio analy ™ Historical exchange ratio analysis Illustrates the relative movement in stock prices (and implied exchange ratios, aka “natural exchange ratios”) looking back over a certain timeframe = Calculated simply as the target share price on a given date divided by the acquiror share price on the same date Does not include any premium to the target = Provides a historical benchmark to justify the contemplated exchange ratio, 1 Issues to consider when analyzing data include Liquidity of shares / trading volume (small vs. large cap) Relative market attention / analyst coverage ‘Multiple expansion of one of the company's peer group versus the other over the selected time horizonIlustrative historical trading and exchange ratio analysis os LES oe Sees) a Se ett ae ee ftts TPs eee ott deca pa wp [es = eg eee ees ee = favorable | 03%" -------------/) 7 - Ss peal | : 2 Eee EE PE SELES yh 5 Less 0.15% Current = 0.194x | ice : ie : Sepa a ee Saal a eae e "eran sean sichnge ato othe ain prod nde ine, 22 "Closes aot hn 7200. snes pears rn pe ofS 50 pe are Syemorgan 39Contribution analysis = Compares the relative equity valuation of two parties to their respective “contribution” to a combined company’s financial performance = Typical firm value metrics would include Revenues EBITDA EBIT Unlevered free cash flow measures Industry-specific (i.e. customers, reserves, etc.) & Typical equity value metrics would include Net income Levered free cash flow measures 2 = Cautionary note: contribution analysis does not measure the growth and risk profile of the two companies’ financial performance and differing multiples may be Justifiablie when assessing relative values urs RELATIVE VALUE ANA Relative contribution analysis ‘contribution Firm value! ‘ a om RES ae teen "asd on he fer ech rt of 31s and Pesi'sleshe pce $27.1 7/12/04 "Canoe maroler ied pede enc ave bre addy flexing hea the navenat nonin ol ack ret fc conga 2 “tnd on BS ES grown ana nd sera argh emt flag po SyemorganSample relative value football field: Acquiror valuation ss0.00 ~~ 22 ae pase © sonas oe et 7: : a em ; = ete) soo “sn128 ane pe arent = $27.19 $10.00 0.00 steel Ow Ro Aw HE H.C IBOX ———Sumotears sce rate 905 evn oor arn footer “mre ee ern i et te oe usm wot ivecw iso eee eel ered ovecompryaae OCF ana? "compari dent corny nad pb compry aa ae bad on ela pet xan "ned en monogenean Syemorgan ‘4s urs RELATIVE VALUE ANA Relative valuation summary tne ‘aire Exchange ratio! Hightow ow sttgh ee $5.00/520.50 s5iay/$83.00 Wigh/tow tow igh $5.50/830.15. §3:50/848.25 si 0106 “ aaa Offer: 0 wane cn ca a = i oan Nimnleccung: RE Tanacion | Siectenc re. SnecensoAgne Mm curcAga.MymtcaQnt. Coben ‘ote eA vie ee socnes co Gavin & Gamelan ‘Deentia) Eremted) ae ama *Gachenge ato rage cowpte yo the iow ety alo esha of Target ig arts vation meee rhe l/h alain ‘heocurar sngreanvasatn metasene, SsermorganRELATIVE VALUE ANALYSIS Merger of Equals transactions—example Pers tant te pre one cay io to ammouncorent Source Pes else, Eis, SC SyemorganANALYSIS AND -MERG vce wer Agenda Ssermorgan Pace Introduction 1 Discounted cash flow analysis 6 Relative value analysis 56 ™ Accretion/(dilution) review = Pro forma balance sheet analysis reviewIntroduction = Pro forma analysis provides both acquirers and targets insight into the income statement and balance sheet impact of a transaction Revenue, EBITDA or earnings impact Capitalization, leverage and credit capacity impact = Valuable tool for both acquirer and target Indicates buyer’s ability to pay Suggests most appropriate form of consideration to offer Allows buyer to predict or manage market reaction to announcement Demonstrates landscape of competing buyers ™ Balance sheet and income statement impact go hand-in-hand Both driven by form and amount of consideration SsermorganANALYSIS ER CF AND MERGE ° wer Agenda Ssermorgan Pace Introduction 1 Discounted cash flow analysis 6 Relative value analysis 56 = Accretion/(dilution) review = Pro forma balance sheet analysis reviewOverview of accretion/(dilution) analysis = Accretion/ (dilution) primarily measures the impact of a merger or acquisition on the income statement of a potential buyer = Accretion/ (dilution) analysis can be based on revenue, EBITDA, earnings, after-tax cash flow, and dividends per share EPS is most commonly used form of accretion/ (dilution) analysis. Industry will typically dictate which are the most relevant metrics (e.g. wireless telecom companies may prefer to show EBITDA) = Two methods exist for calculating accretion/ (dilution) “Top down”: integrated merger model “Bottom up”: transaction-adjusted, estimate-based model = Key measures for accretion/ (dilution) Dollar and percent change of acquirer earnings per share Pre-tax synergies required for break-even impact to EPS Pro forma ownership when stock is used as an acquisition currency Pro forma leverage/capitalization' "Wt that opto wl harge when ack sed a et dt rages lange when ahs ed SsermorganPurpose of accretion/(dilution) analysis Ssermorgan = Accretion/ (dilution) analysis can be used to determine ‘The capacity of the acquirer (or potential acquirers) to pay a premium for a target Optimal form of consideration (cash, stock, other securities, combination) = Used by both buyers and sellers Buyers identify highest price they can afford to pay and what currency to offer Buyers evaluate how much competing bidders can afford to pay Sellers evaluate what price potential buyers can afford to pay and in what currency In the context of a divestiture, sellers also evaluate their break-even sale price and required currency = Typically, JPMorgan performs sensitivity analyses to find break-even points where the offer price for a target results in no incremental earnings or losses to acquirer's earnings per shareCONSEQUENCES weERG Two primary methods exist to compute accretion/(dilution) Description Benefits Considerations ‘Top down Integrated merger model with projected balance shest nd cach flow statement for target, Acqui=r ane the combined company 1 Provides most accurate picture of combined companies 1 Reflects impact of det pay-down and other cashflow impiieations to nt intrest expense and net income 1 Cleary ard accurately shows balance sheet lrmpact in ro forma statistics 1 Difficult to efficinty incorporate multiple acquirers and targets for competitive analysts 1 Relies on estimates which, although more Tobust, afe also subject to uncertainty oF ‘uestionable assumptions ‘Bottom up £5 estimate-based analysis that combines acquirer and target projection, adjusting for impact of ‘ncremartal roneaetion rated expenses and 1 Quick and intuitive demonstration of acretive or cutive impact 1 Flexible analysis that can incorporate multiple buyers or targets ' Risks over-simpifying pro forma analysis and ove. crunderstating impact to acquirer ' Way be inappropriate for a deal where the acquirer’ creat rating i impacted by the transaction 1 Aust be customized for asset deals, joint ventures and other transactions SsermorganCONSEQUENCES weERG Sample transaction assumptions = Acquirer buying target with the following transaction assumptions: Transaction closes 12/31/04 Advisory fees of 0.25% of transaction value Financing fees of 1.0% on debt issued (amortized a deferred financing fees over 7 years) Interest rates assumptions Tranche | ($300mm maximum senior debt): 7.0% Tranche Il (subordinated debt): 12.5% Interest rate earned on existing cash: 3.0% ‘Tax rate on incremental earnings and expenses (including net interest expense): 35% Dividend policy of acquirer remains unchanged 50% of excess purchase price allocated to goodwill (approximately $70 million) Remaining 50% of excess purchase price allocated to asset write-up and depreciated over 20 years, Targets existing debt not refinanced Syemorgan ara catateton ‘a et ee 62050) sooo “ioe 120 ride per star mal: soa Ip er pd om. Sen 592 Sure captain st Frmvaloe wast ‘oot 36 en este ae os Ime tienes a rs Si BaeMERGER CONSEQUENCES Key adjustments to pro forma income statement Consideration ‘Adjustment Stock Cash Mix After-tax financing fee amortization x x Non-deductible advisory fee amortization After-tax incremental DDA from asset write-up x x x After-tax interest on transaction debt x x After-tax interest deduction from cash used x x x After-tax interest (loss) gain on dividend shortfall x x x After-tax synergies x x x ‘Transaction goodwill impairment x x x ‘Change in pro forma fully diluted shares x x Ssermorganconsequences ERGE What is in a “consensus” estimate? 1 First Call and 1/8/E/S consensus estimates are based on an aggregation of research analysts’ estimates, with little discretion applied to mean and median calculations Quality of estimates and analysts varies dramatically across consensus samples Modeling conventions are often not explained or apparent Analysts may be assuming different projected share counts, rather than net income '= Some estimates included in consensus numbers are out-dated May not reflect updated company guidance or recent financial results May not reflect abrupt changes to underlying industry economics May not reflect recent M&A transactions or securities offerings 1m Items embedded in consensus estimates are not always clearly explained or uniform across samples Fully diluted share assumptions and treatment of options and convertibles may vary Interest expense Tax rates Accounting policies Stock-based compensation and amortization of intangibles other than goodwill SyemorganCONSEQUEN WERGE Transaction assumptions are the foundation of all sound analysis '= Choose an appropriate closing date reflecting available information and transaction structure Timing of process requirements for closing (share registration, shareholder votes, etc.) Timing of regulatory requirements for closing (HSR review, etc.) Seasonality of industry economics and impact on estimates or calendarization = Capital structures should best reflect current circumstances Equity currency should be reviewed in context of recent share price and larger equity market performance Cash deals should reflect reasonable interest rates and lending market capacity Pro forma leverage and interest coverage levels should be consistent with acquirer's desired credit rating = Both advisory and financing fees have a meaningful impact on pro forma financials Although equity analysts tend to “look through” some extraordinary charges, advisory and other one- time fees will impact the cash balance used in the transaction and subsequent annual interest expense Amortization of financing fees will impact EPS aver the immediate future of the combined entity = Tax rate on incremental earnings and expenses should reflect acquiror’s and target’s combined tax efficiencies and adjustments should be made to post-transaction tax expenses for potential NOLs assumed by an acquirer Syemorgan 80MERGER CONSEQUENCES Sample transaction 00% stock consideration Teer hare pie 5200 nage res 2003 Fe tax arte ster dare tn To as 8 Acquirer shares outstanding 58.669 —— - -_ secrets Tage share price: sins Tone abe Arts ne anoraton oo mo oot re 84 Moockton suerte a a nets vrei ek oa, oa Traction assuring 25% prem ‘ttre and ehd on on Otter rc (essing 25% premio) $1531 incre onygenon averse a sy Shares acaured" aes Maclean 30 ipl exchange ati (T/A) ioe ‘aman ananon inom) 80 ‘Shares issued 32.466 “Total adjustments to net income as Tecra on erent eens 3508 rotomane care ssa tar nem ean) Gam goon ‘ta tin een dtc pepo so "od bec wine te or pert caret rt ke "nea finden exer ne aren for 2.9 on SsermorganConsiderations for a stock transaction = P/Es and relative valuations play a meaningful role in accretion/ (dilution) analysis High P/E of an acquirer may imply stock may be “cheap” acquisition currency, relative to lower P/E stock or the “implied debt P/E” = A number of issues will play an important role in the optics, attitudes and receptivity of principals and investors in a transaction Exchange ratios should not be grossly inconsistent with historical relative trading performance of acquirer and target Purchase price and pro forma ownership should take into account contribution analysis, = Flow back and sell-off of acquirer stock could meaningfully affect acquirer’s share prices on announcement/closing Cross-shareholder analysis, Whether acquirer and target are included in the same indexes, if any Fund limitations on owning international stocks and/or stocks not listed on local lexchanges Dividend policy implications of receiving acquirer stock SsermorganSample transaction 00% cash consideration Figures nitions, except per share data 20032004 Target share pri: $1225 Aequer ES suet S10 (ter rice (assuring 258 premium) 15.31 Acquirer ne income 98.3057 Shares sequres! 42.48 Taner tS 5095515 Debt suet unt scquiton: uty porches with ash $6503 Adjustments Tranaction feet 29° ate-taxtnancng fee amortization 150.6) 608) Francis fees 6 Nondedette névizn fee aartzaton 00 a0 (ash balance used in trarsacton (0.0) Atertax OD8A fom az writeup aa 2 Teal dete raed $6598 eras interest on ansation debt 29) a4) ‘Aer tax terest edict rom cath wed 00 00 Debt alocation: ‘Avera ees (ass) gain on vena dal, 408 Teache | $9000 Atertar series 00 00 Teanete 359.8 Taysactlon ocowl amortzation or inpatment) «0900 Other eductone 00 00 . erst ates: Total adjusts to net income a 470) o Tranche | 70% z ‘Tranche I 123% Proforma net income sm4 51189 7 Proforma shares ottandng sas 58.089 3 erst at on foregone cash balance ow 2 Pro forma £P5 st 2.03 z Tax rate on rcrementl earings 35.0% Aecretion/uton (5) (19 9023 S ‘Accretion (tution) (5) (61%) 2.3% S Pre-tax synergies to break-even sur onw "Sou be calle ins te lr pert cent are rk SsermorganConsiderations for a cash transaction Ssermorgan = Use multiple tranches of debt where appropriate Reflects capital structure and market capacity limitations for larger deals Varying interest rate on debt tranches will impact interest expense on offer price increases or decreases, Note that depending on debt mix, stock may be more or less appropriate as an acquisition currency '= Financing assumptions should reflect both acquirer's stand-alone and combined debt capacity and ratings circumstances Debt coverage and capitalization statistics should be included to highlight potential ratings issues ‘and support interest rate assumptions Current and recent ratings history of acquirer should be reviewed to confirm ability to issue debt securities Covenants of existing acquirer debt should be considered Review transaction and pro forma financials with ratings advisory and DCM teams to determine appropriate rates = Use existing acquirer cash sparingly, if at all Existing cash is likely used to meet working capital funding requirements ‘Minimum cash balance may be required for debt covenants Opportunity cost of using cash on hand should always be contemplated and reflected in interest expense Restricted cash considerationsSample transaction—50% cash/50% stock consideration Figures nitions, excet per share data 20012004 Target sare price $12.25 Aeqier ES suet S10 (er rice (suing 258 premium) 15.31 Acquirer net income 3057 Shares acquires 424s Targets 5095 $15 shares eed ‘2a Asserts Debt sted to fund acautton: ‘tera tnncne fee amortization 150.3) 603) aut parched with cash $525.1 Non deductible advisory’ other fee 09 00 Tramaction fees 29° Ater-ax DDGA tom ast write-up an 2 Frarcig fees 3:3 Mera neres on transaction debt 116.2) 169) ash balance ue in tarsacton (0) Ater-tax interest dedveten fom cash used 20 00 Teal dee raed 201g Atertax interest (os gai on viene short, 1 a2 ‘er tax sets 00 a0 ext allocation ‘Trorsactlon wool amortization or impatiment) «0.9. Teanehe 2000 Other reductions 00 00 Fi Tranche I 313 Tota adjustments tone income 18.7) (93) z Interest Rates: Proforma net income SUPA 51466 7 Tranche | 1. ey rason 74.902 S Teanehe 1258 2 Pro forma EPS 5159 $1.96 2 erst ate foregone an cath balance 310k Aecreton/atuton (5) (0.0) S016 § ‘eceton/ ton) (5) Gy 868 as rate on cremental earings a0 Pretax syeres to break-even soo ow SsermorganERGE The role of P/E valuations in accretion/(dilution) 1 For stock-for-stock deals, accretion or dilution potential will usually be evident by simply comparing the P/E multiples of the acquirer and the target, I the acquirer has a higher P/E than the target, the deal will be accretive because the acquirer is buying more EPS than the target shareholders are accepting as consideration If the acquirer has a lower P/E than the target, the deal will be dilutive because the acquirer is buying less EPS than the target shareholders are accepting as consideration, Remember to take the premium into account when calculating the target's P/E UUulity of comparison will also depend on transaction assumptions regarding goodwill impairment fr other asset amortization "= For 100% cash transactions, the cost of debt (interest payments) and cost of acquiring the target’s earnings will determine the accretive or dilutive impact af a transaction Where the inverse cost of debt (1/(after-tax cost of debt)) is greater than the P/E of the target, ‘the deal will be accretive Where the inverse cost of debt is lower than the P/E of the target, the deal will be dilutive SsermorganCONSEQUENCES weERG Presenting accretion/(dilution) with sensitivities = Sensitivities provide the total picture of a transaction’s potential impact; relevant sensitivities to demonstrate may include Premium (discount) Consideration offered (% of stock/% of cash) ‘Acquirer’s stock price Earnings per share Synergies Interest rate(s) on debt issued § Sensitivities should reflect consideration specifics Purchase price and ownership (stock) Stock consideration Stock ensderatin 500% 25% 750K —B7SK 100.0% Sos 625% 75.08 75K 100.08 100%, Lk 1%) GONE AH) HOGER? 883 SHOA STA 200%) 6.0K) 45K) GSK) 3K) BK) GOK, 5883 18S B F200 7-7) as) HO2N) (LH) CAB —EB.OH Os 2 Esox) (4.1m (35% (15.28) (68H) (181K) Ean) 82 BH _s09%| 02%) (9.9 49.9%) AIBN) BSR) MOAT M888 SyemorganRelevant sample transaction sensitivities Acquirer stock price Pre-tax synergies realized 2003, $19.00 $20.03, $21.00 $22.00 $23.00 $50 S100 $150 $200 $25.0 tom! 61) 6) GOH GSH) TOOK TH OK —OHES CATE 20.0% (11.68) 8X) B38) 8H) GSA) g2OOK, TH] SSK) IK). 1.08 B00 | 115.25) BAN) (1.8K) (10.38) IN EB.OK) 11.35) 2A) OY. IK 40.0% 200%) (18.1%) 16.9%) (5.0%) (1338) EaDOF (16.1) (14TH) (IZIKY—HO.AB)— 8.18) soc) 244s) 22.5% OR) 119.38) (7.8) 5.0K) OSS) 187) (168K) (14.9%) (13.08) Interest rate on senior debt (Tranche 1) Blended interest rate (8) 655 7.08 75K BOBS 11.08 1058 10.08 9.58 9.0K tom, 3 kN OOK) toe! 3H) GIS) LIN ANCOR gm A) OH) IN) GIN) IH gMDOW, 7H GSH GH). 8H ERK) Ax) AR) (HOARY (HFK) (1A E3D.9R) (13.80) (1.6K) .ZR)_—AR) Ero) a7 819 (9.1% oy atiy — Eaooe) a2se) 038) (8.1) (5.9K) 1.7%) 50.0% (25.98) (25.98) 27.9%) 8.9%) 9.98) 5DOK| 1.38) HAS) 6-98)_—RA.TH)_—_ 2.6K) CONSEQUEN weERG SsermorganSynergies and transaction related cos = Synergies For top-down modeling simplicity, assume synergies come from cost-savings unless told otherwise Revenue synergies Incremental revenues may have costs associated with them that need to be reflected in any synergy calculations (e.g variable margins on incremental revenues) Equity markets heavily discount or, in many cases, disregard revenue synergies, as they are typically difficult to quantify and accurately project Synergies are typically realized gradually over time and should be phased in accordingly It may be prudent to “risk-adjust” any expected synergies to account for ability to realize them and/or for negative synergies (i.e., integration costs) Consider the cash flow impact of synergies = One-time charges and expenses ‘Acquiring companies will incur one-time merger-related costs due to reorganization, severance packages One-time charges are disclosed in SEC filings From a valuation perspective, the Street “looks through” one-time charges Include the net interest impact of cash changes ERGE SsermorganAdditional items to consider = Tax benefits In assuming additional options are exercised under premium scenarios a tax shield will be generated based on the implied deductible compensation expense generated from the vesting / exercise of options at a discount to the acquisition price Asset write-ups have tax implications" ™ Acquirers may be forced to pay “interest on interest” In using cash and thereby raising debt, an acquirer will incur future interest and amortization payments that may require additional borrowing. AccretionOne calculation method = Asset write-ups and additional depreciation expenses While asset write-ups will reduce goodwill generated in a transaction, they will increase annual depreciation expenses based on the incremental increase in depreciable assets Limiting asset write-ups will reduce negative impact of increased depreciation expenses In some cases, asset write-downs may impact EPS accretion / dilution = Impact of dividends paid by acquirer ‘Additional cash will be necessary to fund new dividends paid and should be reflected in incremental expenses Dividend accretion /(dilution) analysis may be relevant to determine appropriate premium ‘Weaupcrat teeta nity gil he teupmutedby te ace) ERGE Ssermorgan 0Summary considerations for EPS accretion/(dilution) analysis '= EPS-based accretion/ (dilution) is only a back-of-the-envelope exercise and is not a substitute for an integrated merger model Does not necessarily reflect cash flow implications and debt pay-down capabilities of combined company = EPS estimates should be used with caution First Call and 1/B/E/S estimates are consensus numbers that do not always reflect consistent underlying assumptions ‘Small differences in EPS figures can have dramatic impact on net income ($0.05 per share on 200 million shares reflects a $10 million variance in net income) = Share count of target must be a dynamic number Share count should increase (decrease) with offer price to reflect additional (reduced) shares underlying in-the-money options = Negative net income targets CANNOT create meaningful accretion '= Accretion/ (dilution) should always be sanity-checked Relative P/Es Acquirer's cost of debt vs. cost of target’s earnings = Aceretion/(dilution) should always be checked with your calculator SsermorganANALYSIS ER CF AND MERGE ° wer Agenda Ssermorgan Pace Introduction 1 Discounted cash flow analysis 6 Relative value analysis 56 ® Accretion/ (dilution) reviewOverview of pro forma balance sheet analysis Ssermorgan = Pro forma balance sheet analysis provides a means of assessing the impact of a potential transaction on an acquirer’s cost of borrowing, market access, and financial flexibility = Two methods exist for demonstrating balance sheet impact: “Top down”: integrated merger model with income statement, balance sheet and cash flow statement (preferred) “Bottom up”: transaction-adjusted, LTM-based model 1 Pro forma balance sheet analysis relies primarily upon a comparison of an acquirer's pre- and post-acquisition credit metrics = Key credit metrics include: Pretax interest coverage EBITDA interest coverage Funds from operations to interest Funds from operations to debt Debt to EBITDA Debt to book capitalizationSignificance of pro forma balance sheet analysis = Pro forma balance sheet analysis is critical in determining ‘The debt-financed acquisition capacity of an acquirer (or competing bidders) Required equity component of an offer to ensure a particular rating outcome Financing implications of a particular transaction structure (cost of capital and market access) Ina divestiture, the pro forma credit rating of the seller and the minimum level of cash consideration needed = Used by both buyers and sellers Buyers identify highest price they can afford to pay and how much cash can be offered Buyers evaluate how much other competitive bidders can afford to pay Sellers evaluate how much potential buyers can afford to pay and how much cash to demand a = Typically, JPMorgan performs sensitivity analyses to address relevant inflection = points where the offer price for a target results in meaningful changes to a combined 7 capital structure SsermorganCredit ratings as a key financing decision driver = A company’s corporate credit rating determines its Cost of borrowing Breadth and depth of access to the capital markets Financial flexibility (liquidity /covenant constraints) = Pro forma balance sheet analysis allows potential acquirers to assess leverage breakpoints and their associated ratings outcomes in order to develop a comprehensive financing plan & Significant debt-financed transactions can erode credit profile and can lead to a ratings downgrade = The determination of potential financing structures is often bound by the trade-offs between maximizing EPS subject to limiting ratings pressure SsermorganSample transaction —100%cash consideration ‘equirer Terget ‘Adjustments Proforma Total debt $800.0 $975.0 $089.8 52,034.8 Sharcholders equity value 9500 325.0 (525.0) 950.0 Minority interest oo 00. 00 00 Income statement: LrmesrTo8 $226.0 sis 5345.0 Lrmearr 176.0 940 2700 LIM interest expense 350 00 28 ur epitalization Debtreuity oar 105.58 2428 Debt/total capitalization’ 6m 5238 68.2% Debt/LTM EBITDA 35 48 5% Debe/LTH EBT 45 on ts LIMEBITDA interest 4a 30 2s LIMEBIT/interest 32 2 20 oe: xcs ee ets ever ne yb secs MInise iory morse SsermorganSample transaction 00% stock consideration ‘equirer Terget ‘Adjustments Proforma Total debt $800.0 $975.0 90 51375.0 Sharcholders equity value 950.0 525.0 053 1600.3 Minority interest oo 00. 00 00 Income statement: LrmesrTo8 5226.0 si. 5345.0 Umea 1760 940 270.0 LIM interest expense 550 00 00 95.0 epiztization Debtreity bare 105.58 55.9% Debt/total capitalization’ 6m 5238 462% Debt/LTM EBITDA 3 4 408 Debe/LTH EBT 45 6a 54 LIMEBITDA interest 4a 30 36 LIMEBIT/interest 32 2a 28 oe: xcs ee ets ever ne yb secs MInise iory morse SsermorganPro forma balance sheet sensitivities Stock consideration 0.0% 250% 500K 75.0% __ 100.08 woos! 67k Sak STMSCBRSR TSS lm Sensitivities should demonstrate the impact g 20.08) 67.9% 61.6% 57.3% 52.0% 46.6% of changes to relevant metrics 300%) 65.5% 68% STIRS 45. Consideration (stock vs. cash) cy) SSO at 1 Oe a Estimates (EBITDA) 08) 7.38 698 s6ax sock 8.28 Assumptions (premium, interest rates, etc.) © Similar to EPS analysis, sensitivities provide the “whole picture” reer Siok crt oo 5 SO Tem 0M ee er ee ee ston See S20 ste Aste 598 NOOR e283 ae ae E) Finon 60 57am wa Esme 26k 5) Ean 6s sus nase Eom ue es) S) sno a0 sas sas att) som) 222s) weERG