3. Most, if not all of the value of this deal is coming from the RHS.

Typically, strategic buyers look to create value on the LHS, but in the case of Carters management had done a very good job at increasing revenues and EBITDA, lowering cost structure, expanding into discount channels and pursuing offshore manufacturing. These measures effectively decreased many of the potential synergies a strategic buyer may have been able to generate lowering the attractiveness of Carters as a target. Additionally, the current market environment, high growth and bullish market, could result in temporarily inflated prices for strategic buyers who might view this investment as too expensive. On the other hand many of these attributes are exactly the thing that financial sponsors are looking for in LBO targets. 8. Managements projections are optimistic, especially regarding sale growth, profit margin and SG&A margins. With regards to profit and SG&A margins this is particularly true since the company has already undertaken significant efficiency improvements so it is unclear where this performance increases are coming from over the next five years. With regards to sales growth, managements 2000-2005 growth assumptions rely heavily on new untested business ventures, including Target and full-priced retail stores. As it is, they are already 4-5% higher than historical performance. Exhibit X lays out several sensitivity analysis based on these variables, projected CAGR, new business CAGR, gross margins and SG&A margins. We find that based on historical assumptions vs. management forecasts, 2005 EBITDA would be 55-65% lower than projected. 9. There are a few reasons why a private equity firms hurdle rate would be higher than cost of capital calculated using CAPM. Specifically, the principle-agent problem and the opportunity cost of any investment. In the PE industry, hurdle rates stand for minimum rates of return for external investors that have to be met before the management of the PE firm receives carried interest. This misalignment of incentives causes firms to have hurdle rates higher than CAPM. Because a PE firm must commit a significant amount of capital to an investment, the firms required rate of return must reflect the total risk of the investment, the correlation of that risk with the risk of other investment opportunities, and achievable diversification. PE firms are typically less diversified and the investments are illiquid and therefore want to be rewarded for holding idiosyncratic risk. Additionally, PE firms uses high hurdle rates to discount only a success scenario projection for the investment. The firm does not explicitly value scenarios other than success and by biasing the discount rate upward; the investor implicitly addresses prospects for failure and for less-than-envisioned performance.

Corporate Restructuring: Jos Liberti