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P R I V A T E
AN D
C O N F I D E N T I A L
DECEMBER 2004
M&A:
DCF
AND
MERGER
ANALYSIS
[For any pitchbook or presentation including advisory, equity or debt security or loan product or combinations thereof.
NOT for use in fairness/valuation or Commercial Bank presentations.]
DC F
AN D
M E R G E R
AN ALY SI S
This presentation was prepared exclusively for the benefit and internal use of the JPMorgan client to whom it is directly addressed and delivered (including
such clients subsidiaries, the Company) in order to assist the Company in evaluating, on a preliminary basis, the feasibility of a possible transaction or
transactions and does not carry any right of publication or disclosure, in whole or in part, to any other party. This presentation is for discussion purposes
only and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this
presentation nor any of its contents may be disclosed or used for any other purpose without the prior written consent of JPMorgan.
The information in this presentation is based upon any management forecasts supplied to us and reflects prevailing conditions and our views as of this date,
all of which are accordingly subject to change. JPMorgans opinions and estimates constitute JPMorgans judgment and should be regarded as indicative,
preliminary and for illustrative purposes only. In preparing this presentation, we have relied upon and assumed, without independent verification, the
accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of the Company or which was
otherwise reviewed by us. In addition, our analyses are not and do not purport to be appraisals of the assets, stock, or business of the Company or any
other entity. JPMorgan makes no representations as to the actual value which may be received in connection with a transaction nor the legal, tax or
accounting effects of consummating a transaction. Unless expressly contemplated hereby, the information in this presentation does not take into account
the effects of a possible transaction or transactions involving an actual or potential change of control, which may have significant valuation and other
effects.
Notwithstanding anything herein to the contrary, the Company and each of its employees, representatives or other agents may disclose to any and all
persons, without limitation of any kind, the U.S. federal and state income tax treatment and the U.S. federal and state income tax structure of the
transactions contemplated hereby and all materials of any kind (including opinions or other tax analyses) that are provided to the Company relating to such
tax treatment and tax structure insofar as such treatment and/or structure relates to a U.S. federal or state income tax strategy provided to the Company
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entities.
M&A:
This presentation does not constitute a commitment by any JPMorgan entity to underwrite, subscribe for or place any securities or to extend or arrange
credit or to provide any other services.
Agenda
Introduction
56
Merger consequences
71
M&A:
DC F
AN D
M E R G E R
AN ALY SI S
Page
Valuation methodologies
Valuation
methodologies
Publicly traded
comparable
companies
analysis
Public Market
Valuation
Value based on
market trading
multiples of
comparable
companies
I N T R O D U C TI O N
Applied using
historical and
prospective
multiples
Does not include a
control premium
Comparable
transactions
analysis
Private Market
Valuation
Value based on
premium
Discounted
cash flow
analysis
Intrinsic value
of business
Present value of
projected free
cash flows
Incorporates both
short-term and
long-term
expected
performance
Risk in cash flows
and capital
structure captured
in discount rate
Leveraged
buyout/recap
analysis
Value to a
financial/LBO
buyer
Value based on
debt repayment
and return on
equity investment
Other
Liquidation
analysis
Break-up analysis
Historical trading
performance
Expected IPO
valuation
Discounted future
share price
EPS impact
Dividend discount
model
I N T R O D U C TI O N
(1) Discounted
Cash Flow
Analyzes the
present value of
a company's free
cash flow.
(3) Comparable
Acquisition
Transactions
Utilizes data from
M&A transactions
involving similar
companies.
(4) Leveraged
Buy Out
Used to determine
range of potential
value for a
company based on
maximum leverage
capacity.
The science is performing each valuation method correctly, the art is using each
method to develop a valuation recommendation
Price per share
$20.00
$26.75
$15.00
$15.00
Implied
offer =
$8.46
$9.75
$10.00
$10.25
$5.00
$5.00
$5.00
$5.50
$6.00
$4.00
$4.94
$4.00
$3.75
$3.50
$3.00
I N T R O D U C TI O N
$0.00
52-week
high/low
15.0x to 19.0x
2005E EBIT
of $20.6
19.0x to 25.0x
2005E cash
EPS of $0.16
15.0x to 20.0x
2006E cash
EPS of $0.25
2.5x to 4.0x
LTM revenue
of $185.7
Transaction
comparables
Mgmt. Case
Street Case
12% to 15%
Discount Rate
EBIT exit mult.
of 15.0x to 20.0x
12% to 15%
Discount Rate
EBIT exit mult.
of 15.0x to 20.0x
DCF analysis
Equity value
I N T R O D U C TI O N
Assets
Enterprise
value
Enterprise
Value
Equity value
1
The value of debt should be a market value. It may be appropriate to assume book value of debt approximates the market
value as long as the companys credit profile has not changed significantly since the existing debt was issued.
5
Agenda
Introduction
56
Merger consequences
71
M&A:
DC F
AN D
M E R G E R
AN ALY SI S
Page
Valuation
methodologies
Publicly traded
comparable
companies
analysis
Valuation
Value based on
Applied using
historical and
prospective
multiples
D I S C O UN T E D
F L OW
market trading
multiples of
comparable
companies
C A S H
AN AL Y SI S
Public Market
control premium
Comparable
transactions
analysis
Private Market
Valuation
Value based on
premium
Discounted
cash flow
analysis
Intrinsic value
of business
Present value of
projected free
cash flows
Incorporates both
short-term and
long-term
expected
performance
Risk in cash flows
and capital
structure captured
in discount rate
Leveraged
buyout/recap
analysis
Value to a
financial/LBO
buyer
Value based on
debt repayment
and return on
equity investment
Other
Liquidation
analysis
Break-up analysis
Historical trading
performance
Expected IPO
valuation
Discounted future
share price
EPS impact
Dividend discount
model
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
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
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
What is the cost of capital (equity and debt) for the business?
Depending on practical requirements and availability of data, DCF analysis can
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Project the operating results and free cash flows of the business
Projections/FCF
Projections/FCF
over the forecast period (typically 10 years, but can be 520 years
depending on the profitability horizon)
Estimate the exit multiple and/or growth rate in perpetuity of the
Terminal
Terminal value
value
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
Adjust the resulting valuation for all assets and liabilities not
Adjustments
Adjustments
10
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
DCF theory: The value of a productive asset is equal to the present value of all
expected future cash flows that can be removed without affecting the assets value
(including an estimated terminal value), discounted using an appropriate weightedaverage cost of capital
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
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
These future free cash flows are discounted to the present at a discount rate
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
11
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
excess cash
Present value obtained is the value of assets, assuming no debt or excess cash
interest income
Present value obtained is the value of equity
Cash flows are discounted at the cost of equity
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
12
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
Other considerations
WACC
Other topics
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
approximate. Use several scenarios to bound the targets value. Generally, the best
variables to sensitize are sales, EBITDA margin, WACC and exit multiples or
perpetuity growth rate
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
Remember that DCF valuations are based on assumptions and are therefore
13
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
Always remember
WACC
Other topics
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
14
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
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
Acquiring companys management
Research analysts
Bankers
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
15
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Ideally projections should go out as far into the future as can reasonably be
costs
Synergies: Estimate dollars in Year 1 and evaluate margin impact over time
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
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
16
Overview
Free cash flow is the cash that remains for creditors and
owners after taxes and reinvestment
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Unlevered free cash flows can be forecast from a firms financial projections, even if
taxes)
EBIT (from the income statement)
F L OW
D I S C O UN T E D
C A S H
Although beyond the scope of our current discussions, you should only include actual cash taxes paid in the DCF. Depending on the firm and industry, you may want to adjust
for the non-cash (or deferred) portion of a firms tax provision. The tax footnote in the financial statements will give you a good idea of whether this is a meaningful issue
for your analysis
17
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Stand-alone
Stand-alone DCF
DCF analysis
analysis of
of Company
Company X
X
$
millions
$ millions
Fiscal year ending December 31,
Net sales
AN AL Y SI S
2004P
2005P
2006P
2007P
2008P
$440.0
$484.0
$532.4
$585.6
$644.2
$708.6
$779.5
80.0
88.0
96.8
106.5
117.1
128.8
141.7
155.9
Less: Depreciation
12.0
13.2
14.5
16.0
17.6
19.3
21.3
23.4
EBITA
68.0
74.8
82.3
90.5
99.6
109.5
120.5
132.5
27.2
29.9
32.9
36.2
39.8
43.8
48.2
53.0
$40.8
$44.9
$49.4
$54.3
$59.7
$65.7
$72.3
$79.5
16.0
17.6
19.3
21.3
23.4
20.0
22.0
24.2
26.6
29.3
10.0
8.5
7.0
5.5
4.0
40.3
46.8
53.8
61.4
69.6
(40.3)
$0.0
$46.8
$53.8
$61.4
$69.6
F L OW
2003
$400.0
Plus: Depreciation
C A S H
2002
EBITDA
Tax-effected EBITA
D I S C O UN T E D
2001
Key assumptions:
Deal/valuation date = 12/31/04
Marginal tax rate = 40%
18
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Revenue
Cost
Capital expenditures
Expansion plans
Cost reductions
Change in sales growth
taxes) or by adjusting the DCF model and simply measuring the incremental impact
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
Margin improvements
19
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
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
Present value =
FCF1
(1+r)1
FCF2
(1+r)2
FCF3
(1+r)3
...
FCFn
(1+r)n
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
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 socalled mid-year convention, which takes into account the fact that free cash flows occur
during the year
JPMorgan
JPMorgan
standard
standard
Present value =
FCF1
(1+r)0.5
FCF2
(1+r)1.5
FCF3
(1+r)2.5
...
FCFn
(1+r)n-0.5
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)
20
Transaction
Transaction date:
date: 01/01
01/01
Year
0.5
Discounting =
(1+r)0.5
1.5
CF3
(1+r)1.5
2.5
3.5
3.5
(1+r)2.5
Period 1 CF to buyer
Year
D I S C O UN T E D
0.5
0.75
C A S H
F L OW
AN AL Y SI S
Transaction
Transaction date:
date: 06/30
06/30
Discounting =
CF1
(0.75-0.5)
(1+r)
1.5
(1+r)
2.5
(2.5-0.5)
(1+r)
21
Practice exercise
Transaction
Transaction date:
date: 09/30
09/30
Period 1 CF
to buyer
Year
0.5
0.75
Discounting =
CF1
(1+r)(0.875-0.75)
(1+r)(1.5-0.75)
2.5
3.5
(1+r)(2.5-0.75)
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
1st flow,
mid-period 1
1.5
22
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Stand-alone
Stand-alone DCF
DCF analysis
analysis of
of Company
Company X
X
$
millions
$ millions
Fiscal year ending December 31,
2001
2002
2003
2004P
2005P
2006P
2007P
2008P
$400.0
$440.0
$484.0
$532.4
$585.6
$644.2
$708.6
$779.5
EBITDA
80.0
88.0
96.8
106.5
117.1
128.8
141.7
155.9
Less: Depreciation
12.0
13.2
14.5
16.0
17.6
19.3
21.3
23.4
EBITA
68.0
74.8
82.3
90.5
99.6
109.5
120.5
132.5
27.2
29.9
32.9
36.2
39.8
43.8
48.2
53.0
$40.8
$44.9
$49.4
$54.3
$59.7
$65.7
$72.3
$79.5
16.0
17.6
19.3
21.3
23.4
20.0
22.0
24.2
26.6
29.3
10.0
8.5
7.0
5.5
4.0
40.3
46.8
53.8
61.4
69.6
(40.3)
$0.0
$46.8
$53.8
$61.4
$69.6
0.0
0.5
1.5
2.5
3.5
$0.0
$44.6
$46.7
$48.4
$49.9
Net sales
Tax-effected EBITA
Plus: Depreciation
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
Formula
Key assumptions:
Deal/valuation date = 12/31/04
Marginal tax rate = 40%
Discount rate = 10%
$189.6 =
189.6
$46.8
(1+.10)0.5
$53.8
(1+.10)1.5
$61.4
(1+.10)2.5
$69.6
(1+.10)3.5
23
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Terminal value represents the businesss value at the end of the projection period;
i.e., the portion of the companys 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)
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
Once calculated, the terminal value is discounted back to the appropriate date using
Attempt to reduce dependence on the terminal value
D I S C O UN T E D
F L OW
essential to review the implied multiple/growth rate for sanity check purposes
C A S H
AN AL Y SI S
24
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
This method assumes that the business will be valued at the end of the last year of
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
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
calculated at the end of the final projected year, irrespective of whether you are
using the mid-year convention
25
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
Reinvestment rate
26
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Stand-alone
Stand-alone DCF
DCF analysis
analysis of
of Company
Company X
X
$
$ millions
millions
Fiscal year ending December 31,
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
Net sales
EBITDA
Less: Depreciation
EBITA
Less: Taxes at marginal rate
Tax-effected EBITA
Plus: Depreciation
Plus: Deferred taxes
Less: Capital expenditures
Less: Incr./(decr.) in working capital
Unlevered free cash flow
Adjustment for deal date
Unlevered FCF to acquirer
2001
$400.0
80.0
12.0
68.0
27.2
$40.8
2001
$440.0
88.0
13.2
74.8
29.9
$44.9
2003
$484.0
96.8
14.5
82.3
32.9
$49.4
Key assumptions:
Deal/valuation date = 12/31/04
Marginal tax rate = 40%
Discount rate = 10%
Exit multiple of EBITDA = 7.0x
2004P
$532.4
106.5
16.0
90.5
36.2
$54.3
16.0
20.0
10.0
40.3
(40.3)
$0.0
2005P
$585.6
117.1
17.6
99.6
39.8
$59.7
17.6
22.0
8.5
46.8
$46.8
2006P
$644.2
128.8
19.3
109.5
43.8
$65.7
19.3
24.2
7.0
53.8
$53.8
2007P
$708.6
141.7
21.3
120.5
48.2
$72.3
21.3
26.6
5.5
61.4
$61.4
2008P
$779.5
155.9
23.4
132.5
53.0
$79.5
23.4
29.3
4.0
69.6
$69.6
0.0
0.5
1.5
2.5
3.5
$0.0
189.6
$44.6
$46.7
$48.4
$49.9
$155.9
7.0x
1,091.3
745.4
$934.9
Formula
($155.9 * 7.0x)
$745.4 =
(1+.10)4
27
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Stand-alone
Stand-alone DCF
DCF analysis
analysis of
of Company
Company X
X
$
millions,
except
per
share
data
$ millions, except per share data
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
Discounted
Firm value
FCF
Discount rate
20052008
6.0x
7.0x
8.0x
6.0x
7.0x
8.0x
8%
$196.8
$687.5
$802.1
$916.7
$884.4
$999.0
$1,113.6
9%
193.1
662.6
773.1
883.5
855.8
966.2
1,076.7
10%
189.6
638.9
745.4
851.8
828.4
934.9
1,041.4
11%
186.1
616.2
718.9
821.6
802.3
904.9
1,007.6
12%
182.7
594.5
693.5
792.6
777.2
876.3
975.3
Net debt
Discount rate
12/31/04
8%
Equity value
6.0x
7.0x
8.0x
6.0x
7.0x
8.0x
$100.0
$784.4
$899.0
$1,013.6
$19.17
$21.97
$24.77
9%
100.0
755.8
866.2
976.7
$18.47
$21.17
$23.87
10%
100.0
728.4
834.9
941.4
$17.80
$20.41
$23.01
11%
100.0
702.3
804.9
907.6
$17.16
$19.67
$22.18
12%
100.0
677.2
776.3
875.3
$16.55
$18.97
$21.39
28
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
This method assumes that the business will be owned in perpetuity and that the
more year to n+1;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
JPM
JPM recommended
recommended method
method
F L OW
where
D I S C O UN T E D
Academic
Academic formula
formula
C A S H
AN AL Y SI S
project one year past the projection year and allow for normalizing adjustments;
this FCFn+1 is then discounted by the perpetuity formula
FCFn+1
g
WACC
This step is taken because the perpetuity growth formula is based on the principle that the terminal value of a business is the value of its next cash flow, divided by the
difference between the discount rate and a perpetual growth rate
29
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Note that when using the mid-year convention, terminal value is discounted as if
relationship between revenues, EBIT and capital spending, which in turn affects
CAPEX and depreciation
Working capital may also need to be adjusted
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
30
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Stand-alone
Stand-alone DCF
DCF analysis
analysis of
of Company
Company X
X
$
millions
$ millions
Fiscal year ending December 31,
2001
2002
2003
2004P
2005P
2006P
2007P
2008P
$400.0
$440.0
$484.0
$532.4
$585.6
$644.2
$708.6
$779.5
EBITDA
80.0
88.0
96.8
106.5
117.1
128.8
141.7
155.9
Less: Depreciation
12.0
13.2
14.5
16.0
17.6
19.3
21.3
23.4
EBITA
68.0
74.8
82.3
90.5
99.6
109.5
120.5
132.5
27.2
29.9
32.9
36.2
39.8
43.8
48.2
53.0
$40.8
$44.9
$49.4
$54.3
$59.7
$65.7
$72.3
$79.5
16.0
17.6
19.3
21.3
23.4
20.0
22.0
24.2
26.6
29.3
10.0
8.5
7.0
5.5
4.0
40.3
46.8
53.8
61.4
69.6
(40.3)
$0.0
$46.8
$53.8
$61.4
$69.6
0.0
0.5
1.5
2.5
3.5
$0.0
$44.6
$46.7
$48.4
$49.9
Net sales
Tax-effected EBITA
Plus: Depreciation
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
189.6
PV of Terminal Value
733.7
$923.3
Formula
$69.6 * (1 + .03)
$733.6 =
(.10 - .03)*(1+.10)3.5
31
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Stand-alone
Stand-alone DCF
DCF analysis
analysis of
of Company
Company X
X
$
$ millions,
millions, except
except per
per share
share data
data
A
Discount rate
8%
9%
10%
11%
12%
Firm value
FCF
2.5%
$991.0
811.9
681.5
582.6
505.1
3.0%
$1,095.4
883.8
733.7
622.0
535.8
3.5%
$1,223.0
968.9
794.0
666.7
570.1
12/31/04
$100.0
100.0
100.0
100.0
100.0
2.5%
$1,187.8
1,005.0
871.1
768.7
687.9
3.0%
$1,292.2
1,077.0
923.3
808.1
718.5
3.5%
$1,419.8
1,162.0
983.6
852.8
752.8
E
Equity value
2.5%
$1,087.8
905.0
771.1
668.7
587.9
3.0%
$1,192.2
977.0
823.3
708.1
618.5
3.5%
$1,319.8
1,062.0
883.6
752.8
652.8
2.5%
$26.59
$22.12
$18.84
$16.34
$14.37
3.0%
$29.14
$23.88
$20.12
$17.31
$15.12
3.5%
$32.26
$25.96
$21.59
$18.40
$15.95
D I S C O UN T E D
C A S H
F L OW
Net debt
Discount rate
8%
9%
10%
11%
12%
Discounted
20052008
$196.8
193.1
189.6
186.1
182.7
AN AL Y SI S
32
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Assumptions regarding exit multiples are often checked for reasonableness by calculating the
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
These formulas adjust for the different approaches to discounting terminal value when using
33
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Standalone
Standalone Company
Company X
X DCF
DCF analysis
analysis
$
$ millions
millions
A
Discounted
FCF
20052008
$196.8
193.1
189.6
186.1
182.7
Discount
rate
8%
9%
10%
11%
12%
AN AL Y SI S
D
Net debt
12/31/04
$100.0
100.0
100.0
100.0
100.0
D I S C O UN T E D
C
Firm value
at 2008P EBITDA multiple of
6.0x
7.0x
8.0x
$884.4
$999.0 $1,113.6
855.8
966.2
1,076.7
828.4
934.9
1,041.4
802.3
904.9
1,007.6
777.2
876.3
975.3
E
Equity value
at 2008P EBITDA multiple of
6.0x
7.0x
8.0x
$784.4
$899.0 $1,013.6
755.8
866.2
976.7
728.4
834.9
941.4
702.3
804.9
907.6
677.2
776.3
875.3
C A S H
F L OW
Discount
rate
8%
9%
10%
11%
12%
6.0x
0.2%
1.1%
2.0%
2.9%
3.8%
7.0x
1.3%
2.2%
3.1%
4.0%
4.9%
8.0x
2.1%
3.0%
3.9%
4.8%
5.8%
34
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Standalone
Standalone Company
Company X
X DCF
DCF analysis
analysis
$
$ millions
millions
A
Discounted
FCF
20052008
$196.8
193.1
189.6
186.1
182.7
Discount
rate
8%
9%
10%
11%
12%
D
Net debt
12/31/04
$100.0
100.0
100.0
100.0
100.0
D I S C O UN T E D
Firm value
at perpetuity growth rate of
2.5%
3.0%
3.5%
$991.0 $1,095.4 $1,223.0
811.9
883.8
968.9
681.5
733.7
794.0
582.6
622.0
666.7
505.1
535.8
570.1
2.5%
3.0%
3.5%
$1,187.8 $1,292.2 $1,419.8
1,005.0
1,077.0
1,162.0
871.1
923.3
983.6
768.7
808.1
852.8
687.9
718.5
752.8
3.0%
85%
82%
79%
77%
75%
3.5%
86%
83%
81%
78%
76%
E
Equity value
at perpetuity growth rate of
2.5%
3.0%
3.5%
$1,087.8 $1,192.2 $1,319.8
905.0
977.0 1,062.0
771.1
823.3
883.6
668.7
708.1
752.8
587.9
618.5
652.8
C A S H
F L OW
AN AL Y SI S
Discount
rate
8%
9%
10%
11%
12%
3.0%
$29.14
$23.88
$20.12
$17.31
$15.12
3.5%
$32.26
$25.96
$21.59
$18.40
$15.95
3.0%
9.6x
8.0
6.9
6.1
5.4
3.5%
10.7x
8.8
7.5
6.5
5.8
35
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
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
opportunities that are similar in nature and risk to the one being analyzed
The WACC is related to the risk of the investment, not the risk or creditworthiness of
D I S C O UN T E D
C A S H
F L OW
the investor
In valuing a company, always use the riskiness of its cash flows or comparable companies in estimating a weighted average cost of capital. Never use the acquirers cost
capital unless, by some chance, it is engaged in an extremely similar line of business. However, if a business is small relative to an acquirors, sometimes ti may be
appropriate to consider the use of the acquirors WACC in performing the valuation. The additional value created by using the acquirors WACC can be viewed as a synergy to
the acquiror in the context of the transaction.
36
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
The Capital Asset Pricing Model (CAPM) classifies risk as systematic and
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
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
There is also an error term in the CAPM formula, but this is usually omitted
37
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
The cost of equity reflects the long-term return expected by the market (dividend
Cost of equity
D I S C O UN T E D
Beta
Adjustment for
correlation to
stock market
returns
Appropriate extra
return above risk free
x
rate
Long-term return on
equity investment in
=
todays market
Long-term risk-free
rate of return
(beta=0)
Predicted betas
Estimated using
various techniques
4.97%
1.00
5.00%
9.97%
C A S H
F L OW
AN AL Y SI S
38
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Equity risk premiums is estimated based on expected returns and recent historical returns
Equity
Equity premiums
premiums
Rolling
Rolling average
average over
over 10-year
10-year bond
bond
14%
Rolling 30 years
Rolling 40 years
Equity
Equity returns
returns less
less 10-year
10-year bond
bond yield
yield
Arithmetic
average
Arithmetic average
Rolling 50 years
12%
1994
2.7
1995
3.4
1996
4.4
1997
4.7
1998
5.2
1999
6.2
2000
5.8
2001
5.0
8%
6%
4%
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
10%
30 years ending
2%
1955 1959 1963 1968 1972 1976 1980 1984 1988 1993 1997 2001
39
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
Beta
WACC
Other topics
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
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
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
40
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Predicted betas are constructed to adjust for many risk factors, incorporating firms earnings
D I S C O UN T E D
C A S H
Distribution
Distribution of
of predicted
predicted and
and historical
historical betas
betas for
for 5,600
5,600 publicly-traded
publicly-traded companies
companies
800
Historical Beta
Predicted Beta
800
600
# of companies
# of companies
F L OW
AN AL Y SI S
400
200
0
(1.5) (1.0) (0.5) 0.0
Supermarkets
0.78
Predicted betas
600
400
200
Cellular
1.62
Food
0.52
Internet
2.09
Utilities
0.43
0
0.5
1.0
1.5
Beta
2.0
2.5
3.0
3.5
4.0
(0.5)
0.2
1.0
Beta
1.9
2.6
41
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 is then
used in the CAPM formula to determine the appropriate cost of capital for various
debt levels
The formula follows:
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
Where:
U = unlevered (asset) beta
BL = leveraged beta
T = marginal tax rate
To relever the beta at a target capital structure:
42
rate, T
Tau, currently equal to 0.26, represents the average blended benefit a
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
43
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Size
Size premium
premium by
by market
market cap
cap
Based
on
historical
Based on historical returns
returns analysis
analysis
5.2%
Increased risk
3.1%
Lower liquidity
2.5%
1.9%
1.7%
1.4%
1.1%
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
size
0.8%
0.0%
$0
100
$100
250
$250
500
$500
700
$7001,000
Size
Size premium
premium by
by market
market cap
cap
Based
on
PE/growth
Based on PE/growth (PEG)
(PEG)
Market cap ($mm)
2.2%
1.6%
1.1%
0.8%
0.0%
$100500
$5001,000
$1,0002,500
$2,5005,000
$5,000+
44
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
The long-term cost of debt is used because the cost of capital is normally applied to
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
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
45
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
position
Most firms are at their target capital structure
Adjustments should be made for seasonal or cyclical swings, as well as for firms moving toward a target
Using a weighted average cost of capital assumes that all investments are funded with the same mix of equity
WACC = rd *
Where:
re = Return on equity
rd = Return on debt
Illustrative
Illustrative SYSCO
SYSCO weighted
weighted average
average cost
cost of
of capital
capital calculation
calculation
F L OW
Cost of equity
Cost of debt
Cost of capital
10-year T-bond (Avg)
C A S H
D I S C O UN T E D
[D *(1-T)] + re * E
D+E
D+E
4.97%
5.00%
0.62
3.10%
=
Cost of debt
6.25%
2.19%
4.06%
8.07%
46
Target
Target WACC
WACC analysis
analysis as
as of
of 1/1/01
1/1/01
Macroeconomic
Macroeconomic assumptions
assumptions
Risk free rate1
5.40%
40.0%
4.0%
Industry
Industry beta
beta analysis
analysis
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
Comparable
company
Projected
levered beta3
Net
debt/mkt.
cap
Total
debt/mkt.
equity
Tax rate
Unlevered
beta4
Cost of
levered
equity
Cost of
unlevered
equity
Company A
1.06
17.2%
22.5%
0.40
0.93
9.6%
9.1%
Company B
0.90
18.0
22.2
0.40
0.79
9.0
8.6
Company C
0.90
40.3
78.4
0.40
0.61
9.0
7.8
Company D
0.89
8.6
10.1
0.40
0.84
9.0
8.8
Average
0.94
21.0%
33.3%
0.40
0.79
9.1%
8.6%
Levered beta
assuming
unlevered
beta of 0.79
Cost of
levered
equity
Target
nominal
WACC
Target
Target WACC
WACC calculation
calculation
Optimal
debt/market
capitalization
Optimal debt/equity
Spread to
10-yr
treasuries
(bp)
Country risk
premium
Pre-tax long
term cost of
debt
30.0%
42.9%
175.0
0.00%
7.1%
1.00
9.4%
7.9%
40.0
66.7
200.0
0.00
7.4
1.11
9.8
7.7
50.0
100.0
300.0
0.00
8.4
1.27
10.5
7.8
60.0
150.0
400.0
0.00
9.4
1.51
11.4
8.0
70.0
233.3
500.0
0.00
10.4
1.91
13.0
8.3
47
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
For
For illustrative
illustrative purposes
purposes
Risk
premium
Unlevered
beta
Optimal
debt/equity
Re-levered
beta
Cost of
equity
Cost of
financing
WACC
5.0%
0.70
20%
0.80
9.0%
6.25%
8.2%
$1BN target
5.0%-6.5%
0.70
20%
0.80
9.0%10.3%
6.25%7.50%
8.3%9.3%
$500mm target
5.0%-7.0%
0.70
20%
0.80
9.0%10.6%
6.25%8.00%
8.4%9.7%
$200mm target
5.0%-7.5%
0.70
20%
0.80
9.0%11.0%
6.25%8.50%
8.4%10.1%
SYSCO
SYSCO
SYSCO WACC
WACC sensitivity
sensitivity
$1bn target
target WACC
WACC sensitivity
sensitivity
$1bn
10%
20%
30%
40%
0.65 7.8%
7.5%
7.3%
7.0%
0.70 8.1%
7.7%
7.5%
7.2%
0.75 8.3%
7.9%
7.7%
7.4%
0.80 8.5%
8.2%
7.8%
7.6%
0.85 8.8%
8.4%
8.0%
7.8%
Levered beta
Levered beta
Debt/equity
Debt/equity
10%
20%
30%
40%
0.70
9.1%
8.7%
8.4%
8.2%
0.75
9.4%
9.0%
8.7%
8.4%
0.80
9.7%
9.3%
8.9%
8.7%
0.85
10.0%
9.6%
9.2%
8.9%
0.90
10.3%
9.8%
9.4%
9.1%
10%
20%
30%
40%
0.70
9.8%
9.4%
9.1%
8.9%
0.75
10.1%
9.8%
9.4%
9.1%
0.80
10.5%
10.1%
9.7%
9.4%
0.85
10.8%
10.4%
10.0%
9.7%
0.90
11.2%
10.7%
10.3% 10.0%
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
Debt/equity
$200mm target
target WACC
WACC sensitivity
sensitivity
$200mm
Levered beta
Company
48
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
The Forecasted EBITDA and FCF for the next three years (2005, 2006, 2007) are
EBITDA (US $mm): 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%
Cost of debt: 6.2%
Marginal tax rate: 35%
Market value of equity=US $4,541mm
Net debt= US $2,524mm
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
49
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
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:
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
What is the valuation if we need to value the company as on March 31, 2005?
50
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
Cost of equity
Equity risk premium based on very long time frame (post 1926: Ibbotson data)
Substitute hurdle rate (goal) for cost 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
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
51
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
Valuing synergies
WACC
Other topics
When two businesses are combined, the term synergies refers to the changes in
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
a proposed transaction
Calculate synergies for both the acquiring company and the target
Remember incremental cash flow
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
52
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
Valuing synergies
WACC
Other topics
margin etc.)
DCF with synergies
Valued separately from standalone DCF
Run sensitivity on synergy valuations
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
Other considerations
53
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
enables users of DCF output to assess the degree of fuzziness in the results
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
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
As shown in our previous examples, DCF analyses using exit multiples and perpetuity
54
Overview
M&Aflow
- DCF and M&A analysis
Free cash
Terminal value
WACC
Other topics
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
D I S C O UN T E D
C A S H
F L OW
AN AL Y SI S
especially those that are clearly shared across businesses (like corporatelevel SG&A)
Need to consider different characteristics of each business segment
55
Agenda
Introduction
56
Merger consequences
71
M&A:
DC F
AN D
M E R G E R
AN ALY SI S
Page
56
another company
Typically, relative valuation analysis is utilized in the context of stock-for-stock
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
Contribution analysis
Relative multiple and discounted cash flow analysis
Valuation of synergies
R E L A T I V E
V A L U E
AN A L Y S I S
57
(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
R E L A T I V E
V A L U E
AN A L Y S I S
58
Ratio at
$12.00
Current1
0.347x
0.194x
Last
month1
0.184x
Last 3
months1
Last 6
months1
Last 12
months1
0.203x
0.236x
0.270x
$12.00
$6.70
$6.38
$7.02
$8.15
$9.33
0%
79.1%
88.2%
71.0%
47.3%
28.7%
38.7%
24.6%
23.6%
25.6%
28.9%
32.2%
Historical
Historical exchange
exchange ratio
ratio
Current stock price2
Acquiror
Target
Acquiror
Target
$34.60
$6.70
$274.8
$89.7
0.40x
More
favorable
to Target
0.35x
0.30x
R E L A T I V E
V A L U E
AN A L Y S I S
0.25x
0.20x
Less
favorable
to Target
Source:
Current = 0.194x
0.15x
0.10x
0.05x
0.00x
Jun-00
1
2
3
Sep-00
Dec-00
Mar-01
Jun-01
Sep-01
Dec-01
Mar-02
Jun-02
Represents average exchange ratio over the trailing period ended June 27, 2002
Closing prices as of June 27, 2002
Assumes acquirors current price of $34.60 per share
59
Contribution analysis
Compares the relative equity valuation of two parties to their respective
Cautionary note: contribution analysis does not measure the growth and risk profile
R E L A T I V E
V A L U E
AN A L Y S I S
60
Implied
Acquiror
Target
Total
Acquiror
Target
exchange ratio
$18,150
$7,653
$25,803
$18,150
$7,653
0.4340x
70.3%
29.7%
70.3%
29.7%
$38,450
$19,592
$18,150
$7,653
66.2%
33.8%
70.3%
29.7%
$5,275
$3,528
$14,482
$11,322
59.9%
40.1%
56.1%
43.9%
$5,320
$3,253
$15,716
$10,087
62.1%
37.9%
60.9%
39.1%
$1,790
$1,210
$15,397
$10,406
59.7%
40.3%
59.7%
40.3%
$2,018
$1,380
$15,326
$10,477
59.4%
40.6%
59.4%
40.6%
$58,042
0.4340x
EBITDA
2004E
% contribution
2005E
% contribution
$8,803
$8,573
0.8046x
0.6606x
Net income
2004E
% contribution
R E L A T I V E
V A L U E
AN A L Y S I S
2005E
% contribution
$3,000
$3,398
0.6956x
0.7036x
As of 2/6/02; net debt for ACQUIROR as of 12/31/01 (per press release) and for TARGET as of 9/30/01 (per 10-Q); pro forma for acquisitions
2001A for ACQUIROR; based on company press release; other estimates based on JPMorgan Equity Research
3 Based on I/B/E/S consensus estimates; ACQUIROR 2002E EPS based on company guidance; TARGET EPS estimates based on I/B/E/S consensus estimates post 1/29/02
1
2
61
Target
$25,308
$58,042
$8,803
56.1%
70.3%
70.3%
Acquiror
Exchange r atio
0.5385x
Tar get
35.0%
Acquir or
65.0%
$8,573
$3,000
$3,398
60.9%
59.7%
59.4%
R E L A T I V E
V A L U E
AN A L Y S I S
Offer =
35.0%
43.9%
29.7%
29.7%
Market value
Firm value
.4340x
Implied
ER
.4340x
39.1%
40.3%
40.6%
2002E EBITDA
2003E EBITDA
.8046x
.6606x
.6956x
.7036x
62
Implied
Implied exchange
exchange ratio
ratio (equity
(equity value
value metrics)
metrics)
Acquiror
Current share price
$34.22
59.7%
531
18,150
530
Net debt
20,300
888
EBITDA
5,320
Net income
1,790
358
515
Target
Current share price
$14.85
515
7,653
Net debt
11,939
3,253
Net income
1,210
0.6956x
0.4340x
R E L A T I V E
V A L U E
AN A L Y S I S
EBITDA
63
Implied
Implied exchange
exchange ratio
ratio (firm
(firm value
value metrics)
metrics)
Acquiror
Current share price
$34.22
531
18,150
Net debt
20,300
EBITDA
Net income
58,042
25,803
62.1%
5,320
36,044
1,790
15,744
60.9%
Target
Fully-diluted acquiror share count
531
871
11,939
340
EBITDA
3,253
515
Net income
1,210
515
7,653
Net debt
0.66x
0.43x
R E L A T I V E
V A L U E
AN A L Y S I S
$14.85
64
Class exercise
Company
Company statistics
statistics
Acquiror
Current share price
$12.1
110.3
Net debt
450
EBITDA
172
Net income
65
Target
Current share price
Fully-diluted share count
Net debt
$14.1
30.4
295
81
Net income
25
R E L A T I V E
V A L U E
AN A L Y S I S
EBITDA
65
R E L A T I V E
V A L U E
AN A L Y S I S
66
$20.00
$26.75
$15.00
$15.00
$9.75
$10.00
$5.00
R E L A T I V E
V A L U E
AN A L Y S I S
Highest public
comp price
$0.00
$5.00
$4.94
$5.00
$4.00
$4.00
$10.25
$5.50
$6.00
$3.75
$3.50
$3.00
Lowest public
comp price
52-week
high/low
15.0x to 19.0x
2001E EBIT
of $20.6
19.0x to 25.0x
2001E cash
EPS of $0.16
15.0x to 20.0x
2002E cash
EPS of $0.25
2.5x to 4.0x
LTM revenue
of $185.7
Transaction
comparables2
Mgmt. Case
Street Case3
12% to 15%
Discount Rate
EBIT exit mult.
of 15.0x to 20.0x
12% to 15%
Discount Rate
EBIT exit mult.
of 15.0x to 20.0x
DCF analysis
Based on the offer exchange ratio of 0.311x and Pedros closing price $27.19 as of 7/12/01
Certain of the multiples implied by precedent transactions have been adjusted by indexing them to the movement in an index of stock prices of companies comparable to
Pablo
3 Based on IBES EPS growth estimate and average margin estimates of brokerage reports
1
2
67
$50.00
DCF
$40.00
Highest public
comp price
$43.25
$33.00
$28.00
$30.00
$29.25
$29.50
$30.75
$26.50
$20.00
$21.28
Lowest public
comp price
$21.00
$22.50
$20.50
Current = $27.19
AN A L Y S I S
$10.00
$0.00
R E L A T I V E
V A L U E
52-week
high/low
10.0x to 12.0x
2001E EBITDA
of $346
12.0x to 15.0x
2001E EBIT
of $239
19.0x to 25.0x
2001E EPS
of $1.18
Sum-of-the-parts
DCF analysis2
Comparable diversified company analysis and public company analysis are based on brokerage report estimates
Based on management projections
68
Exchange ratio1
1.000x
0.750x
High/Low
Low/High
$5.00/$20.50 $3.00/$33.00
High/Low
Low/High
$5.50/$30.75 $3.50/$43.25
0.488x
0.476x
0.500x
0.441x
0.313x
Offer: 0.311x
0.311x
0.244x
0.250x
0.179x
0.219x
0.162x
0.237x
R E L A T I V E
V A L U E
AN A L Y S I S
0.182x
Natural exchange
ratio
More
favorable to
Acquiror
0.081x
0.091x
0.000x
Public
comparables to
Public
comparables
(Sum of Parts &
Diversified)
Transaction
comparables to
Public
comparables
(Sum of Parts &
Diversified)
0.217x
0.074x
0.073x
Contribution
analysis
Exchange ratio ranges computed by taking the high/low equity value per share of Target using various valuation methodologies over the low/high valuation of
the acquiror using various valuation methodologies
69
Acquiror/
NewCo
pro forma
target
Chairman
CEO
ownership
Board Split
Accounting
regime
date
Target
Acquiror
value
Premium1
3/19/01
Billiton PLC
BHP Ltd
$11,511
20.9%
Acquiror
Acquiror
58.0%
9/9
United Kingdom
6/20/00
Seagram
Vivendi
40,428
22.8%
Acquiror
Acquiror
59.0%
14/6
France
5/17/00
8,089
3.4%
Acquiror
Joint
66.3%
8/8
United Kingdom
5/16/00
Lycos Inc.
6,188
58.3%
Acquiror
Target
63.0%
11/3
Spain
2/21/00
CGU PLC
11,858
(12.2%)
Acquiror
Target
58.5%
9/8
United Kingdom
1/17/00
SmithKline Beecham
Glaxo Wellcome
75,961
(2.3%)
Acquiror
Target
58.8%
8/8
United Kingdom
12/21/99
Monsanto
26,486
(7.1%)
Acquiror
Target
51.0%
9/9
United States
9/27/99
VIAG AG
VEBA AG
13,153
6.8%
Acquiror
Joint
67.0%
7/3
United States
6/30/99
15,940
8.5%
Acquiror
Joint
57.0%
NA
Italy
5/17/99
Hoechst
Rhone Poulenc
21,918
(9.9%)
Target
Target
47.0%
5/5
France
1/5/99
AirTouch Communications
60,287
40.6%
Target
Acquiror
50.0%
7/7
United Kingdom
1/15/99
Banco de Santander SA
11,320
(3.6%)
Joint
Target
63.8%
13/12/2
Spain
12/9/98
Astra AB
32,199
9.8%
Target
Acquiror
53.5%
7/7
United Kingdom
France
12/2/98
Synthelabo SA
Sanofi SA
11,234
5.7%
Acquiror
Joint
64.1%
4/3/5
8/11/98
Amoco
British Petroleum
55,040
22.7%
Joint
Acquiror
60.0%
13/9
United Kingdom
5/7/98
Chrysler Corp
Daimler-Benz AG
40,467
38.0%
Joint
Joint
58.0%
6/6
United States
United Kingdom
2/25/98
General Accident
Commercial Union
11,152
(4.2%)
Acquiror
Target
53.6%
7/7
12/8/97
Swiss Bank
22,765
0.3%
Acquiror
Target
60.0%
4/4/1
IAS
5/12/97
Guinness PLC
Grand Metropolitan
15,970
1.3%
Joint
Acquiror
52.8%
5/5
United Kingdom
3/7/96
Ciba-Geigy AG
Sandoz AG
29,000
9.5%
Target
Acquiror
55.0%
8/8
IAS
R E L A T I V E
V A L U E
AN A L Y S I S
Ann.
70
Agenda
Introduction
56
Merger consequences
71
Accretion/(dilution) review
Pro forma balance sheet analysis review
M&A:
DC F
AN D
M E R G E R
AN ALY SI S
Page
71
Introduction
Pro forma analysis provides both acquirers and targets insight into the
M E R G E R
C O N S E Q U EN C E S
72
Agenda
Introduction
56
Merger consequences
71
Accretion/(dilution) review
Pro forma balance sheet analysis review
M&A:
DC F
AN D
M E R G E R
AN ALY SI S
Page
73
M E R G E R
C O N S E Q U EN C E S
Note that capitalization will change when stock is used and net debt leverage levels will change when cash is used
74
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
M E R G E R
C O N S E Q U EN C E S
the offer price for a target results in no incremental earnings or losses to acquirers
earnings per share
75
Description
Description
Benefits
Benefits
Top down
Bottom up
M E R G E R
C O N S E Q U EN C E S
Considerations
Considerations
Risks over-simplifying pro forma analysis and overor under-stating impact to acquirer
76
Target
Target
transaction assumptions:
$12.25
41.500
Market capitalization
$508.4
500.0
Firm value
Earnings per share:
2004E
2005E
2006E
$1,008.4
7.0%
Tranche II (subordinated debt): 12.5%
$1.20
0.95
1.45
$0.48
$19.2
Acquirer
Acquirer
M E R G E R
C O N S E Q U EN C E S
$20.03
58.669
$1,175.1
750.0
$1,925.1
$1.56
1.68
1.80
$0.85
$44.6
77
Consideration
Adjustment
Stock
Cash
Mix
M E R G E R
C O N S E Q U EN C E S
After-tax synergies
78
First Call and I/B/E/S consensus estimates are based on an aggregation of research analysts
M E R G E R
C O N S E Q U EN C E S
across samples
Fully diluted share assumptions and treatment of options and convertibles may vary
Interest expense
Tax rates
Accounting policies
Stock-based compensation and amortization of intangibles other than goodwill
79
Always
Always clearly
clearly describe
describe transaction
transaction assumptions
assumptions
Choose an appropriate closing date reflecting available information and transaction structure
Timing of process requirements for closing (share registration, shareholder votes, etc.)
Timing of regulatory requirements for closing (HSR review, etc.)
Seasonality of industry economics and impact on estimates or calendarization
Capital structures should best reflect current circumstances
Equity currency should be reviewed in context of recent share price and larger equity market
performance
Cash deals should reflect reasonable interest rates and lending market capacity
Pro forma leverage and interest coverage levels should be consistent with acquirers desired credit
rating
Both advisory and financing fees have a meaningful impact on pro forma financials
M E R G E R
C O N S E Q U EN C E S
Although equity analysts tend to look through some extraordinary charges, advisory and other one-
time fees will impact the cash balance used in the transaction and subsequent annual interest
expense
Amortization of financing fees will impact EPS over the immediate future of the combined entity
Tax rate on incremental earnings and expenses should reflect acquirors and targets combined tax
efficiencies and adjustments should be made to post-transaction tax expenses for potential NOLs
assumed by an acquirer
80
Earnings
Earnings impact
impact ($
($ millions,
millions, except
except per
per share
share data)
data)
$20.03
12.0x
11.1
58.669
$12.25
12.9x
8.4
$15.31
42.468
0.764x
32.466
2003
2004
Acquirer EPS
Acquirer net income
$1.68
98.3
$1.80
105.7
Target EPS
Target net income
$0.95
39.4
$1.45
60.2
Adjustments
M E R G E R
C O N S E Q U EN C E S
35.0%
($0.0)
0.0
(2.3)
(0.0)
(0.1)
(0.2)
0.0
0.0
0.0
(2.5)
$135.2
91.135
$1.48
($0.19)
(11.5%)
$26.9
($0.0)
0.0
(2.3)
(0.0)
(0.1)
(0.3)
0.0
0.0
0.0
(2.7)
$163.2
91.135
$1.79
($0.01)
(0.6%)
$1.5
1 Should be calculated using the offer price not current target price
Used to fund transaction expenses and advisory fees of $2.9 million
81
analysis
Flow back and sell-off of acquirer stock could meaningfully affect acquirers share
prices on announcement/closing
Cross-shareholder analysis
M E R G E R
C O N S E Q U EN C E S
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
exchanges
Dividend policy implications of receiving acquirer stock
82
Earnings
Earnings impact
impact
Figures in millions, except per share data
$12.25
15.31
42.468
Acquirer EPS
Acquirer net income
Target EPS
Target net income
2003
2004
$1.68
$1.80
98.3
105.7
$0.95
$1.45
39.4
60.2
($0.6)
($0.6)
$650.3
2.9
6.6
(0.0)
$659.8
Debt allocation:
Tranche I
$300.0
Tranche II
359.8
Interest Rates:
C O N S E Q U EN C E S
M E R G E R
Adjustments
7.0%
Tranche II
12.5%
(42.9)
(44.8)
0.0
0.0
0.4
0.8
After-tax synergies
0.0
0.0
0.0
0.0
Other reductions
0.0
0.0
(45.4)
(47.0)
$92.4
$118.9
58.669
58.669
$1.57
$2.03
3.0%
35.0%
Accretion/(dilution) ($)
($0.10)
$0.23
Accretion/(dilution) (%)
(6.1%)
12.5%
$9.1
NM
0.0
(2.3)
Tranche I
0.0
(2.3)
Should be calculated using the offer price not current target price
83
decreases
Note that depending on debt mix, stock may be more or less appropriate as an acquisition
currency
Financing assumptions should reflect both acquirers stand-alone and combined debt capacity and
ratings circumstances
Debt coverage and capitalization statistics should be included to highlight potential ratings issues
securities
Covenants of existing acquirer debt should be considered
Review transaction and pro forma financials with ratings advisory and DCM teams to determine
M E R G E R
C O N S E Q U EN C E S
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
84
Earnings impact
impact
Earnings
Figures in millions, except per share data
$12.25
15.31
42.468
Acquirer EPS
Acquirer net income
Target EPS
Target net income
Shares issued
2003
2004
$1.68
$1.80
98.3
105.7
$0.95
$1.45
39.4
60.2
($0.3)
($0.3)
16.233
Adjustments
After-tax financing fee amortization
0.0
0.0
(2.3)
(2.3)
(16.2)
(16.9)
0.0
0.0
0.1
0.2
After-tax synergies
0.0
0.0
Debt allocation:
0.0
0.0
Tranche I
$300.0
Other reductions
Tranche II
31.3
C O N S E Q U EN C E S
2.9
Financing fees
M E R G E R
$325.1
3.3
(0.0)
$331.3
0.0
0.0
(18.7)
(19.3)
$119.1
$146.6
74.902
74.902
$1.59
$1.96
Accretion/(dilution) ($)
($0.09)
$0.16
Accretion/(dilution) (%)
(5.1%)
8.6%
$9.9
NM
Interest Rates:
Tranche I
7.0%
Tranche II
12.5%
3.0%
35.0%
85
is buying more EPS than the target shareholders are accepting as consideration
If the acquirer has a lower P/E than the target, the deal will be dilutive because the acquirer is
buying less EPS than the target shareholders are accepting as consideration
Remember to take the premium into account when calculating the targets P/E
Utility of comparison will also depend on transaction assumptions regarding goodwill impairment
M E R G E R
C O N S E Q U EN C E S
Where the inverse cost of debt is lower than the P/E of the target, the deal will be dilutive
86
2003
2003 synergies
synergies to
to break-even($mm)
break-even($mm)
Stock consideration
Stock consideration
M E R G E R
62.5%
75.0%
87.5%
100.0%
50.0%
62.5%
75.0%
87.5%
100.0%
10.0%
1.0%
(1.1%)
(3.0%)
(4.8%)
(6.4%)
10.0%
NM
$2.2
$6.3
$10.4
$14.4
20.0%
(3.0%)
(4.6%)
(6.5%)
(8.3%)
(9.8%)
20.0%
5.8
9.3
13.8
18.3
22.8
30.0%
(7.7%)
(8.4%)
(10.2%)
(11.9%)
(13.4%)
30.0%
15.0
17.3
22.3
27.2
32.1
40.0%
(14.1%)
(13.5%)
(15.2%)
(16.8%)
(18.1%)
40.0%
28.2
28.8
34.3
39.9
45.3
50.0%
(20.2%)
(19.0%)
(19.9%)
(21.3%)
(22.5%)
50.0%
41.7
41.9
46.6
52.8
58.9
Premium
Premium
C O N S E Q U EN C E S
50.0%
87
2003
2003 accretion/(dilution)(%
accretion/(dilution)(% per
per share)
share)
$21.00
$22.00
$23.00
$5.0
$10.0
$15.0
$20.0
$25.0
10.0%
(8.1%)
(6.4%)
(5.0%)
(3.5%)
(2.2%)
10.0%
(4.2%)
(2.0%)
0.2%
2.5%
4.7%
20.0%
(11.6%)
(9.8%)
(8.3%)
(6.8%)
(5.5%)
20.0%
(7.7%)
(5.5%)
(3.3%)
(1.2%)
1.0%
30.0%
(15.2%)
(13.4%)
(11.8%)
(10.3%)
(8.9%)
30.0%
(11.3%)
(9.2%)
(7.1%)
(5.0%)
(2.9%)
40.0%
(20.0%)
(18.1%)
(16.5%)
(15.0%)
(13.5%)
40.0%
(16.1%)
(14.1%)
(12.1%)
(10.1%)
(8.1%)
50.0%
(24.4%)
(22.5%)
(20.9%)
(19.3%)
(17.8%)
50.0%
(20.6%)
(18.7%)
(16.8%)
(14.9%)
(13.0%)
Premium
Premium
$19.00
Cash
Cash deals
deals
2003
2003 accretion/(dilution)(%
accretion/(dilution)(% per
per share)
share)
2003
2003 accretion/(dilution)(%
accretion/(dilution)(% per
per share)
share)
M E R G E R
6.5%
7.0%
7.5%
8.0%
8.5%
10.0%
3.1%
2.1%
1.1%
0.1%
(0.9%)
20.0%
(2.4%)
(3.4%)
(4.3%)
(5.3%)
(6.3%)
30.0%
(8.4%)
(9.4%)
(10.4%)
(11.4%)
(12.4%)
40.0%
(17.1%)
(18.1%)
(19.1%)
(20.1%)
(21.1%)
50.0%
(25.9%)
(26.9%)
(27.9%)
(28.9%)
(29.9%)
Premium
Premium
C O N S E Q U EN C E S
10.5%
10.0%
9.5%
9.0%
10.0%
(2.3%)
(0.1%)
2.1%
4.2%
6.4%
20.0%
(7.7%)
(5.5%)
(3.4%)
(1.2%)
1.0%
30.0%
(13.8%)
(11.6%)
(9.4%)
(7.2%)
(5.1%)
40.0%
(22.5%)
(20.3%)
(18.1%)
(15.9%)
(13.7%)
50.0%
(31.3%)
(29.1%)
(26.9%)
(24.7%)
(22.6%)
88
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
M E R G E R
C O N S E Q U EN C E S
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
89
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 implications1
Acquirers may be forced to pay interest on interest
In using cash and thereby raising debt, an acquirer will incur future interest and amortization
M E R G E R
C O N S E Q U EN C E S
expenses
Dividend accretion/(dilution) analysis may be relevant to determine appropriate premium
Write-ups create a deferred tax liability (equal to the write-up multiplied by the tax rate)
90
combined company
EPS estimates should be used with caution
First Call and I/B/E/S estimates are consensus numbers that do not always reflect
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)
M E R G E R
C O N S E Q U EN C E S
91
Agenda
Introduction
56
Merger consequences
71
Accretion/(dilution) review
Pro forma balance sheet analysis review
M&A:
DC F
AN D
M E R G E R
AN ALY SI S
Page
92
M E R G E R
C O N S E Q U EN C E S
93
market access)
In a divestiture, the pro forma credit rating of the seller and the minimum level of
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
M E R G E R
C O N S E Q U EN C E S
to demand
Typically, JPMorgan performs sensitivity analyses to address relevant inflection
points where the offer price for a target results in meaningful changes to a combined
capital structure
94
M E R G E R
C O N S E Q U EN C E S
95
Acquirer
Target
Adjustments
Pro forma
Balance sheet:
Total debt
Shareholders equity value
Minority interest
$800.0
950.0
0.0
$575.0
525.0
0.0
$659.8
(525.0)
0.0
$2,034.8
950.0
0.0
Income statement:
LTM EBITDA
LTM EBIT
LTM interest expense
$226.0
176.0
55.0
$119.0
94.0
40.0
42.6
$345.0
270.0
137.6
84.2%
45.7%
109.5%
52.3%
214.2%
68.2%
3.5x
4.5
4.1
3.2
4.8x
6.1
3.0
2.4
5.9x
7.5
2.5
2.0
M E R G E R
C O N S E Q U EN C E S
Capitalization:
Debt/equity
Debt/total capitalization1
Coverage ratios:
Debt/LTM EBITDA
Debt/LTM EBIT
LTM EBITDA/interest
LTM EBIT/interest
96
Acquirer
Target
Adjustments
Pro forma
Balance sheet:
Total debt
Shareholders equity value
Minority interest
$800.0
950.0
0.0
$575.0
525.0
0.0
$0.0
125.3
0.0
$1,375.0
1,600.3
0.0
Income statement:
LTM EBITDA
LTM EBIT
LTM interest expense
$226.0
176.0
55.0
$119.0
94.0
40.0
0.0
$345.0
270.0
95.0
84.2%
45.7%
109.5%
52.3%
85.9%
46.2%
3.5x
4.5
4.1
3.2
4.8x
6.1
3.0
2.4
4.0x
5.1
3.6
2.8
M E R G E R
C O N S E Q U EN C E S
Capitalization:
Debt/equity
Debt/total capitalization1
Coverage ratios:
Debt/LTM EBITDA
Debt/LTM EBIT
LTM EBITDA/interest
LTM EBIT/interest
97
Premium
Estimates (EBITDA)
0.0%
25.0%
50.0%
75.0%
100.0%
10.0%
67.3%
62.4%
57.4%
52.5%
47.5%
20.0%
67.9%
62.6%
57.3%
52.0%
46.6%
30.0%
68.5%
62.8%
57.2%
51.5%
45.7%
40.0%
69.4%
63.2%
57.0%
50.7%
44.4%
50.0%
70.3%
63.5%
56.8%
50.0%
43.2%
etc.)
Debt/EBITDA
Debt/EBITDA
EBITDA/interest
EBITDA/interest
M E R G E R
Stock consideration
0.0%
25.0%
50.0%
75.0%
100.0%
10.0%
5.66x
5.24x
4.83x
4.41x
3.99x
20.0%
5.82
5.36
4.91
4.45
3.99
30.0%
6.00
5.49
4.99
4.49
3.99
40.0%
6.25
5.68
5.12
4.56
3.99
50.0%
6.50
5.88
5.25
4.62
3.99
Premium
Premium
C O N S E Q U EN C E S
Stock consideration
0.0%
25.0%
50.0%
75.0%
100.0%
10.0%
2.63x
2.89x
3.19x
3.39x
3.63x
20.0%
2.54
2.81
3.13
3.37
3.63
30.0%
2.45
2.73
3.06
3.35
3.63
40.0%
2.34
2.62
2.97
3.32
3.63
50.0%
2.23
2.51
2.88
3.29
3.63
98