2007 Summer Analyst Valuation Book

CONFIDENTIAL

VALUATION PROJECT WORKBOOK SUMMER ANALYST PROGRAM – 2007

PRELIMINARY | SUBJECT TO FURTHER REVIEW AND EVALUATION THESE MATERIALS MAY NOT BE USED OR RELIED UPON FOR ANY PURPOSE OTHER THAN AS SPECIFICALLY CONTEMPLATED BY A WRITTEN AGREEMENT WITH CREDIT SUISSE.

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Table of Contents 1

Overview of Valuation Project

2

Sample Project

3

Weekly Assignments and Resources A

Public Information Book (PIB)

B

Company Profile

C

Equity Comps / M&A Comps

D

DCF and WACC Analysis

E

Merger Consequences Analysis

If you have any questions regarding materials in this book, or the valuation project in general, don’t hesitate to call us: Anna Golynskaya Training Leader [email protected] (212) 538-5442

Phil Kohn Training Leader [email protected] (212) 538-0558

Miriam Roshan Training Leader (212) 325-1822 [email protected]

Jeff Volling Training Leader (212) 325-5529 [email protected] 1

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1. Overview of Valuation Project

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Overview of Valuation Project Welcome to Credit Suisse! In addition to meeting a ton of new people and having fun for the next 10 weeks, we figured it would be helpful for you to return to college your senior year having learned something about what Investment Bankers do  Several analysts, associates, and Vice Presidents from across the division have worked hard to put the

following materials together as your “one-stop shop” for banking how to’s  In addition to your group staffing assignments over the next two months, you will also be asked to

complete a group valuation project to be submitted by Week 9 of your program. The submission will include the following:

   

A company profile Equity comps and M&A comps DCF valuation Merger consequences analysis

 At the end of the summer, August 2nd, your team will be asked to present, in a short session, your

analyses and conclusions to a team of bankers  This project will be completed gradually over the course of the summer and we will be holding 4

sessions (1 every week) to cover each of the topics or analysis we will be asking you to do  You will be required to turn in you work for the topic covered each week at the following weeks session

(i.e., you will go over profiles in first session and turn them in at the second session)

 We plan to return your assignment within one week so you can see if you are on the right track and where you may need to improve

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Project Schedule and Key Dates Date Session 1

Session 2

Session Details

June 29



Finding public information and creating a PIB



Create Knight Ridder PIB

10 am & 2 pm



Creating a company profile



Create Knight Ridder profile

July 6



Equity Comps and Acquisition Comp Analysis



Find Knight Ridder trading comparables



Find important average trading stats



For given comparable acquisitions, find key multiples



Create projected Knight Ridder income statement



Determine WACC based on comps



Project free cash flows and discount at WACC



Evaluate transaction consequences including EPS accretion/dilution, pro forma credit stats, pro forma ownership



Create premiums paid and synergies sensitivity tables



Good Luck!!

10 am & 2 pm Session 3

July 13



Discounted Cash Flow

10 am & 2 pm Session 4

July 27



Merger Consequences

10 am & 2 pm

PRESENTATION

Next Steps

August 6



Present final projects

Note: Due to the fact that the deal was announced on 3/13/06, for all valuations, please use all public information available as of then (latest filing would be the 12/25/05 10-K) and stock prices and research as of 3/10/06.

This schedule provides a set of guidelines to help you plan your final project. 4

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2. Sample Project

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USF Corporation – Company Profile Status: Website:

Public (Nasdaq: USFC) www.usfc.com

Management and Board of Directors

Company Overview 



Provides comprehensive supply chain management services in four business segments:  “Less-than-truckload” segment, carriers provide regional and interregional delivery throughout the United States  “Truckload” segment offers premium regional and national truckload services  “Logistics” segment provides dedicated fleet, cross-dock operations, supply chain management, contractual warehousing, domestic ocean freight forwarding and reverse logistics services  “Information Technology” segment provides support activities including corporate sales and various financial management functions

Name

USF provide services to a wide variety of customers, with no single customer accounting for more than 3.3% of revenue

Source: Company filings and Capital IQ.

Recent News  1/28/2005: USF Corporation reported fourth quarter and full

year 2004 results, missed Wall Street earnings  12/13/2004: Announced opening of two new terminals serving

the Southern Minnesota and Decatur, Alabama areas  11/2/2004: Richard P. DiStasio stepped down as CEO, Paul

Liska was named interim CEO  10/22/2004: Reported third quarter 2004 results, missed Wall

Street earnings  9/9/2004: USF Holland announced the opening of eight (8)

Northeast terminals, service city includes: Baltimore, MD Albany, NY, Allentown, PA, Harrisburg, PA, Philadelphia, PA, Wilkes Barre, PA, Syracuse, NY, and Richmond, VA Source: Company filings, and website.

Headquarters: Chicago, IL Employees: 21,000

Position and Affiliation

Thomas E. Bergmann

Interim CEO, CFO

Steven Caddy

President and CEO, USF Holland

Edward R. Fitzgerald

President and CEO, USF Reddaway

Douglas R. Waggoner

President and CEO, USF Bestway

Paul J. Liska

Chairman of the Board

Morley Koffman

Director

Stephen W. Lilienthal

Director

Anthony J. Paoni

Director

Glenn R. Richter

Director

Neil A. Springer

Director

Michael L. Thompson

Director

Source: Company filings and FactSet.

Ownership HOLDERS Citigroup Inc. Fidelity Management & Research Dimensional Fd Advisors, Inc. Barclays Bank Allianz Dresdner Asset Mgmt. Top 5 Institutions Other Institutions Total Institutions Insiders Other Total

SHARES 2,595,871 2,410,515 1,831,607 1,567,377 1,234,140 9,639,510 15,892,218 25,531,728 473,040 196,072 26,200,840

% OF TOTAL 9.9% 9.2% 7.0% 6.0% 4.7% 36.8% 60.7% 97.4% 1.8% 0.7% 100.0%

Source: Company filings and ShareWorld.

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USF Corporation (Cont’d) Stock Price Performance $40

2,000

1,500

$34 1,000 $31 500

$28 $25 2/4/04

4/5/04 6/5/04 USF Corp. Volume

8/5/04

Volume in Thousands

$37 Stock Price

Market and Trading Data

0 10/5/04 12/5/04 2/4/05 USF Corp. Stock Price

Stock Price (2/4/05)

$32.44

% of 52-Week High 52-Week High / Low

83.6% $38.80 /

Diluted Shares

$27.51 28.2

Equity Market Value

916.0

(+) Debt

250.1

(–) Cash & Equivalents

150.8

Enterprise Value

$1,015.3

Enterprise Value to:

Financial Overview

2004E Revenue

$2,516.9 /

0.4x

2005E Revenue

$2,658.8 /

0.4x

2004E EBITDA

$169.2 /

6.0x

2005E EBITDA

$253.7 /

4.0x

2004E EPS

$0.85 /

38.2x

2005E EPS

$2.48 /

13.1x

($ in millions)

Revenues % Growth EBIT % Margin EBITDA % Margin Net Income % Margin EPS Capex

2004A $2,394.6 4.5% $112.1 4.7% $169.2 7.1% $55.8 2.3% $0.85 145.0

December 31, 2005E $2,516.9 5.1% $130.0 5.2% $253.7 10.1% $66.5 2.6% $2.48 185.0

Source: Company filings and Wall Street equity research.

2006E $2,658.8 5.6% $150.1 5.6% $273.1 10.3% $78.8 3.0% $2.82 190.0

EPS Estimates / P/E Ratio

Source: Company filings and Wall Street equity research. Note: EPS projections based on I/B/E/S consensus.

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Comparable Company Analysis ($ in millions)

COMPANY

SHARE PRICE

% OF 52-WEEK

EQUITY

ENTERPRISE

02/04/05

HIGH

VALUE

VALUE

ENTERPRISE VALUE AS A MULTIPLE OF SALES MULTIPLE OF EBITDA

P/E

2004E

2005E

2004E

2005E

2004E

2005E

LONG-TERM EPS

LTM OPERATING

GROWTH

RATIO

Truck Load JB Hunt Transportation (1)

Swift Transportation Werner Enterprises Heartland Express

(1)

(1) (1)

$45.00

97.7%

$3,682

$3,697

1.3x

1.2x

8.2x

7.2x

17.5x

15.5x

15.8%

92.9%

22.61

99.4%

1,671

2,265

0.8x

0.7x

6.2x

5.9x

14.8x

12.6x

12.6%

93.6%

20.94

90.1%

1,679

1,570

0.9x

0.9x

5.5x

4.9x

19.6x

16.1x

15.3%

91.6%

20.93

90.2%

1,570

1,311

2.9x

2.6x

10.8x

9.7x

25.2x

22.0x

13.8%

79.6%

Knight Transportation

25.71

99.3%

1,460

1,434

3.5x

2.9x

11.9x

10.1x

29.4x

23.1x

16.6%

80.7%

Covenant Transportation

20.86

97.8%

312

372

0.6x

0.6x

4.8x

4.1x

18.9x

15.8x

12.0%

94.0%

1.7x 1.1x

1.5x 1.0x

7.9x 7.2x

7.0x 6.5x

20.9x 19.3x

17.5x 16.0x

14.4% 14.6%

88.7% 92.3%

0.6x

0.6x

6.2x

5.3x

17.8x

14.3x

14.1%

92.3%

Mean Median Less Than Truckload CNF Inc

(1)

$46.49 (1)

Overnite Corp

Arkansas Best Corp

(1)

Old Dominion Freight

(1)

91.2%

$2,457

$2,400

30.35

78.5%

850

925

0.6x

0.5x

5.3x

4.6x

13.2x

11.0x

15.5%

82.8%

41.77

89.5%

1,069

1,000

0.6x

0.5x

4.9x

4.7x

13.0x

11.2x

12.5%

92.8%

35.60

97.5%

885

961

1.2x

0.9x

7.9x

6.6x

21.6x

16.9x

17.5%

91.4%

SCS Transportation

22.55

81.6%

354

470

0.5x

0.4x

5.2x

4.6x

17.8x

13.0x

15.0%

95.6%

Yellow Roadway Corp(1)

56.31

97.8%

2,769

(1)

3,320 Mean Median

Logistics C.H. Robinson Worldwide UTi Worldwide Inc Sirva Inc EGL Inc (1) Landstar System Inc Pacer International Forward Air Corp Hub Group Quality Distribution Inc

$51.38 71.88 9.40 31.18 35.25 22.19 43.33 56.46 8.62

91.1% 98.5% 36.2% 89.1% 91.4% 91.0% 91.7% 96.6% 53.4%

$4,435 2,307 693 1,461 1,083 837 944 529 164

$4,201 2,297 1,165 1,475 1,113 1,007 840 529 436 Mean Median

(1)

USF Corp

$32.44

83.6%

$916

$1,015

0.5x

0.5x

6.3x

5.0x

14.2x

10.9x

10.5%

94.6%

0.7x 0.6x

0.6x 0.5x

6.0x 5.8x

5.2x 4.9x

16.3x 16.0x

12.9x 12.1x

14.2% 14.5%

91.6% 92.6%

1.0x 1.5x 1.1x 0.5x 0.6x 2.6x 3.0x 0.4x 0.7x

0.9x 1.1x 1.0x 0.5x 0.5x 2.4x 2.6x 0.4x 0.6x

18.5x 30.8x 6.9x 19.1x 8.3x 11.2x 13.9x 10.2x 6.6x

16.1x 13.0x 5.2x 14.7x 7.2x 9.8x 11.5x 8.9x 5.5x

32.9x 27.9x 11.1x 27.7x 29.0x 16.2x 27.7x 25.3x 12.3x

28.4x 21.6x 7.4x 23.1x 23.8x 13.7x 23.1x 22.6x 8.5x

14.5% 20.0% 20.0% 17.4% 17.0% 14.6% 14.5% 25.0% NA

94.9% 94.0% 94.6% 97.2% 94.1% 94.8% 81.1% 96.6% 93.9%

1.3x 1.0x

1.1x 0.9x

14.0x 11.2x

10.2x 9.8x

23.3x 27.7x

19.1x 22.6x

17.9% 17.2%

93.5% 94.6%

0.4x

0.4x

6.0x

4.0x

38.2x

13.1x

10.2%

97.3%

Source: Public filings and Wall Street research reports. (1) Based on 4Q '04 earnings releases.

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Selected Precedent Transactions ($ in millions)

EQUITY DATE Jul-03

TARGET Roadway Corporation (US)

TARGET DESCRIPTION LTL carrier providing freight services on major city-to-city routes in North America

ACQUIROR Yellow Corporation

Nov-01

Motor Cargo Industries Provides regional less-than truckload services in the western U.S.

Union Pacific Corp.

Nov-01

Arnold Industries

Provides regional less-than-truckload services in northeastern states and also provides truckload and logistics services

Aug-01

Arnold Industries (US)

N/A

Aug-01

G.I. Trucking Company Provides regional less-than-truckload services in western and southwestern states

Nov-00

American Freightways Operates as a scheduled common and Corporation contract carrier transporting primarily lessthan-truckload shipments of general commodities.

Jun-99

Jevic Transportation Inc.

Jun-98

VALUE $966

ENTERPRISE VALUE $1231

(1)

ENTERPRISE VALUE/ EBITDA 6.7x

(2)

TARGET UNIONIZED NA

83

78

4.0

No

Roadway Corp.

558

510

5.7

Yes

Roadway Corporation

539

510

5.4

No

Investor Group (Estes)

40

40

5.0

No

FedEx Corp.

934

1,196

6.3

No

Provides regional and interregional transportation of general commodity freight

Yellow Corp.

158

197

5.9

No

Preston Trucking

Provides les-than-truckload transportation of general commodity freight

Management Group

NM

NA

Oct-97

Caliber System, Inc.

Provides transportation, logistics and related information services through its five subsidiaries

FedEx Corp.

2,489

Jul-95

Worldway Corp.

Transporter of freight throughout United States; also provides truckload services and driver leasing services through its subsidiaries

Arkansas Best Corp.

Nov-92

Central Freight Lines Inc.

Carrier of intrastate and foreign commerce within Texas, Arizona, and New Mexico

Nov-92

Preston Trucking

Jul-88 Jun-88

NA

Yes

2,681

10.3

No

82

153

9.0

Yes

Roadway Services Inc.

102

148

6.8

No

Provides less-than-truckload transportation of general commodity freight

Yellow Freight Systems

24

146

5.8

Yes

Viking Freight Inc.

Provides regional carrier services in California and 9 other Western States

Roadway Services Inc.

135

172

7.8

No

Arkansas Best Corp.

LTL and TL carriage, furniture manufacturing and tire retreading

Kelso & Co.

317

472

6.2

Yes

Median Average

6.1x 6.5x

High

10.3x

Low

4.0x

Source: Securities Data Corporation, public filings and news reports. (1) Enterprise Value = Value of Common + Total Debt – Cash. (2) EBITDA, EBIT and Net Income exclude extraordinary items and accounting changes.

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WACC Schedule Industry Statistics (in millions) Beta (1)

Company Arkansas Best Corp Cnf Inc Old Dominion Freight Overnite Corp Scs Transportation Inc Yellow Roadway Corp

Total

Mkt

Debt /

Tax

Levering

Unlevered

Debt

Equity

Mkt Equity

Rate (2)

Factor (3)

Beta (4)

1,069 2,457 885 850 354 2,769

1.4% 29.1% 9.2% 14.9% 34.7% 26.3%

40.1% 41.0% 39.1% 40.0% 37.6% 39.1%

1.01 1.17 1.06 1.09 1.22 1.16

0.82 0.76 0.59 0.87 0.52 0.86

19.3% 20.6%

39.5% 39.6%

1.12 1.12

0.74 0.79

0.83 0.89 0.62 0.95 0.63 1.00 Mean Median

15 714 81 127 123 728

0.82 0.86

Assumptions Target Marginal Tax Rate Risk Free Rate (5) Equity Risk Premium (6) Size Premia ("Sp") (7)

38.0% 4.330% 7.20% 1.59%

Schedule A (Sensitivity of Capital Structure) Debt / Capital

Debt / Mkt Equity

0.0% 10.0% 20.0% 30.0% 40.0% 50.0%

0.0% 11.1% 25.0% 42.9% 66.7% 100.0%

Average Unlev'd Beta 0.74 0.74 0.74 0.74 0.74 0.74

Levering Factor

Levered Beta (8)

1.00 1.07 1.16 1.27 1.41 1.62

0.74 0.79 0.85 0.93 1.04 1.19

Cost of Equity (9) 11% 12% 12% 13% 13% 15%

5.0% 11.2% 10.7% 10.3% 9.8% 9.3% 8.8%

Weighted Average Cost of Capital (10) Pre-tax Cost of Debt 6.0% 7.0% 8.0% 11.2% 10.8% 10.4% 10.0% 9.5% 9.1%

11.2% 10.9% 10.5% 10.1% 9.8% 9.4%

11.2% 10.9% 10.6% 10.3% 10.0% 9.7%

9.0%

10.0%

11.2% 11.0% 10.8% 10.5% 10.3% 10.0%

11.2% 11.1% 10.9% 10.7% 10.5% 10.4%

Schedule B (Sensitivity of Unlevered Beta) Weighted Average Cost of Capital (10) Pre-tax Cost of Debt 6.0% 7.0% 8.0%

Debt / Capital

Debt / Mkt Equity

Levering Factor

Unlevered Beta

9.0%

10.0%

0.0%

0.0%

1.00

0.65

10.6%

10.6%

10.6%

10.6%

10.6%

10.6%

10.0%

11.1%

1.07

0.70

10.5%

10.5%

10.6%

10.7%

10.7%

10.8%

20.0%

25.0%

1.16

0.75

10.3%

10.5%

10.6%

10.7%

10.8%

11.0%

30.0% 40.0% 50.0%

42.9% 66.7% 100.0%

1.27 1.41 1.62

0.80 0.85 0.90

10.2% 10.0% 9.8%

10.4% 10.2% 10.1%

10.5% 10.5% 10.4%

10.7% 10.7% 10.7%

10.9% 11.0% 11.0%

11.1% 11.2% 11.3%

(1) Barra US equity Book predictions (2) Based on marginal tax rate (3) Levering Factor: 1 + [ ( 1 - Tax Rate ) * ( Debt / Equity ratio ) ] (4) Unlevered Beta: ( Beta / Levering Factor ) (5) Yield on Interpolated 20-Year US treasury Bonds which corresponds to Ibbotson's long-term equity risk premium (as of 2/04/05). Source: Bloomberg. (6) The average historic period between the return on stocks and L-T bonds (2004 Ibbotson Associates).

5.0%

(7) Cost of equity premia based on equity market capitalization. low-cap ($797mm - $1,167mm) = 1.59%. Amounts per 2004 Ibbotson. (8) Levered Beta: (Beta * Levering Factor) (9) Cost of Equity: Rf + B * ( Rm - Rf ) + Sp, or the risk-free rate plus the beta * the eq (10) WACC: Rd = Return on Debt; Re = Return on Equity [ Rd * (1 - tax rate) * (D / (D + E) ) ] + [ Re * (E / (D + E) ) ]

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Discounted Cash Flow Analysis ($ in millions)

EBITDA Less: D&A EBIT Less: Tax Effect Unlevered Net Income Plus: D&A Less: Capex Plus: Changes in WC Unlevered Free Cash Flow

2005E

2006E

2007E

2008E

2009E

$250.7 (113.6) $137.1 (52.1) $85.0 113.6 (103.2) (13.7) $81.7

$278.5 (121.6) $156.9 (59.6) $97.3 121.6 (110.5) (7.2) $101.1

$307.2 (130.3) $176.9 (67.2) $109.7 130.3 (118.4) (7.7) $113.9

$317.6 (134.2) $183.4 (69.7) $113.7 134.2 (122.0) (3.2) $122.7

$328.2 (138.2) $190.0 (72.2) $117.8 138.2 (125.7) (3.2) $127.1

Source: Wall Street research projections and Credit Suisse estimates. ($ in millions, except per share data)

Discount Rate

4.50x

Terminal Value EBITDA Multiple 5.00x 5.50x

6.00x

9.0%

$417.5 960.0 $1,377.5 (99.3) $1,278.2 $44.42 36.9% 0.4%

$417.5 1,066.7 $1,484.2 (99.3) $1,384.9 $47.92 47.7% 1.2%

$417.5 1,173.3 $1,590.9 (99.3) $1,491.6 $51.42 58.5% 1.8%

$417.5 1,280.0 $1,697.5 (99.3) $1,598.2 $54.92 69.3% 2.4%

Present Value of Free Cash Flows Present Value of Terminal Value Enterprise Value Less: Net Debt Equity Value Equity Value per Share (1) Implied Premium / (Discount) to Current Implied Perpetuity Growth Rate

10.0%

$406.1 917.1 $1,323.3 (99.3) $1,224.0 $42.64 31.4% 1.3%

$406.1 1,019.1 $1,425.2 (99.3) $1,325.9 $45.98 41.8% 2.1%

$406.1 1,121.0 $1,527.1 (99.3) $1,427.8 $49.33 52.1% 2.8%

$406.1 1,222.9 $1,629.0 (99.3) $1,529.7 $52.67 62.4% 3.3%

Present Value of Free Cash Flows Present Value of Terminal Value Enterprise Value Less: Net Debt Equity Value Equity Value per Share (1) Implied Premium / (Discount) to Current Implied Perpetuity Growth Rate

11.0%

$395.2 876.6 $1,271.8 (99.3) $1,172.5 $40.95 26.2% 2.2%

$395.2 974.0 $1,369.2 (99.3) $1,269.9 $44.15 36.1% 3.0%

$395.2 1,071.4 $1,466.6 (99.3) $1,367.3 $47.34 45.9% 3.7%

$395.2 1,168.8 $1,564.0 (99.3) $1,464.7 $50.54 55.8% 4.3%

Present Value of Free Cash Flows Present Value of Terminal Value Enterprise Value Less: Net Debt Equity Value Equity Value per Share Implied Premium / (Discount) to Current (1) Implied Perpetuity Growth Rate

(1) Based on share price of $32.44 as of 02/04/05.

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Potential Merger Assumptions Key Assumptions Projections

 USF

Corporation and Yellow Roadway projections based on Wall Street equity research; estimated marginal tax rate of 38%

 Prospective

Financing

 50%

Purchase Price

 Range

FMV Adjustments

 Fair

Goodwill

 Goodwill

Timing

 Assumed

Fees

 M&A

Synergies

 None

acquiror net income based on Wall Street equity research

Stock – 50% Cash Consideration assumed; financed by 100% bank debt at 3-Months LIBOR plus 100 basis points of $1,015 – $1,410 mm, corresponding to 4.0x – 5.6x 2005E EBITDA

market value adjustment estimated at 12% of book value; depreciated over 20 years not amortized to gain full 2005 earnings

Fees of 0.5% of transaction value  Financing fees of 2.5% of debt raised assumed; pre-tax synergies required to achieve acquiror break-even EPS inferred

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Merger Consequences Analysis Yellow Roadway Acquisition of USF Corporation ($ in millions)

–

Premium to Share Price Price Per Share

5.0%

10.0%

50% Cash / 50% Stock Consideration 15.0% 20.0% 25.0% 30.0%

35.0%

40.0%

$32.44

$34.06

$35.68

$37.31

$38.93

$40.55

$42.17

$43.79

$45.42

Equity Value (1) Net Debt

$918 99

$966 99

$1,014 99

$1,062 99

$1,111 99

$1,160 99

$1,210 99

$1,259 99

$1,309 99

Enterprise Value

1,017

1,065

1,114

1,162

1,210

1,259

1,309

1,358

1,408

Enterprise Value / 2005E EBITDA Enterprise Value / 2006E EBITDA

4.1x 3.7x

4.2x 3.8x

4.4x 4.0x

4.6x 4.2x

4.8x 4.3x

5.0x 4.5x

5.2x 4.7x

5.4x 4.9x

5.6x 5.1x

Equity Value / 2005E Net Income Equity Value / 2006E Net Income

13.3x 11.4x

14.0x 12.0x

14.7x 12.6x

15.4x 13.2x

16.1x 13.8x

16.9x 14.4x

17.6x 15.0x

18.3x 15.6x

19.0x 16.2x

2005E Stand Alone Diluted EPS 2005E Pro Forma Diluted EPS

$5.25 5.59

$5.25 5.53

$5.25 5.48

$5.25 5.43

$5.25 5.38

$5.25 5.33

$5.25 5.28

2005E Accretion / (Dilution) Acc / (Dil) – $ Acc / (Dil) – % Pre-Tax Breakeven Synergies

$0.34 6.4% –

$0.28 5.4% –

$0.23 4.4% –

$0.18 3.5% –

$0.13 2.6% –

$0.08 1.6% –

$0.03 0.7% –

($0.01) (0.3%) $1.3

($0.06) (1.2%) $6.1

1.6x 45.28%

1.7x 45.36%

1.7x 45.45%

1.7x 45.53%

1.8x 45.61%

1.8x 45.69%

1.8x 45.76%

1.9x 45.83%

1.9x 45.91%

14.2% 85.8%

14.9% 85.1%

15.5% 84.5%

16.1% 83.9%

16.7% 83.3%

17.3% 82.7%

17.9% 82.1%

18.5% 81.5%

19.1% 80.9%

(2)

Pro-Forma Debt / LTM EBITDA Debt-to-Capitalization (at closing) % Shares issued as currency ProForma Ownership%

$5.25 5.24

$5.25 5.19

Source: Wall Street Projections, Credit Suisse Estimates. (1) Net Debt numbers as of 12/31/04. (2) Based on LTM EBITDA of $697mm.

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3. Weekly Assignments and Resources A.

Public Information Book (PIB)

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Summer Assignment – PIB Assignment  Prior to the June 30th training session, please assemble a PIB on Knight Ridder  Make sure that your PIB has all the sections outlined on the next page  Insert numbered tabs between each section “blue sheets” between each item in the same tab, if

multiple items exist. For example, put a blue sheet between each research report  Have the Copy Center make a double-sided bound copy of your PIB

Key Takeaways  After completing this section, you should be familiar with most of the tools that are available to

access public information  Research reports are expensive!!! Purchase only those that are appropriate  Be prepared to answer questions like:

1. Where do I go to get the latest SEC filing? 2. Where do I go to get an ownership run? 3. Have any major events occurred at the Company in the recent quarter?

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Public Information Book Resources Sample Table of Contents

Where to Get the Material

1. General Public Information – – – –

S&P Stock Report Bloomberg Data Price/Volume Web Site

Company Website

2. Prospectus –

Usually follows a major event (M&A, Equity offering, Debt offering)

3. Annual Report

Company Website

4. Form 10-K –

Annual filing with the SEC, similar to an annual report

5. Form 10-Q –

Quarterly filing with the SEC

6. Proxy Statement –

Covers information about company shares and shareholders

7. Research Report – –

Include CS if available Look for longer, more recent research

CS Research & Analytics

8. News Run –

Back two – six months is standard

Company Website

9. Ownership Run –

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3. Weekly Assignments and Resources B.

Company Profile

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Summer Assignment – Company Profile Assignment  In the format shown on the sample pages, create a two page company profile for Knight Ridder Corporation  Make sure you include:  Company Overview  Market Statistics (download from FactSet)  Financial Overview  Stock Price Performance  Directors and Officers  Products  Current Ownership Helpful Hint: The financial overview summary sheet in your Abacus shell (see Tab C) is a good template from which to copy and paste market stats and financial overviews Key Takeaways  At the end of this section, you should be able to answer the following: 1. What are Knight Ridder Corporation’s primary business segments? 2. How has Knight Ridder Corporation performed in the last year with respect to: – Earnings? – Stock price? – Any relationship between the two? 3. Any important events occur at the Company over the past year?

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Agenda  Creating a general two page company profile  Keys to a successful acquisition ideas presentation

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Keys to a Successful Acquisition Ideas Presentation  Know Your Audience  Use a Systematic Approach  Remember the Formula: Strategic Fit + Availability = A Good Idea  Demonstrate Industry Knowledge  Revisit “Old” Ideas Selectively  Stimulate Discussion and Ask Questions  Summarize Conclusions and Develop Follow-up Plan

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Considerations in Determining Fit Strategic  Client specified

   

Size

General  Organic growth prospects of

target

Industry

 Management talent

Technology

 Technology or other

Geographic scope (international vs. domestic)

Financial  Leverage  Accretion / dilution  Market perception

proprietary assets

 Product synergies

   

Markets Customers Distribution Manufacturing

 Operating synergies

 Corporate cost savings  S,G & A cost savings  Other

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Signals of Availability / Lack Thereof Signs of Availability  Parent is a LBO sponsor  Filed equity offering with large secondary component  Previous failed attempt to sell (“busted auction”) or spin-off

(“busted IPO”)  Takeover speculation  Undervalued, depressed or declining stock price  Shareholder activism  Potential odd man out in rapidly consolidating industry or

segment  Changes in senior management or aging senior management

with no obvious successor  Dramatic revisions in corporate strategy  Need to expand internationally or to retrench  Need for capital  Failure or inability to grow new products organically  Parent reorganizing or realigning businesses, possibly in

preparation for a sale  Division with no logical strategic fit with the parent (“corporate

orphan”)

Signs of Lack of Availability  Insiders control a meaningful percent of the stock and have no

evident need for liquidity  Family-owned with the next generation preparing or prepared

to assume leadership  Majority owned by another company that has obvious reason to

hold onto the business  Strong and consistent stock performance  The current parent is the most obvious best owner for the

business The current parent has identified the business as a core business and/or the equity market is in favor of current parent owning the business Consider the target’s defensive posture vis-a-vis a hostile offer, but remember … the valuation/rationale must be even more compelling to justify an unsolicited approach Note: It is also important to review the valuation multiples of the publicly-traded Parent Company which owns the “target” subsidiary. If sale proceeds (after tax) imply lower valuation multiples (EBITDA, EBITA and Net Income) than those at which the parent stock is selling, the transaction would be dilutive to overall value and thus would probably be a nonstarter as a sale candidate today

 Division underperforming or less profitable than core business

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Acquisition Screening – Information Sources  SIC code lists  Equity analyst research  “Competition” sections of prospectuses and 10-Ks of comparable companies  Research reports relating to the Client and its core industry group competitors  Value Line for Client and its competitors  S&P Tear Sheets (with word search)  OneSource (U.S. Public, U.S. Private, and U.K. Public SIC Code Summary Analyses)  Industry trade association lists  Trade publications  WorldScope database (Global Buyers List)  FactSet “comp builder”  SDC M&A summaries

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Creating a General Company Profile  Business section of 10K / Annual Report

Company Overview Business Description The Boeing Company is an aerospace firm. The Company operates in principal areas that include commercial airplanes, military aircraft, missile systems, space and communications and customer and commercial financing. Business Segments 

The Commercial Airplanes segment is involved in development, production and marketing of commercial jet aircraft and providing related support services, principally to the commercial airline industry worldwide.



The Military Aircraft and Missile Systems segment is involved in the research, development, production, modification and support of military aircraft including fighter, transport and attack aircraft, as well as helicopters and missiles.



The Space and Communications segment is involved in the research, development, production, modification and support of space systems, missile defense systems, satellites and satellite launching vehicles, rocket engines and information and battle management systems.



The Customer and Commercial Financing segment is primarily engaged in the financing of commercial and private aircraft and commercial equipment.

Competitors The Company competes with Lockheed Martin, Raytheon, BAE Systems, Northrop Grumman, Matra BAe Dynamics Alenia and The European Aeronautics Defense & Space Corporation.

 finance.yahoo.com business profile  Research reports  Company Web site  VentureSource (private companies)  Your PIB can be a great resource (See

Tab A)  10K / Annual Report  Research reports  Company Web site  PIB

 10K / Annual Report  Research reports  finance.yahoo.com business profile  Company Web site  PIB

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Creating a General Company Profile Therapeutic Focus – 2003 Highlight product mix or any particular asset that might be of interest to your Audience

Osteoporosis $1.0 BN

Sexual Antibiotics Dysfunction $0.7 BN $0.2 BN

Oncology $1.0 BN

Cardiology $0.5 BN

 Company Web site  Research reports  10K / Annual report Note:

Currently there is no similar pie graph in USF profile but it is a possibility for your Knight Ridder profile (or other profiles you will be expected to do in your respective groups).

Diabetes/ Metabolic $2.1 BN

CNS $5.4 BN

Financial Overview ($ in millions)

 You can find the historical information

from company filings  The projections will come from

research  PIB

Revenues % Growth EBIT % Margin EBITDA % Margin Net Income % Margin EPS Capex

2004A $2,394.6 4.5% $112.1 4.7% $169.2 7.1% $55.8 2.3% $0.85 145.0

December 31, 2005E $2,516.9 5.1% $130.0 5.2% $253.7 10.1% $66.5 2.6% $2.48 185.0

2006E $2,658.8 5.6% $150.1 5.6% $273.1 10.3% $78.8 3.0% $2.82 190.0

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Creating a General Company Profile Market and Trading Data  This should come from your equity

Stock Price (2/4/05)

$32.44

% of 52-Week High 52-Week High / Low

83.6% $38.80 /

Diluted Shares

$27.51 28.2

Equity Market Value

916.0

(+) Debt

250.1

(–) Cash & Equivalents

150.8

Enterprise Value

comp shell (See Tab C)  Keep in mind, you may update this

profile often (e.g. latest stock price or estimates) so keeping your comps flexible is key

$1,015.3

Enterprise Value to: 2004E Revenue

$2,516.9 /

0.4x

2005E Revenue

$2,658.8 /

0.4x

2004E EBITDA

$169.2 /

6.0x

2005E EBITDA

$253.7 /

4.0x

2004E EPS

$0.85 /

38.2x

2005E EPS

$2.48 /

13.1x

EPS Estimates / P/E Ratio

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Creating a General Company Profile Stock Price Performance $40

2,000

Stock Price

1,500

$34 1,000 $31 500

$28 $25 2/4/04



ActiveGraph made from Excel and FactSet



Keep in mind, you may update this often



Plot either standalone or against peer group. If showing peer group, use the companies in your equity comps (see Tab C) but exclude the company you are profiling

4/5/04 6/5/04 USF Corp. Volume

8/5/04

Volume in Thousands

$37

0 10/5/04 12/5/04 2/4/05 USF Corp. Stock Price

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Creating a General Company Profile Ownership HOLDERS Citigroup Inc. Fidelity Management & Research Dimensional Fd Advisors, Inc. Barclays Bank Allianz Dresdner Asset Mgmt. Top 5 Institutions Other Institutions Total Institutions Insiders Other Total

SHARES 2,595,871 2,410,515 1,831,607 1,567,377 1,234,140 9,639,510 15,892,218 25,531,728 473,040 196,072 26,200,840

% OF TOTAL 9.9% 9.2% 7.0% 6.0% 4.7% 36.8% 60.7% 97.4% 1.8% 0.7% 100.0%

 ShareWorld  Proxy (for insider ownership)  FactSet

Recent News  1/28/2005: USF Corporation reported fourth quarter and full

year 2004 results, missed Wall Street earnings  12/13/2004: Announced opening of two new terminals serving

the Southern Minnesota and Decatur, Alabama areas  11/2/2004: Richard P. DiStasio stepped down as CEO, Paul

Liska was named interim CEO

 Company news releases  Factiva  Equity research

 10/22/2004: Reported third quarter 2004 results, missed Wall

Street earnings  9/9/2004: USF Holland announced the opening of eight (8)

Northeast terminals, service city includes: Baltimore, MD Albany, NY, Allentown, PA, Harrisburg, PA, Philadelphia, PA, Wilkes Barre, PA, Syracuse, NY, and Richmond, VA

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Creating a General Company Profile Management and Board



Proxy



finance.yahoo.com



Company Web site



Sometimes you will see profiles with a brief biography of the directors and officers

Name

Position and Affiliation

Thomas E. Bergmann

Interim CEO, CFO

Steven Caddy

President and CEO, USF Holland

Edward R. Fitzgerald

President and CEO, USF Reddaway

Douglas R. Waggoner

President and CEO, USF Bestway

Paul J. Liska

Chairman of the Board

Morley Koffman

Director

Stephen W. Lilienthal

Director

Anthony J. Paoni

Director

Glenn R. Richter

Director

Neil A. Springer

Director

Michael L. Thompson

Director

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3. Weekly Assignments and Resources C.

Equity Comps

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Summer Assignment – Equity Comps  For your assignment, you are to submit an Equity Comp output page for Knight Ridder AS OF THE

DATE OF THE ACQUISITION (3/10/06)  You must first find comparable companies. For this project, you need only Knight Ridder

Corporation and three comparable companies

 Include McClatchy Company and New York Times Co as comps and find one comp on your own  Input ABACUS shells for these comps using FactSet, the companies’ financials and Wall Street

research to find the following multiples:

    

2006E and 2007EV/revenue 2006E and 2007E EV/EBITDA 2006E and 2007E EV/EBIT 2006E and 2007E P/E 2006E and 2007E EBITDA margins

 When necessary, make sure to calendarize the financials  Make sure to check your output and see if something looks abnormal

 If so, you’ve likely made a mistake

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Summer Assignment – Equity Comps (Cont’d) Helpful Hint #1: If you’ve inserted your data properly into the input pages, ABACUS will generate a formatted and linked output page for you: Go to ABACUS / New Summary Sheet / Forward Multiple Analysis Helpful Hint #2: The output page converts all currencies to US$. If you are using a foreign company, make sure you input the proper exchange rate in the appropriate section of the shell Key Takeaways  At the end of this section, you should be able to answer the following:

   

1. On what basis did you choose your one other comparable? 2. In retrospect, are they “good” comps? Why or why not? 3. How is Knight Ridder trading relative to its peer group? 4. Can you explain its relative valuation? Why does it trade at a premium or discount to its peers? Think of its relative earnings, margins, market share, size, etc.

 5. What does this mean to a potential buyer?

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Agenda  What are Equity Comps and Why Do We Do Them?  Finding Comparable Companies  Collecting the Data  Using the Compco Model  Common Pitfalls  Interpreting the Results  USF Corporation: sample equity comps

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What Are Equity Comps and Why Do We Do Them?  A big part of an investment banker’s job is to value companies

 More than anything else, clients want to know what their companies are worth – especially relative to their peers  One way to value companies is to infer (or compare) their value based on the public trading

values of other companies with similar characteristics  Because not all companies are the same size or have the same capital structure, we need to

establish universal metrics that can apply to all companies within a group

 These metrics almost always take the form of a ratio or “multiple”, where the numerator is a measure of trading value (Enterprise Value; Market Value) and the denominator is an operating statistic (EBITDA, Net Income)

 The most common metrics are Enterprise Value / EBITDA and Market Value / Net Income (or P/E)  The calculation and interpretation of these metrics is a Comparable Company Analysis, or

Compco Analysis Helpful Hint: The right terminology for this analysis is the Comparable Company Analysis, but since bankers like to complicate matters, this analysis is referred to differently by each group. Don’t get confused if you’re asked to do equity comps, compcos, comps, and a comparable company analysis all in one night: They all mean the same thing!

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OK, So What Are Enterprise and Equity Value?  Enterprise Value is the total dollar value of a business, represented by the sum of all of the

ownership interests in the business

 Note: Enterprise Value is sometimes referred to as Adjusted Market Value, Firm Value or (in early-stage biotech) Technology Value  In broad terms, there are two types of ownership interests in a business – Debt and Equity

 The public market value of a business’ equity is referred to as its equity value, market value or market capitalization  We calculate a business’ Enterprise Value by summing the public market values of its debt and

equity

 Caveat: Because the trading value of debt securities is less volatile than equity securities, we typically use the book value of debt rather than the market value to save time  Enterprise Value is an important measure because it makes companies with different capital

structures more comparable

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OK, So What Are Enterprise and Equity Value?

Enterprise Value = Value of All Business’ Assets = Equity Value + Net Debt(1) Equity Value = Value of the Shareholders’ Equity = Current Stock Price x Shares Outstanding(2)

Liabilities and Shareholders’ Equity

Assets

Net Debt Enterprise Value

Enterprise Value

Equity Value

(1) (2)

Net Debt equals long-term debt + short-term debt + “out of the money” convertible debt + minority interest + preferred stock + capitalized leases – cash and cash equivalents. The proper way to calculate Equity Value is to use the diluted number of shares outstanding, which includes all “in the money” and exercisable stock options.

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Fair Enough, But Help Me With This EBITDA Thing  EBITDA is an accounting measure of how much cash flow a business generates from its

operations  EBITDA excludes interest, taxes and depreciation and amortization because these items vary

from company to company – for reasons which generally do not impact value – making them harder to compare on a consistent basis

 Interest is a function of capital structure  Taxes are a function of incorporation and tax structure  Depreciation is a function of depreciation policy / asset lives  Amortization is a function of how acquisitive a company has been EBITDA = Earnings before Interest, Taxes, Depreciation and Amortization  We place emphasis on Enterprise Value / EBITDA because this metric excludes most variables

which do not affect value (or can be easily changed) making companies more comparable for valuation purposes

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Let’s Recap  The absolute value of a business is expressed by its Enterprise and Equity Value

 Enterprise Value is the total value of all ownership interests in a business  Equity Value is the value of the equity in a business  The relative value of a business is expressed by a “multiple” of its absolute value to its operating

results

 “GE is trading at 22x its 2006E projected EBITDA” – Translation: The ratio of GE’s Enterprise Value to its forecasted 2006E EBITDA is 22

 “Walmart’s 2006E P/E multiple is 18x” – Translation: The ratio of Walmart’s equity value to its forecasted 2006 net income is 18  Enterprise Value / EBITDA is an important metric because it eliminates non-value impacting

variables which otherwise make companies less comparable Enterprise Value Multiples

Equity Value Multiples

Enterprise Value / Sales

Equity Value / Net Income

Enterprise Value / EBITDA

Price / Earnings

Enterprise Value / EBIT

Equity Value / Tangible Book Value

Industry Specific Metrics (EV / Fiber Miles)

Other Industry Specific Metrics

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Finding Comparable Companies Look for companies with characteristics similar to those of the business being valued: Operational

Financial

 Industry

 Seasonality

 Size

 Products

 Cyclicality

 Growth Profile (Sales, EBITDA, Earnings)

 Distribution Channels

 Strategy

 Margins (Gross Profit, EBIT, Net Income)

 Markets

 Customers

 Leverage

Sources to check to initially select comparables:  Your colleagues (before you start, make sure someone hasn’t done it already!)  Associates and Officers – most of the time they will pick them for you  Proxy Statements  Equity research reports and analysts  SIC code searches – FactSet, OneSource, Library  S&P Tearsheets  Value Line

Note: This rule does not apply to your summer valuation project – sorry guys!

 Trade publications  IPO or other prospectuses  10K – Competition section

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Collecting The Data – What Do I Need?  Most recent financial statements – LTM financials

 10-K, 20-F or Annual Report (available 90 days after end of period)  10-Q quarterly or interim report (available 45 days after end of period)  Earnings Releases (typically available 2-3 weeks after the end of the quarter) – Don’t miss these – they are the most updated information available – Often have complete income statements and balance sheets

 Other Press Releases  EPS Forecasts – Be Consistent!

 First Call  I/B/E/S  Operating Projections

 CS Equity Research  Equity Research from other firm  I/B/E/S  Stock Price Information

 Current / 52 week high-low

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Why Do I Need It and Where Do I Get It? Why Do I Need It?  10-K / Annual Report

 LTM Income Statement Information  Options/Convertible Data  10-Q / Quarterly Report

10-Ks, 10-Qs, 8-Ks

 LTM Income Statement Information  Balance Sheet Information  Basic Shares Outstanding  8-Ks / Report of a Material Event

 Pro Forma Information for Acquisitions or Other Transactions

Where Do I Get It?  Thomson Research (from InfoCentral – IBD

Internal website)  FactSet on your PC  OneSource on your PC  SEC Edgar Archives (www.sec.gov)  Disclosure workstations (in library)  Sedar.com (for Canadian companies)  Documents Library on EMA 28 at x5-4000

(use library as a last resort – they will always take longer to pull docs than you will)

 Earnings Announcements

 Research analysts submit their EPS

EPS Forecasts

estimates to publicly available centralized databases (First Call, I/B/E/S)  The mean or “consensus” estimate

represents the Street view of a Company’s expected performance

 FactSet (First Call, I/B/E/S) on your PC  First Call website (InfoCentral)  Detailed First Call reports (6th Floor)  Bloomberg terminals (Nelson's)

 We use Street view to calculate P/E multiples

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Why Do I Need It and Where Do I Get It? Why Do I Need It?  Research analysts project what a Company’s

income statement will look like in the future  We use these models to calculate projected

EBITDA

Operating Projections

 The research report you select is VERY

important and will influence your valuation multiples  You should always select a research report

which has an EPS forecast close to the consensus

 To calculate equity and enterprise value

 CS Research & Analytics  Call CS Research Analyst for updated model  Research Bank Web (Info Central) – for

non-CS research  Multex.com – for non-CS research  Research Bank workstations (older reports)  Library request at x5-4000 (for older or hard

to find research reports)

 FactSet on your PC  Investment Banking Workstation on your PC

Stock Price Information

 Bloomberg terminals

 To calculate equity and enterprise value

Other Information

Where Do I Get It?

 FactSet on your PC  Investment Banking Workstation on your PC  Bloomberg terminals

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CONFIDENTIAL

Data Collection Best Practices (How To Keep My Associate Happy and Get a Big Bonus)  Keep a Record

 Print out hardcopies of all source documents (10-Ks, 10-Qs, EPS Projections, Analyst Reports)  Leave a Trail / Be Organized

 Highlight data and tab pages used from source documents and use folders for each company  Use “Comments” function in Excel to footnote items that need explanation (i.e., approximations, assumptions, calculations and unusual items)  Be Complete

 Supply your Associate with all source documents, a printout of the equity comps and an electronic copy for all companies to be checked  Be Efficient

 Work sequentially through companies, so that your Associate can start checking while you continue working  Be a Thinker

 Check your results. If something looks wrong, it probably is  Never assume FactSet downloads or other people’s comps are correct

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1. General Company Information / User General Company Information Primary Company Ticker Last Fiscal Year Ended Latest Balance Sheet as of Source of Latest Balance Sheet LTM Earnings as of Source of LTM Earnings First Projected Calendar Year End: Calendarization Factor

 The ticker identifies the company you are CHRW 12/31/04 3/31/05 10-Q 3/31/05 10-Q 12/31/05 0.0%

 The financial statement dates identify which

historical and projected years you are generating multiples for. These dates drive the model’s column headings

 Note: The dates do not drive which data

Research Research Source Analyst Date of Research Recommendation Target Price

creating a comp file for and is used by Factset to select data to download

Morgan Stanley James Valentine 5/01/05

FactSet downloads; FactSet defaults to the most recently available data

–

User Information Analysis Prepared by Preparer Phone Number Analysis Checked by Checker Phone Number

kjackso3 62714 T_Bushey 65888

 It is important to fill out the user information

so that other people using your model can call you with questions

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2. Diluted Share Calculation / Options and Convertible Debt Schedules  In general, Equity Value = Current Stock Price x Basic Shares Outstanding  However, most companies have securities which represent contingent shares – meaning they

are not shares today, but can become shares if certain conditions are met – and as a result, we need to make adjustments to basic shares outstanding  The most common of these securities are options / warrants

 Options are a price right or option granted to management to purchase their company’s stock at a pre-specified or strike price

 Management profits if the market price of the stock exceeds the strike price when they exercise the options. Hence, Management is only likely to exercise his/her options under these circumstances  Options are reported in the 10-K. Companies typically disclose the number of options that are

outstanding and exercisable

 Exercisable options are vested and can be used to purchase shares today. Exercisable options, NOT outstanding, are relevant for equity comp purposes  The method we use for calculating the impact on basic shares outstanding of options is called

the Treasury Stock Method

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Calculating Diluted Shares Outstanding Using the Treasury Stock Method Scenario:

197.3 million basic shares outstanding 8.2 million exercisable options with a weighted average strike price of $14.02 Current stock price is $17.74.

Translation:

8.2 million options are “in the money,” meaning they are exercisable at a lower price than the current market price. This means the owner of these options has the right to buy stock from the Company at $14.02 and could sell it in today’s market at $17.74. If the owner of the options did this, he would pay the Company $14.02 for each share, sell it in the market for $17.74 and pocket the $3.72 spread.

Treasury Method Calculations:

The treasury stock method assumes the above transaction occurs and that the Company uses the $14.02 they receive to repurchase shares in the market at $17.74, thus: Basic Shares Outstanding Plus: Shares Issued to Options Holder

($14.02 x 8.2) / $17.74

Less: Shares Repurchased with Proceeds Diluted Shares Outstanding

197.3 8.2 205.5 (6.5) 199.0

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What About Convertible Debt and Preferred?  Investment Bankers have created hybrid securities which pay interest like straight debt, but

become common stock if certain conditions are met

 Convertible Debt  Convertible Preferred  Other Equity-Linked Securities  Convertible securities are NOT evaluated using the Treasury Stock Method  Most important thing to remember: Convertible Securities are treated as either debt or equity

for valuation purposes – NOT both

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CONFIDENTIAL

What About Convertible Debt and Preferred? Example: A company has a convertible preferred security with a face value of $1,114 million that pays a dividend of 6.5% and has a conversion price of $18.00

Current Price < $18.00  Treated as Debt  Income Statement Effect

 None  Equity Value Effect

 None  Net Debt Effect

 Should include full amount of convertibles ($1,114)

Current Price > $18.00  Treated as Equity  Income Statement Effect

 Debt: Interest backed out  Preferred: Dividend backed out ($1,114 x 6.5% = $72.4)  Equity Value Effect

 Additional shares outstanding from conversion (add $1,114/$18 = 61.9 to shares outstanding)  Net Debt Effect

 Debt does NOT include face value of converted debt/preferred

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2. Treasury Method Diluted Share Calculation / Options and Convertible Debt Schedules Treasury Method Fully Diluted Share Calculation ($ in millions, except per share data)

CLASS SHS. OUT. A 1,129.5 B 0.0 C 0.0 D 0.0 E 0.0 Total Primary Shares Outstanding 1,129.5 New Shares Issued Converted Debt shares (Schedule A) Converted Preferred Shares (Schedule B) Converted Options/Warrants (Schedule C) Shares Buy-Back from Options/Warrants exercise proceeds Fully Diluted Shares Outstanding

PRICE 74.36 0.00 0.00 0.00 0.00 74.36 0.0 0.0 0.0 59.6 (48.5) 1,140.6

Schedule A - Convertible Debt ANNUAL INTEREST

MATURITY Debt Series 1

1/00/00

0.00%

BOOK VALUE

TRADING VALUE

0.0

0.0

BOOK VALUE

TRADING VALUE

0.0

0.0

# SHARES CONV INTO 0.0

IMPLIED CONV PR

DEBT CONVTD

SHARES ISSUED

0.00

0.0

0.0

IMPLIED CONV PR

PREF CONVTD

SHARES ISSUED

0.00

0.0

0.0

Schedule B - Convertible Preferred ANNUAL INTEREST

MATURITY Preferred Series 1

1/00/00

0.00%

# SHARES CONV INTO

Schedule C - Options/Warrants using Outstanding PRICE Options/Warrants 1 Options/Warrants 2 Options/Warrants 3 Options/Warrants 4

# EXER 6.760 7.970 21.340 12.590

LOW 21.29 53.27 71.03 79.44

PRICE HIGH 21.29 56.14 71.93 77.90

# OUTS 6.760 21.370 31.510 23.170

LOW 21.29 56.14 71.93 77.90

HIGH 21.29 56.14 71.93 77.90

WEIGHTED AVERAGE PRICE 21.29 56.14 71.93 77.90

# EXERCISED 6.8 21.4 31.5 0.0

Note: Option Schedule Includes all series.

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3. Debt & Preferred Schedule Debt & Preferred Schedule

 Debt can be listed on the balance sheet

($ in millions)

DESCRIPTION

under a variety of names

VALUE

NAME RATE SENIORITY Long-Term 0.0% Sen Long-Term 0.0% Sen Long-Term 0.0% Sub Long-Term 0.0% Sub Long-Term 0.0% Sen LT Debt Adj 0.0% Sen Total Long-Term Debt Sub Out-of-the-Money Convertible Short-Term 0.0% Sen Short-Term 0.0% Sub ST Debt Adj 0.0% Sen Total Short-Term Debt 0.0% Sub Capital Leases 0.0% Sub Capital Leases Cap. L. Adj. 0.0% Sub Total Capital Leases Other 0.0% Sen Other Adj. 0.0% Sen Total Other Debt Out-of-the-Money Convertible Preferred Preferred 0.0% Preferred 0.0% Pref. Adj. 0.0% Total Preferred Total Debt & Preferred

BOOK 4,503.6 0.0 0.0 0.0 0.0 0.0 4,503.6 0.0 807.1 0.0 0.0 807.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 5,310.7

MARKET 4,503.6 0.0 0.0 0.0 0.0 0.0 4,503.6 0.0 807.1 0.0 0.0 807.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 5,310.7

Total Senior Debt Total Subordinated Debt Total Convertible Debt (assumes no conversion Total Convertible Preferred (assumes no conve

5,310.7 0.0 0.0 0.0

5,310.7 0.0 0.0 0.0

     

Notes Commercial Paper (CP) Current Portion of LT debt Credit Facility Revolver Loans

 The ABACUS model allows you to calculate

the net debt based on book or market values  If the Company issued additional debt or

convertible securities since its latest filing, input these securities in adjustment rows (additional equity securities would increase shares outstanding and book equity)  For Credit Stats identify Seniority of the

outstanding debt

 1 = Senior Debt  2 = Sub. Debt

Note: 1=Senior Debt, 2=Subordinated Debt.

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4. Historical / LTM Income Statement Step 1  FactSet downloads the historicals automatically. Check downloaded FactSet information and

make changes as required  Fill in Last Fiscal Year column exactly as shown on financial statement (we’ll get to adjustments

later)  You will find all the line items on the income statement, except Depreciation & Amortization, which

are on typically the cashflow statement  If the latest fiscal year end is the most recent quarter, you can ignore the other two columns

Step 2  Fill in the most current quarter and prior corresponding quarter to get to LTM  Make sure you use cumulative amounts (i.e. if the fiscal year end is 12/31 and you are looking at

9/30 10-Q, use “nine months ended” data) Step 3  The model automatically calculates LTM for you. Make sure you set CS as the LTM source under

settings/options so the output picks up your hard work

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Great, But What’s LTM?  LTM = Last Twelve Months  Companies report financial results on a quarterly basis (every 3 months)  LTM represents the sum of the last four quarters’ results  LTM is important because it shows what the company’s reported performance has been over

the last year (though not necessarily a calendar year)

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5. Income Statement Adjustments – Unusual and Non-Recurring Items Companies often report one-time gains or extraordinary charges in accordance with GAAP. As financial analysts, we do not view these charges as related to operations and thus exclude them.  Typical “non-operating” charges include gains/losses on sale of assets, inventory write-downs

and restructuring charges  It is important to remember that not all unusual or non-recurring items will be broken out on the

financial statements. This is the result of:

 Accountants will not always allow companies to break-out certain charges on the financial statements because they are not unusual in the strictest sense

 Some companies may not want to highlight that they “made their numbers” as a result of an extraordinary gain  Charges or gains not broken out in the financials can always be found in the MD&A – that’s why

you need to read it!

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6. Projected and Calendarized Income Statement  Projected income statement data comes from the research report you have selected  This data generates your projected EBITDA  It is important to make sure your projected data is presented on the same basis as your

historical data  Completing the equity comp projected data is similar to the historical / LTM data

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A Note On Calendarizing Estimates Some companies do not have December 31 fiscal year ends. As a result, the earnings of these companies are not comparable to the earnings of companies with a December 31 year end. Therefore:  EPS estimates must be adjusted to a December year end to make companies with different

fiscal year ends comparable on a P/E basis

 First Call and I/B/E/S generally download a CYEPS (Calendar Year EPS)  This is intuitively clear when considering two companies – one with a fiscal year ending

September 30, 2005 and the other with a fiscal year ending December 31, 2005

 The 2005 earnings estimates associated with the “September” company have a higher degree of certainty than the “December” company and thus should receive a higher multiple than an identical “December” company  Our objective is to eliminate this artificial valuation differential by “calendarizing” the estimates  If you choose not to calendarize it, please set calendarization date equal to last fiscal year end

Helpful Hint: In the top right corner of your ABACUS shell, you have the option to calendarize manually (meaning you do all the work) or by formula (meaning FactSet generates the formula for you). In most cases, use the Formula option, but make sure you know how it is deriving its ratio.

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Calendarizing EPS Estimates Example #1: “Fiscal year ends September 30” What does this mean? It means that 9 months (or ¾) of the Company’s fiscal 2004 results (Jan. 2004 – Sept. 2004) are included in the 2004 calendar year with the remaining 3 months (or ¼) of the calendar year estimated in the fiscal 2005 results. Illustration:

FISCAL YEAR ENDED SEPT. 30, 2004A 2005E 2006E Sales

$1,000

$1,010

FACTOR 75.0%

CALENDAR YEAR ENDED DEC. 31, 2004A 2005E

25% $1,020

$1,002.5

$1,012.5

75%

EBITDA

150

200

250

162.5

212.5

EPS

1.00

1.10

1.20

1.03

1.13

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The Sanity Check How to avoid the dreaded, “This doesn’t look right” response  Take 5 minutes to look at the output when you’re done – the team will wait  Look for outliers in the data

 Comparable companies usually have comparable multiples – If 9 out of 10 companies in your equity comps are trading between 8x and 10x EBITDA, and one is trading at 20x, you might have a problem – Possible explanations: 1. You’ve made a mistake, 2. This isn’t a good comp, or 3. There is something unusual about this company – In the unlikely event of Case 3, be sure you can explain the situation

 Likewise, the relationship between Enterprise Value / EBITDA and P/E should be roughly the same across companies – Not always true, but be prepared to explain why it’s not  Check your multiples against research to be sure you’re in the right ballpark  If the business is showing momentum and estimated annual operating statistics are improving

over current year figures, your consecutive multiples should be declining (e.g., 16.5x 2005E P/E vs. 14.6x 2006E P/E)

 If the multiples are increasing, make sure you understand why

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CONFIDENTIAL

Great Equity Comp Mysteries  What do I do with Minority Interests?

 Include with total capital for Enterprise Value calculation, exclude from debt for credit statistics

 Include with net income if it appears to be a “normal” part of business  What do I do with Equity Earnings when I am calculating Net Income?

 Include if it is a “normal” part of the business  How do I know if a company has “done something” recently?

 “Something’s not right”  Common “light bulbs” – dramatic change in stock price or shares outstanding, jump in sales or margins

 Look in News Runs, SDC, Documents Library  What if a company has done something recently?

 Pro forma the event, e.g., for equity or debt offerings, use the prospectus  Make sure your forecasts (EPS and operating) reflect the event  Footnote!

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Great Equity Comp Mysteries  What do I do with all those weird “extraordinary” charges?

 Is it really extraordinary?  Most common are Environmental Charges, Restructuring, Gain/Losses on Sales, Changes in Accounting

 Get rid of it – don’t forget tax effects  Don’t forget to adjust historical EPS  Can I trust FactSet (FDS) codes?

 In general, no (exception is security prices)  Do I do anything different with options in an M&A situation?

 Assume all in-the-money options are exercisable (change of control provisions)

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Great Equity Comp Mysteries What do I do if a company has had a stock split?  Look in the Stock Guide, footnotes to financial statements, Bloomberg  Make sure historical and forecast EPS reflect the split  Example:

BEFORE SPLIT

Stock Price EPS P/E

AFTER SPLIT: CORRECT

AFTER SPLIT: INCORRECT

$100

$50

$50

$10.00

$5.00

$10.00

10x

10x

5x

2:1 Stock Split

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Definitions  Equity Value (also referred to as Market Value)

 The market value of a company’s equity: (Number of fully diluted shares x current stock price) - option/warrant proceeds

 Number of fully diluted shares = “What the market thinks is outstanding” = Primary shares + “in the money” exercisable options/warrants + shares from the conversion of “in the money” convertible debt/convertible preferred stock

 What to do with option/warrant proceeds – Subtract from market value  Enterprise Value (also referred to as Adjusted Market Value, or AMV)

 The market value of the total enterprise  Market value of equity + net debt  Net Debt = Long-term debt (including current portion) + short-term debt + “out of the money” convertible debt + minority interest + capitalized leases – (cash + equivalents)

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Interpreting the Results – A Few General Themes  A larger business is viewed as less risky than a smaller business. However, smaller

entrepreneurial companies may get a premium valuation if they are growing quickly  Higher projected earnings growth implies faster stock appreciation potential and will positively

impact valuation  Higher leverage implies less financial flexibility and will negatively impact valuation  Higher profitability margins imply better expense controls and better ability to stay price

competitive and will positively impact valuation  The higher the economic cyclicality or seasonality of earnings, the riskier the stock  Dividend payments positively impact valuation. Dividends are usually paid by mature

companies that need further incentives for investors. High growth companies do not need a dividend to get a high valuation  Higher trading multiples (e.g., price/earnings ratio) make the stock less attractive than a similar

company with lower statistics

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Your Enterprise Value Is Not Correct  You forgot Minority Interest

 Should be included in total capital for enterprise value calculation  Is not included in total capital when calculating credit stats  You missed a debt instrument on the balance sheet  You missed a cash equivalent on the balance sheet  The Company may have done a debt offering after the balance sheet date

 You can find out in the “subsequent events” section of the 10-K or 10-Q, from a company news run or Bloomberg

 Make sure that you check what the proceeds were used for – if they were used to pay down other debt, then you should not change anything  Your Equity Value is not correct

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Your Equity Value Is Not Correct  The Company has done a stock split  The Company has issued or repurchased shares after the 10-K or 10-Q date  The Company has additional classes of common stock outstanding  You forgot to include the stock options  You forgot to include convertible debt or convertible preferred stock

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Your LTM Data Is Incorrect  You forgot to pro forma for all the charges – make sure to thoroughly read the MD&A and

financial notes  You forgot to use cumulative quarterly data (i.e. “three months ended” 9/30 vs. “nine months

ended” 9/30)  You forgot to adjust your income statement for acquisitions/divestitures  You forgot to check for press releases and are not using the most up-to-date data  You assume D&A is included in operating expenses but it isn’t

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Your Projected Data Is Incorrect  Your research report is outdated – make sure that the research report you are using has EPS

estimates in line with I/B/E/S or First Call  You did not calendarize  You did calendarize but used the wrong ratios  Your research report had a mistake you did not catch  Your research report currency does not match the rest of your input currency

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CONFIDENTIAL

Comparable Company Analysis ($ in millions)

COMPANY

SHARE PRICE

% OF 52-WEEK

EQUITY

ENTERPRISE

02/04/05

HIGH

VALUE

VALUE

ENTERPRISE VALUE AS A MULTIPLE OF SALES MULTIPLE OF EBITDA

P/E

2004E

2005E

2004E

2005E

2004E

2005E

LONG-TERM EPS

LTM OPERATING

GROWTH

RATIO

Truck Load JB Hunt Transportation

$45.00

97.7%

$3,682

$3,697

1.3x

1.2x

8.2x

7.2x

17.5x

15.5x

15.8%

92.9%

Swift Transportation(1)

22.61

99.4%

1,671

2,265

0.8x

0.7x

6.2x

5.9x

14.8x

12.6x

12.6%

93.6%

Werner Enterprises(1)

20.94

90.1%

1,679

1,570

0.9x

0.9x

5.5x

4.9x

19.6x

16.1x

15.3%

91.6%

Heartland Express(1)

20.93

90.2%

1,570

1,311

2.9x

2.6x

10.8x

9.7x

25.2x

22.0x

13.8%

79.6%

Knight Transportation(1)

25.71

99.3%

1,460

1,434

3.5x

2.9x

11.9x

10.1x

29.4x

23.1x

16.6%

80.7%

Covenant Transportation

20.86

97.8%

312

372

0.6x

0.6x

4.8x

4.1x

18.9x

15.8x

12.0%

94.0%

1.7x 1.1x

1.5x 1.0x

7.9x 7.2x

7.0x 6.5x

20.9x 19.3x

17.5x 16.0x

14.4% 14.6%

88.7% 92.3% 92.3%

Mean Median Less Than Truckload CNF Inc(1)

$46.49

91.2%

$2,457

$2,400

0.6x

0.6x

6.2x

5.3x

17.8x

14.3x

14.1%

Overnite Corp(1)

30.35

78.5%

850

925

0.6x

0.5x

5.3x

4.6x

13.2x

11.0x

15.5%

82.8%

Arkansas Best Corp(1)

41.77

89.5%

1,069

1,000

0.6x

0.5x

4.9x

4.7x

13.0x

11.2x

12.5%

92.8%

Old Dominion Freight(1)

35.60

97.5%

885

961

1.2x

0.9x

7.9x

6.6x

21.6x

16.9x

17.5%

91.4%

SCS Transportation(1)

22.55

81.6%

354

470

0.5x

0.4x

5.2x

4.6x

17.8x

13.0x

15.0%

95.6%

Yellow Roadway Corp(1)

56.31

97.8%

2,769

3,320

0.5x

0.5x

6.3x

5.0x

14.2x

10.9x

10.5%

94.6%

0.7x 0.6x

0.6x 0.5x

6.0x 5.8x

5.2x 4.9x

16.3x 16.0x

12.9x 12.1x

14.2% 14.5%

91.6% 92.6%

1.0x 1.5x 1.1x 0.5x 0.6x 2.6x 3.0x 0.4x 0.7x

0.9x 1.1x 1.0x 0.5x 0.5x 2.4x 2.6x 0.4x 0.6x

18.5x 30.8x 6.9x 19.1x 8.3x 11.2x 13.9x 10.2x 6.6x

16.1x 13.0x 5.2x 14.7x 7.2x 9.8x 11.5x 8.9x 5.5x

32.9x 27.9x 11.1x 27.7x 29.0x 16.2x 27.7x 25.3x 12.3x

28.4x 21.6x 7.4x 23.1x 23.8x 13.7x 23.1x 22.6x 8.5x

14.5% 20.0% 20.0% 17.4% 17.0% 14.6% 14.5% 25.0% NA

94.9% 94.0% 94.6% 97.2% 94.1% 94.8% 81.1% 96.6% 93.9%

1.3x 1.0x

1.1x 0.9x

14.0x 11.2x

10.2x 9.8x

23.3x 27.7x

19.1x 22.6x

17.9% 17.2%

93.5% 94.6%

0.4x

0.4x

6.0x

4.0x

38.2x

13.1x

10.2%

97.3%

Mean Median Logistics C.H. Robinson Worldwide UTi Worldwide Inc Sirva Inc EGL Inc Landstar System Inc(1) Pacer International Forward Air Corp Hub Group Quality Distribution Inc

$51.38 71.88 9.40 31.18 35.25 22.19 43.33 56.46 8.62

91.1% 98.5% 36.2% 89.1% 91.4% 91.0% 91.7% 96.6% 53.4%

$4,435 2,307 693 1,461 1,083 837 944 529 164

$4,201 2,297 1,165 1,475 1,113 1,007 840 529 436 Mean Median

USF Corp(1)

$32.44

83.6%

$916

$1,015

Source: Public filings and Wall Street research reports. (1) Based on 4Q '04 earnings releases.

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3. Weekly Assignments and Resources D.

M&A Comps

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Summer Assignment – M&A Comps Assignment  For the following two acquisitions, create a deal list similar to that on the sample page

Date Jan-05 Jun-00

Acquiror Lee Enterprises Gannett

Target Pulitzer Central Newspapers

 Include target business description, as well as the the following statistics:

 EV / LTM sales  EV / LTM EBIT  EV / LTM EBITDA Key Takeaways  At the end of this section you should be able to answer the following:

1. At what multiples have similar transactions been closed in the past? 2. What valuation (approximately) does this imply for Knight Ridder? 3. Is this valuation different than what was implied from the equity comp analysis, can you explain the difference?

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Agenda  What are M&A Comps and Why Do We Do Them?  Finding Comparable Transactions  Practical Guidelines  M&A related SEC filings  USF Corporation: Sample M&A comps

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Comparable Acquisitions Analysis  Comparable acquisitions analysis values a company by reference to other sale transactions of similar

businesses. Comparable acquisitions analysis is based on the same multiples as those used in comparable companies analysis

 Enterprise Value / EBITDA  Equity Value / Net Income  Enterprise Value / Sales (usually less relevant)  Enterprise Value / EBIT (usually less relevant)  The trick is to find the right comparable transactions and to ferret out the relevant information required  As in comparable company analyses, look for acquisitions of companies with comparable operational and

financial characteristics  Recent transactions are a more accurate reflection of the values buyers are currently willing to pay than

are acquisitions completed in the distant past. This is because market fundamentals are subject to dramatic change over periods of time. In addition, cyclical businesses will trade at widely different valuations at the peak and ebb of a cycle  Multiples should be based on the latest public financial information available to the Acquiror at the time of the

acquisition Helpful Hint #1: Unlike Equity Comps, which value companies off of forward looking estimates, M&A Comps are historical looking Helpful Hint #2: Comparable acquisition multiples include consideration which is paid for "control" of the Target. Since this "control premium" is not reflected in the comparable company valuation, comparable acquisition multiples tend to be higher and more indicative of the value of a company in a sale context 71

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Finding Comparable Acquisitions Sources to check for comparable acquisitions include:  Other comparable acquisitions schedules  Previous presentations/valuation analyses  SDC database (Securities Data Corporation)  News runs  Equity analysts  Public tender offer documents and merger proxies  Colleagues

Never rely on the multiples of a schedule with an unknown author or with an author who is not sure that the multiples are correct.

Look for recent acquisitions of companies with operational and financial characteristics similar to those of the business being valued. 72

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Calculation of Transaction Value Total Transaction Value

Equity Value

=

Equity Value

+

Total Debt

=

Fully Diluted Shares Outstanding

x

Purchase Price

+

Preferred Stock

+

Minority Interest

-

Cash and Equivalents

Helpful Hint: The major difference between a Transaction Value and an Enterprise Value lies in the share count. In any “Change of Control,” all outstanding and “in-the-money” options, regardless of whether they are exercisable or not , get converted at the weighted average strike price. This differs from the Enterprise Value calculation, where only those options that are exercisable get converted

Total Transaction Value of an M&A deal is similar to Enterprise Value used in Comparable Companies Analysis. 73

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Calculation of Shares Outstanding Fully Diluted Shares Outstanding

=

Basic Shares Outstanding

+

Option/ Warrant Shares

 Basic Shares Outstanding are taken from the cover of the most recent 10-K or 10-Q.  Option/Warrant Shares are calculated using the treasury method, which assumes that all in-the-money

options/warrants are exercised and the proceeds are used to repurchase shares at today’s market price  For example:

Basic Shares

Option/Warrant Shares

20 million shares

500,000 in-the-money options $25 is the average strike price $35 is today’s stock price

Helpful Hint: There are two independent concepts regarding option/warrants that tend to confuse people:

1. Outstanding versus Exercisable 2. “In-the-money” versus “out-of-the-money”  In an acquisition context, all outstanding and “in-the-money” options/warrants get converted. In a market value

(equity comp) context, only those options that are both exercisable and “in-the-money” convert  Options/warrants “out-of-the-money” never convert

To calculate equity value, we must always use fully diluted shares outstanding. 74

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Calculation of Shares Outstanding (Cont’d)  In-The-Money Option/Warrant Shares:

 Step 1: 500,000 x $25 = $12.5 million  Step 2: $12.5 million / $35 = 357,143 shares  Step 3: 500,000 - 357,143 = 142,857  Finally . . . To Calculate Fully Diluted Shares Outstanding.

Fully Diluted = Shares Outstanding

20,000,000

+

142,857

=

20,142,857

 Now You Can Solve For The Equity Value

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Determination of Purchase Price per Share  Cash consideration is straightforward  Common stock issued by an acquiror is valued using the acquiror’s stock price on the day prior

to announcement of the transaction  Other securities are valued at market

 Existing publicly traded securities should be valued at market on the day prior to announcement

 New classes of securities should be valued at market value on the first day of trading

Calculating the purchase price per share is not always as simple as it may first appear 76

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Enterprise Value vs. Equity Value General Overview  There are typically two stakeholders in any firm, the Debt Holders and the Equity Holders. The

concept of Enterprise Value contemplates that the earnings of the Company are allocated to both the Debt Holders (through interest payments) and the Equity Holders (through dividends and appreciation in stock price) When You Use Enterprise Value  Typically, you will use Enterprise Value in circumstances when the financial statistic being

utilized is flowing to the debt and equity holders. In general, this means that any financial statistic that is pre-interest expense will use an Enterprise Value concept to determine valuation When You Use Equity Value  Typically, you will use Equity Value in circumstances when the financial statistic being utilized is

flowing only to the equity holders. In general, this means that any financial statistic that is postinterest expense will use an Equity Value concept to determine valuation  Public market valuations tend to use earnings multiples (typically forward earnings multiples)

because the investment decision is being made based upon a capital structure that is already in place and cannot be influenced by the common stock holder

When do you use what? 77

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Stock Price Premiums

% Premium = Paid

[

Purchase Price ______________ -1 Historical Price

]

* 100

 Often calculated from day prior to announcement of transaction  Often news and rumors of a potential transaction often leak to the market and affect the stock

price prior to announcement. We also look at premiums over the stock price at other points in time relative to announcement including:

 One Day  One Week  One Month

For public companies, we often look at the percent premium paid to shareholders. 78

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Practical Guidelines 1)

Obtain SDC run to get general information regarding announcement dates, target/acquirors, structure of transactions, etc. When doing an SDC run, you typically search by industry SIC codes to find M&A deals for certain industries. If a deal has just been announced, you'll need to get a news run done on the deal

2)

Make sure the announcement date is correct by checking Bloomberg

3)

Retrieve appropriate documents from SEC. You will need a merger document and 10-K and 10-Q. Make sure that the 10-K and 10-Q are for the target company financials for the LTM period before the announcement date. M&A comps are usually done on an LTM basis. At some point you may have to do an M&A comp on a forward basis, but this is uncommon

4)

Read a summary of the terms of the transaction in the merger doc. This is especially true for stock-for-stock transactions. Understand whether the transaction was a stock-for-stock, cash tender offer, asset sale, minority interest investment, etc. This will help you determine the purchase price later on

5)

Scan the notes of the 10-K and the 10-Q for any significant items not reflected in the statements. Sometimes the target has been involved in other significant mergers, divestitures, or other consequential events. If so, then read the appropriate 8-K or other document in order to pro forma the financials. Also, do a quick Bloomberg scan to see if anything has happened after the filing of the last financial statement and the announcement of the merger, which could also affect the valuation

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Practical Guidelines (Cont’d) 6)

Once you have checked SDC’s announcement date, enter this and the effective date. Generally, you can trust SDC on the effective date

7)

Get the business description from the Bloomberg or from the 10-K. Be brief but not vague

8)

The type of merger doc you get will tell you what the structure of the deal is. If you’ve got a stock deal, then you will have a merger proxy S-4. If you have a cash tender offer, then you will have a 14D-1. Attitude (friendly vs. hostile) can be obtained from SDC. For the type of consideration offered, read the summary of the terms of the merger. You may not always need to show this in your comps

9)

Calculate equity value using fully diluted shares outstanding and the offer price per share. This sounds straightforward, but it is often easy to get tripped up here. Things to consider:

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Practical Guidelines (Cont’d) a) For a stock-for-stock deal, the price per share is implied. Some terms to get familiar with:  The exchange ratio is simply the number of shares of the acquiror being offered for every share of the target. So if Target Corp. received one share of Acquisition Corp. stock for every five of its shares, then the exchange ratio would be 1/5, or 0.2.  If you read the summary of the terms, you will either get a fixed ratio or a fixed price. In the case of a fixed price, the exchange ratio adjusts to fit the price. For example, if Acquisition Corp. knows it wants to pay $5 per share for Target Corp., then the number of shares it must offer to get to that $5 will depend on its own stock price. If its price were $2 per share, then it would have to offer 2.5 of its own shares, and 2.5 would be the exchange ratio. In other cases, the exchange ratio is fixed. So if Acquisition Corp. offered 2.5 of its shares for every Target share, then the implied value of the Target share is (2.5 x Acquisition Corp. share price). Therefore, the implied price will fluctuate over time. So you can see, either you hold the exchange ratio constant and vary the implied purchase price, or you have a fixed price and vary the exchange ratio  For our purposes, what we care about is what the shares were valued at prior to the announcement. So if the Acquiror’s share price was $10 on the day prior to the announcement and the exchange ratio was 2, then the implied price per Target share would be $20. Often the merger proxy will state that the actual exchange ratio at the closing will depend on “the average closing price of the twenty trading days prior to the three days before the Effective Date...” Ignore it, unless for some reason this language is related to the announcement date somehow, because this is the actual price to be paid. Remember, our job is to determine how the transaction is valued as of the announcement, so just assume that such a price is whatever it was on the day prior to the announcement 81

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Practical Guidelines (Cont’d) b) Check the capitalization of the company to see if they have any convertible securities (debt and preferred stock). Often such securities have takeover provisions which allow them to convert upon a merger, in which case you want to include their value in the equity purchase price (of course, you will have to back out their value later when calculating the enterprise value) c) Options. Generally, upon a change of control in a company, the options are bought out by the acquiror. We need to account for this in the equity purchase price, so there are columns which will calculate this value for you. You can get this info either from the 10-K, or if available, from the merger proxy (you generally wont find this info in a 14D-1). Since we will usually not have a detailed breakout of what each individual option is, it is sufficient to take the average exercise price. When doing so, you should never get to a negative purchase price for the options because when the exercise price is less than the offer price, the options are worthless (“out of the money”) 10) Calculate the enterprise value by entering the appropriate debt and cash figures. Remember, include marketable securities in the cash figure, and if you converted some pieces of debt or preferred in calculating them in the equity purchase price, do not include them here. Otherwise, that would be double counting 11) For LTM figures, make sure the numbers you input do not include unusual or nonrecurring items. Simply subtract them out from EBITDA and EBIT. For the net income line, make sure you take these out tax-affected. This means that for a net income calculation you would back out the unusual multiplied by (1-tax rate)

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Practical Guidelines (Cont’d) 12) There might have been significant events for which you did not pro forma the numbers. Did the target purchase another company prior to being acquired that is not reflected in the numbers? Did the target sell off assets or spin off a division? Use your judgment. Companies in high-growth industries can trade at high multiples (for example, technology deals can be done at 4x revenues, 15–20x EBITDA). Slow, prodding industries should not have such multiples. Also, if it is a hostile deal, then you may have pretty high multiples since the acquiror has to pay a big premium to get the deal done

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M&A – Related SEC Filings SEC FORM/ SCHEDULE 14D-1

DOCUMENT NAME

DESCRIPTION

Tender Offer/Offer Filed by the acquiror when launching a tender offer to Purchase Has to be opened for a minimum of 20 days Must be amended for changes in deal/material events Some information disclosed in document:

Price per share Number of shares sought Conditions to closing Source of financing Background and purpose of offer Financial data on acquiror Information on acquiror’s investment banker and fees 14D-9

Target’s Recommendation to Tender Offer

Filed by the target within 10 business days of the commencement of a tender offer Contains a recommendation from the target’s Board of Directors about how to respond to the Tender Offer, along with reasons for such recommendation Also contains other disclosures

Background of transaction Agreements involving management Fairness opinion for target’s shareholders Information on target’s investment banker and fees

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M&A – Related SEC Filings (Cont’d) SEC FORM/ SCHEDULE 13D

DOCUMENT NAME –

DESCRIPTION Filed by any person or group which has acquired 5% of a public company within 10 days of such acquisition Required disclosures include:

Identity and background of acquiror Amount and source of funds Purpose/intent of purchase Number of shares owned Must be amended for material charges Proxy/S-4 (if securities involved)

Merger Proxy; Joint Filed by target and/or acquiror Proxy/Prospectus Comprehensive document used to solicit votes to approve transaction Serves as a registration statement if securities are to be issued as consideration (versus all cash) Selected disclosures include:

Vote required for approval Terms of transaction Recommendation of board Fairness opinions for target’s (and possibly acquiror’s) shareholders May describe analysis supporting fairness opinions Summary financial data, including pro formas May have full financial statements as an exhibit Form F-4 (versus S-4) is used by foreign acquirors

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M&A – Related SEC Filings (Cont’d)

SEC FORM/ SCHEDULE 8K

DOCUMENT NAME –

DESCRIPTION Filed for material corporate events or disclosures; not only used for M&A deals In M&A context, filed to announce a material acquisition and/or sale of a division/subsidiary Filed by either seller or acquiror if the transaction is material to such party Typically gives the key terms of a transaction, with the sale/purchase contract filed as an exhibit Financial statements and/or pro forma financials are often filed as an amendment on Form 8 as companies are given time to include financials on the filing

10K, 10Q

13E-3

Annual, Quarterly Filings ”Ks” and “Qs”

Contain required financial statements and MD&A filings May also contain M&A-related disclosures which could have been made on Form 8K

Going Private Filing Used in connection with a significant affiliated party M&A transaction (i.e., LBO or Minority Buyout) Discloses fairness of transaction to such minority shareholders, usually determined by Special Committee Often contains filing of actual Board presentation by financial advisor to Special Committee

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Comparable Acquisition Analysis ($ in millions)

EQUITY DATE Jul-03

TARGET Roadway Corporation (US)

TARGET DESCRIPTION LTL carrier providing freight services on major city-to-city routes in North America

ACQUIROR Yellow Corporation

Nov-01

Motor Cargo Industries Provides regional less-than truckload services in the western U.S.

Union Pacific Corp.

Nov-01

Arnold Industries

Provides regional less-than-truckload services in northeastern states and also provides truckload and logistics services

Aug-01

Arnold Industries (US)

N/A

Aug-01

G.I. Trucking Company Provides regional less-than-truckload services in western and southwestern states

Nov-00

American Freightways Operates as a scheduled common and Corporation contract carrier transporting primarily lessthan-truckload shipments of general commodities.

Jun-99

Jevic Transportation Inc.

Jun-98

ENTERPRISE

VALUE $966

VALUE $1231

(1)

ENTERPRISE VALUE/ EBITDA 6.7x

(2)

TARGET UNIONIZED NA

83

78

4.0

No

Roadway Corp.

558

510

5.7

Yes

Roadway Corporation

539

510

5.4

No

Investor Group (Estes)

40

40

5.0

No

FedEx Corp.

934

1,196

6.3

No

Provides regional and interregional transportation of general commodity freight

Yellow Corp.

158

197

5.9

No

Preston Trucking

Provides les-than-truckload transportation of general commodity freight

Management Group

NM

NA

Oct-97

Caliber System, Inc.

Provides transportation, logistics and related information services through its five subsidiaries

FedEx Corp.

2,489

Jul-95

Worldway Corp.

Transporter of freight throughout United States; also provides truckload services and driver leasing services through its subsidiaries

Arkansas Best Corp.

Nov-92

Central Freight Lines Inc.

Carrier of intrastate and foreign commerce within Texas, Arizona, and New Mexico

Nov-92

Preston Trucking

Jul-88 Jun-88

NA

Yes

2,681

10.3

No

82

153

9.0

Yes

Roadway Services Inc.

102

148

6.8

No

Provides less-than-truckload transportation of general commodity freight

Yellow Freight Systems

24

146

5.8

Yes

Viking Freight Inc.

Provides regional carrier services in California and 9 other Western States

Roadway Services Inc.

135

172

7.8

No

Arkansas Best Corp.

LTL and TL carriage, furniture manufacturing and tire retreading

Kelso & Co.

317

472

6.2

Yes

Median Average

6.1x 6.5x

High

10.3x

Low

4.0x

Source: Securities Data Corporation, public filings and news reports. (1) Enterprise Value = Value of Common + Total Debt – Cash. (2) EBITDA, EBIT and Net Income exclude extraordinary items and accounting changes.

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Discounted Cash Flow Analysis

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Summer Assignment – DCF  Project Knight Ridder’s income statement for five years

 Make note of what assumptions you use to grow the income statement  From these projections, calculate Knight Ridder’s annual free cash flows

 Using your equity comps, find the terminal EBITDA multiple and calculate the terminal value  Using your comps, calculate the proper WACC that should be used to discount Knight Ridder’s

cash flows

 Unlever the Beta for each comp and re-lever at Knight Ridder’s leverage  Discount the Free Cash Flows and terminal multiple at the WACC

 Use the terminal multiple and WACC to calculate an implied perpetuity growth rate  Calculate the equity value per share and compare to Knight Ridder’s current price  Create a sensitivity table showing the changes in enterprise value and equity value per share as

impacted by the WACC and terminal multiple Helpful Hint #1: ABACUS has a WACC summary sheet that unlevers and relevers the betas for you. This schedule can be very helpful, but make sure you understand how it works. You will have to input company betas, the risk-free rate, market risk premiums and tax rates manually

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Summer Assignment – DCF (Cont’d) Key Takeaways  At the end of this section, you should be able to answer the following:

1. What projected income statement assumptions did you use and why? 2. How do you calculate a WACC? Why is it important to unlever and then re-lever your beta? 3. What risk-free rate, equity risk premium and size premium did you use and where do these numbers come from? 4. Explain how you determined your Terminal Multiple 5. What value range does your DCF imply for Knight Ridder? 6. Given this valuation, is Knight Ridder currently under- or over-valued in the marketplace? 7. What does this mean for a potential buyer?

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Agenda  What is a DCF and why do we do it?  Projections  Terminal Value  Weighted Average Cost of Capital (“WACC”)  Present Value  Sample Discounted Cash Flow Analysis  Sample WACC Schedule

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Discounted Cash Flow Analysis  Comparable company and comparable acquisition analyses are often used as confirming

methodologies  Specific asset values are sometimes used if other methodologies are inapplicable

Applications of valuation analysis include:  Acquisitions: How much should we pay to buy the company / division?  Divestitures: How much could we sell our company / division for?  Defense: Is our company undervalued / vulnerable to a raider?  Fairness Opinions: Is the price offered for our company / division fair from a financial point of

view?  Public Equity Offerings: For how much could we sell our company / division in the public

market?  New Business Presentations: Various applications

Discounted Cash Flow analysis is typically the primary valuation methodology used by CS in M&A and certain capital markets transactions. 92

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DCF Versus Other Valuation Methodologies Discounted Cash Flow Analysis Methodology:

Issues:

Comparable Company Analysis

Comparable Acquisition Analysis

 Present value of projected

 Value based on market trading

 Value based on multiples paid

unlevered free cash flows  “Inherent” value  Best captures business in transition  Sensitivity analysis  Synergies analysis  Buy vs. build

multiples of comparable companies·  Implied value in public securities markets (IPO analysis); fullydistributed value  Usually focus on forward looking EBITDA, earnings and cash flow

for comparable companies/assets in sale transactions  Implied value in private market  Focuses mainly on multiples of historical EBITDA, earnings and cash flow

 Financial forecasts developed

 Market environment  Quality of comparables  Public data  Consistent accounting treatment  Less meaningful benchmark for

 Market environment  Quality of comparables  Availability of data  Consistent accounting

with management  Discount rate  Terminal value method

assets with unique cash flow patterns

treatment  Less meaningful benchmark for

assets with unique cash flow patterns

Of the three principal valuation methodologies used on Wall Street, DCF analysis frequently carries significant weight. 93

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Discounted Cash Flow Analysis Components Remarks

Valuation Steps  Define

Forecast of Unlevered FCFs

Calculate Terminal Value

components of free cash flow (“FCF”)  Develop historical perspective  Produce financial forecasts and sensitivity analysis  Step back and interpret the results  Exit

multiples, perpetuity formula, other approaches

 Cost

Calculate WACC

Discount FCFs

of equity  Cost of debt  Theoretical optimal capital structure  FCF

for periods 1 to n  Terminal value  Adjustment

Enterprise Value

Less net debt

Equity Value

for non-operating items (e.g., extraordinary items, cash flow from unconsolidated subsidiaries, hidden assets, contingent liabilities, etc.)

 Take

market value of financial debt, plus minority interests plus other non-working capital liabilities less excess cash and marketable securities (sometimes referred to as “corporate adjustments”)

 Interpret

results findings with other valuation methods

 Compare

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

Liabilities and Shareholders’ Equity

Net Assets

Net Debt

Enterprise Value

Enterprise Value Equity Value

(1)

Net Debt (Corporate Adjustments) is equal to total debt + minority interest + preferred stock + capitalized leases - excess cash and cash equivalents.

We use discounted cash flow analysis to calculate the enterprise value of the firm, which then allows us to calculate its equity value. 95

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DFC Analysis: The Process

Step 1

Project the operating results and free cash flows of a business over a particular forecast period.

Projections

Step 2

Terminal Value

Step 3

Estimate the terminal value of the business, often by using terminal multiples, at the end of the forecast period. Use the weighted average cost of capital to determine the appropriate discount rate range.

WACC

Present Value

Step 4

Step 5

Adjustments

Determine a range of values for the enterprise by discounting the projected free cash flows and terminal value to the present. Adjust your valuation for all assets and liabilities not accounted for in the cash flow projections.

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Step 1: Projections  DCF analysis is an attempt to look at the company’s pure operating results, free and clear of financial leverage,

extraordinary items, discontinued operations, etc.  Many times, we are given financial projections from the management of a particular company; however, there

are situations in which we must develop our own forecast for a particular company or business – It is extremely important to look at the historical performance of a company or business to understand how future cash flows relate to past performance  A company’s unlevered free cash flows represent the cash generating ability of that particular company, without

regard to its present or prospective capital structure – As a result, unlevered free cash flows are projected before subtracting interest and financing expenses or related tax shields  DCF projections should be based on:

    

Historical performance Company projections (when available) Equity research analyst estimates Industry data Common sense

 The forecast horizon should be long enough so that the company reaches “steady state” by the end of the

forecast period – Typically, forecasts of 5 - 10 years are used for DCF analyses of maturing or mature firms

The free cash flows from a business can be projected using information about the industry in which the business operates and information specific to the business. 97

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Step 1: Projections Extract historical financials  Sales  Operating cash flow  Depreciation & amortization  Deferred taxes  Capital expenditures  Working capital (receivables, inventories and prepaid expenses less current payables and other

current operating liabilities)  Analyze numbers  How relevant are historical figures?

 Major changes in business or industry  Management’s discussion of results  Are numbers “clean”?

 Extraordinary items  Acquisitions / divestitures  Is anything excluded?

 Compare to cash flow statement 98

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Step 1: Projections – Sales Sales Buildup  Build a separate schedule for sales analysis which will feed through to consolidated statement  Breakdown by market segment (different prevailing market dynamics), product type/class, etc.  Assumptions on volumes and unit prices  Base assumptions on:

– Research reports – Management or client forecasts (if available) – Overall industry trends  Sales growth is usually an input; aggregate sales are derived from this input

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Step 1: Projections – Operating Expenses, Depreciation Expenses and Taxes Operating Expenses  Build a separate schedule for cost analysis:

 Breakdown by main category of costs – Cost of goods sold, personnel costs, SG&A expenses – Fixed vs. variable costs

 Understand cost behavior/sensitivity to changes in sales level  Understand key cost drivers (e.g., price of raw materials, inflation, etc.)  Estimate as a percentage of sales Depreciation Expense  Usually expressed as a percentage of sales, comparing to historical trend or hardcoded and set

relatively flat throughout the period Tax  Tax charge that the Company would pay if it had no debt

– Assess tax rate based on previous marginal tax rate (composite local and corporate tax rates) as well as current and future tax regulation – Reflect operating loss carry forwards, if any

(1)

Exclude land because it is not depreciable.

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Step 1: Projections – Capital Expenditures  Capital expenditures (“Capex”) are the investments necessary to maintain the required capital

intensity, which includes expenditures on new as well as replacement property plant and equipment (“PP&E”)  Base assumptions on:

– Company forecasts – Industry levels – Research reports – Percentage of sales, percentage of PP&E  Build a CapEx schedule breaking down expenditures by type of asset (buildings, machinery and

equipment, other assets) and between new and replacement CapEx – Show beginning and ending PP&E by type of asset  At the end of forecast period, the CapEx level should be in line (equal or slightly higher) with

depreciation (i.e., assume that capital intensity is maintained going forward)  For a given year, CapEx is equal to end of year net PP&E less beginning of year net PP&E plus

depreciation expense for the year

(1)

Net PP&E is equal to gross PP&E less accumulated depreciation.

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Step 1: Projections – Working Capital  Working capital is defined as the sum of accounts receivable, inventories, pre-paid expenses

and other current assets, less the sum of accounts payable, accrued expenses and other current liabilities – This definition can change slightly for companies in different industries  Exclude excess cash and marketable securities and short-term debt

– We often use the term “net working capital” to distinguish the investment banking concept from the accountant’s definition of working capital  Build a working capital schedule breaking down the main components of working capital

– Estimate balances for the components of working capital as a percentage of sales, cost of goods sold or other appropriate metrics (or using year-on-year growth rates) for each projection year – Calculate the net increase/decrease in working capital for each year  When forecasting working capital, consider whether the company’s changing mix of business

affects its need for working capital – Any action to squeeze cash from working capital by operating more efficiently (e.g., reducing working capital as a percentage of sales, for instance via implementation of a just-in-time inventory system, a change in receivable/payable policy, etc.); whether there is a discernible trend in working capital, and if so, whether the improvement/deterioration will continue or stabilize?  Increases in net working capital are a use of cash and decreases in net working capital are a

source of cash – Remember that increases in assets and decreases in liabilities are uses of cash and decreases in assets and increases in liabilities are sources of cash 102

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Step 1: Projections – Deferred Taxes Deferred Taxes  For valuation purposes, taxes should be stated on a cash basis  Deferred tax assets and liabilities arise due to differences between financial (book) accounting

and tax accounting – The most significant differences in book and tax accounting typically arise with regard to the depreciation of assets. In the U.S., assets often can be depreciated on an accelerated basis for tax purposes, lowering taxable income in the current period and thus lowering actual cash taxes paid. – On a book basis, however, often times the same assets cannot be depreciated on such an accelerated basis, thus taxable income is higher, as are book taxes per the income tax provision. The increase in deferred tax liabilities accounts for the difference between book taxes and the actual taxes paid to the government  Increases in deferred tax liabilities (net of deferred tax assets) are a source of a cash and

should be added in calculating free cash flow (and alternatively, decreases in deferred tax liabilities are a use of cash and should be subtracted in calculating free cash flow)

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Step 1: Projections – Reality Check 

Confront sales growth assumptions with underlying market dynamics – Be skeptical of projected sales growth curves that look show dramatic improvements versus recent actual performance. Does the increase in sales reflect a constant market share in an expanding market? If so, why is the market expanding? Does that assumption agree with industry projections? If it is an expanding market, why will the company be able to maintain a constant market share? Or does the increase reflect a rising market share in a stagnant market? If yes, why? Are some firms leaving the industry? Why?



Check reasonableness of margins – Avoid margin “hockey sticks”. Be clear on the actions and/or events needed to trigger improvements in margins (or reasons for decreases in margins). Are the margin levels consistent with the structure of competition in the industry? Any risk of new entrants/substitute products that will drive margins down?



Capital Expenditures – Watch out for step-up of production capacity required as sales increase. Is the CapEx level sufficient to support the forecasted increase in sales? Factor in the impact of industry trends on CapEx (e.g., increased environmental expenditures, technology changes, etc.)



Working Capital – Are inventory and other working capital forecasts consistent with the sales increase? What is the pattern of accounts receivable collection? How is it practically achieved? Assess bargaining power of customers (receivables terms) and suppliers (account payable terms). Are your assumptions in line with industry standards?



Be Critical About Buyer’s and Seller’s Projections – Use due diligence/access to seller's management to gain in-depth understanding of company's assumptions and challenge them (if and when appropriate). Where possible, compare the company's past record of actual versus budgeted results – Add value/ “manage” client's expectations (both on buy and sell sides) by thoroughly understanding the company's market dynamics and competitive positioning

As always, it is important to perform a “Reality Check” on the main components of FCF 104

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Step 1: Projections Unlevered Free Cash Flow  Unlevered Free Cash Flow is the unlevered after-tax cash flow generated by the Company

(including the impact of any reinvestment)  Unlevered Free Cash Flow is available to all providers of the Company’s capital, both creditors

and shareholders  Unlevered Free Cash Flow is best determined by considering sources and uses of cash:

METHOD 1

METHOD 2

Net Income

EBIT (1)

Note: (1) (2)

(2)

(+) After-Tax Interest Expense

(-) Tax Effect

= Unlevered Net Income

= Unlevered Net Income

(+) Increase in net Deferred Tax Liability

(+) Increase in net Deferred Tax Liability

(+) Depreciation and Amortization

(+) Depreciation and Amortization

(-) Increase in Net Working Capital

(-) Increase in Net Working Capital

(-) Capital Expenditures

(-) Capital Expenditures

= Unlevered Free Cash Flow

= Unlevered Free Cash Flow

Changes in other long term assets/liabilities may affect Unlevered Free Cash Flow. After-Tax Interest Expense is defined as interest expense less the applicable interest tax shield. In most cases, amortization expense is not tax-deductible.

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Step 2: Determination of Terminal Value  Firm value, based on free cash flows, can be separated into two components:

Company Value

=

PV of FCF during explicit forecast period

+

PV of FCF after explicit forecast period

 Since DCF analysis is based on a limited forecast period, a terminal value must be used to capture the

value of the business at the end of the projection period  The terminal value is usually added to the free cash flow in the final year of the projections and then

discounted back to the valuation date, or it can be discounted separately to the valuation date  The terminal value typically constitutes a substantial portion of the total enterprise value. Critical

thinking about prospects of the business, and therefore the terminal value, results in a more meaningful, accurate and defensible DCF analysis  Note that the terminal year free cash flow has to be normalized to ensure that the company has

reached a steady state – Normalized operating assumptions: sales and profitability assumptions for the final year should reflect a “steady state” year, not a peak or trough in the business cycle; and depreciation and capex should be within the same range  Terminal value is determined through either application of a valuation multiple (the “terminal multiple”)

or the perpetuity growth method

The terminal value captures the value of the business at the end of the projection period, which is based on the free cash flows of the business beyond the explicit forecast period. 106

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Step 2: Terminal Value – Terminal Multiple Method  Terminal Value = Statistic x Multiple

– Statistic: Operating statistic used (e.g., EBITDA in year 10) – Multiple: Selected multiple (e.g., 10.0x)  Multiple is based on the most appropriate multiple for the company’s industry (e.g., EBIT versus

EBITDA versus EBITDAR)  The multiple applied should reflect the long-term market valuation of the company/industry,

rather than a current multiple that may be distorted by industry or economic cycles  When applying the multiple it is important to distinguish between:

 Comparable trading company multiples and comparable acquisitions multiples – It is almost always more appropriate to base terminal multiples on the figures derived via comparable companies analysis, rather than those from comparable transactions analysis

 LTM and forward multiples  Always show a range of multiples

Terminal value based on assumed trading or acquisition multiple at the end of the projection period. 107

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Step 2: Terminal Value – Perpetuity Growth Method  The Gordon Growth formula:

Terminal Valuen = Unlevered FCFn+1 (r - g)

 Unlevered FCF n+1: Unlevered free cash flow in the first year after the explicit projection period – Note that we often estimate FCF n+1 by taking FCF n and growing it by the growth rate g, but this is not always appropriate

 r: Discount rate (based on weighted average cost of capital)  g: Perpetuity growth rate  The perpetuity growth rate used must be realistic

 Reference point should be nominal GDP growth  Expected long-term growth rate of the industry (e.g., utility industry growth rate versus cable TV industry growth rate)  Always show a range of perpetuity growth rates

Terminal value based on business operating into perpetuity, growing free cash flow at some constant rate. 108

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Step 2: Terminal Value – Cross Referencing  Check the reasonableness of the terminal value by linking the terminal multiple and perpetuity growth rate

– Calculate the implied perpetuity growth rate for a range of terminal multiples or, conversely check how the perpetuity growth rate translates into terminal multiples. For example, the terminal multiple you used may imply too high a perpetuity growth rate for the industry, or vice versa  The formula below demonstrates how to ‘reverse’ into the implied terminal multiple from the perpetuity growth

method Implied terminal multiple = PV TV x (1+r)n FV TV = Statistic Statistic – – – – –

PV TV: Present Value of Terminal Value FV TV: Future Value of Terminal Value r: Discount rate n: Number of years discounted Statistic: Operating statistic on which multiple applied (e.g., EBITDA in year 10)

 The formula below demonstrates how to ‘reverse’ into the implied perpetuity growth rate from the terminal

multiple method (assuming FCFn+1 = FCFn x (1+g) ) Implied perpetuity growth rate = (r x Statistic x Multiple) – Unlevered FCFn (Statistic x Multiple) + Unlevered FCFn – Multiple: Selected valuation multiple (e.g., 10.0x) – Unlevered FCF n: Unlevered free cash flow in last year of the projection

Does the terminal value make sense? 109

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Step 3: WACC – Discount Rate Overview The Weighted Average Cost Capital (“WACC”) is the recommended discount rate to be used in the unlevered discounted cash flow valuation of an asset.  The WACC should be thought of as the opportunity cost of capital, the long-term return an

investor expects to earn in an alternative investment of equivalent risk  The WACC to be used in a DCF analysis is specific to the business or asset being valued. It

does not necessarily depend on the buyer’s or seller’s overall cost of capital  WACC is used by firms as the hurdle rate for a project or division, as a performance benchmark

for return on capital calculations, to determine desirability of stock repurchases or issuance, or for valuation purposes  Mathematically, WACC is expressed as:

WACC

(1) (2) (3)

(1)

=

After-tax Cost of Debt

x

Proportion of Debt in Capital Structure

+

Cost of Equity

Cost of (2) = Equity

Risk-Free Rate

+

Levered Beta

Levered = Beta (3)

Unlevered Beta

x

1 + (1 - Tax Rate) x (Debt/Equity Ratio)

x

x

Equity Market Risk Premium

Proportion of Equity in Capital Structure

;

;

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

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Step 3: WACC – Target Capital Structure  The “weights” applied to the costs of equity and debt used in computing WACC for an asset represent the

theoretical “optimal” capital structure for that asset  Finance theory (Modigliani-Miller’s three propositions) suggests that in the absence of taxes and financial

distress/bankruptcy costs, changing leverage has no effect on WACC, and therefore no effect on firm value – However, in a world with taxes and financial distress, increasing leverage is predicted to result in a decrease in the cost of capital, permitting the determination of a theoretically “optimal” capital structure – Common applications of WACC do not directly factor in financial distress costs, thus they underestimate WACC at high levels of leverage – Another shortcoming of WACC is that it assumes capital weights (i.e., leverage) are held constant through time (%) Cost of Equity

Weighted Average Cost of Capital (WACC)

Cost of Debt

Debt as a % of Enterprise Value

Prior to calculating the cost of equity and debt for the company you are valuing, you need to define a target capital structure that reflects the debt to equity ratio that is expected to prevail over the life of the business.

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Step 3: WACC – Target Capital Structure  Calculate the current market value-based capital structure for the company

To estimate the market value of equity (market capitalization), multiply the stock price by the shares outstanding. Exercisable stock options that are “in-the-money” should be included in the equity value to the extent the current stock price exceeds the exercise price. If the company is not public, you can estimate the equity value by some alternative method. To estimate the market value of debt, look to see if the debt is publicly traded; if so multiply the trading price by the number of securities outstanding. If the debt is not traded, estimate the market value by comparing with similarly rated publicly traded debt. Book value of debt is sometimes used as an approximation if value of bonds is close to par (issue price) – Typically convertibles that are “out-of-the-money” are treated as debt at book value. Convertibles that are “in-the-money” are converted into shares of common stock at the conversion price and treated as equity. Theoretically, convertibles consist of both equity and debt components, but rarely do Wall Street firms break them into separate parts for WACC analysis – Include capital leases in the total debt calculation. Operating leases require case-specific judgment - they are frequently converted into capital leases by applying a multiple (typically 6x - 8x) to the annual operating lease payments – For companies with captive finance subsidiaries, we typically exclude finance companyrelated debt You can use a combination of the following three approaches to estimate the appropriate target capital structure. 112

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Step 3: WACC – Target Capital Structure  Review the capital structures of comparable companies

– Assess the average market capital structure prevailing in the company’s sector  Review management’s financing philosophy

– When possible, discuss with management of the company that you are valuing their financing policy and their explicit or implicit target capital structure on a normalized basis. If you don’t have access to management, look for any statements in the press, research reports, annual report, etc. that give hints on the company’s medium to long-term financing objectives

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Step 3: WACC – Cost of Equity  Typically, the Capital Asset Pricing Model (CAPM) is used to estimate the cost of equity; there

are other approaches that are occasionally used in valuation, including:

 Rate of return required by private equity investors in the market (i.e., LBO or venture capital transactions)

 Arbitrage Pricing Theory  Fama-French three factor model  An investor may obtain a risk-free rate by investing in governmental bonds. By purchasing

equities, he or she assumes general market risk and therefore will expect a certain premium for doing so. CAPM quantifies the relationship between risk and return in a well functioning market  To implement the CAPM approach, you need to estimate three factors that determine the

Security Market Line: the risk-free rate, the market risk premium and the levered beta Security Market Line Expected Return (in percent)

20

15 Market Return

M

10

Risk Premium

Risk-free Rate 5

0 0.0

0.5

1.0 Beta

1.5

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Step 3: WACC – The Risk-Free Rate  Finance theory recommends using a “true” risk-free rate that has the same term as the cash

flows projected  Since long term bond rates have intrinsic interest rate risk factored in, some theorists have

suggested making a “liquidity” adjustment to the long bond rate representing the term premium implicit in those rates – However, this is rarely done in practice by Wall Street professionals  At CS, we typically use the 20-year treasury bond for the U.S. risk-free rate, as it matches the

risk-free rate used in the calculation of the equity risk premium – Ibbotson uses the 20-year because there has only been a 30-year bond since 1977 and their data analysis goes back to 1926 – There is no longer a 20-year bond issued by the U.S. Government, so you must look for a 30-year bond that has been outstanding for 10 years or use interpolated yields from Bloomberg (type “ICUR20” and hit GO) or another source – Treasury strips typically are not used but may be appropriate if the asset being valued provides a single payoff at the end of a specified term  To access current yields to maturity on U.S. Government bills, notes and bonds on Bloomberg,

type “T” and the “Government” key and hit GO

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Step 3: WACC – The Equity Risk Premium  The equity risk premium (ERP) is the difference between the expected rate of return on the market portfolio and

the risk-free rate  Proper methodology for estimating the equity risk premium is the subject of much debate in academia

– Equity premia ranging from as low as 3% to as high as 8% are used on Wall Street  CS IBD uses estimates for ERP from Ibbotson Associates; the current ERP figure is 7.1%

– This figure is calculated by looking at stock market returns relative to returns on long-term government bonds from 1926 through 2005 – Some argue that use of this period over-estimates the risk premium, and that data over a more recent period would suggest a lower premium – Also, some argue that using historical data presents a conundrum - equity returns over the last 20 years have been significantly higher than returns on government bonds, however the performance of the equity markets may have been, in part, driven by a reduction in the equity risk premium – Nevertheless, most (if not all) major Wall Street firms rely on the Ibbotson data for their cost of capital analyses  Where applicable, the WACC must be adjusted to reflect fact that betas for small companies do not account for

all of the risks faced by investors in those companies. The following size premia (Ibbotson, 2006) should be added to the cost of equity calculation where appropriate: Mid-Cap ($1,729 million to $7,187 million) = 1.02% Low-Cap ($587 million to $1,729 million) = 1.81% Micro-Cap (Below $586 million) = 3.95%

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Step 3: WACC – Beta  CAPM holds that investors are only rewarded for bearing systematic risk and are not rewarded for bearing

unique or unsystematic risk. It is assumed that investors can eliminate unsystematic risk on their own through portfolio diversification  Beta represents a measure of the systematic risk that exists in an asset, and is central to CAPM

Beta

= COV[Rasset, Rmarket] / VAR[Rmarket], or equivalently = CORR[Rasset, Rmarket] x STDasset / STDmarket – High volatility is not necessarily an indication of high beta

 Historical betas of publicly traded equity securities can be calculated based on an analysis of the actual returns

on the security vs. the actual market returns over the same period – Unfortunately, historical betas can be poor predictors of expected beta, which is what we need in our analysis – BARRA, a financial research firm, computes predicted betas for most public companies  Use a portfolio or average of peer company betas where available because significant error can exist in

individual betas – R-Squared (R2) measures the “goodness of fit” of the regression line, and describes the percentage of variation in the dependent variable that is explained by the independent variable. R2 may vary from 0 to 1 with 1 meaning that the independent variable explains 100% of the variation of the dependent variable, although R2 for individual equity betas seldom rise above 0.2  Observed betas reflect both the business and financial risk of the company. Betas are unlevered to measure

only the business risk of a company and then relevered to the target capital structure of the company that is being valued to reflect both business and financial risk – Increasing leverage will, according to theory, increase the beta of a firm’s equity and hence its cost of equity ßL ßL = ßU [ 1 + D (1-T) ] ßU = D (1-T) E 1+ E 117

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Step 3: WACC – Cost of Debt  The cost of debt is measured as the expected return on the company’s long-term debt securities

– The cost of debt is dependent on both the general interest rate environment in the economy and the credit quality of the business or asset being valued  The cost of debt is measured on an after-tax basis because interest payments are tax deductible in the U.S.

– The tax rate to be used is the company’s marginal tax rate, typically 40% in the U.S.  The cost of debt can be measured in several ways:

If the company has public debt outstanding, take the weighted average of current yields to maturity or yields to worst on all issues in the target capital structure – The yield to maturity (or for callable bonds, the yield to worst) embodies the market’s expectations of future returns on debt and should be used instead of the coupon rate – Average cost of debt (not marginal) may be more appropriate when the entire enterprise is being valued – Include short-term and medium-term debt (along with long-term debt) if it is expected to be part of the permanent capital structure going forward – Talk to Debt Capital Markets (DCM) if debt securities are only thinly traded or if it is difficult to obtain a market price  Risk-free rate + current corporate spread over treasuries of selected comparable credits

– Must either use the bond rating given to the company by Standard & Poors or Moody’s, or estimate the company’s bond rating by comparing the company’s financial ratios (i.e., Debt / EBITDA, EBITDA / Interest) to those of its peers who have such ratings  Be wary of debt securities that have options attached (e.g., convertible bonds or callable bonds) that affect the

overall yield to maturity and thus may not reflect the true cost of straight debt securities

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Step 3: WACC – Cost of Capital Build-up

Corporate Bonds Long-Term Treasury Bonds

Default Premium

Long Horizon Premium

Long Horizon Premium

Inflation

Inflation

Inflation

Real Riskless Rate

Real Riskless Rate

Real Riskless Rate

Treasury Bills

Small Cap Stocks

Foreign Stocks

Size Premium

Foreign Stock Premium

Equity Risk Premium

Equity Risk Premium

Equity Risk Premium

Inflation

Inflation

Inflation

Large Cap Stocks

Real Riskless Rate

Real Riskless Rate

Real Riskless Rate

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Step 3: CS U.S. WACC Methodology  In practice, we typically make the following assumptions at CS:

Target Capital Structure

 Average of ratio of debt and equity market capitalization of selected comparable companies

Risk Free Rate:

 20 year US Treasury coupon bond yield (Bloomberg: ICUR20)

Tax Rate:

 Estimated future marginal tax rate (usually 40%)

Equity Market Risk Premium:

 Ibbotson equity market premium (currently 7.1%), calculated based on historical (arithmetic) return of

Beta:

 Take predicted levered betas of comparable companies (use Barra predicted betas), unlever them

Cost of Debt:

equity market relative to 20 year treasury bond according to capital structure, average the unlevered betas, and re-lever the average to the target capital structure of the company being valued  Risk-free rate + current corporate spread over treasury for comparable credits

 In general, WACC calculation is not a science; there are no exact answers, judgment and reality

checks are essential – Typically, discount rate ranges centered around a best estimate for WACC are used in DCF valuations – Small differences in WACC/discount rate can have huge impacts on value

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Step 4: Present Value Time Value of Money A dollar today is worth more than a dollar tomorrow. Discounting – Discounting is the process of finding the present value of a future sum Very Simple Example – Assumes the discount rate is 10%; uses end of period discounting for all cash flows Free Cash Flow

2003

2004

2005

2006

2007

$10

$15

$20

$24

$89

Period Discount Factor Discount Factor Present Value

1 1

/1.10

2 1

1

/1.10

3 2

1

/1.10

4 3

1

/1.10

5 4

1

/1.10

5

0.9091

0.8264

0.7513

0.6830

0.6209

$9

$12

$15

$16

$55

 The total present value at December 31, 2002 is equal to the sum of the present values of the

individual cash flows ($108) Mid-year Discounting – The above example assumes end of the period discounting, that is it assumes all of the cash flows come at the end of each period. A more accurate method may be mid-year discounting, which assumes that the cash flows come in the middle of each period (this is essentially equivalent to evenly spreading the cash flows throughout the period) – When performing mid-year discounting, one must still discount the terminal value from the end of the forecast period 121

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Step 4: Present Value Valuation  To calculate the value of a business using DCF analysis, the projected free cash flows over the

forecast period are discounted to the present over the appropriate range of discount rates  A range of terminal values for the business is added to the cash flows in the last year of

projections and discounted to a present value  The resulting values represent the total or “enterprise” value of the business, including both debt

and equity. To calculate the value of a company’s equity, subtract the company’s net debt from its enterprise value  In addition, the enterprise value should be adjusted by adding other unusual assets or

subtracting liabilities to reflect the company’s fair equity value DCF pointers  Assumption Summaries: Write up summaries of the key assumptions underlying your cash flow

projections  Sensitivity Analysis: It is useful to vary some of the important assumptions (e.g., sales growth

rate, margins) to determine how sensitive your value range is to key determinants of future results  Calculator Check: Always check Excel numbers with a calculator

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Step 5: Corporate Adjustments  DCF analysis calculates the Enterprise Value (also known as Adjusted Market Value) of a

company – The Equity Value of a company is equal to its Enterprise Value less Corporate Adjustments  Corporate Adjustments include the company’s net debt plus other obligations, less other assets

not included in the DCF analysis or financial forecasts  Long

term debt (including current portion)  Short term debt  Minority interest  Capitalized leases

 Contingent

liabilities  Excess Cash  Value of other assets not in DCF

 The Equity Value per diluted share is equal to the Equity Value divided by the number of net

fully-diluted shares outstanding – Number of net fully diluted shares = Basic shares + net shares underlying “in the money” options / warrants + net shares from the conversion of “in the money” convertible debt and convertible preferred stock  Incremental common-equivalent shares are typically calculated using the treasury stock method

– Note that this is a circular calculation – the treasury stock calculation depends on an assumed share repurchase price, which is dependent upon the number of net fully-diluted shares outstanding – Outstanding vs. exercisable options (1)

Note that “out of the money” options, while not converted per the treasury stock method, represent a cost that is not captured in the analysis (typically this error is a small one).

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Sample Discounted Cash Flow Valuation ($ in millions)

EBITDA Less: D&A EBIT Less: Tax Effect Unlevered Net Income Plus: D&A Less: Capex Plus: Changes in WC Unlevered Free Cash Flow

2005E

2006E

2007E

2008E

2009E

$250.7 (113.6) $137.1 (52.1) $85.0 113.6 (103.2) (13.7) $81.7

$278.5 (121.6) $156.9 (59.6) $97.3 121.6 (110.5) (7.2) $101.1

$307.2 (130.3) $176.9 (67.2) $109.7 130.3 (118.4) (7.7) $113.9

$317.6 (134.2) $183.4 (69.7) $113.7 134.2 (122.0) (3.2) $122.7

$328.2 (138.2) $190.0 (72.2) $117.8 138.2 (125.7) (3.2) $127.1

Source: Wall Street research projections and Credit Suisse estimates. ($ in millions, except per share data)

Discount Rate

4.50x

Terminal Value EBITDA Multiple 5.00x 5.50x

6.00x

9.0%

$417.5 960.0 $1,377.5 (99.3) $1,278.2 $44.42 36.9% 0.4%

$417.5 1,066.7 $1,484.2 (99.3) $1,384.9 $47.92 47.7% 1.2%

$417.5 1,173.3 $1,590.9 (99.3) $1,491.6 $51.42 58.5% 1.8%

$417.5 1,280.0 $1,697.5 (99.3) $1,598.2 $54.92 69.3% 2.4%

Present Value of Free Cash Flows Present Value of Terminal Value Enterprise Value Less: Net Debt Equity Value Equity Value per Share (1) Implied Premium / (Discount) to Current Implied Perpetuity Growth Rate

10.0%

$406.1 917.1 $1,323.3 (99.3) $1,224.0 $42.64 31.4% 1.3%

$406.1 1,019.1 $1,425.2 (99.3) $1,325.9 $45.98 41.8% 2.1%

$406.1 1,121.0 $1,527.1 (99.3) $1,427.8 $49.33 52.1% 2.8%

$406.1 1,222.9 $1,629.0 (99.3) $1,529.7 $52.67 62.4% 3.3%

Present Value of Free Cash Flows Present Value of Terminal Value Enterprise Value Less: Net Debt Equity Value Equity Value per Share (1) Implied Premium / (Discount) to Current Implied Perpetuity Growth Rate

11.0%

$395.2 876.6 $1,271.8 (99.3) $1,172.5 $40.95 26.2% 2.2%

$395.2 974.0 $1,369.2 (99.3) $1,269.9 $44.15 36.1% 3.0%

$395.2 1,071.4 $1,466.6 (99.3) $1,367.3 $47.34 45.9% 3.7%

$395.2 1,168.8 $1,564.0 (99.3) $1,464.7 $50.54 55.8% 4.3%

Present Value of Free Cash Flows Present Value of Terminal Value Enterprise Value Less: Net Debt Equity Value Equity Value per Share Implied Premium / (Discount) to Current (1) Implied Perpetuity Growth Rate

(1) Based on share price of $32.44 as of 02/04/05.

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WACC Schedule Industry Statistics (in millions) Beta (1)

Company Arkansas Best Corp Cnf Inc Old Dominion Freight Overnite Corp Scs Transportation Inc Yellow Roadway Corp

Total

Mkt

Debt /

Tax

Levering

Unlevered

Debt

Equity

Mkt Equity

Rate (2)

Factor (3)

Beta (4)

1,069 2,457 885 850 354 2,769

1.4% 29.1% 9.2% 14.9% 34.7% 26.3%

40.1% 41.0% 39.1% 40.0% 37.6% 39.1%

1.01 1.17 1.06 1.09 1.22 1.16

0.82 0.76 0.59 0.87 0.52 0.86

19.3% 20.6%

39.5% 39.6%

1.12 1.12

0.74 0.79

0.83 0.89 0.62 0.95 0.63 1.00 Mean Median

15 714 81 127 123 728

0.82 0.86

Assumptions Target Marginal Tax Rate Risk Free Rate (5) Equity Risk Premium (6) Size Premia ("Sp") (7)

38.0% 4.330% 7.20% 1.59%

Schedule A (Sensitivity of Capital Structure) Debt / Capital

Debt / Mkt Equity

0.0% 10.0% 20.0% 30.0% 40.0% 50.0%

0.0% 11.1% 25.0% 42.9% 66.7% 100.0%

Average Unlev'd Beta 0.74 0.74 0.74 0.74 0.74 0.74

Levering Factor

Levered Beta (8)

1.00 1.07 1.16 1.27 1.41 1.62

0.74 0.79 0.85 0.93 1.04 1.19

Cost of Equity (9) 11% 12% 12% 13% 13% 15%

5.0% 11.2% 10.7% 10.3% 9.8% 9.3% 8.8%

Weighted Average Cost of Capital (10) Pre-tax Cost of Debt 6.0% 7.0% 8.0% 11.2% 10.8% 10.4% 10.0% 9.5% 9.1%

11.2% 10.9% 10.5% 10.1% 9.8% 9.4%

11.2% 10.9% 10.6% 10.3% 10.0% 9.7%

9.0%

10.0%

11.2% 11.0% 10.8% 10.5% 10.3% 10.0%

11.2% 11.1% 10.9% 10.7% 10.5% 10.4%

Schedule B (Sensitivity of Unlevered Beta) Weighted Average Cost of Capital (10) Pre-tax Cost of Debt 6.0% 7.0% 8.0%

Debt / Capital

Debt / Mkt Equity

Levering Factor

Unlevered Beta

9.0%

10.0%

0.0%

0.0%

1.00

0.65

10.6%

10.6%

10.6%

10.6%

10.6%

10.6%

10.0%

11.1%

1.07

0.70

10.5%

10.5%

10.6%

10.7%

10.7%

10.8%

20.0%

25.0%

1.16

0.75

10.3%

10.5%

10.6%

10.7%

10.8%

11.0%

30.0% 40.0% 50.0%

42.9% 66.7% 100.0%

1.27 1.41 1.62

0.80 0.85 0.90

10.2% 10.0% 9.8%

10.4% 10.2% 10.1%

10.5% 10.5% 10.4%

10.7% 10.7% 10.7%

10.9% 11.0% 11.0%

11.1% 11.2% 11.3%

(1) Barra US equity Book predictions (2) Based on marginal tax rate (3) Levering Factor: 1 + [ ( 1 - Tax Rate ) * ( Debt / Equity ratio ) ] (4) Unlevered Beta: ( Beta / Levering Factor ) (5) Yield on Interpolated 20-Year US treasury Bonds which corresponds to Ibbotson's long-term equity risk premium (as of 2/04/05). Source: Bloomberg. (6) The average historic period between the return on stocks and L-T bonds (2004 Ibbotson Associates).

5.0%

(7) Cost of equity premia based on equity market capitalization. low-cap ($797mm - $1,167mm) = 1.59%. Amounts per 2004 Ibbotson. (8) Levered Beta: (Beta * Levering Factor) (9) Cost of Equity: Rf + B * ( Rm - Rf ) + Sp, or the risk-free rate plus the beta * the eq (10) WACC: Rd = Return on Debt; Re = Return on Equity [ Rd * (1 - tax rate) * (D / (D + E) ) ] + [ Re * (E / (D + E) ) ]

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3. Weekly Assignments and Resources F.

Merger Consequences Analysis

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Summer Assignment – Accretion / Dilution  Evaluate the transaction consequences of McClatchy buying Knight Ridder:

 100% Cash, 0% Stock  50% Cash, 50% Stock  0% Cash, 100% Stock  What are the Income Statement consequences?

 Accretion / Dilution impact  What are the Balance Sheet consequences?

 Total Debt / Total Capitalization  Total Debt / EBITDA  EBITDA / Interest  Other consequences?

 Ownership Helpful Hint: We use all outstanding and exercisable shares due to change of control. If you properly filled in the option schedule on the input tab, this should be a quick manual fix.  Key Takeaways

 At the end of this section, you should be able to answer the following: 1. 2. 3. 4.

Is an acquisition accretive or dilutive How do premiums paid, financing and level of synergies affect accretion / dilution How is accretion / dilution tied to the relative P/E multiples of the acquiror and target Can an accretive deal be achieved given the DCF and comp valuations?

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Agenda 1. Overview of Merger Consequences 2. Recent Developments in Merger Accounting 3. Earnings Per Share Defined 4. Introduction to Modeling an Acquisition USF Corporation: Sample Merger Consequences Yellow Roadway buys USF Corporation

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Mergers and Acquisitions: What’s the Difference?  Acquiring company purchases a part or all of the assets of the Target

company Asset Acquisition

 Target remains in existence post-transaction, as does Target

ownership structure  Requires that each asset and liability acquired be separately conveyed

contractually

 More complicated and time consuming than transfer of stock  Acquiring company buys the stock of the Target company from

Stock Acquisition

stockholder(s)

 Stockholders’ may be a parent company or individuals  Corporate shell of Target survives in Acquiror’s hands

 Two or more corporations combine such that one of the combining

Statutory Merger

corporations remains in existence while the other participating corporation(s) disappear

 Frequently follows a stock acquisition

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What are the Consequences of a Merger? Income Statement Consequences  Corporate performance

yardstick impacting stock price

 Earnings per share impact of a transaction

 Quality of earnings – growth,

Balance Sheet Consequences  Leverage & Coverage ratios

Social Consequences  Stock options / “Golden

Parachutes”

 Debt/Total Cap  Debt/EBITDA  EBITDA/Interest

 Management/Board composition  Pro Forma Ownership

volatility, customer concentration, etc.

Antitrust Consequences  Does the combined firm have

market power in any particular market?

 Evaluate stand-alone and pro forma market shares in all affected markets

 Must some business units

Regulatory Consequences  Would a variety of regulators

(e.g. FCC, FAA, state insurance commissioners) permit the merger to take place?

 Market power concerns similar to FTC

 Other regulatory concerns

be sold?

 Will the FTC block the merger (e.g., Staples / Office Depot)

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Accounting Treatments Old Purchase Accounting  Excess of purchase price over fair market value

(FMV) of identifiable assets less liabilities is recorded as goodwill

New Purchase Accounting  Excess of purchase price over FMV of identifiable

assets and liabilities is recorded as goodwill  Goodwill not systematically amortized. Instead,

 Goodwill amortized by the straight line method

over a period not exceeding 40 years

subject to an impairment test at least once per year and on an interim basis as warranted

 No more systematic income statement “hit”  Because goodwill is not amortized but most other

intangible assets will be, FASB wants companies to separately identify more intangible assets rather than simply allocating such amounts to goodwill

The Financial Accounting Standards Board (FASB) has modified the existing purchase accounting rules and has eliminated the way we treat Goodwill. 131

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Earnings Per Share  Corporate Performance yardstick – –

Growth Stability

– –

Stock price Executive compensation

 Cornerstone in merger consequences  2 Earnings per share (“EPS”) measures:

– Basic EPS – Diluted EPS

Basic EPS

 Net

Income ÷ Shares Outstanding

Diluted EPS

 Accounting  Factors

concept only

in impact of options and convertible securities, if dilutive

–

Option: right to buy a share from the Company at a predetermined price

–

Convertible Security: Preferred Stock or Bond whose owner has right to surrender security for a certain number of common shares

 Options

– Treasury Method

 Convertible

Securities – “If-Converted” Method

 Shares

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Earnings Per Share – The Treasury Method Key Information

 Standalone EPS calculations - Use Options Exercisable from 10-K

Stock Price (P)

=

$10.00

Basic Shares (B)

=

20.00

Options (N)

=

3.00

Strike Price (K)

=

$8.00

Net Income (NI)

=

$50.0

1. Basic EPS

=

NI B

=

NI Diluted Shares

=

B

 Acquisition Target - Options Outstanding from 10-K

 Change of Control usually leads to accelerated vesting for all options

=

$50.0 20.00

=

$2.50

Single Option “intrinsic value” Intuition:

2. Diluted EPS

Diluted Shares

Diluted EPS

+

Max (0, P – K) x N P Max (0, 10.00 – 8.00) x 3.00 10.00

=

20 +

=

20 +

=

20.60 shares

=

$50.0 20.60

0.60

=

$2.43

1. Company issues one share for each option = 3.00 shares 2. Company collects strike price of 3.00 X $8.00 = $24.00 3. Company uses $24.00 to repurchase shares at market price of $10.00  Shares repurchased: $24.00 = 2.40 $10.00 4. Incremental shares = Shares Issued - Shares Repurchased 3.00 - 2.40 = 0.60  Accounting Convention – Diluted shares not ACTUALLY outstanding – Allows for consistent treatment of options and computing EPS 133

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Earnings Per Share – Convertible Securities  Convertible Bonds and convertible preferred securities are bonds and preferred shares from an

economic perspective as well as in terms of their impact on financial statements until holder exercises his option to convert into common shares  Diluted EPS calculation follows a different logic – the “If-Converted” method

 Compare Diluted EPS on a converted and not converted basis, and choose the lower of the two Convertible Preferred

Convertible Bonds

If converted test:

If converted test:

 Add back preferred dividend to net income

 Add back after-tax interest to net income

 Add the number of common shares the

convertible converts into to the basic share count  Compute EPS  Is EPS lower than Basic EPS?

[I x (1-t)]  Add the number of common shares the

convertible converts into to the basic share count  Compute EPS  Is EPS lower than Basic EPS?

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Accounting for Investment in Equity Securities METHOD OF ACCOUNTING

BALANCE SHEET

INCOME STATEMENT

Cost Method (less than 20% in a nonmarketable security)

Investment is shown at cost. Changes in value (from original cost) are reported only as realized

Dividends received from target are shown as dividend income

Fair Value (less than 20% ownership in a marketable security)

Investment account is shown at fair value. Changes in fair value are reported as a separate component of shareholders’ equity until realized

Dividends received from target are shown as dividend income. Losses are also realized upon recognition of permanent impairment

Equity Method (generally when voting ownership percentage is at least 20 percent but not more than 50 percent)

Investment account is shown at cost plus share of target’s net income less share of target’s dividends since acquisition

Equity in target’s net income is shown as investment income in period during which target earns income

Consolidation Method (generally when voting ownership percentage is greater than 50 percent). Tax consolidation requires at least 80% voting and value ownership  “M&A Purchase Accounting”  “Control”  If own less than 100%, recognize minority interest

Consolidate 100% of individual assets and liabilities of subsidiary. Minority interest in subsidiary’s net assets is shown between liabilities and equity

100% revenues and expenses of subsidiary are combined with those of acquiror. Minority interest in subsidiary’s net income is shown as a subtraction

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CONFIDENTIAL

Purchase Accounting – Framework

Acquiror Income Statement

NewCo

Adjustments

Target

1. Synergies

Income Statement

Pro Forma Income Statement

2. Transaction expenses Balance Sheet Cashflow Statement

Balance Sheet

+

Cashflow Statement

3. Capital Structure

+

 Acquisition Debt  Common shares issued

 Refinancing

=

Pro Forma Balance Sheet Pro Forma Cashflow Statement

existing debt

 Other 4. Goodwill & Depreciation 5. Date acquisition closes

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Purchase Accounting  Determine buyer

 Group that receives the most voting shares of post merger company is presumed to be the accounting acquirer; regardless of the legal acquiror

 If no definitive share count, other factors are: – Board of Directors – Management – Relative size  Determine acquisition cost

 Valuation of securities  Earnings contingency  Share price contingency  Closing date

 Target financials combined with Acquiror financials as of the closing date  Allocation of Purchase Price

 Allocate to identifiable assets acquired and liabilities assumed to reflect fair value at date of acquisition

 Include any newly identified intangible assets  Excess of cost of acquired company over the FMV is recorded as goodwill 137

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Purchase Accounting – Balance Sheet Impact  Accounting: Acquisition of stock (Carryover basis)

Goodwill

 Purchase Price – $100MM  50% stock, 45% debt, 5% cash on hand

GOODWILL

 Closing Date: December 31, 20XX

Purchase Price

 $5MM in synergies

Less: Book Value

 Question to class: Why is there a deferred tax

Excess Purchase Price

95.0

Less: Asset Write-ups

30.0

liability?

$100.0 5.0

$65.0

Goodwill

 Asset step-up: $30MM  Step-up amortization: 15 years ($ in millions)

ACQUIROR

Cash

TARGET

ACCOUNTING ADJUSTMENT

FINANCING ADJUSTMENT

$30.0

$5.0

10.0

5.0

0.0

0.0

$40.0

$10.0

Debt

0.0

0.0

Other Liabilities

5.0

5.0

10.0

Deferred Tax Liability

0.0

0.0

2.0

Total Liabilities

$5.0

$5.0

$57.0

Equity

35.0

5.0

$40.0

$10.0

Other Assets Goodwill Total Assets

Total Liabilities & Equity

$(5.0)

PRO FORMA

$30.0 20.0

65.0

92.0 $142.0 45.0

(5.0)

50.0

45.0

=

85.0 $142.0

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Purchase Accounting – Income Statement Impact ($ in millions)

ACQUIROR

Sales EBITDA

TARGET

ACCOUNTING ADJUSTMENT

FINANCING ADJUSTMENT

PRO FORMA

$150.0

$100.0

30.0

21.0

5.0

56.0

5.0

1.0

2.0

6.3

0.0

Depreciation Amortization

$250.0

0.0

0.0

0.0

EBIT

25.0

20.0

Net Interest Expense (Income)

(1.5)

(0.3)

PBT

26.5

20.3

46.7

Tax

10.6

8.1

18.7

Net Income

15.9

12.2

28.0

Tax – %

40%

Diluted Shares

10.00

EPS

$1.59

4.8

3.0

40% 2.50

40% (2.50)

0.67

10.67 $2.62

EPS Accretion / (Dilution) – $ Stock Price

49.7

$1.03 $75.00

$40.00

?

Implied Cost of Funds Cost of Cash

5% x

$5.0

Cost of Debt

10% x $45.0

Total Interest

$4.8

Shares Issued = $50.0MM ÷ $75.00 = 0.67

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The P/E Ratio Shortcut  If the P/E of your acquisition currency is higher than the P/E of the stock of the Target at the

price you propose to pay, the acquisition will likely be accretive, and vice-versa  Robust rule of thumb in the absence of goodwill amortization / impairment KEY DATA ACQUIRER $10.00 $1.00 10.0x 1 10% 40.0%

Price Net Income P/E # of Shares Int. rate Tax Rate

TARGET $5.00 $1.00 5.0x 1

Example 1 – Acquirer pays for Target with Acquirer Stock 1. Target Purchase Price

$5.00 x 1 share = $5.00 Purchase Price

2. Acquirer Shares Issued

=

3. Combined Net Income

=

$1.00 + $1.00 = $2.00

4. New Share Count

=

1 + 0.5 = 1.5

5. Earnings per Share

=

$2.00 / 1.5 = $1.33

$5.00 =

Acquirer Stock Price

=

$10.00

0.50 shares

6. New EPS of $1.33 greater than Acquirer EPS of $1.00 – transaction is accretive

Example 2 – Acquirer pays for Target with Borrowed Money P/E of Cash

=

Pro forma EPS

=

1 Rate x (1 – t)

=

1 10% (1 – 40%)

= 16.7x

Acquirer NI + Target NI – After Tax Interest Cost Acquirer Shares

=

$1.00 + $1.00 – [$5.00 x 10% x (1-40%)] 1

= $1.70

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The Incremental Method Useful for

 AcquirCo and TargetCo Debt is not

refinanced

 Preliminary Analysis

 Transaction closes 12/01

 Limited Information

 No Synergies

 Multiple Companies / Permutations

Purchase Price: $100MM; Book Value: $80MM 50% Stock / 50% Debt Financing

+ – – – =

AcquirCo Net Income TargetCo Net Income Incremental D&A Goodwill Amortization After-Tax Interest Exp. PF Net Income Initial AcquirCo Diluted Shares Pro forma AcquirCo Diluted Shares Stand-alone EPS (Diluted) Pro forma EPS (Diluted) EPS Accretion (Dilution) – $ EPS Accretion (Dilution) – %

2002

}

$50.0 20.0 0.5 } 0.0 } 3.0 66.5 10.00 15.00 $5.00 $4.43 $(0.57) (11.4%)

 Purchase Price – Book value = Excess

Purchase Price  FMV adjustment: $10.0  Deferred Tax Liability = $4.0  Goodwill = $14.0  Tax deductible or non-deductible  Asset vs. stock transaction  New Debt x int. x (1 – tax)

50.0 x 10% x (1 – 40%) = 3.0  Per Treasury Method  Shares issued = Equity issued AcquirCo

Stock Price = $50.0 / 10.00 = 5.00 141

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Merger Consequences: Yellow Roadways Buys USF  For Knight Ridder project show:

 3 Considerations (100% Cash, 50%/50% Cash Stock and 100% Stock)  3 Premiums (10%, 20% and 30%) ($ in millions)

–

Premium to Share Price Price Per Share

5.0%

10.0%

50% Cash / 50% Stock Consideration 15.0% 20.0% 25.0% 30.0%

35.0%

40.0%

$32.44

$34.06

$35.68

$37.31

$38.93

$40.55

$42.17

$43.79

$45.42

Equity Value (1) Net Debt

$918 99

$966 99

$1,014 99

$1,062 99

$1,111 99

$1,160 99

$1,210 99

$1,259 99

$1,309 99

Enterprise Value

1,017

1,065

1,114

1,162

1,210

1,259

1,309

1,358

1,408

Enterprise Value / 2005E EBITDA Enterprise Value / 2006E EBITDA

4.1x 3.7x

4.2x 3.8x

4.4x 4.0x

4.6x 4.2x

4.8x 4.3x

5.0x 4.5x

5.2x 4.7x

5.4x 4.9x

5.6x 5.1x

Equity Value / 2005E Net Income Equity Value / 2006E Net Income

13.3x 11.4x

14.0x 12.0x

14.7x 12.6x

15.4x 13.2x

16.1x 13.8x

16.9x 14.4x

17.6x 15.0x

18.3x 15.6x

19.0x 16.2x

2005E Stand Alone Diluted EPS 2005E Pro Forma Diluted EPS

$5.25 5.59

$5.25 5.53

$5.25 5.48

$5.25 5.43

$5.25 5.38

$5.25 5.33

$5.25 5.28

2005E Accretion / (Dilution) Acc / (Dil) – $ Acc / (Dil) – % Pre-Tax Breakeven Synergies

$0.34 6.4% –

$0.28 5.4% –

$0.23 4.4% –

$0.18 3.5% –

$0.13 2.6% –

$0.08 1.6% –

$0.03 0.7% –

($0.01) (0.3%) $1.3

($0.06) (1.2%) $6.1

1.6x 45.28%

1.7x 45.36%

1.7x 45.45%

1.7x 45.53%

1.8x 45.61%

1.8x 45.69%

1.8x 45.76%

1.9x 45.83%

1.9x 45.91%

14.2% 85.8%

14.9% 85.1%

15.5% 84.5%

16.1% 83.9%

16.7% 83.3%

17.3% 82.7%

17.9% 82.1%

18.5% 81.5%

19.1% 80.9%

(2)

Pro-Forma Debt / LTM EBITDA Debt-to-Capitalization (at closing) % Shares issued as currency ProForma Ownership%

$5.25 5.24

$5.25 5.19

Source: Wall Street Projections, Credit Suisse Estimates. (1) Net Debt numbers as of 12/31/04. (2) Based on LTM EBITDA of $697mm.

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These materials have been provided to you by Credit Suisse ("CS") in connection with an actual or potential mandate or engagement and may not be used or relied upon for any purpose other than as specifically contemplated by a written agreement with CS. In addition, these materials may not be disclosed, in whole or in part, or summarized or otherwise referred to except as agreed in writing by CS. The information used in preparing these materials was obtained from or through you or your representatives or from public sources. CS assumes no responsibility for independent verification of such information and has relied on such information being complete and accurate in all material respects. To the extent such information includes estimates and forecasts of future financial performance (including estimates of potential cost savings and synergies) prepared by or reviewed or discussed with the managements of your company and/or other potential transaction participants or obtained from public sources, we have assumed that such estimates and forecasts have been reasonably prepared on bases reflecting the best currently available estimates and judgments of such managements (or, with respect to estimates and forecasts obtained from public sources, represent reasonable estimates). These materials were designed for use by specific persons familiar with the business and the affairs of your company and CS assumes no obligation to update or otherwise revise these materials. Nothing contained herein should be construed as tax, accounting or legal advice. You (and each of your employees, representatives or other agents) may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the transactions contemplated by these materials and all materials of any kind (including opinions or other tax analyses) that are provided to you relating to such tax treatment and structure. For this purpose, the tax treatment of a transaction is the purported or claimed U.S. federal income tax treatment of the transaction and the tax structure of a transaction is any fact that may be relevant to understanding the purported or claimed U.S. federal income tax treatment of the transaction. CS has adopted policies and guidelines designed to preserve the independence of its research analysts. CS’s policies prohibit employees from directly or indirectly offering a favorable research rating or specific price target, or offering to change a research rating or price target, as consideration for or an inducement to obtain business or other compensation. CS’s policies prohibit research analysts from being compensated for their involvement in investment banking transactions.

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