JP Morgan M&a DCF and Merger Analysis

S T R I C TL Y

P R I V A T E

AN D

C O N F I D E N T I A L

DECEMBER 2004

M&A: DCF AND MERGER ANALYSIS

M&A - DCF and M&A analysis

[For any pitchbook or presentation including advisory, equity or debt security or loan product or combinations thereof. NOT for use in fairness/valuation or Commercial Bank presentations.]

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This presentation was prepared exclusively for the benefit and internal use of the JPMorgan client to whom it is directly addressed and delivered (including such client’s subsidiaries, the “Company”) in order to assist the Company in evaluating, on a preliminary basis, the feasibility of a possible transaction or transactions and does not carry any right of publication or disclosure, in whole or in part, to any other party. This presentation is for discussion purposes only and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this presentation nor any of its contents may be disclosed or used for any other purpose without the prior written consent of JPMorgan. The information in this presentation is based upon any management forecasts supplied to us and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. JPMorgan’s opinions and estimates constitute JPMorgan’s judgment and should be regarded as indicative, preliminary and for illustrative purposes only. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of the Company or which was otherwise reviewed by us. In addition, our analyses are not and do not purport to be appraisals of the assets, stock, or business of the Company or any other entity. JPMorgan makes no representations as to the actual value which may be received in connection with a transaction nor the legal, tax or accounting effects of consummating a transaction. Unless expressly contemplated hereby, the information in this presentation does not take into account the effects of a possible transaction or transactions involving an actual or potential change of control, which may have significant valuation and other effects. Notwithstanding anything herein to the contrary, the Company and each of its employees, representatives or other agents may disclose to any and all persons, without limitation of any kind, the U.S. federal and state income tax treatment and the U.S. federal and state income tax structure of the transactions contemplated hereby and all materials of any kind (including opinions or other tax analyses) that are provided to the Company relating to such tax treatment and tax structure insofar as such treatment and/or structure relates to a U.S. federal or state income tax strategy provided to the Company by JPMorgan. JPMorgan’s policies prohibit employees from offering, directly or indirectly, a favorable research rating or specific price target, or offering to change a rating or price target, to a subject company as consideration or inducement for the receipt of business or for compensation. JPMorgan also prohibits its research analysts from being compensated for involvement in investment banking transactions except to the extent that such participation is intended to benefit investors. JPMorgan is a marketing name for investment banking businesses of JPMorgan Chase & Co. and its subsidiaries worldwide. Securities, syndicated loan arranging, financial advisory and other investment banking activities are performed by a combination of J.P. Morgan Securities Inc., J.P. Morgan plc, J.P. Morgan Securities Ltd. and the appropriately licensed subsidiaries of JPMorgan Chase & Co. in Asia-Pacific, and lending, derivatives and other commercial banking activities are performed by JPMorgan Chase Bank, N.A. JPMorgan deal team members may be employees of any of the foregoing entities.

M&A:

This presentation does not constitute a commitment by any JPMorgan entity to underwrite, subscribe for or place any securities or to extend or arrange credit or to provide any other services.

M&A - DCF and M&A analysis

Agenda

Introduction

1

Discounted cash flow analysis

6

Relative value analysis

56

Merger consequences

71

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M&A - DCF and M&A analysis

Valuation methodologies

Valuation methodologies

Publicly traded comparable companies analysis „ “Public Market

Valuation” „ Value based on

market trading multiples of comparable companies

I N T R O D U C TI O N

„ Applied using

historical and prospective multiples „ Does not include a

control premium

Comparable transactions analysis „ “Private Market

Valuation” „ Value based on

multiples paid for comparable companies in sale transactions „ Includes control

premium

Discounted cash flow analysis „ “Intrinsic” value

of business „ Present value of

projected free cash flows „ Incorporates both

short-term and long-term expected performance „ Risk in cash flows

and capital structure captured in discount rate

Leveraged buyout/recap analysis „ Value to a

financial/LBO buyer „ Value based on

debt repayment and return on equity investment

Other

„ Liquidation

analysis „ Break-up analysis „ Historical trading

performance „ Expected IPO

valuation „ Discounted future

share price „ EPS impact „ Dividend discount

model

2

M&A - DCF and M&A analysis

The valuation process Determining a final valuation recommendation is a process of triangulation using insight from each of the relevant valuation methodologies

I N T R O D U C TI O N

(1) Discounted Cash Flow Analyzes the present value of a company's free cash flow.

(2) Publicly Traded Comparable Companies Utilizes market trading multiples from publicly traded companies to derive value.

(3) Comparable Acquisition Transactions Utilizes data from M&A transactions involving similar companies.

(4) Leveraged Buy Out Used to determine range of potential value for a company based on maximum leverage capacity.

3

The valuation summary is the most important slide in a valuation presentation

M&A - DCF and M&A analysis

The science is performing each valuation method correctly, the art is using each method to develop a valuation recommendation Price per share

$20.00

$26.75

$15.00 $15.00

Implied offer = $8.46

$9.75 $10.00

$10.25

$5.00

$5.00

$5.00

$5.50 $6.00

$4.00

$4.94 $4.00

$3.75

$3.50

$3.00

I N T R O D U C TI O N

$0.00 52-week high/low

15.0x to 19.0x 2005E EBIT of $20.6

19.0x to 25.0x 2005E cash EPS of $0.16

Public trading comparables

15.0x to 20.0x 2006E cash EPS of $0.25

2.5x to 4.0x LTM revenue of $185.7

Transaction comparables

Mgmt. Case

Street Case

12% to 15% Discount Rate EBIT exit mult. of 15.0x to 20.0x

12% to 15% Discount Rate EBIT exit mult. of 15.0x to 20.0x

DCF analysis

4

M&A - DCF and M&A analysis

A primer: firm value vs. equity value Firm value

=

Market value of all capital invested in a business(1) (often referred to as “enterprise value” or “firm value” or “asset value”) The value of the total enterprise: market value of equity + (total debt + Capitalized Leases - Cash and Cash equivalents) + Minority Interest + Preferred Equity Total debt includes all Long term debt, Current portion of Long term debt, short term debt and overdrafts

Equity value

=

I N T R O D U C TI O N

Assets

Enterprise value

Market value of the shareholders’ equity (often referred to as “offer value”) The market value of a company’s equity (shares outstanding x current stock price)

Liabilities and Shareholders’ Equity

Enterprise Value

Net debt, etc.

Equity value 1

The value of debt should be a market value. It may be appropriate to assume book value of debt approximates the market value as long as the company’s credit profile has not changed significantly since the existing debt was issued. 5

M&A - DCF and M&A analysis

Agenda

Introduction

1

Discounted cash flow analysis

6

Relative value analysis

56

Merger consequences

71

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M&A - DCF and M&A analysis

Discounted cash flow analysis as a valuation methodology

Valuation methodologies

Publicly traded comparable companies analysis Valuation” „ Value based on

„ Applied using

historical and prospective multiples

D I S C O UN T E D

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market trading multiples of comparable companies

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„ “Public Market

„ Does not include a

control premium

Comparable transactions analysis „ “Private Market

Valuation” „ Value based on

multiples paid for comparable companies in sale transactions „ Includes control

premium

Discounted cash flow analysis „ “Intrinsic” value

of business „ Present value of

projected free cash flows „ Incorporates both

short-term and long-term expected performance „ Risk in cash flows

and capital structure captured in discount rate

Leveraged buyout/recap analysis „ Value to a

financial/LBO buyer „ Value based on

debt repayment and return on equity investment

Other

„ Liquidation

analysis „ Break-up analysis „ Historical trading

performance „ Expected IPO

valuation „ Discounted future

share price „ EPS impact „ Dividend discount

model

7

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Overview of DCF analysis

WACC Other topics

„ Discounted cash flow analysis is based upon the theory that the value of a

business is the sum of its expected future free cash flows, discounted at an appropriate rate „ DCF analysis is one of the most fundamental and commonly-used valuation

techniques „ Widely accepted by bankers, corporations and academics

— Corporate clients often use DCF analysis internally

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„ One of several techniques used in M&A transactions; others include:

— — — —

Comparable companies analysis Comparable transaction analysis Leveraged buyout analysis Recapitalization analysis, liquidation analysis, etc.

„ DCF analysis may be the only valuation method utilized, particularly if no

comparable publicly-traded companies or precedent transactions are available

8

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Overview of DCF analysis

WACC Other topics

„ DCF analysis is a forward-looking valuation approach, based on several key

projections and assumptions „ Free cash flows

— What is the projected operating and financial performance of the business? „ Terminal value „ What will be the value of the business at the end of the projection period? „ Discount rate

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— What is the cost of capital (equity and debt) for the business? „ Depending on practical requirements and availability of data, DCF analysis can

be simple or extremely elaborate „ There is no single “correct” method of performing DCF analysis, but certain

rules of thumb always apply „ Do not simply plug numbers into equations „ You must apply judgment in determining each assumption

9

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

The process of DCF analysis

WACC Other topics

„ Project the operating results and free cash flows of the business Projections/FCF Projections/FCF

over the forecast period (typically 10 years, but can be 5–20 years depending on the profitability horizon) „ Estimate the exit multiple and/or growth rate in perpetuity of the

Terminal Terminal value value

business at the end of the forecast period

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„ Estimate the company’s weighted-average cost of capital to Discount Discount rate rate

determine the appropriate discount rate range

„ Determine a range of values for the enterprise by discounting the Present Present value value

projected free cash flows and terminal value to the present

„ Adjust the resulting valuation for all assets and liabilities not Adjustments Adjustments

accounted for in cash flow projections

10

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

DCF theory and its application

WACC Other topics

DCF theory: The value of a productive asset is equal to the present value of all expected future cash flows that can be removed without affecting the asset’s value (including an estimated terminal value), discounted using an appropriate weightedaverage cost of capital „ The cash-flow streams that are discounted include „ Unlevered or levered free cash flows over the projection period „ Terminal value at the end of the projection period

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„ These future free cash flows are discounted to the present at a discount rate

commensurate with their risk „ If you are using unlevered free cash flows (our preferred approach), the

appropriate discount rate is the weighted-average cost of capital for debt and equity capital invested in the enterprise in optimal/targeted proportions „ If you are using levered free cash flows, the appropriate discount rate is simply

the cost of equity capital (often referred to as flows to shareholders or dividend discount model)

11

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

The two basic DCF approaches must not be confused

WACC Other topics

„ DCF of unlevered cash flows (the focus of these materials) „ Projected income and cash-flow streams are free of the effects of debt, net of

excess cash „ Present value obtained is the value of assets, assuming no debt or excess cash

(“firm value” or “enterprise value”) „ Debt associated with the business is subtracted (and excess cash balances are

added) to determine the present value of the equity (“equity value”)

„ DCF of levered cash flows (most common in valuation of financial institutions) „ Projected income and cash-flow streams are after interest expense and net of any

interest income „ Present value obtained is the value of equity „ Cash flows are discounted at the cost of equity

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„ Cash flows are discounted at the weighted-average cost of capital

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Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Other considerations

WACC Other topics

Reliability of projections „ DCF results are generally more sensitive to cash flows (and terminal value) than to

small changes in the discount rate. Care should be taken that assumptions driving cash flows are reasonable. Generally, we try to use estimates provided by analysts from reputable Wall Street firms if the client has not provided projections

Sensitivity analysis approximate. Use several scenarios to bound the target’s value. Generally, the best variables to sensitize are sales, EBITDA margin, WACC and exit multiples or perpetuity growth rate

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„ Remember that DCF valuations are based on assumptions and are therefore

Hence, always present a range for the valuation!

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Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Always remember…

WACC Other topics

„ Three key drivers „ Projections and incremental cash flows (unlevered free cash flow) „ Residual value at end of the projection period (terminal value) „ Weighted-average cost of capital (discount rate) „ Avoid pitfalls „ Validate and test projection assumptions „ Determine appropriate cash flow stream „ Thoughtfully consider terminal value methodology „ Carefully consider all variables in calculation of the discount rate „ Sensitize appropriately (base projection variables, synergies, discount rates,

terminal values, etc.) „ Footnote assumptions in detail „ Think about other value enhancers and detractors

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„ Use appropriate cost of capital approach

Always double-check with a calculator!

14

Overview

The first step in DCF analysis is projection of unlevered free cash flows

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

„ Calculation of unlevered free cash flow begins with financial projections „ Comprehensive projections (i.e., fully-integrated income statement, balance

sheet and statement of cash flows) typically provide all the necessary elements „ Quality of DCF analysis is a function of the quality of projections „ Often required to “fill in the gaps” „ Confirm and validate key assumptions underlying projections „ Sensitize variables that drive projections „ Sources of projections include „ Acquiring company’s management „ Research analysts „ Bankers

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„ Target company’s management

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Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Projecting financial statements

WACC Other topics

„ Ideally projections should go out as far into the future as can reasonably be

estimated to reduce dependence on the terminal value „ Most important assumptions „ Sales growth: Use divisional, product-line or location-by-location build-up or

simple growth assumptions „ Operating margins: Evaluate improvement over time, competitive factors, SG&A

costs „ Synergies: Estimate dollars in Year 1 and evaluate margin impact over time

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„ Depreciation: Should conform with historic and projected capex „ Capital expenditures: Consider both maintenance and expansion capex „ Changes in net working capital: Should correspond to historical patterns and grow

as the business grows „ Should show historical financial performance and sanity check projections against

past results. Be prepared to articulate why projections may or may not be similar to past results (e.g. reasons behind margin improvements, increased sales growth, etc.) „ Analyze projections for consistency „ Sales increases usually require working capital increases „ CAPEX and depreciation should converge over time

16

Overview

Free cash flow is the cash that remains for creditors and owners after taxes and reinvestment

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

„ Unlevered free cash flows can be forecast from a firm’s financial projections, even if

those projections include the effects of debt „ To do this, simply start your calculation with EBIT (earnings before interest and

taxes) „ EBIT (from the income statement)

Plus: Non-tax-deductible goodwill amortization Less: Taxes (at the marginal tax rate) „ Equals: Tax-effected EBITA AN AL Y SI S

Plus: Deferred taxes1 Plus: Depreciation and any tax-deductible amortization

F L OW

Less: Capital expenditures Plus/(less): Decrease/(increase) in net working investment

D I S C O UN T E D

C A S H

„ Equals: Unlevered free cash flow

1

Although beyond the scope of our current discussions, you should only include actual cash taxes paid in the DCF. Depending on the firm and industry, you may want to adjust for the non-cash (or deferred) portion of a firm’s tax provision. The tax footnote in the financial statements will give you a good idea of whether this is a meaningful issue for your analysis

17

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Example: Calculating unlevered free cash flows

WACC Other topics

Stand-alone Stand-alone DCF DCF analysis analysis of of Company Company X X $ millions $ millions Fiscal year ending December 31, Net sales

AN AL Y SI S

2004P

2005P

2006P

2007P

2008P

$440.0

$484.0

$532.4

$585.6

$644.2

$708.6

$779.5

80.0

88.0

96.8

106.5

117.1

128.8

141.7

155.9

Less: Depreciation

12.0

13.2

14.5

16.0

17.6

19.3

21.3

23.4

EBITA

68.0

74.8

82.3

90.5

99.6

109.5

120.5

132.5

Less: Taxes at marginal rate

27.2

29.9

32.9

36.2

39.8

43.8

48.2

53.0

$40.8

$44.9

$49.4

$54.3

$59.7

$65.7

$72.3

$79.5

16.0

17.6

19.3

21.3

23.4

–

–

–

–

–

Less: Capital expenditures

20.0

22.0

24.2

26.6

29.3

Less: Incr./(decr.) in working capital

10.0

8.5

7.0

5.5

4.0

Unlevered free cash flow

40.3

46.8

53.8

61.4

69.6

Adjustment for deal date

(40.3)

—

—

—

—

$0.0

$46.8

$53.8

$61.4

$69.6

Plus: Deferred taxes

F L OW

2003

$400.0

Plus: Depreciation

C A S H

2002

EBITDA

Tax-effected EBITA

D I S C O UN T E D

2001

Unlevered FCF to acquirer

Key assumptions: Deal/valuation date = 12/31/04 Marginal tax rate = 40%

18

Overview

Valuing the incremental effects of changes in projected operating results

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

„ In performing DCF analysis, we often need to determine the incremental impact on

value of certain events or adjustments to the projections, including: „ Synergies achievable through the M&A transaction

— Revenue — Cost — Capital expenditures „ Expansion plans „ Cost reductions „ Change in sales growth

„ These incremental effects can be valued by discounting them independently (net of

taxes) or by adjusting the DCF model and simply measuring the incremental impact

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„ Margin improvements

19

Overview

Once unlevered free cash flows are calculated, they must be discounted to the present

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

„ The standard present value calculation takes into account the cost of capital by attributing

greater value to cash flows generated earlier in the projection period than later cash flows

Present value =

FCF1 (1+r)1

+

FCF2 (1+r)2

+

FCF3 (1+r)3

+

...

FCFn

+

(1+r)n

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„ Since most businesses do not generate all of their free cash flows on the last day of the

year, but rather more-or-less continuously during the year, DCF analyses often use the socalled “mid-year convention,” which takes into account the fact that free cash flows occur during the year

JPMorgan JPMorgan standard standard

Present value =

FCF1 (1+r)0.5

+

FCF2 (1+r)1.5

+

FCF3 (1+r)2.5

+

...

+

FCFn (1+r)n-0.5

„ This approach moves each cash flow from the end of the applicable period to the middle of

the same period (i.e., cash flows are moved closer to the present)

20

It is important to differentiate between the transaction date and the mid-year convention

M&A - DCF and M&A analysis

Transaction Transaction date: date: 01/01 01/01

Year

0

0.5

1

First cash flow, mid-year 1 CF1

Discounting =

2

Second cash flow, mid-year 2 CF2

+

(1+r)0.5

1.5

CF3

+

(1+r)1.5

2.5

3

3.5

3

3.5

Third cash flow, mid-year 3 ….

+

(1+r)2.5

Period 1 CF to buyer

Year

0

D I S C O UN T E D

0.5

0.75

1

First cash flow, mid-period 1

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AN AL Y SI S

Transaction Transaction date: date: 06/30 06/30

Discounting =

CF1 (0.75-0.5)

(1+r)

+

1.5

2

Second cash flow, mid-year 2 CF2 (1.5-0.5)

(1+r)

+

2.5

Third cash flow, mid-year 3 CF3

+

….

(2.5-0.5)

(1+r)

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M&A - DCF and M&A analysis

Practice exercise Transaction Transaction date: date: 09/30 09/30

Period 1 CF to buyer

Year

0

0.5

0.75

1

Discounting =

CF1 (1+r)(0.875-0.75)

+

2

2nd cash flow, mid-year 2 CF2

(1+r)(1.5-0.75)

+

2.5

3

3.5

3rd cash flow, mid-year 3 CF3

+

….

(1+r)(2.5-0.75)

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1st flow, mid-period 1

1.5

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Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Example: Discounting free cash flows

WACC Other topics

Stand-alone Stand-alone DCF DCF analysis analysis of of Company Company X X $ millions $ millions Fiscal year ending December 31, 2001

2002

2003

2004P

2005P

2006P

2007P

2008P

$400.0

$440.0

$484.0

$532.4

$585.6

$644.2

$708.6

$779.5

EBITDA

80.0

88.0

96.8

106.5

117.1

128.8

141.7

155.9

Less: Depreciation

12.0

13.2

14.5

16.0

17.6

19.3

21.3

23.4

EBITA

68.0

74.8

82.3

90.5

99.6

109.5

120.5

132.5

Less: Taxes at marginal rate

27.2

29.9

32.9

36.2

39.8

43.8

48.2

53.0

$40.8

$44.9

$49.4

$54.3

$59.7

$65.7

$72.3

$79.5

16.0

17.6

19.3

21.3

23.4

–

–

–

–

–

Less: Capital expenditures

20.0

22.0

24.2

26.6

29.3

Less: Incr./(decr.) in working capital

10.0

8.5

7.0

5.5

4.0

Unlevered free cash flow

40.3

46.8

53.8

61.4

69.6

Adjustment for deal date

(40.3)

—

—

—

—

Unlevered FCF to acquirer

$0.0

$46.8

$53.8

$61.4

$69.6

Memo: Discounting factor

0.0

0.5

1.5

2.5

3.5

$0.0

$44.6

$46.7

$48.4

$49.9

Net sales

Tax-effected EBITA Plus: Depreciation

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Plus: Deferred taxes

Discounted value of unlevered FCF Discounted value of FCF 2005P–2008P

Formula Key assumptions: Deal/valuation date = 12/31/04 Marginal tax rate = 40% Discount rate = 10%

$189.6 =

189.6

$46.8 (1+.10)0.5

+

$53.8 (1+.10)1.5

+

$61.4 (1+.10)2.5

+

$69.6 (1+.10)3.5

23

Overview

Terminal value can account for a significant portion of value in a DCF analysis

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

„ Terminal value represents the business’s value at the end of the projection period;

i.e., the portion of the company’s total value attributable to cash flows expected after the projection period „ Terminal value is typically based on some measure of the performance of the

business in the terminal year of the projection (which should depict the business operating in a steady-state/normalized manner) „ Terminal (or “Exit”) multiple method

— Assumes that the business is valued/sold at the end of the terminal year at a multiple of some financial metric (typically EBITDA) — Assumes that the business is held in perpetuity and that free cash flows continue to grow at an assumed rate „ A terminal multiple will have an implied growth rate and vice versa. It is „ Once calculated, the terminal value is discounted back to the appropriate date using „ Attempt to reduce dependence on the terminal value

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essential to review the implied multiple/growth rate for sanity check purposes

C A S H

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„ Growth in perpetuity method

the relevant rate

„ What is appropriate projection time frame? „ What percentage of total value comes from the terminal value?

24

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Terminal multiple method

WACC Other topics

„ This method assumes that the business will be valued at the end of the last year of

the projected period „ The terminal value is generally determined as a multiple of EBIT, EBITDA or

EBITDAR; this value is then discounted to the present, as were the interim free cash flows „ The terminal value should be an asset (firm) value; remember that not all

multiples produce an asset value „ Note that in the exit multiple method terminal value is always assumed to be

„ Should the terminal multiple be an LTM multiple or a forward multiple? „ If the terminal value is based on the last year of your projection then the multiple

should be based on an LTM multiple (most common) „ There are circumstances where you will project an additional year of EBITDA and

apply a forward multiple

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calculated at the end of the final projected year, irrespective of whether you are using the mid-year convention

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Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Most common error: The final year is not normalized

WACC Other topics

„ Consider adding a year to the projections which represents a normalized year „ A steady-state, long-term industry multiple should be used rather than a current

multiple, which can be distorted by contemporaneous industry or economic factors „ Treat the terminal value cash flow as a separate, critical forecast „ Growth rate

— Consistent with long-term economic assumptions — Net working investment consistent with projected growth — Capital expenditures needed to fuel estimated growth — Depreciation consistent with capital expenditures „ Margins

— Adjusted to reflect long-term estimated profitability „ Normalized tax rate

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

„ Reinvestment rate

26

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Example: Terminal multiple method

WACC Other topics

Stand-alone Stand-alone DCF DCF analysis analysis of of Company Company X X $ $ millions millions Fiscal year ending December 31,

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

Net sales EBITDA Less: Depreciation EBITA Less: Taxes at marginal rate Tax-effected EBITA Plus: Depreciation Plus: Deferred taxes Less: Capital expenditures Less: Incr./(decr.) in working capital Unlevered free cash flow Adjustment for deal date Unlevered FCF to acquirer

2001 $400.0 80.0 12.0 68.0 27.2 $40.8

2001 $440.0 88.0 13.2 74.8 29.9 $44.9

2003 $484.0 96.8 14.5 82.3 32.9 $49.4

Memo: Discounting factor Discounted value of unlevered FCF Discounted value of FCF 2005P–2008P EBITDA in 2008P Exit multiple Firm value at exit Discounted terminal value Total present value to acquirer

Key assumptions: Deal/valuation date = 12/31/04 Marginal tax rate = 40% Discount rate = 10% Exit multiple of EBITDA = 7.0x

2004P $532.4 106.5 16.0 90.5 36.2 $54.3 16.0 — 20.0 10.0 40.3 (40.3) $0.0

2005P $585.6 117.1 17.6 99.6 39.8 $59.7 17.6 — 22.0 8.5 46.8 — $46.8

2006P $644.2 128.8 19.3 109.5 43.8 $65.7 19.3 — 24.2 7.0 53.8 — $53.8

2007P $708.6 141.7 21.3 120.5 48.2 $72.3 21.3 — 26.6 5.5 61.4 — $61.4

2008P $779.5 155.9 23.4 132.5 53.0 $79.5 23.4 — 29.3 4.0 69.6 — $69.6

0.0

0.5

1.5

2.5

3.5

$0.0 189.6

$44.6

$46.7

$48.4

$49.9

$155.9 7.0x 1,091.3 745.4 $934.9

Formula

($155.9 * 7.0x) $745.4 =

(1+.10)4 27

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Example: Terminal multiple method (cont’d)

WACC Other topics

Stand-alone Stand-alone DCF DCF analysis analysis of of Company Company X X $ millions, except per share data $ millions, except per share data

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

A

+

B

=

C

Discounted

Discounted terminal value

Firm value

FCF

at 2008P EBITDA multiple of

at 2008P EBITDA multiple of

Discount rate

2005–2008

6.0x

7.0x

8.0x

6.0x

7.0x

8.0x

8%

$196.8

$687.5

$802.1

$916.7

$884.4

$999.0

$1,113.6

9%

193.1

662.6

773.1

883.5

855.8

966.2

1,076.7

10%

189.6

638.9

745.4

851.8

828.4

934.9

1,041.4

11%

186.1

616.2

718.9

821.6

802.3

904.9

1,007.6

12%

182.7

594.5

693.5

792.6

777.2

876.3

975.3

—

D

=

E

Net debt Discount rate

12/31/04

8%

Equity value

Equity value per share1

at 2008P EBITDA multiple of

at 2008P EBITDA multiple of

6.0x

7.0x

8.0x

6.0x

7.0x

8.0x

$100.0

$784.4

$899.0

$1,013.6

$19.17

$21.97

$24.77

9%

100.0

755.8

866.2

976.7

$18.47

$21.17

$23.87

10%

100.0

728.4

834.9

941.4

$17.80

$20.41

$23.01

11%

100.0

702.3

804.9

907.6

$17.16

$19.67

$22.18

12%

100.0

677.2

776.3

875.3

$16.55

$18.97

$21.39

Note: DCF value as of 12/31/01 based on mid-year convention 1 Based on 40.91 million diluted shares outstanding

28

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Growth in perpetuity method

WACC Other topics

„ This method assumes that the business will be owned in perpetuity and that the

business will grow at approximately the long-term macroeconomic growth rate „ Few businesses can be expected to have cash flows that truly grow forever; be

conservative when estimating growth rates in perpetuity „ Take free cash flow in the last year of the projection period, n, and grow it one

more year to n+1;1 this free cash flow is then capitalized at a rate equal to the discount rate minus the growth rate in perpetuity „ To ensure that the terminal year is normalized, JPMorgan models are set up to

JPM JPM recommended recommended method method

Terminal value = (FCFn * (1 + g))/(WACC — g)

Terminal value = (FCFn+1)/(WACC — g)

F L OW

where FCFn = FCF in final projected period g = growth rate in perpetuity WACC = weighted-avg. cost of capital

where

PV of terminal value = terminal value/(1+WACC)n-0.5

PV of terminal value = terminal value/(1+WACC)n-0.5

D I S C O UN T E D

Academic Academic formula formula

C A S H

AN AL Y SI S

project one year past the projection year and allow for normalizing adjustments; this FCFn+1 is then discounted by the perpetuity formula

1

FCFn+1 g WACC

= FCF in year after projections = growth rate in perpetuity = weighted-avg. cost of capital

This step is taken because the perpetuity growth formula is based on the principle that the terminal value of a business is the value of its next cash flow, divided by the difference between the discount rate and a perpetual growth rate

29

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Growth in perpetuity method (cont’d)

WACC Other topics

„ Note that when using the mid-year convention, terminal value is discounted as if

cash flows occur in the middle of the final projection period „ Here the growth-in-perpetuity method differs from the exit-multiple method „ Typical adjustments to normalize free cash flow in Year n include revising the

relationship between revenues, EBIT and capital spending, which in turn affects CAPEX and depreciation „ Working capital may also need to be adjusted

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

„ Often CAPEX and depreciation are assumed to be equal

30

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Example: Growth in perpetuity method

WACC Other topics

Stand-alone Stand-alone DCF DCF analysis analysis of of Company Company X X $ millions $ millions Fiscal year ending December 31, 2001

2002

2003

2004P

2005P

2006P

2007P

2008P

$400.0

$440.0

$484.0

$532.4

$585.6

$644.2

$708.6

$779.5

EBITDA

80.0

88.0

96.8

106.5

117.1

128.8

141.7

155.9

Less: Depreciation

12.0

13.2

14.5

16.0

17.6

19.3

21.3

23.4

EBITA

68.0

74.8

82.3

90.5

99.6

109.5

120.5

132.5

Less: Taxes at marginal rate

27.2

29.9

32.9

36.2

39.8

43.8

48.2

53.0

$40.8

$44.9

$49.4

$54.3

$59.7

$65.7

$72.3

$79.5

16.0

17.6

19.3

21.3

23.4

–

–

–

–

–

Less: Capital expenditures

20.0

22.0

24.2

26.6

29.3

Less: Incr./(decr.) in working capital

10.0

8.5

7.0

5.5

4.0

Unlevered free cash flow

40.3

46.8

53.8

61.4

69.6

Adjustment for deal date

(40.3)

—

—

—

—

Unlevered FCF to acquirer

$0.0

$46.8

$53.8

$61.4

$69.6

Memo: Discounting factor

0.0

0.5

1.5

2.5

3.5

$0.0

$44.6

$46.7

$48.4

$49.9

Net sales

Tax-effected EBITA Plus: Depreciation

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

Plus: Deferred taxes

Discounted value of unlevered FCF Discounted value of FCF 2005P–2008P

189.6

PV of Terminal Value

733.7

Total present value to acquirer Key assumptions: Deal/valuation date = 12/31/04 Marginal tax rate = 40% Discount rate = 10% Perpetuity growth rate = 3%

$923.3

Formula

$69.6 * (1 + .03) $733.6 = (.10 - .03)*(1+.10)3.5 31

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Example: Growth in perpetuity method (cont’d)

WACC Other topics

Stand-alone Stand-alone DCF DCF analysis analysis of of Company Company X X $ $ millions, millions, except except per per share share data data A

Discount rate 8% 9% 10% 11% 12%

B

Firm value

FCF

at perpetuity growth rate of

at perpetuity growth rate of

D

2.5% $991.0 811.9 681.5 582.6 505.1

3.0% $1,095.4 883.8 733.7 622.0 535.8

3.5% $1,223.0 968.9 794.0 666.7 570.1

=

12/31/04 $100.0 100.0 100.0 100.0 100.0

2.5% $1,187.8 1,005.0 871.1 768.7 687.9

3.0% $1,292.2 1,077.0 923.3 808.1 718.5

3.5% $1,419.8 1,162.0 983.6 852.8 752.8

E Equity value

Equity value per share1

at perpetuity growth rate of

at perpetuity growth rate of

2.5% $1,087.8 905.0 771.1 668.7 587.9

3.0% $1,192.2 977.0 823.3 708.1 618.5

3.5% $1,319.8 1,062.0 883.6 752.8 652.8

2.5% $26.59 $22.12 $18.84 $16.34 $14.37

3.0% $29.14 $23.88 $20.12 $17.31 $15.12

3.5% $32.26 $25.96 $21.59 $18.40 $15.95

D I S C O UN T E D

C A S H

F L OW

C

Discounted terminal value

Net debt Discount rate 8% 9% 10% 11% 12%

=

Discounted 2005–2008 $196.8 193.1 189.6 186.1 182.7

— AN AL Y SI S

+

Note: DCF value as of 12/31/04 based on mid-year convention 1

Based on 40.91 million diluted shares outstanding

32

Overview

Terminal multiples and perpetuity growth rates are often considered side-by-side

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

„ Assumptions regarding exit multiples are often checked for reasonableness by calculating the

growth rates in perpetuity that they imply (and vice versa) „ To go from the exit-multiple approach to an implied perpetuity growth rate:

g = [(WACC*terminal value) / (1+WACC)0.5 - FCFn] / [FCFn + (terminal value / (1 + WACC)0.5)] „ To go from the growth-in-perpetuity approach to an implied exit multiple:

multiple = [FCFn * (1 + g)(1 + WACC)0.5] / [EBITDAn * (WACC - g)] the mid-year convention

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

„ These formulas adjust for the different approaches to discounting terminal value when using

33

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Terminal multiple method and implied growth rates

WACC Other topics

Standalone Standalone Company Company X X DCF DCF analysis analysis $ $ millions millions A Discounted FCF 2005–2008 $196.8 193.1 189.6 186.1 182.7

Discount rate 8% 9% 10% 11% 12%

AN AL Y SI S

—

D Net debt 12/31/04 $100.0 100.0 100.0 100.0 100.0

B

D I S C O UN T E D

=

Discounted terminal value at 2008P EBITDA multiple of 6.0x 7.0x 8.0x $687.5 $802.1 $916.7 662.6 773.1 883.5 638.9 745.4 851.8 616.2 718.9 821.6 594.5 693.5 792.6

=

C Firm value at 2008P EBITDA multiple of 6.0x 7.0x 8.0x $884.4 $999.0 $1,113.6 855.8 966.2 1,076.7 828.4 934.9 1,041.4 802.3 904.9 1,007.6 777.2 876.3 975.3

Terminal value as percent of total firm value 6.0x 7.0x 8.0x 78% 80% 82% 77% 80% 82% 77% 80% 82% 77% 79% 82% 76% 79% 81%

Equity value per share1 at 2008P EBITDA multiple of 6.0x 7.0x 8.0x $19.17 $21.97 $24.77 $18.47 $21.17 $23.87 $17.80 $20.41 $23.01 $17.16 $19.67 $22.18 $16.55 $18.97 $21.39

Implied perpetuity growth rate at 2008P EBITDA multiple of

E Equity value at 2008P EBITDA multiple of 6.0x 7.0x 8.0x $784.4 $899.0 $1,013.6 755.8 866.2 976.7 728.4 834.9 941.4 702.3 804.9 907.6 677.2 776.3 875.3

C A S H

F L OW

Discount rate 8% 9% 10% 11% 12%

+

6.0x 0.2% 1.1% 2.0% 2.9% 3.8%

7.0x 1.3% 2.2% 3.1% 4.0% 4.9%

8.0x 2.1% 3.0% 3.9% 4.8% 5.8%

At a 9% discount rate and an 8.0x exit multiple the price is $23.87 and the implied terminal growth rate is 3.0% Note: DCF value as of 12/31/04 based on mid-year convention 1

Based on 40.91 million diluted shares outstanding

34

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Perpetuity growth rate and implied terminal multiples

WACC Other topics

Standalone Standalone Company Company X X DCF DCF analysis analysis $ $ millions millions A Discounted FCF 2005–2008 $196.8 193.1 189.6 186.1 182.7

Discount rate 8% 9% 10% 11% 12%

D Net debt 12/31/04 $100.0 100.0 100.0 100.0 100.0

B

D I S C O UN T E D

=

C

Discounted terminal value at perpetuity growth rate of

Firm value at perpetuity growth rate of

2.5% 3.0% 3.5% $991.0 $1,095.4 $1,223.0 811.9 883.8 968.9 681.5 733.7 794.0 582.6 622.0 666.7 505.1 535.8 570.1

2.5% 3.0% 3.5% $1,187.8 $1,292.2 $1,419.8 1,005.0 1,077.0 1,162.0 871.1 923.3 983.6 768.7 808.1 852.8 687.9 718.5 752.8

=

Terminal value as percent of total firm value 2.5% 83% 81% 78% 76% 73%

3.0% 85% 82% 79% 77% 75%

3.5% 86% 83% 81% 78% 76%

E Equity value at perpetuity growth rate of 2.5% 3.0% 3.5% $1,087.8 $1,192.2 $1,319.8 905.0 977.0 1,062.0 771.1 823.3 883.6 668.7 708.1 752.8 587.9 618.5 652.8

C A S H

F L OW

AN AL Y SI S

— Discount rate 8% 9% 10% 11% 12%

+

Equity value per share1 at perpetuity growth rate of 2.5% $26.59 $22.12 $18.84 $16.34 $14.37

3.0% $29.14 $23.88 $20.12 $17.31 $15.12

3.5% $32.26 $25.96 $21.59 $18.40 $15.95

Implied EBITDA exit multiple at perpetuity growth rate of 2.5% 8.6x 7.4 6.4 5.7 5.1

3.0% 9.6x 8.0 6.9 6.1 5.4

3.5% 10.7x 8.8 7.5 6.5 5.8

At a 9% discount rate and a terminal growth rate of 3.0%, the price is $23.88 and the implied exit multiple is 8.0x Note: DCF value as of 12/31/04 based on mid-year convention 1 Based on 40.91 million diluted shares outstanding

35

Overview

Choosing the discount rate is a critical step in DCF analysis

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

„ The discount rate represents the required rate of return given the risks inherent in

the business, its industry, and thus the uncertainty regarding its future cash flows, as well as its optimal capital structure „ Typically the weighted average cost of capital (WACC) will be used as a foundation

for setting the discount rate „ The WACC is always forward-looking and is predicted based on the expectations of

an investment's future performance; an investor contributes capital with the expectation that the riskiness of cash flows will be offset by an appropriate return „ The WACC is typically estimated by studying capital costs for existing investment AN AL Y SI S

opportunities that are similar in nature and risk to the one being analyzed „ The WACC is related to the risk of the investment, not the risk or creditworthiness of

D I S C O UN T E D

C A S H

F L OW

the investor¹

1

In valuing a company, always use the riskiness of its cash flows or comparable companies in estimating a weighted average cost of capital. Never use the acquirer’s cost capital unless, by some chance, it is engaged in an extremely similar line of business. However, if a business is small relative to an acquiror’s, sometimes ti may be appropriate to consider the use of the acquiror’s WACC in performing the valuation. The additional value created by using the acquiror’s WACC can be viewed as a synergy to the acquiror in the context of the transaction.

36

Overview

JPMorgan estimates the cost of equity using the capital asset pricing model

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

„ The Capital Asset Pricing Model (CAPM) classifies risk as systematic and

unsystematic. Systematic risk is unavoidable. Unsystematic risk is that portion of risk that can be diversified away, and thus will not be paid for by investors „ The CAPM concludes that the assumption of systematic risk is rewarded with a risk

premium, which is an expected return above and beyond the risk-free rate. The size of the risk premium is linearly proportional to the amount of risk taken. Therefore, the CAPM defines the cost of equity as equaling the risk-free rate plus the amount of systematic risk an investor assumes

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

„ The CAPM formula follows:

Cost of equity = Risk-free rate + (beta * market risk premium) re = rf + ß * (rm - rf) Where re = rf = rm = β =

the required market return on the equity of the company the risk-free rate the return on the market the company’s projected (leveraged) beta

„ There is also an error term in the CAPM formula, but this is usually omitted

37

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

The cost of equity is the major component of the WACC

WACC Other topics

„ The cost of equity reflects the long-term return expected by the market (dividend

yield plus share appreciation) „ Risk-free rate based on the 10 year bond yield „ Incorporates the undiversifiable risk of an investment (beta) „ Equity risk premium reflects expectations of today’s market „ The market risk premium (rm - rf; i.e., the spread of market return over the risk-free

Cost of equity

D I S C O UN T E D

=

Risk free rate

+

Beta

x

Equity risk premium

+

Adjustment for correlation to stock market returns

Appropriate “extra” return above risk free x rate

Long-term return on equity investment in = today’s market

Long-term risk-free rate of return (beta=0)

=

10-year bond yield (annual average)

+

Predicted betas

x

Estimated using various techniques

=

4.97%

+

1.00

x

5.00%

=

9.97%

C A S H

F L OW

AN AL Y SI S

rate) is periodically estimated by M&A research based on analysis of historical data

For market average

38

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

JPMorgan estimates the equity risk premium at 5.0%

WACC Other topics

Equity risk premiums is estimated based on expected returns and recent historical returns Equity Equity premiums premiums Rolling Rolling average average over over 10-year 10-year bond bond 14%

Rolling 30 years

Rolling 40 years

Equity Equity returns returns less less 10-year 10-year bond bond yield yield Arithmetic average Arithmetic average Rolling 50 years

12%

Equity risk premium (%)

1994

2.7

1995

3.4

1996

4.4

1997

4.7

1998

5.2

1999

6.2

2000

5.8

2001

5.0

8%

6%

4%

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

10%

30 years ending

2% 1955 1959 1963 1968 1972 1976 1980 1984 1988 1993 1997 2001

39

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Beta

WACC Other topics

„ Beta provides a method to estimate an asset's systematic (non-diversifiable) risk „ Beta equals the covariance between expected returns on the asset and on the stock

market, divided by the variance of expected returns on the stock market „ A company whose equity has a beta of 1.0 is “as risky” as the overall stock market

and should therefore be expected to provide returns to investors that rise and fall as fast as the stock market; a company with an equity beta of 2.0 should see returns on its equity rise twice as fast or drop twice as fast as the overall market „ Returning to our CAPM formula, the beta determines how much of the market risk „ Since the cost of capital is an expected value, the beta value should be an expected

value as well „ Although the CAPM analysis, including the use of beta, is the overwhelming favorite

for DCF analysis, other capital asset pricing models exist, such as multi-factor models like the Arbitrage Pricing Theory

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

premium will be added to or subtracted from the risk-free rate

40

Overview

JPMorgan uses predicted betas to calculate the cost of equity

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

„ Predicted betas are constructed to adjust for many risk factors, incorporating firms’ earnings

volatility, size, industry exposure, and leverage „ Predicted betas are more consistent and less volatile than historical betas „ Historical betas only measure the past relationship between a firm’s return and market returns

and are often distorted „ Projected betas can be obtained from Barra or an online database (e.g., IDD) „ Barra predicted betas can be found through the Investment Bank Home Web page1 „ Note that Bloomberg betas are based on historic prices and are therefore not forward-looking

D I S C O UN T E D

C A S H

Distribution Distribution of of predicted predicted and and historical historical betas betas for for 5,600 5,600 publicly-traded publicly-traded companies companies 800

Historical Beta

Predicted Beta

800

600

# of companies

# of companies

F L OW

AN AL Y SI S

„ Impute unlevered beta for private company from public comparables

400 200 0 (1.5) (1.0) (0.5) 0.0

Supermarkets 0.78

Predicted betas

600 400 200

Cellular 1.62

Food 0.52

Internet 2.09

Utilities 0.43

0 0.5

1.0

1.5 Beta

2.0

2.5

3.0

3.5

4.0

(0.5)

0.2

1.0 Beta

1.9

2.6

41

M&A - DCF and M&A analysis

Delevering and relevering beta „ Recalling our previous discussion regarding the difference between asset values and

equity values, a similar argument exists for betas. The predicted equity beta, i.e., the observed beta, included the effects of leverage. In the course of performing a variance analysis, which looks at different target capitalizations, the equity beta must be delevered to get an asset, or unlevered, beta. This asset beta is then used in the CAPM formula to determine the appropriate cost of capital for various debt levels „ The formula follows:

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

βU= βL/[1 = ((1 –T) * (Debt/Equity))]

Where: βU = unlevered (asset) beta

BL = leveraged beta T = marginal tax rate „ To relever the beta at a target capital structure:

βL= βU*[1 + ((1 –T) * (Debt/Equity))]

42

M&A - DCF and M&A analysis

Delevering and relevering beta (cont’d) „ Note that JPMorgan M&A sometimes uses a factor, tau, in place of the marginal tax

rate, T „ Tau, currently equal to 0.26, represents the average blended benefit a

shareholder gets from a company borrowing (reflects many factors) „ The value of Tau is derived by researchers using complicated statistical analyses „ Although the delevering/relevering methodology is standard for WACC analyses, the

formula does not produce a highly accurate result „ Remember the fundamentals: the market charges more for equity of companies that „ Exercise „ 1. Levered Beta = 1.25, T = 40%, D/E= 0.75; What is the Beta Unlevered? „ 2. Find the levered Beta at a D/E = 1.0

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

are financially risky

43

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

The cost of a firm’s equity should be adjusted for size

WACC Other topics

Size Size premium premium by by market market cap cap Based on historical Based on historical returns returns analysis analysis

„ Investors typically expect higher returns

when investing in smaller companies

Market cap ($mm)

5.2%

„ Increased risk

3.1%

„ Lower liquidity

2.5%

1.9%

1.7%

1.4%

1.1%

„ Betas vary very little by size „ Historical equity returns suggest higher

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

return required by investors in smaller companies „ P/E growth ratios (PEG) tend to decline with

size

0.8% 0.0%

$0– 100

$100– 250

$250– 500

$500– 700

$7001,000

$1,000– $1,500– $2,500– $5,000+ 1,500 2,500 5,000

Size Size premium premium by by market market cap cap Based on PE/growth Based on PE/growth (PEG) (PEG) Market cap ($mm)

2.2% 1.6%

„ Empirical data combined with judgement

1.1%

should be applied when estimating the cost of equity for smaller firms

0.8% 0.0% $100–500

$500–1,000

$1,000–2,500

$2,500–5,000

$5,000+

44

Overview

JPMorgan uses the long-term cost of debt in estimating WACC

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

„ The long-term cost of debt is used because the cost of capital is normally applied to

long-term cash flows „ Using the long-term cost of debt removes any refinancing costs/risks from the

valuation analysis „ To the extent a company can fund its investments at a lower cost of debt (with

the same risk), this value should be attributed to the finance staff

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

„ JPMorgan uses the company’s normalized cash tax rate

45

Overview

The cost of equity and debt are blended together based on a target capital structure

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

„ The target capital structure reflects the company’s rating objective „ Firms generally try to minimize the cost of capital through the appropriate use of leverage „ The percentage weighting of debt and equity is usually based on the market value of a firm’s equity and debt

position „ Most firms are at their target capital structure „ Adjustments should be made for seasonal or cyclical swings, as well as for firms moving toward a target „ Using a weighted average cost of capital assumes that all investments are funded with the same mix of equity

and debt as the target capital structure WACC WACC formula formula AN AL Y SI S

WACC = rd *

Where:

T = Marginal tax rate

E = Market value of equity D = Market value of debt

re = Return on equity rd = Return on debt

Illustrative Illustrative SYSCO SYSCO weighted weighted average average cost cost of of capital capital calculation calculation

F L OW

Cost of equity

Cost of debt

Cost of capital 10-year T-bond (Avg)

C A S H D I S C O UN T E D

[D *(1-T)] + re * E D+E D+E

4.97%

Market risk premium (x) Beta (current predicted) Adjusted market premium Cost of equity

5.00% 0.62 3.10% =

Target capital structure (Assumes current = optimal)

Cost of debt

6.25%

(-) Tax shield1

2.19%

After-tax cost of debt

4.06%

Debt/total capital2 = 6.1%

8.07%

Nominal WACC = 7. 82% 1 2

Assumes 35% marginal tax rate Total capital = debt + market value of equity

46

Example: Calculating WACC based on comparable companies

M&A - DCF and M&A analysis

Target Target WACC WACC analysis analysis as as of of 1/1/01 1/1/01 Macroeconomic Macroeconomic assumptions assumptions Risk free rate1

5.40%

Estimated market equity risk premium

Projected Target marginal tax rate

40.0%

4.0%

Industry Industry beta beta analysis analysis

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

Comparable company

Projected levered beta3

Net debt/mkt. cap

Total debt/mkt. equity

Tax rate

Unlevered beta4

Cost of levered equity

Cost of unlevered equity

Company A

1.06

17.2%

22.5%

0.40

0.93

9.6%

9.1%

Company B

0.90

18.0

22.2

0.40

0.79

9.0

8.6

Company C

0.90

40.3

78.4

0.40

0.61

9.0

7.8

Company D

0.89

8.6

10.1

0.40

0.84

9.0

8.8

Average

0.94

21.0%

33.3%

0.40

0.79

9.1%

8.6%

Levered beta assuming unlevered beta of 0.79

Cost of levered equity

Target nominal WACC

Target Target WACC WACC calculation calculation Optimal debt/market capitalization

Optimal debt/equity

Spread to 10-yr treasuries (bp)

Country risk premium

Pre-tax long term cost of debt

30.0%

42.9%

175.0

0.00%

7.1%

1.00

9.4%

7.9%

40.0

66.7

200.0

0.00

7.4

1.11

9.8

7.7

50.0

100.0

300.0

0.00

8.4

1.27

10.5

7.8

60.0

150.0

400.0

0.00

9.4

1.51

11.4

8.0

70.0

233.3

500.0

0.00

10.4

1.91

13.0

8.3

1 Risk-free rate=yield-to-maturity of 10-year U.S. Treasury bond as of 1/1/01 (Source: Bloomberg) 2 Source: JPMorgan M&A research 3 Source: Barra predicted betas 4 Unlevered beta=Levered beta/(1 + (total debt/market value of equity)*(1-tax rate)). Assumes beta of debt equals zero

47

Overview

The appropriate cost of capital will depend on the entity which is being valued

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

For For illustrative illustrative purposes purposes

Risk premium

Unlevered beta

Optimal debt/equity

Re-levered beta

Cost of equity

Cost of financing

WACC

5.0%

0.70

20%

0.80

9.0%

6.25%

8.2%

$1BN target

5.0%-6.5%

0.70

20%

0.80

9.0%—10.3%

6.25%—7.50%

8.3%—9.3%

$500mm target

5.0%-7.0%

0.70

20%

0.80

9.0%—10.6%

6.25%—8.00%

8.4%—9.7%

$200mm target

5.0%-7.5%

0.70

20%

0.80

9.0%—11.0%

6.25%—8.50%

8.4%—10.1%

SYSCO

SYSCO SYSCO WACC WACC sensitivity sensitivity

$1bn target target WACC WACC sensitivity¹ sensitivity¹ $1bn

10%

20%

30%

40%

0.65 7.8%

7.5%

7.3%

7.0%

0.70 8.1%

7.7%

7.5%

7.2%

0.75 8.3%

7.9%

7.7%

7.4%

0.80 8.5%

8.2%

7.8%

7.6%

0.85 8.8%

8.4%

8.0%

7.8%

Levered beta

Levered beta

Debt/equity

Debt/equity

10%

20%

30%

40%

0.70

9.1%

8.7%

8.4%

8.2%

0.75

9.4%

9.0%

8.7%

8.4%

0.80

9.7%

9.3%

8.9%

8.7%

0.85

10.0%

9.6%

9.2%

8.9%

0.90

10.3%

9.8%

9.4%

9.1%

10%

20%

30%

40%

0.70

9.8%

9.4%

9.1%

8.9%

0.75

10.1%

9.8%

9.4%

9.1%

0.80

10.5%

10.1%

9.7%

9.4%

0.85

10.8%

10.4%

10.0%

9.7%

0.90

11.2%

10.7%

10.3% 10.0%

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

Debt/equity

$200mm target target WACC WACC sensitivity² sensitivity² $200mm

Levered beta

Company

Note: Assumes 35% marginal tax rate 1 Assuming an equity risk premium of 6.5% 2 Assuming an equity risk premium of 7.5%

48

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

DCF in-class exercise

WACC Other topics

„ The Forecasted EBITDA and FCF for the next three years (2005, 2006, 2007) are „ EBITDA (US $mm): 450, 500, 550 „ FCF (US $mm): 250, 261, 277 „ Other assumptions: „ Perpetuity growth rate of 3.0% „ Terminal exit multiple of 7.5x „ Unlevered beta of 0.80 „ Risk free rate= 4.6% „ Cost of debt: 6.2% „ Marginal tax rate: 35% „ Market value of equity=US $4,541mm „ Net debt= US $2,524mm

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

„ Market risk premium= 6%

49

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

DCF in-class exercise (cont’d)

WACC Other topics

„ Calculate „ The cost of equity „ WACC „ PV of FCF „ NPV of company Perpetual growth method „ PV of Exit multiple method „ What if we use end period discounting in:

— Perpetual growth method — Exit multiple method — Use Exit/Perpetual growth methods using mid year conventions — Use Exit/Perpetual growth methods using end year conventions

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

„ What is the valuation if we need to value the company as on March 31, 2005?

50

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Most common errors in calculating WACC

WACC Other topics

Cost of equity „ Equity risk premium based on very long time frame (post 1926: Ibbotson data) „ Substitute hurdle rate (goal) for cost of capital „ Use of historical (or predicted) betas that are clearly wrong „ Investment specific risk not fully incorporated (e.g., country risk premiums) „ Incorrect releveraging of the cost of equity

Target capital structure „ The actual, not target, capital structure is used „ WACC calculated based on book weights

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

„ Cost of equity based on book returns, not market expectations

51

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Valuing synergies

WACC Other topics

„ When two businesses are combined, the term “synergies” refers to the changes in

their aggregate operating and/or financial results attributable to their being operated as a combined enterprise. Synergies can take many forms „ Revenue enhancements „ Cost savings

— — — —

Raw material discounts/purchasing power Sales and marketing overlap, Corporate overhead reductions Distribution cost reductions, Facilities consolidation Tax savings

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

„ Merger related expenses (restructuring, additional CAPEX, integration expenses) „ The value of achievable synergies is often a key element in whether to proceed with

a proposed transaction „ Calculate synergies for both the acquiring company and the target „ Remember incremental cash flow „ Synergies are generally valued by toggling pre-tax changes to various financial

statement line items into a DCF model of the combined enterprise and simply measuring the incremental impact

52

Overview M&Aflow - DCF and M&A analysis Free cash

Terminal value

Valuing synergies

WACC Other topics

„ Sources of synergy projections „ Management „ Research „ Estimates from comparable transaction (% of sales, increase in EBITDA

margin etc.) „ DCF with synergies „ Valued separately from standalone DCF „ Run sensitivity on synergy valuations

„ Timeline for achieving synergies „ Run as sensitivity various cases of realization e.g., 25%, 50%, 75%, 100% realization „ Tax impact „ Costs incurred to achieve synergies

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

„ Other considerations

53

Overview

Sensitivity analysis is vital when presenting the results of DCF analysis

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

„ Recall that DCF valuation is highly sensitive to projections and assumptions „ So-called “sensitivity tables” chart the output based on ranges of input variables „ It is common to use a 3x3 table (i.e., showing three different values for each of

two input variables) to enable the reader to “triangulate” to the appropriate inferences „ Since DCF results are by their nature approximate, depicting sensitivity tables

enables users of DCF output to assess the degree of “fuzziness” in the results growth rates generally show sensitivities for the method used to calculate terminal value and a range of discount rates „ Sensitivities can be shown for any variable in the model (including financial

projections) „ Judge which sensitivities would be useful to decision makers

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

„ As shown in our previous examples, DCF analyses using exit multiples and perpetuity

54

Overview

Companies with multiple businesses are often valued on a sum-of-the-parts basis

M&Aflow - DCF and M&A analysis Free cash

Terminal value WACC Other topics

„ This approach is sometimes referred-to as a “break-up” valuation „ Particularly common when the company is believed to be undervalued by

the public „ Better accounts for discrepancies in market conditions facing the businesses „ The methodology requires estimating financial results for each business (EBIT,

EBITDA and/or net income), which can then be used with appropriate multiples or growth rates in order to arrive at a firm value for each part before the results are summed

D I S C O UN T E D

C A S H

F L OW

AN AL Y SI S

„ Completing a sum-of-the-parts valuation can be more challenging than a

straightforward (single-business/consolidated) DCF analysis „ Typically less detailed financial data is publicly-available for segments „ Often assumptions must be made about how to allocate expenses,

especially those that are clearly shared across businesses (like corporatelevel SG&A) „ Need to consider different characteristics of each business segment

(discount rate, terminal value assumptions, etc.)

55

M&A - DCF and M&A analysis

Agenda

Introduction

1

Discounted cash flow analysis

6

Relative value analysis

56

Merger consequences

71

M&A:

DC F

AN D

M E R G E R

AN ALY SI S

Page

56

M&A - DCF and M&A analysis

Introduction to relative valuation „ Relative valuation is utilized to illustrate how the value of one company compares to

another company „ Typically, relative valuation analysis is utilized in the context of stock-for-stock

exchanges to determine the appropriate exchange ratio offered to shareholders in a transaction „ The exchange ratio reflects the number of acquiror shares offered for each target

share „ So if you are a target shareholder and you are offered an exchange ratio of

0.500x, you are being offer 1/2 of an acquiror share for each share of the target you own „ Several relative valuation approaches exist „ Contribution analysis „ Relative multiple and discounted cash flow analysis „ Valuation of synergies

R E L A T I V E

V A L U E

AN A L Y S I S

„ Historical trading and exchange ratio analysis

57

M&A - DCF and M&A analysis

Historical trading and exchange ratio analysis „ Historical exchange ratio analysis Illustrates the relative movement in stock prices

(and implied exchange ratios, aka “natural exchange ratios”) looking back over a certain timeframe „ Calculated simply as the target share price on a given date divided by the acquiror

share price on the same date „ Does not include any premium to the target „ Provides a historical benchmark to justify the contemplated exchange ratio „ Issues to consider when analyzing data include „ Liquidity of shares / trading volume (small vs. large cap) „ Relative market attention / analyst coverage „ Multiple expansion of one of the company’s peer group versus the other over the

R E L A T I V E

V A L U E

AN A L Y S I S

selected time horizon

58

M&A - DCF and M&A analysis

Illustrative historical trading and exchange ratio analysis

Acquiror shares per Target share Implied Target share price

3

$12.00 ratio as a premium Implied Target pro forma ownership

Ratio at $12.00

Current1

0.347x

0.194x

Last month1 0.184x

Last 3 months1

Last 6 months1

Last 12 months1

0.203x

0.236x

0.270x

$12.00

$6.70

$6.38

$7.02

$8.15

$9.33

0%

79.1%

88.2%

71.0%

47.3%

28.7%

38.7%

24.6%

23.6%

25.6%

28.9%

32.2%

Historical Historical exchange exchange ratio ratio Current stock price2

# of acquiror shares per target share 0.45x

Current market capitalization2

Acquiror

Target

Acquiror

Target

$34.60

$6.70

$274.8

$89.7

0.40x

More favorable to Target

At $12 per share = 0.347x

0.35x 0.30x

R E L A T I V E

V A L U E

AN A L Y S I S

0.25x 0.20x

Less favorable to Target Source:

Current = 0.194x

0.15x 0.10x 0.05x 0.00x Jun-00

1 2 3

Sep-00

Dec-00

Mar-01

Jun-01

Sep-01

Dec-01

Mar-02

Jun-02

Represents average exchange ratio over the trailing period ended June 27, 2002 Closing prices as of June 27, 2002 Assumes acquiror’s current price of $34.60 per share

59

M&A - DCF and M&A analysis

Contribution analysis „ Compares the relative equity valuation of two parties to their respective

“contribution” to a combined company’s financial performance „ Typical firm value metrics would include „ Revenues „ EBITDA „ EBIT „ Unlevered free cash flow measures „ Industry-specific (i.e. customers, reserves, etc.) „ Typical equity value metrics would include „ Net income

„ Cautionary note: contribution analysis does not measure the growth and risk profile

of the two companies’ financial performance and differing multiples may be justifiablie when assessing relative value

R E L A T I V E

V A L U E

AN A L Y S I S

„ Levered free cash flow measures

60

M&A - DCF and M&A analysis

Relative contribution analysis $ $ millions millions Implied equity value Market value % contribution Firm value¹ % contribution

Implied

Acquiror

Target

Total

Acquiror

Target

exchange ratio

$18,150

$7,653

$25,803

$18,150

$7,653

0.4340x

70.3%

29.7%

70.3%

29.7%

$38,450

$19,592

$18,150

$7,653

66.2%

33.8%

70.3%

29.7%

$5,275

$3,528

$14,482

$11,322

59.9%

40.1%

56.1%

43.9%

$5,320

$3,253

$15,716

$10,087

62.1%

37.9%

60.9%

39.1%

$1,790

$1,210

$15,397

$10,406

59.7%

40.3%

59.7%

40.3%

$2,018

$1,380

$15,326

$10,477

59.4%

40.6%

59.4%

40.6%

$58,042

0.4340x

EBITDA 2004E % contribution 2005E % contribution

$8,803 $8,573

0.8046x 0.6606x

Net income 2004E % contribution

R E L A T I V E

V A L U E

AN A L Y S I S

2005E % contribution

$3,000 $3,398

0.6956x 0.7036x

As of 2/6/02; net debt for ACQUIROR as of 12/31/01 (per press release) and for TARGET as of 9/30/01 (per 10-Q); pro forma for acquisitions 2001A for ACQUIROR; based on company press release; other estimates based on JPMorgan Equity Research 3 Based on I/B/E/S consensus estimates; ACQUIROR 2002E EPS based on company guidance; TARGET EPS estimates based on I/B/E/S consensus estimates post 1/29/02 1 2

61

M&A - DCF and M&A analysis

Sample contribution analysis

Target

$25,308

$58,042

$8,803

56.1% 70.3%

70.3%

Relative owner ship

Acquiror

Exchange r atio

0.5385x

Tar get

35.0%

Acquir or

65.0%

$8,573

$3,000

$3,398

60.9%

59.7%

59.4%

R E L A T I V E

V A L U E

AN A L Y S I S

Offer = 35.0% 43.9% 29.7%

29.7%

Market value

Firm value

.4340x

Implied ER .4340x

39.1%

40.3%

40.6%

2002E EBITDA

2003E EBITDA

2002E Net Income

2003E Net Income

.8046x

.6606x

.6956x

.7036x

62

M&A - DCF and M&A analysis

Calculating the implied exchange ratio Company statistics statistics Company

Implied Implied exchange exchange ratio ratio (equity (equity value value metrics) metrics)

Acquiror Current share price

$34.22

% of net income contributed by acquiror

59.7%

Fully-diluted share count

531

Fully-diluted market cap

18,150

Fully-diluted acquiror shares

530

Net debt

20,300

888

EBITDA

5,320

Pro forma shares outstanding to yield 59.7% ownership

Net income

1,790

Implied shares issued to target

358

Current target shares outstanding

515

Target Current share price

$14.85

Fully-diluted share count

515

Fully-diluted market cap

7,653

Net debt

11,939 3,253

Net income

1,210

0.6956x

Natural exchange ratio based on current share prices ($14.85 / $34.22)

0.4340x

R E L A T I V E

V A L U E

AN A L Y S I S

EBITDA

Implied exchange ratio based on net income (358 / 515)

63

M&A - DCF and M&A analysis

Calculating the implied exchange ratio (cont’d) Company Company statistics statistics

Implied Implied exchange exchange ratio ratio (firm (firm value value metrics) metrics)

Acquiror Current share price

$34.22

Fully-diluted share count

531

Fully-diluted market cap

18,150

Net debt

20,300

EBITDA Net income

Combined firm value

58,042

Combined equity value

25,803

% EBITDA contributed by acquiror

62.1%

5,320

Firm value based on EBITDA contribution

36,044

1,790

Implied equity value

15,744

As a % of total equity value

60.9%

Target Fully-diluted acquiror share count

531

Pro forma shares outstanding to yield 61.0% acquiror ownership

871

11,939

Implied shares issued to target

340

EBITDA

3,253

Fully-diluted target share count

515

Net income

1,210

Current share price Fully-diluted share count

515

Fully-diluted market cap

7,653

Net debt

Implied exchange ratio based on EBITDA (338 / 515)

0.66x

Natural exchange ratio based on current share prices ($14.85 / $34.22)

0.43x

R E L A T I V E

V A L U E

AN A L Y S I S

$14.85

64

M&A - DCF and M&A analysis

Class exercise Company Company statistics statistics

„ Calculate the % contribution based on

Acquiror Current share price

$12.1

Fully-diluted share count (mm)

110.3

Net debt

450

EBITDA

172

Net income

the EBITDA and the Net income „ What is the implied exchange ratio?

65

Target Current share price Fully-diluted share count Net debt

$14.1 30.4 295 81

Net income

25

R E L A T I V E

V A L U E

AN A L Y S I S

EBITDA

65

M&A - DCF and M&A analysis

Relative multiple and discounted cash flow valuation „ Compares the ranges suggested by stand-alone valuations of two companies on a

multiples or discounted cash flow basis „ Step 1: Valuation the acquiror and the target separately „ Step 2: Create a relative value summary „ Need to consider which ends of the range it is appropriate to compare when

determining an appropriate exchange ratio / ownership percentage „ High/Low and Low/High

R E L A T I V E

V A L U E

AN A L Y S I S

„ High/High and Low/Low

66

M&A - DCF and M&A analysis

Sample relative value football field: Target valuation Price Price per per share share

$20.00

$26.75

$15.00

$15.00

$9.75

$10.00

$5.00

R E L A T I V E

V A L U E

AN A L Y S I S

Highest public comp price

$0.00

$5.00 $4.94

$5.00 $4.00

$4.00

$10.25

Implied offer1 = $8.46

$5.50 $6.00

$3.75

$3.50

$3.00

Lowest public comp price

52-week high/low

Street case DCF

15.0x to 19.0x 2001E EBIT of $20.6

19.0x to 25.0x 2001E cash EPS of $0.16

Public trading comparables

15.0x to 20.0x 2002E cash EPS of $0.25

2.5x to 4.0x LTM revenue of $185.7

Transaction comparables2

Mgmt. Case

Street Case3

12% to 15% Discount Rate EBIT exit mult. of 15.0x to 20.0x

12% to 15% Discount Rate EBIT exit mult. of 15.0x to 20.0x

DCF analysis Based on the offer exchange ratio of 0.311x and Pedro’s closing price $27.19 as of 7/12/01 Certain of the multiples implied by precedent transactions have been adjusted by indexing them to the movement in an index of stock prices of companies comparable to Pablo 3 Based on IBES EPS growth estimate and average margin estimates of brokerage reports 1 2

67

M&A - DCF and M&A analysis

Sample relative value football field: Acquiror valuation Price Price per per share share

$50.00

DCF $40.00

Highest public comp price

$43.25

$33.00 $28.00

$30.00

$29.25

$29.50 $30.75

$26.50 $20.00

$21.28

Lowest public comp price

$21.00

$22.50

$20.50

Current = $27.19

AN A L Y S I S

$10.00

$0.00

R E L A T I V E

V A L U E

52-week high/low

10.0x to 12.0x 2001E EBITDA of $346

12.0x to 15.0x 2001E EBIT of $239

19.0x to 25.0x 2001E EPS of $1.18

Comparable diversified company analysis 1 2

Sum-of-the-parts

Discount rate 9% to 13% EBITDA with exit multiple of 11.0x to 13.0x

Public company analysis

DCF analysis2

Comparable diversified company analysis and public company analysis are based on brokerage report estimates Based on management projections

68

M&A - DCF and M&A analysis

Relative valuation summary Less favorable to Acquiror

Exchange ratio1 1.000x

0.750x

High/Low Low/High $5.00/$20.50 $3.00/$33.00 High/Low Low/High $5.50/$30.75 $3.50/$43.25 0.488x 0.476x

0.500x

0.441x

0.313x

Offer: 0.311x 0.311x

0.244x 0.250x 0.179x 0.219x

0.162x

0.237x

R E L A T I V E

V A L U E

AN A L Y S I S

0.182x

Natural exchange ratio

More favorable to Acquiror

1

0.081x

0.091x

0.000x

Public comparables to Public comparables (Sum of Parts & Diversified)

Transaction comparables to Public comparables (Sum of Parts & Diversified)

0.217x

0.074x

Street case/Mgmt. Street case/Mgmt. Mgmt. case/Mgmt. Mgmt. case/Mgmt. case case w ith $40 mm case case w ith $40 mm of synergies of synergies

0.073x Contribution analysis

Discounted Cash Flow Analysis

Exchange ratio ranges computed by taking the high/low equity value per share of Target using various valuation methodologies over the low/high valuation of the acquiror using various valuation methodologies

69

M&A - DCF and M&A analysis

Merger of Equals transactions—example $ $ in in millions millions Acquiror Transaction

Acquiror/

NewCo

pro forma

target

Chairman

CEO

ownership

Board Split

Accounting regime

date

Target

Acquiror

value

Premium1

3/19/01

Billiton PLC

BHP Ltd

$11,511

20.9%

Acquiror

Acquiror

58.0%

9/9

United Kingdom

6/20/00

Seagram

Vivendi

40,428

22.8%

Acquiror

Acquiror

59.0%

14/6

France

5/17/00

Compass Group PLC

Granada group PLC

8,089

3.4%

Acquiror

Joint

66.3%

8/8

United Kingdom

5/16/00

Lycos Inc.

Terra Networks (Telefonica SA)

6,188

58.3%

Acquiror

Target

63.0%

11/3

Spain

2/21/00

Norwich Union PLC

CGU PLC

11,858

(12.2%)

Acquiror

Target

58.5%

9/8

United Kingdom

1/17/00

SmithKline Beecham

Glaxo Wellcome

75,961

(2.3%)

Acquiror

Target

58.8%

8/8

United Kingdom

12/21/99

Pharmacia & Upjohn

Monsanto

26,486

(7.1%)

Acquiror

Target

51.0%

9/9

United States

9/27/99

VIAG AG

VEBA AG

13,153

6.8%

Acquiror

Joint

67.0%

7/3

United States

6/30/99

Banca Commerciale Italiana SpA

Banca Intesa Spa

15,940

8.5%

Acquiror

Joint

57.0%

NA

Italy

5/17/99

Hoechst

Rhone Poulenc

21,918

(9.9%)

Target

Target

47.0%

5/5

France

1/5/99

AirTouch Communications

Vodafone group PLC

60,287

40.6%

Target

Acquiror

50.0%

7/7

United Kingdom

1/15/99

Banco Central Hispanoamericano

Banco de Santander SA

11,320

(3.6%)

Joint

Target

63.8%

13/12/2

Spain

12/9/98

Astra AB

Zeneca Group plc

32,199

9.8%

Target

Acquiror

53.5%

7/7

United Kingdom France

12/2/98

Synthelabo SA

Sanofi SA

11,234

5.7%

Acquiror

Joint

64.1%

4/3/5

8/11/98

Amoco

British Petroleum

55,040

22.7%

Joint

Acquiror

60.0%

13/9

United Kingdom

5/7/98

Chrysler Corp

Daimler-Benz AG

40,467

38.0%

Joint

Joint

58.0%

6/6

United States United Kingdom

2/25/98

General Accident

Commercial Union

11,152

(4.2%)

Acquiror

Target

53.6%

7/7

12/8/97

Swiss Bank

Union Bank of Switzerland

22,765

0.3%

Acquiror

Target

60.0%

4/4/1

IAS

5/12/97

Guinness PLC

Grand Metropolitan

15,970

1.3%

Joint

Acquiror

52.8%

5/5

United Kingdom

3/7/96

Ciba-Geigy AG

Sandoz AG

29,000

9.5%

Target

Acquiror

55.0%

8/8

IAS

Premium to target share price one day prior to announcement Source: Press releases, SEC filings, SDC

1

R E L A T I V E

V A L U E

AN A L Y S I S

Ann.

70

M&A - DCF and M&A analysis

Agenda

Introduction

1

Discounted cash flow analysis

6

Relative value analysis

56

Merger consequences

71

„ Accretion/(dilution) review „ Pro forma balance sheet analysis review

M&A:

DC F

AN D

M E R G E R

AN ALY SI S

Page

71

M&A - DCF and M&A analysis

Introduction „ Pro forma analysis provides both acquirers and targets insight into the

income statement and balance sheet impact of a transaction „ Revenue, EBITDA or earnings impact „ Capitalization, leverage and credit capacity impact „ Valuable tool for both acquirer and target „ Indicates buyer’s ability to pay „ Suggests most appropriate form of consideration to offer „ Allows buyer to predict or manage market reaction to announcement „ Demonstrates landscape of competing buyers „ Balance sheet and income statement impact go hand-in-hand

M E R G E R

C O N S E Q U EN C E S

„ Both driven by form and amount of consideration

72

M&A - DCF and M&A analysis

Agenda

Introduction

1

Discounted cash flow analysis

6

Relative value analysis

56

Merger consequences

71

„ Accretion/(dilution) review „ Pro forma balance sheet analysis review

M&A:

DC F

AN D

M E R G E R

AN ALY SI S

Page

73

M&A - DCF and M&A analysis

Overview of accretion/(dilution) analysis „ Accretion/(dilution) primarily measures the impact of a merger or acquisition on the

income statement of a potential buyer „ Accretion/(dilution) analysis can be based on revenue, EBITDA, earnings, after-tax

cash flow, and dividends per share „ EPS is most commonly used form of accretion/(dilution) analysis „ Industry will typically dictate which are the most relevant metrics (e.g. wireless

telecom companies may prefer to show EBITDA) „ Two methods exist for calculating accretion/(dilution) „ “Top down”: integrated merger model „ “Bottom up”: transaction-adjusted, estimate-based model „ Key measures for accretion/(dilution) „ Dollar and percent change of acquirer earnings per share

M E R G E R

C O N S E Q U EN C E S

„ Pre-tax synergies required for break-even impact to EPS „ Pro forma ownership when stock is used as an acquisition currency „ Pro forma leverage/capitalization¹

1

Note that capitalization will change when stock is used and net debt leverage levels will change when cash is used

74

M&A - DCF and M&A analysis

Purpose of accretion/(dilution) analysis „ Accretion/(dilution) analysis can be used to determine „ The capacity of the acquirer (or potential acquirers) to pay a premium for a

target „ Optimal form of consideration (cash, stock, other securities, combination) „ Used by both buyers and sellers „ Buyers identify highest price they can afford to pay and what currency to offer „ Buyers evaluate how much competing bidders can afford to pay „ Sellers evaluate what price potential buyers can afford to pay and in what

currency „ In the context of a divestiture, sellers also evaluate their break-even sale price

and required currency

M E R G E R

C O N S E Q U EN C E S

„ Typically, JPMorgan performs sensitivity analyses to find break-even points where

the offer price for a target results in no incremental earnings or losses to acquirer’s earnings per share

75

Two primary methods exist to compute accretion/(dilution)

Description Description

Benefits Benefits

M&A - DCF and M&A analysis

Top down

Bottom up

Integrated merger model with projected balance sheet and cash flow statement for target, acquirer and the combined company

EPS estimate-based analysis that combines acquirer and target projections, adjusting for impact of incremental transaction-related expenses and income

„ Provides most accurate picture of combined companies

„ Quick and intuitive demonstration of accretive or dilutive impact

„ Reflects impact of debt pay-down and other cash flow implications to net interest expense and net income

„ Flexible analysis that can incorporate multiple buyers or targets

„ Clearly and accurately shows balance sheet impact in pro forma statistics

M E R G E R

C O N S E Q U EN C E S

Considerations Considerations

„ Difficult to efficiently incorporate multiple acquirers and targets for competitive analysis

„ Risks over-simplifying pro forma analysis and overor under-stating impact to acquirer

„ Relies on estimates which, although more robust, are also subject to uncertainty or questionable assumptions

„ May be inappropriate for a deal where the acquirer’s credit rating is impacted by the transaction „ Must be customized for asset deals, joint ventures and other transactions

76

M&A - DCF and M&A analysis

Sample transaction assumptions Transaction Transaction description description

„ Acquirer buying target with the following

Target Target

transaction assumptions:

Current share price Shares outstanding

$12.25 41.500

„ Transaction closes 12/31/04

Market capitalization

$508.4

„ Advisory fees of 0.25% of transaction value

Net debt (6/30/04)

500.0

Firm value Earnings per share: 2004E 2005E 2006E

$1,008.4

„ Financing fees of 1.0% on debt issued (amortized

as deferred financing fees over 7 years) „ Interest rates assumptions − Tranche I ($300mm maximum senior debt): −

7.0% Tranche II (subordinated debt): 12.5%

Dividend per share (annual): Implied gross dividends paid (annual, $mm):

$1.20 0.95 1.45 $0.48 $19.2

„ Interest rate earned on existing cash: 3.0% „ Tax rate on incremental earnings and expenses

Acquirer Acquirer

(including net interest expense): 35% „ Dividend policy of acquirer remains unchanged

M E R G E R

C O N S E Q U EN C E S

„ 50% of excess purchase price allocated to

goodwill (approximately $70 million) − Remaining 50% of excess purchase price allocated to asset write-up and depreciated over 20 years „ Target's existing debt not refinanced

Current share price Shares outstanding Market capitalization

$20.03 58.669 $1,175.1

Net debt (6/30/04) Firm value Earnings per share: 2004E 2005E 2006E Dividend per share (annual): Implied gross dividends paid (annual, $mm):

750.0 $1,925.1 $1.56 1.68 1.80 $0.85 $44.6

77

M&A - DCF and M&A analysis

Key adjustments to pro forma income statement The The applicability applicability of of most most income income statement statement adjustments adjustments depends depends on on the the consideration consideration issued issued to to the the seller seller and and the the way way the the acquiror funds an acquisition acquiror funds an acquisition

Consideration Adjustment

Stock

After-tax financing fee amortization

Cash

Mix

X

X

X

X

X

X

Non-deductible advisory fee amortization After-tax incremental DD&A from asset write-up

X

M E R G E R

C O N S E Q U EN C E S

After-tax interest on transaction debt After-tax interest deduction from cash used

X

X

X

After-tax interest (loss) gain on dividend shortfall

X

X

X

After-tax synergies

X

X

X

Transaction goodwill impairment

X

X

X

Change in pro forma fully diluted shares

X

X

78

M&A - DCF and M&A analysis

What is in a “consensus” estimate? While While First First Call Call or or I/B/E/S I/B/E/S estimates estimates may may provide provide a a perceived perceived “Street” “Street” consensus, consensus, they they introduce introduce some some degree degree of of uncertainty uncertainty

„ First Call and I/B/E/S consensus estimates are based on an aggregation of research analysts’

estimates, with little discretion applied to mean and median calculations „ Quality of estimates and analysts varies dramatically across consensus samples „ Modeling conventions are often not explained or apparent „ Analysts may be assuming different projected share counts, rather than net income „ Some estimates included in consensus numbers are out-dated „ May not reflect updated company guidance or recent financial results „ May not reflect abrupt changes to underlying industry economics „ May not reflect recent M&A transactions or securities offerings „ Items embedded in consensus estimates are not always clearly explained or uniform

M E R G E R

C O N S E Q U EN C E S

across samples „ Fully diluted share assumptions and treatment of options and convertibles may vary „ Interest expense „ Tax rates „ Accounting policies „ Stock-based compensation and amortization of intangibles other than goodwill

79

Transaction assumptions are the foundation of all sound analysis

M&A - DCF and M&A analysis

Always Always clearly clearly describe describe transaction transaction assumptions assumptions

„ Choose an appropriate closing date reflecting available information and transaction structure „ Timing of process requirements for closing (share registration, shareholder votes, etc.) „ Timing of regulatory requirements for closing (HSR review, etc.) „ Seasonality of industry economics and impact on estimates or calendarization „ Capital structures should best reflect current circumstances „ Equity currency should be reviewed in context of recent share price and larger equity market

performance „ Cash deals should reflect reasonable interest rates and lending market capacity „ Pro forma leverage and interest coverage levels should be consistent with acquirer’s desired credit

rating „ Both advisory and financing fees have a meaningful impact on pro forma financials

M E R G E R

C O N S E Q U EN C E S

„ Although equity analysts tend to “look through” some extraordinary charges, advisory and other one-

time fees will impact the cash balance used in the transaction and subsequent annual interest expense „ Amortization of financing fees will impact EPS over the immediate future of the combined entity „ Tax rate on incremental earnings and expenses should reflect acquiror’s and target’s combined tax

efficiencies and adjustments should be made to post-transaction tax expenses for potential NOLs assumed by an acquirer

80

M&A - DCF and M&A analysis

Sample transaction—100% stock consideration Assumptions Assumptions

Earnings Earnings impact impact ($ ($ millions, millions, except except per per share share data) data)

Acquirer share price: 2003 P/E 2004 P/E

$20.03 12.0x 11.1

Acquirer shares outstanding

58.669

Target share price: 2003 P/E 2004 P/E

$12.25 12.9x 8.4

Transaction assuming 25% premium Offer price (assuming 25% premium) Shares acquired¹ Implied exchange ratio (T/A) Shares issued

$15.31 42.468 0.764x 32.466

2003

2004

Acquirer EPS Acquirer net income

$1.68 98.3

$1.80 105.7

Target EPS Target net income

$0.95 39.4

$1.45 60.2

Adjustments

M E R G E R

C O N S E Q U EN C E S

Tax rate on incremental expenses:

35.0%

After-tax financing fee amortization Non-deductible advisory fee amortization After-tax DD&A from asset write-up After-tax interest on transaction debt After-tax interest deduction from cash used² After-tax interest (loss) gain on dividend shortfall After-tax synergies Transaction goodwill amortization (or impairment) Other reductions Total adjustments to net income Pro forma net income Pro forma shares outstanding

($0.0) 0.0 (2.3) (0.0) (0.1) (0.2) 0.0 0.0 0.0 (2.5) $135.2 91.135

Pro forma EPS Accretion/(dilution) ($) Accretion/(dilution) (%)

$1.48 ($0.19) (11.5%)

Pre-tax synergies to break-even

$26.9

($0.0) 0.0 (2.3) (0.0) (0.1) (0.3) 0.0 0.0 0.0 (2.7) $163.2 91.135 $1.79 ($0.01) (0.6%) $1.5

1 Should be calculated using the offer price not current target price ² Used to fund transaction expenses and advisory fees of $2.9 million

81

M&A - DCF and M&A analysis

Considerations for a stock transaction „ P/Es and relative valuations play a meaningful role in accretion/(dilution) analysis „ High P/E of an acquirer may imply stock may be “cheap” acquisition currency,

relative to lower P/E stock or the “implied debt P/E” „ A number of issues will play an important role in the optics, attitudes and receptivity

of principals and investors in a transaction „ Exchange ratios should not be grossly inconsistent with historical relative trading

performance of acquirer and target „ Purchase price and pro forma ownership should take into account contribution

analysis „ Flow back and sell-off of acquirer stock could meaningfully affect acquirer’s share

prices on announcement/closing „ Cross-shareholder analysis

M E R G E R

C O N S E Q U EN C E S

„ Whether acquirer and target are included in the same indexes, if any „ Fund limitations on owning international stocks and/or stocks not listed on local

exchanges „ Dividend policy implications of receiving acquirer stock

82

M&A - DCF and M&A analysis

Sample transaction—100% cash consideration Earnings Earnings impact impact Assumptions Assumptions

Earnings Earnings impact impact Figures in millions, except per share data

Target share price: Offer price (assuming 25% premium) Shares acquired¹

$12.25 15.31 42.468

Acquirer EPS Acquirer net income Target EPS Target net income

2003

2004

$1.68

$1.80

98.3

105.7

$0.95

$1.45

39.4

60.2

($0.6)

($0.6)

Debt issued to fund acquisition: Equity purchased with cash Transaction fees Financing fees Cash balance used in transaction Total debt raised

$650.3 2.9

After-tax financing fee amortization

6.6

Non-deductible advisory fee amortization

(0.0) $659.8

Debt allocation: Tranche I

$300.0

Tranche II

359.8

Interest Rates:

C O N S E Q U EN C E S M E R G E R

Adjustments

After-tax DD&A from asset write-up After-tax interest on transaction debt

7.0%

Tranche II

12.5%

(42.9)

(44.8)

0.0

0.0

After-tax interest (loss) gain on dividend shortfall

0.4

0.8

After-tax synergies

0.0

0.0

Transaction goodwill amortization (or impairment)

0.0

0.0

Other reductions

0.0

0.0

(45.4)

(47.0)

$92.4

$118.9

58.669

58.669

$1.57

$2.03

Pro forma net income Pro forma shares outstanding

Interest rate on foregone cash balance

3.0%

Pro forma EPS Tax rate on incremental earnings

35.0%

Accretion/(dilution) ($)

($0.10)

$0.23

Accretion/(dilution) (%)

(6.1%)

12.5%

$9.1

NM

Pre-tax synergies to break-even 1

0.0 (2.3)

After-tax interest deduction from cash used

Total adjustments to net income

Tranche I

0.0 (2.3)

Should be calculated using the offer price not current target price

83

M&A - DCF and M&A analysis

Considerations for a cash transaction „ Use multiple tranches of debt where appropriate „ Reflects capital structure and market capacity limitations for larger deals „ Varying interest rate on debt tranches will impact interest expense on offer price increases or

decreases „ Note that depending on debt mix, stock may be more or less appropriate as an acquisition

currency „ Financing assumptions should reflect both acquirer’s stand-alone and combined debt capacity and

ratings circumstances „ Debt coverage and capitalization statistics should be included to highlight potential ratings issues

and support interest rate assumptions „ Current and recent ratings history of acquirer should be reviewed to confirm ability to issue debt

securities „ Covenants of existing acquirer debt should be considered „ Review transaction and pro forma financials with ratings advisory and DCM teams to determine

M E R G E R

C O N S E Q U EN C E S

appropriate rates „ Use existing acquirer cash sparingly, if at all „ Existing cash is likely used to meet working capital funding requirements „ Minimum cash balance may be required for debt covenants „ Opportunity cost of using cash on hand should always be contemplated and reflected in interest

expense „ Restricted cash considerations

84

M&A - DCF and M&A analysis

Sample transaction—50% cash/50% stock consideration Earnings Earnings impact impact Mixed Mixed consideration consideration assumptions assumptions

Earnings impact impact Earnings Figures in millions, except per share data

Target share price: Offer price (assuming 25% premium) Shares acquired

$12.25 15.31 42.468

Acquirer EPS Acquirer net income Target EPS Target net income

Shares issued

2003

2004

$1.68

$1.80

98.3

105.7

$0.95

$1.45

39.4

60.2

($0.3)

($0.3)

16.233

Adjustments After-tax financing fee amortization

Debt issued to fund acquisition: Equity purchased with cash Transaction fees

0.0

0.0

After-tax DD&A from asset write-up

(2.3)

(2.3)

(16.2)

(16.9)

0.0

0.0

After-tax interest (loss) gain on dividend shortfall

0.1

0.2

After-tax synergies

0.0

0.0

Debt allocation:

Transaction goodwill amortization (or impairment)

0.0

0.0

Tranche I

$300.0

Other reductions

Tranche II

31.3

Cash balance used in transaction Total debt raised

C O N S E Q U EN C E S

Non-deductible advisory/ other fee

2.9

After-tax interest deduction from cash used

Financing fees

M E R G E R

$325.1 3.3 (0.0) $331.3

After-tax interest on transaction debt

0.0

0.0

(18.7)

(19.3)

$119.1

$146.6

74.902

74.902

$1.59

$1.96

Accretion/(dilution) ($)

($0.09)

$0.16

Accretion/(dilution) (%)

(5.1%)

8.6%

$9.9

NM

Total adjustments to net income Pro forma net income

Interest Rates: Tranche I

7.0%

Tranche II

12.5%

Pro forma shares outstanding Pro forma EPS

Interest rate foregone on cash balance Tax rate on incremental earnings

3.0% 35.0%

Pre-tax synergies to break-even

85

M&A - DCF and M&A analysis

The role of P/E valuations in accretion/(dilution) „ For stock-for-stock deals, accretion or dilution potential will usually be evident by simply

comparing the P/E multiples of the acquirer and the target „ If the acquirer has a higher P/E than the target, the deal will be accretive because the acquirer

is buying more EPS than the target shareholders are accepting as consideration „ If the acquirer has a lower P/E than the target, the deal will be dilutive because the acquirer is

buying less EPS than the target shareholders are accepting as consideration „ Remember to take the premium into account when calculating the target’s P/E „ Utility of comparison will also depend on transaction assumptions regarding goodwill impairment

or other asset amortization „ For 100% cash transactions, the cost of debt (interest payments) and cost of acquiring the target’s

earnings will determine the accretive or dilutive impact of a transaction „ Where the inverse cost of debt (1/(after-tax cost of debt)) is greater than the P/E of the target,

the deal will be accretive

M E R G E R

C O N S E Q U EN C E S

„ Where the inverse cost of debt is lower than the P/E of the target, the deal will be dilutive

86

M&A - DCF and M&A analysis

Presenting accretion/(dilution) with sensitivities „ Sensitivities provide the total picture of a transaction’s potential impact; relevant

sensitivities to demonstrate may include „ Premium (discount) „ Consideration offered (% of stock/% of cash)

y Acquirer’s stock price y Earnings per share y Synergies „ Interest rate(s) on debt issued „ Sensitivities should reflect consideration specifics „ Purchase price and ownership (stock) 2003 2003 accretion/(dilution)—(% accretion/(dilution)—(% per per share) share)

2003 2003 synergies synergies to to break-even—($mm) break-even—($mm) Stock consideration

Stock consideration

M E R G E R

62.5%

75.0%

87.5%

100.0%

50.0%

62.5%

75.0%

87.5%

100.0%

10.0%

1.0%

(1.1%)

(3.0%)

(4.8%)

(6.4%)

10.0%

NM

$2.2

$6.3

$10.4

$14.4

20.0%

(3.0%)

(4.6%)

(6.5%)

(8.3%)

(9.8%)

20.0%

5.8

9.3

13.8

18.3

22.8

30.0%

(7.7%)

(8.4%)

(10.2%)

(11.9%)

(13.4%)

30.0%

15.0

17.3

22.3

27.2

32.1

40.0%

(14.1%)

(13.5%)

(15.2%)

(16.8%)

(18.1%)

40.0%

28.2

28.8

34.3

39.9

45.3

50.0%

(20.2%)

(19.0%)

(19.9%)

(21.3%)

(22.5%)

50.0%

41.7

41.9

46.6

52.8

58.9

Premium

Premium

C O N S E Q U EN C E S

50.0%

87

M&A - DCF and M&A analysis

Relevant sample transaction sensitivities Stock Stock deals deals 2003 2003 accretion/(dilution)—(% accretion/(dilution)—(% per per share) share)

2003 2003 accretion/(dilution)—(% accretion/(dilution)—(% per per share) share)

Acquirer stock price $20.03

$21.00

$22.00

$23.00

$5.0

$10.0

$15.0

$20.0

$25.0

10.0%

(8.1%)

(6.4%)

(5.0%)

(3.5%)

(2.2%)

10.0%

(4.2%)

(2.0%)

0.2%

2.5%

4.7%

20.0%

(11.6%)

(9.8%)

(8.3%)

(6.8%)

(5.5%)

20.0%

(7.7%)

(5.5%)

(3.3%)

(1.2%)

1.0%

30.0%

(15.2%)

(13.4%)

(11.8%)

(10.3%)

(8.9%)

30.0%

(11.3%)

(9.2%)

(7.1%)

(5.0%)

(2.9%)

40.0%

(20.0%)

(18.1%)

(16.5%)

(15.0%)

(13.5%)

40.0%

(16.1%)

(14.1%)

(12.1%)

(10.1%)

(8.1%)

50.0%

(24.4%)

(22.5%)

(20.9%)

(19.3%)

(17.8%)

50.0%

(20.6%)

(18.7%)

(16.8%)

(14.9%)

(13.0%)

Premium

Premium

$19.00

Pre-tax synergies realized 2003

Cash Cash deals deals 2003 2003 accretion/(dilution)—(% accretion/(dilution)—(% per per share) share)

2003 2003 accretion/(dilution)—(% accretion/(dilution)—(% per per share) share)

M E R G E R

Blended interest rate (%)

6.5%

7.0%

7.5%

8.0%

8.5%

10.0%

3.1%

2.1%

1.1%

0.1%

(0.9%)

20.0%

(2.4%)

(3.4%)

(4.3%)

(5.3%)

(6.3%)

30.0%

(8.4%)

(9.4%)

(10.4%)

(11.4%)

(12.4%)

40.0%

(17.1%)

(18.1%)

(19.1%)

(20.1%)

(21.1%)

50.0%

(25.9%)

(26.9%)

(27.9%)

(28.9%)

(29.9%)

Premium

Premium

C O N S E Q U EN C E S

Interest rate on senior debt (Tranche 1) 11.0%

10.5%

10.0%

9.5%

9.0%

10.0%

(2.3%)

(0.1%)

2.1%

4.2%

6.4%

20.0%

(7.7%)

(5.5%)

(3.4%)

(1.2%)

1.0%

30.0%

(13.8%)

(11.6%)

(9.4%)

(7.2%)

(5.1%)

40.0%

(22.5%)

(20.3%)

(18.1%)

(15.9%)

(13.7%)

50.0%

(31.3%)

(29.1%)

(26.9%)

(24.7%)

(22.6%)

88

M&A - DCF and M&A analysis

Synergies and transaction related costs „ Synergies „ For top-down modeling simplicity, assume synergies come from cost-savings unless told

otherwise „ Revenue synergies

— Incremental revenues may have costs associated with them that need to be reflected in any synergy calculations (e.g variable margins on incremental revenues) — Equity markets heavily discount or, in many cases, disregard revenue synergies, as they are typically difficult to quantify and accurately project „ Synergies are typically realized gradually over time and should be phased in accordingly „ It may be prudent to “risk-adjust” any expected synergies to account for ability to

realize them and/or for negative synergies (i.e., integration costs) „ Consider the cash flow impact of synergies „ One-time charges and expenses

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C O N S E Q U EN C E S

„ Acquiring companies will incur one-time merger-related costs due to reorganization,

severance packages — One-time charges are disclosed in SEC filings — From a valuation perspective, the Street “looks through” one-time charges — Include the net interest impact of cash changes

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M&A - DCF and M&A analysis

Additional items to consider „ Tax benefits „ In assuming additional options are exercised under premium scenarios a tax shield will be generated

based on the implied deductible compensation expense generated from the vesting / exercise of options at a discount to the acquisition price „ Asset write-ups have tax implications1 „ Acquirers may be forced to pay “interest on interest” „ In using cash and thereby raising debt, an acquirer will incur future interest and amortization

payments that may require additional borrowing „ AccretionOne calculation method „ Asset write-ups and additional depreciation expenses „ While asset write-ups will reduce goodwill generated in a transaction, they will increase annual

depreciation expenses based on the incremental increase in depreciable assets „ Limiting asset write-ups will reduce negative impact of increased depreciation expenses

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C O N S E Q U EN C E S

„ In some cases, asset write-downs may impact EPS accretion / dilution „ Impact of dividends paid by acquirer „ Additional cash will be necessary to fund new dividends paid and should be reflected in incremental

expenses „ Dividend accretion/(dilution) analysis may be relevant to determine appropriate premium

1

Write-ups create a deferred tax liability (equal to the write-up multiplied by the tax rate)

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Summary considerations for EPS accretion/(dilution) analysis

M&A - DCF and M&A analysis

„ EPS-based accretion/(dilution) is only a back-of-the-envelope exercise and is not a

substitute for an integrated merger model „ Does not necessarily reflect cash flow implications and debt pay-down capabilities of

combined company „ EPS estimates should be used with caution „ First Call and I/B/E/S estimates are consensus numbers that do not always reflect

consistent underlying assumptions „ Small differences in EPS figures can have dramatic impact on net income ($0.05 per

share on 200 million shares reflects a $10 million variance in net income) „ Share count of target must be a dynamic number „ Share count should increase (decrease) with offer price to reflect additional (reduced)

shares underlying in-the-money options

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C O N S E Q U EN C E S

„ Negative net income targets CANNOT create meaningful accretion „ Accretion/(dilution) should always be sanity-checked „ Relative P/Es „ Acquirer’s cost of debt vs. cost of target’s earnings „ Accretion/(dilution) should always be checked with your calculator

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M&A - DCF and M&A analysis

Agenda

Introduction

1

Discounted cash flow analysis

6

Relative value analysis

56

Merger consequences

71

„ Accretion/(dilution) review „ Pro forma balance sheet analysis review

M&A:

DC F

AN D

M E R G E R

AN ALY SI S

Page

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Overview of pro forma balance sheet analysis „ Pro forma balance sheet analysis provides a means of assessing the impact of a

potential transaction on an acquirer’s cost of borrowing, market access, and financial flexibility „ Two methods exist for demonstrating balance sheet impact: „ “Top down”: integrated merger model with income statement, balance sheet and

cash flow statement (preferred) „ “Bottom up”: transaction-adjusted, LTM-based model „ Pro forma balance sheet analysis relies primarily upon a comparison of an acquirer’s

pre- and post-acquisition credit metrics „ Key credit metrics include: „ Pretax interest coverage „ EBITDA interest coverage

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C O N S E Q U EN C E S

„ Funds from operations to interest „ Funds from operations to debt „ Debt to EBITDA „ Debt to book capitalization

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M&A - DCF and M&A analysis

Significance of pro forma balance sheet analysis „ Pro forma balance sheet analysis is critical in determining „ The debt-financed acquisition capacity of an acquirer (or competing bidders) „ Required equity component of an offer to ensure a particular rating outcome „ Financing implications of a particular transaction structure (cost of capital and

market access) „ In a divestiture, the pro forma credit rating of the seller and the minimum level of

cash consideration needed „ Used by both buyers and sellers „ Buyers identify highest price they can afford to pay and how much cash can be

offered „ Buyers evaluate how much other competitive bidders can afford to pay „ Sellers evaluate how much potential buyers can afford to pay and how much cash

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C O N S E Q U EN C E S

to demand „ Typically, JPMorgan performs sensitivity analyses to address relevant inflection

points where the offer price for a target results in meaningful changes to a combined capital structure

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M&A - DCF and M&A analysis

Credit ratings as a key financing decision driver „ A company’s corporate credit rating determines its „ Cost of borrowing „ Breadth and depth of access to the capital markets „ Financial flexibility (liquidity/covenant constraints) „ Pro forma balance sheet analysis allows potential acquirers to assess

leverage breakpoints and their associated ratings outcomes in order to develop a comprehensive financing plan „ Significant debt-financed transactions can erode credit profile and can

lead to a ratings downgrade „ The determination of potential financing structures is often bound by the

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C O N S E Q U EN C E S

trade-offs between maximizing EPS subject to limiting ratings pressure

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M&A - DCF and M&A analysis

Sample transaction — 100% cash consideration

Acquirer

Target

Adjustments

Pro forma

Balance sheet: Total debt Shareholders’ equity value Minority interest

$800.0 950.0 0.0

$575.0 525.0 0.0

$659.8 (525.0) 0.0

$2,034.8 950.0 0.0

Income statement: LTM EBITDA LTM EBIT LTM interest expense

$226.0 176.0 55.0

$119.0 94.0 40.0

42.6

$345.0 270.0 137.6

84.2% 45.7%

109.5% 52.3%

214.2% 68.2%

3.5x 4.5 4.1 3.2

4.8x 6.1 3.0 2.4

5.9x 7.5 2.5 2.0

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C O N S E Q U EN C E S

Capitalization: Debt/equity Debt/total capitalization1 Coverage ratios: Debt/LTM EBITDA Debt/LTM EBIT LTM EBITDA/interest LTM EBIT/interest

Note: excludes lease-related leverage and hybrid securities 1 Includes minority interest

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M&A - DCF and M&A analysis

Sample transaction—100% stock consideration

Acquirer

Target

Adjustments

Pro forma

Balance sheet: Total debt Shareholders’ equity value Minority interest

$800.0 950.0 0.0

$575.0 525.0 0.0

$0.0 125.3 0.0

$1,375.0 1,600.3 0.0

Income statement: LTM EBITDA LTM EBIT LTM interest expense

$226.0 176.0 55.0

$119.0 94.0 40.0

0.0

$345.0 270.0 95.0

84.2% 45.7%

109.5% 52.3%

85.9% 46.2%

3.5x 4.5 4.1 3.2

4.8x 6.1 3.0 2.4

4.0x 5.1 3.6 2.8

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C O N S E Q U EN C E S

Capitalization: Debt/equity Debt/total capitalization1 Coverage ratios: Debt/LTM EBITDA Debt/LTM EBIT LTM EBITDA/interest LTM EBIT/interest

Note: excludes lease-related leverage and hybrid securities 1 Includes minority interest

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M&A - DCF and M&A analysis

Pro forma balance sheet sensitivities Debt/total Debt/total capitalization capitalization Stock consideration

„ Similar to EPS analysis, sensitivities provide „ Sensitivities should demonstrate the impact

of changes to relevant metrics „ Consideration (stock vs. cash)

Premium

the “whole picture”

„ Estimates (EBITDA)

0.0%

25.0%

50.0%

75.0%

100.0%

10.0%

67.3%

62.4%

57.4%

52.5%

47.5%

20.0%

67.9%

62.6%

57.3%

52.0%

46.6%

30.0%

68.5%

62.8%

57.2%

51.5%

45.7%

40.0%

69.4%

63.2%

57.0%

50.7%

44.4%

50.0%

70.3%

63.5%

56.8%

50.0%

43.2%

„ Assumptions (premium, interest rates,

etc.)

Debt/EBITDA Debt/EBITDA

EBITDA/interest EBITDA/interest

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Stock consideration

0.0%

25.0%

50.0%

75.0%

100.0%

10.0%

5.66x

5.24x

4.83x

4.41x

3.99x

20.0%

5.82

5.36

4.91

4.45

3.99

30.0%

6.00

5.49

4.99

4.49

3.99

40.0%

6.25

5.68

5.12

4.56

3.99

50.0%

6.50

5.88

5.25

4.62

3.99

Premium

Premium

C O N S E Q U EN C E S

Stock consideration 0.0%

25.0%

50.0%

75.0%

100.0%

10.0%

2.63x

2.89x

3.19x

3.39x

3.63x

20.0%

2.54

2.81

3.13

3.37

3.63

30.0%

2.45

2.73

3.06

3.35

3.63

40.0%

2.34

2.62

2.97

3.32

3.63

50.0%

2.23

2.51

2.88

3.29

3.63

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