Credit Suisse Analyst Valuation Book.pdf

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VALUATION PROJECT WORKBOOK SUMMER ANAL ANALYST YST PROGRAM PROGRAM – 2007

PRELIMINARY | SUBJECT SUBJ ECT TO FURTHER FU RTHER REVIEW AND EV EVALUA ALUATION TION THESE MATERIALS MAY NOT BE USED OR RELIED UPON FOR ANY PURPOSE OTHER THAN AS SPECIFICALLY CONTEMPLATED BY A WRITTEN AGREEMENT WITH CREDIT SUISSE.

\\nnyc14p20005\training\_summer \\nnyc14p20005 \training\_summer analysts\Scheduled analysts\Scheduled Credit Suisse Presentation Presentations\Valuation s\Valuation Project Overview (TRAINING LEADERS)\2007 Summer Analyst Valuation Book.ppt /1

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Table bl e of Contents on tents 1

Ov er v i ew of of Va Val u at i o n Pr Pr o j ec t

2

Sam p l e Pr o j ec t

3

Week ly ly A s si si gn gn m en en t s an d Res ou ou rc rc es es

A B C D E

Public Information Book (PIB) Company Profile Equity Comps / M&A Comps DCF and WACC Analysis Merger Co Consequences An Analysis

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

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

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

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


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Table bl e of Contents on tents 1

Ov er v i ew of of Va Val u at i o n Pr Pr o j ec t

2

Sam p l e Pr o j ec t

3

Week ly ly A s si si gn gn m en en t s an d Res ou ou rc rc es es

A B C D E

Public Information Book (PIB) Company Profile Equity Comps / M&A Comps DCF and WACC Analysis Merger Co Consequences An Analysis

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

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

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

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

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1. Overv verview iew of Valu lua ati tion on Pro roject ject

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\\nnyc14p20005\training\_summer analysts\Scheduled Credit Suisse Presentations\Valuation Project Overview (TRAINING LEADERS)\2007 Summer Analyst Valuation Book.ppt /3

Overview of Valuation Project Welcom e to Credit Suiss e! In addit ion to m eeting a ton of new people and having f un for t he next 10 weeks, we figured it w ould be helpful fo r you to r eturn to co llege your senior year having learned somethin g about wh at Investment Bankers do 

Several analysts, associates, and Vice Presidents from across the division have worked hard to put the following materials together as your “one-stop shop” for banking how to’s



In addition to your group staffing assignments over the next two months, you will also be asked to complete a group valuation project to be submitted by Week 9 of your program. The submission will include the following: 

A company profile



Equity comps and M&A comps



DCF valuation



Merger consequences analysis



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



This project will be completed gradually over the course of the summer and we will be holding 4 sessions (1 every week) to cover each of the topics or analysis we will be asking you to do



You will be required to turn in you work for the topic covered each week at the following weeks session (i.e., you will go over profiles in first session and turn them in at the second session) 

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

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Project Schedule and Key Dates Date Session 1

June 29 10 am & 2 pm

Session 2

July 6

Session Details

Next Steps

Finding public information and creating a PIB

Create Knight Ridder PIB

Creating a company profile

Create Knight Ridder profile

Equity Comps and Acquisition Comp Analysis

Find Knight Ridder trading comparables Find important average trading stats

10 am & 2 pm Session 3

July 13

For given comparable acquisitions, find key multiples Discounted Cash Flow

Create projected Knight Ridder income statement Determine WACC based on comps

10 am & 2 pm

Project free cash flows and discount at WACC Session 4

July 27

Merger Consequences

10 am & 2 pm

PRESENTATION

August 6

Evaluate transaction consequences including EPS accretion/dilution, pro forma credit stats, pro forma ownership Create premiums paid and synergies sensitivity tables

Present final projects

Good Luck!!

Note: Due to the fact t hat the deal was announced o n 3/13/06, for all valuation s, please use all publ ic i nformatio n available as of th en (latest fil ing woul d be the 12/25/05 10-K) and st ock pr ices and research as of 3/10/06.

This s chedule provides a set of guid elines to help you p lan your final project. 4

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2. Sample Project

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

Market and Tradin g Data 2,000

$37

1,500

e c i r P k c o t S

$34 1,000

$31 500

$28 $25 2/4/04

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

8/5/04

V o l u m e i n T h o u s a n d s

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

Stock Price (2/4/05)

$32.44

% of 52-Week High

52-Week High / Low

83.6%

$38.80 /

Diluted Shares

28.2

Equity Market Value

916.0

(+) Debt

250.1

(–) Cash & Equivalents

150.8

Enterprise Value

($ in millions)

Revenues % Growth

EBIT % Margin

EBITDA % Margin

Net Income % Margin

EPS Capex

2004A $2,394.6 4.5%

$112.1

5.1%

$130.0

4.7%

$169.2

5.2%

$253.7

7.1%

$55.8 2.3%

$0.85 145.0

Source: Company filings and Wall Street equity research.

10.1%

$66.5 2.6%

$2.48 185.0

$1,015.3

Enterprise Value to:

Financial Overview December 31, 2005E $2,516.9

$27.51

2006E $2,658.8 5.6%

$150.1 5.6%

$273.1 10.3%

$78.8

2004E Revenue

$2,516.9 /

0.4x

2005E Revenue

$2,658.8 /

0.4x

2004E EBITDA

$169.2 /

6.0x

2005E EBITDA

$253.7 /

4.0x

2004E EPS

$0.85 /

38.2x

2005E EPS

$2.48 /

13.1x

EPS Estimates / P/E Ratio

3.0%

$2.82 190.0 Source: Company filings and Wall Street equity research. Note: EPS projections based on I/B/E/S consensus.

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Comparable Company Analysis ($ in millions)

COMPANY

SHARE PRICE

% OF 52-WEEK

EQUITY

ENTERPRISE

02/04/05

HIGH

VALUE

VALUE

ENTERPRISE VALUE AS A MULTIPLE OF SALES MULTIPLE OF EBITDA

P/E

2004E

2005E

2004E

2005E

2004E

2005E

LONG-TERM EPS

LTM OPERATING

GROWTH

RATIO

Truck Load JB Hunt Transportation

$45.00

97.7%

$3,682

$3,697

1.3x

1.2x

8.2x

7.2x

17.5x

15.5x

15.8%

92.9%

Swift Transportation(1)

22.61

99.4%

1,671

2,265

0.8x

0.7x

6.2x

5.9x

14.8x

12.6x

12.6%

93.6%

Werner Enterprises (1)

20.94

90.1%

1,679

1,570

0.9x

0.9x

5.5x

4.9x

19.6x

16.1x

15.3%

91.6%

Heartland Express (1)

20.93

90.2%

1,570

1,311

2.9x

2.6x

10.8x

9.7x

25.2x

22.0x

13.8%

79.6%

Knight Transportation (1)

25.71

99.3%

1,460

1,434

3.5x

2.9x

11.9x

10.1x

29.4x

23.1x

16.6%

80.7%

Covenant Transportation

20.86

97.8%

312

372

0.6x

0.6x

4.8x

4.1x

18.9x

15.8x

12.0%

94.0%

1.7x 1.1x

1.5x 1.0x

7.9x 7.2x

7.0x 6.5x

20.9x 19.3x

17.5x 16.0x

14.4% 14.6%

88.7% 92.3% 92.3%

Mean Median Less Than Truckload CNF Inc

(1)

$46.49

91.2%

$2,457

$2,400

0.6x

0.6x

6.2x

5.3x

17.8x

14.3x

14.1%

30.35

78.5%

850

925

0.6x

0.5x

5.3x

4.6x

13.2x

11.0x

15.5%

82.8%

41.77

89.5%

1,069

1,000

0.6x

0.5x

4.9x

4.7x

13.0x

11.2x

12.5%

92.8%

Old Dominion Freight (1)

35.60

97.5%

885

961

1.2x

0.9x

7.9x

6.6x

21.6x

16.9x

17.5%

91.4%

SCS Transportation (1)

22.55

81.6%

354

470

0.5x

0.4x

5.2x

4.6x

17.8x

13.0x

15.0%

95.6%

Yellow Roadway Corp (1)

56.31

97.8%

2,769

3,320

0.5x

0.5x

6.3x

5.0x

14.2x

10.9x

10.5%

94.6%

0.7x 0.6x

0.6x 0.5x

6.0x 5.8x

5.2x 4.9x

16.3x 16.0x

12.9x 12.1x

14.2% 14.5%

91.6% 92.6%

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

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

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

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

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

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

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

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

1.3x 1.0x

1.1x 0.9x

14.0x 11.2x

10.2x 9.8x

23.3x 27.7x

19.1x 22.6x

17.9% 17.2%

93.5% 94.6%

0.4x

0.4x

6.0x

4.0x

38.2x

13.1x

10.2%

97.3%

Overnite Corp

(1)

Arkansas Best Corp

(1)

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

$51.38 71.88 9.40 31.18 35.25 22.19 43.33 56.46 8.62

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

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

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

USF Corp

(1)

$32.44

83.6%

$916

$1,015

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

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Discounted Cash Flow Analysis ($ in millions)

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

2005E

2006E

2007E

2008E

2009E

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

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

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

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

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

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

Discount Rate

4.50x

Terminal Value EBITDA Multip le 5.00x 5.50x

6.00x

9.0%

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

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

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

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

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

10.0%

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

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

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

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


11.0%

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

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

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

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

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

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

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Potential Merger Assumptions Key Assumptio ns 

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



Prospective acquiror net income based on Wall Street equity research

Financing



50% Stock – 50% Cash Consideration assumed; financed by 100% bank debt at 3-Months LIBOR plus 100 basis points

Purchase Price



Range of $1,015 – $1,410 mm, corresponding to 4.0x – 5.6x 2005E EBITDA

FMV Adjust ments



Fair market value adjustment estimated at 12% of book value; depreciated over 20 years

Goodwill



Goodwill not amortized

Timing



Assumed to gain full 2005 earnings

Fees



Synergies



Projections

M&A Fees of 0.5% of transaction value  Financing fees of 2.5% of debt raised None assumed; pre-tax synergies required to achieve acquiror break-even EPS inferred

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Merger Consequences Analysis e ow

oa way cqu s on o

orpora on

($ in millions)

–

Premium to Share Price Price Per Share

5.0%

10.0%

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

35.0%

40.0%

$32.44

$34.06

$35.68

$37.31

$38.93

$40.55

$42.17

$43.79

$45.42

Equity Value (1) Net Debt

$918 99

$966 99

$1,014 99

$1,062 99

$1,111 99

$1,160 99

$1,210 99

$1,259 99

$1,309 99

Enterprise Value

1,017

1,065

1,114

1,162

1,210

1,259

1,309

1,358

1,408

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

4.1x 3.7x

4.2x 3.8x

4.4x 4.0x

4.6x 4.2x

4.8x 4.3x

5.0x 4.5x

5.2x 4.7x

5.4x 4.9x

5.6x 5.1x

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

13.3x 11.4x

14.0x 12.0x

14.7x 12.6x

15.4x 13.2x

16.1x 13.8x

16.9x 14.4x

17.6x 15.0x

18.3x 15.6x

19.0x 16.2x

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

$5.25 5.59

$5.25 5.53

$5.25 5.48

$5.25 5.43

$5.25 5.38

$5.25 5.33

$5.25 5.28

$5.25 5.24

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

$0.34 6.4% –

$0.28 5.4% –

$0.23 4.4% –

$0.18 3.5% –

$0.13 2.6% –

$0.08 1.6% –

$0.03 0.7% –

($0.01) (0.3%) $1.3

($0.06) (1.2%) $6.1

1.6x 45.28%

1.7x 45.36%

1.7x 45.45%

1.7x 45.53%

1.8x 45.61%

1.8x 45.69%

1.8x 45.76%

1.9x 45.83%

1.9x 45.91%

14.2% 85.8%

14.9% 85.1%

15.5% 84.5%

16.1% 83.9%

16.7% 83.3%

17.3% 82.7%

17.9% 82.1%

18.5% 81.5%

19.1% 80.9%

(2)

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

$5.25 5.19

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

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3. Weekly Assignments and Resources A.

Public Information Book (PIB)

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Summer Assignment – PIB As sign men t 

Prior to the June 30th training session, please assemble a PIB on Knight Ridder



Make sure that your PIB has all the sections outlined on the next page



Insert numbered tabs between each section “blue sheets” between each item in the same tab, if multiple items exist. For example, put a blue sheet between each research report



Have the Copy Center make a double-sided bound copy of your PIB

Key Takeaways 

After completing this section, you should be familiar with most of the tools that are available to access public information



Research reports are expensive!!! Purchase only those that are appropriate



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

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Public Information Book Resources Sample Table of Contents

Where to Get the Material

1. General Publi c Information – – – –

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

Company Websit e

2. Prospectus –

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

3. Annual Report

Company Websit e

4. Form 10-K –

Annual filing with the SEC, similar to an annual report

5. Form 10-Q –

Quarterly filing with the SEC

6. Proxy Statement –

Covers information about company shares and shareholders

7. Research Report – –

Include CS if available Look for longer, more recent research

8. News Run –

Back two – six months is standard

CS Research & Analytics

Company Website

9. Ownership Run –

Tracks ownership structure of company 16

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3. Weekly Assignments and Resources B.

Company Profile

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Summer Assignment – Company Profile As sign men t  In the format shown on the sample pages, create a two page company profile for Knight Ridder Corporation  Make sure you include: Company Overview Market Statistics (download from FactSet) Financial Overview Stock Price Performance Directors and Officers Products Current Ownership Helpful Hint: The financial overview summary sheet in your Abacus shell (see Tab C) is a good template from which to copy and paste market stats and financial overviews Key Takeaways  At the end of this section, you should be able to answer the following: 1. What are Knight Ridder Corporation’s primary business segments? 2. How has Knight Ridder Corporation performed in the last year with respect to: – Earnings? – Stock price? – Any relationship between the two? 3. Any important events occur at the Company over the past year?       

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Agenda 

Creating a general two page company profile



Keys to a successful acquisition ideas presentation

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Keys to a Successful Acquisition Ideas Presentation 

Know Your Audience



Use a Systematic Approach



Remember the Formula: Strategic Fit + Availability = A Good Idea



Demonstrate Industry Knowledge



Revisit “Old” Ideas Selectively



Stimulate Discussion and Ask Questions



Summarize Conclusions and Develop Follow-up Plan

A succ essfu l acquis ition ideas pres ent ation delivers a focused set of ideas with a point of view and a rationale. 20


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Considerations in Determining Fit Strategic 

Client specified 





Organic grow th prospects of target Management talent Technology or other propri etary assets

Size



Industry





Technology







General

Geographic scope (international vs. domestic)

Financial 

Leverage



Ac cr eti on / dil ution



Market perception

Product s ynergies 

Markets



Customers



Distribution



Manufacturing

Operating synergies 

Corporate cost savings



S,G & A cost savings



Other

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Signals of Availability / Lack Thereof Signs of Availability 

Parent is a LBO sponsor



Filed equity offering with large secondary component



Previous failed attempt to sell (“busted auction”) or spin-off (“busted IPO”)



Takeover speculation



Undervalued, depressed or declining stock price



Shareholder activism



Potential odd man out in rapidly consolidating industry or segment



Changes in senior management or aging senior management with no obvious successor



Dramatic revisions in corporate strategy



Need to expand internationally or to retrench



Need for capital



Failure or inability to grow new products organically



Parent reorganizing or realigning businesses, possibly in preparation for a sale



Division with no logical strategic fit with the parent (“corporate orphan”)



Division underperforming or less profitable than core business

Signs of Lack of Availability 

Insiders control a meaningful percent of the stock and have no evident need for liquidity



Family-owned with the next generation preparing or prepared to assume leadership



Majority owned by another company that has obvious reason to hold onto the business



Strong and consistent stock performance



The current parent is the most obvious best owner for the business

The current parent has identified the bus iness as a core business and/or the equity market is in f avor of curr ent parent owni ng the business Consider the target’s defensive posture vis-a-vis a hosti le offer, but remember … the valuation/rationale must be even more compelling to justif y an unsolicited approach Note: It is also important to review the valuation multiples of the publicly-traded Parent Company which owns the “ target” subsidiary. If sale proceeds (after tax) imply low er valuation mult ipl es (EBITDA, EBITA and Net Income) than t hose at which th e parent stock is selling, the transaction wo uld be dilutive to overall value and thus would pr obably be a nonstart er as a sale candid ate today

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Acquisition Screening – Information Sources 

SIC code lists



Equity analyst research



“Competition” sections of prospectuses and 10-Ks of comparable companies



Research reports relating to the Client and its core industry group competitors



Value Line for Client and its competitors



S&P Tear Sheets (with word search)



OneSource (U.S. Public, U.S. Private, and U.K. Public SIC Code Summary Analyses)



Industry trade association lists



Trade publications



WorldScope database (Global Buyers List)



FactSet “comp builder”



SDC M&A summaries

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Creating a General Company Profile Company Overview Business Description

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

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



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



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



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

Competitors

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



Business section of 10K / Annual Report



finance.yahoo.com business profile



Research reports



Company Web site



VentureSource (private companies)



Your PIB can be a great resource (See Tab A)



10K / Annual Report



Research reports



Company Web site



PIB



10K / Annual Report



Research reports



finance.yahoo.com business profile



Company Web site



PIB

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

Company Web site



Research reports



10K / Annual report

Note:

Osteoporosis $1.0 BN

Sexual Antibiotics Dysfunction $0.7 BN $0.2 BN Cardiology $0.5 BN

Oncology $1.0 BN

Diabetes/ Metabolic $2.1 BN

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

CNS $5.4 BN

Financial Overview ($ in millions)







You can find the historical information from company filings The projections will come from research PIB

Revenues % Growth

EBIT % Margin

EBITDA % Margin

Net Income % Margin

EPS Capex

2004A $2,394.6 4.5%

$112.1 4.7%

$169.2 7.1%

$55.8 2.3%

$0.85 145.0

December 31, 2005E $2,516.9 5.1%

$130.0 5.2%

$253.7 10.1%

$66.5 2.6%

$2.48 185.0

2006E $2,658.8 5.6%

$150.1 5.6%

$273.1 10.3%

$78.8 3.0%

$2.82 190.0

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Creating a General Company Profile Market and Tradin g Data Stock Price (2/4/05) % of 52-Week High

52-Week High / Low



This should come from your equity comp shell (See Tab C)



Keep in mind, you may update this profile often (e.g. latest stock price or estimates) so keeping your comps flexible is key

$32.44 83.6%

$38.80 /

Diluted Shares

$27.51 28.2

Equity Market Value

916.0

(+) Debt

250.1

(–) Cash & Equivalents

150.8

Enterprise Value

$1,015.3

Enterprise Value to: 2004E Revenue

$2,516.9 /

0.4x

2005E Revenue

$2,658.8 /

0.4x

2004E EBITDA

$169.2 /

6.0x

2005E EBITDA

$253.7 /

4.0x

2004E EPS

$0.85 /

38.2x

2005E EPS

$2.48 /

13.1x

EPS Estimates / P/E Ratio

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Creating a General Company Profile Stock Price Performance $40

2,000

$37

1,500

e c$34 i r P k c o$31 t S

1,000

500

$28 $25 2/4/04



ActiveGraph made from Excel and FactSet



Keep in mind, you may update this often



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

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

8/5/04

V o l u m e i n T h o u s a n d s

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

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

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

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



ShareWorld



Proxy (for insider ownership)



FactSet



Company news releases



Factiva



Equity research

Recent News 

1/28/2005: USF Corporation reported fourth quarter and full year 2004 results, missed Wall Street earnings



12/13/2004: Announced opening of two new terminals serving the Southern Minnesota and Decatur, Alabama areas



11/2/2004: Richard P. DiStasio stepped down as CEO, Paul Liska was named interim CEO



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



9/9/2004: USF Holland announced the opening of eight (8) Northeast terminals, service city includes: Baltimore, MD Albany, NY, Allentown, PA, Harrisburg, PA, Philadelphia, PA, Wilkes Barre, PA, Syracuse, NY, and Richmond, VA

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Creating a General Company Profile Management and Bo ard Name



Proxy



finance.yahoo.com



Company Web site



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

Position and Affiliatio n

Thomas E. Bergmann

Interim CEO, CFO

Steven Caddy

President and CEO, USF Holland

Edward R. Fitzgerald

President and CEO, USF Reddaway

Douglas R. Waggoner

President and CEO, USF Bestway

Paul J. Liska

Chairman of the Board

Morley Koffman

Director

Stephen W. Lilienthal

Director

Anthony J. Paoni

Director

Glenn R. Richter

Director

Neil A. Springer

Director

Michael L. Thompson

Director

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3. Weekly Assignments and Resources C.

Equity Comps

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Summer Assignment – Equity Comps 

For your assignment, you are to submit an Equity Comp output page for Knight Ridder AS OF THE DATE OF THE ACQUISITION (3/10/06)



You must first find comparable companies. For this project, you need only Knight Ridder Corporation and three comparable companies 



Include McClatchy Company and New York Times Co as comps and find one comp on your own

Input ABACUS shells for these comps using FactSet, the companies’ financials and Wall Street research to find the following multiples: 

2006E and 2007EV/revenue



2006E and 2007E EV/EBITDA



2006E and 2007E EV/EBIT



2006E and 2007E P/E



2006E and 2007E EBITDA margins



When necessary, make sure to calendarize the financials



Make sure to check your output and see if something looks abnormal 

If so, you’ve likely made a mistake

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

At the end of this section, you should be able to answer the following: 

1. On what basis did you choose your one other comparable?



2. In retrospect, are they “good” comps? Why or why not?



3. How is Knight Ridder trading relative to its peer group?





4. Can you explain its relative valuation? Why does it trade at a premium or discount to its peers? Think of its relative earnings, margins, market share, size, etc. 5. What does this mean to a potential buyer?

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Agenda 

What are Equity Comps and Why Do We Do Them?



Finding Comparable Companies



Collecting the Data



Using the Compco Model



Common Pitfalls



Interpreting the Results



USF Corporation: sample equity comps

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What Are Equity Comps and Why Do We Do Them? 

A big part of an investment banker’s job is to value companies 

More than anything else, clients want to know what their companies are worth – especially relative to their peers



One way to value companies is to infer (or compare) their value based on the public trading values of other companies with similar characteristics



Because not all companies are the same size or have the same capital structure, we need to establish universal metrics that can apply to all companies within a group 





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

The calculation and interpretation of these metrics is a Comparable Company Analysis, or Compco Analysis

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

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OK, So What Are Enterprise and Equity Value? 

Enterprise Value is the total dollar value of a business, represented by the sum of all of the ownership interests in the business 



In broad terms, there are two types of ownership interests in a business – Debt and Equity 



The public market value of a business’ equity is referred to as its equity value, market value or market capitalization

We calculate a business’ Enterprise Value by summing the public market values of its debt and equity 



Note: Enterprise Value is sometimes referred to as Adjusted Market Value, Firm Value or (in early-stage biotech) Technology Value

Caveat: Because the trading value of debt securities is less volatile than equity securities, we typically use the book value of debt rather than the market value to save time

Enterprise Value is an important measure because it makes companies with different capital structures more comparable

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OK, So What Are Enterprise and Equity Value?

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

Liabilities and Shareholders’ Equity

Assets

Net Debt Enterprise Value

Enterprise Value

Equity Value

(1) (2)

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

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Fair Enough, But Help Me With This EBITDA Thing 

EBITDA is an accounting measure of how much cash flow a business generates from its operations



EBITDA excludes interest, taxes and depreciation and amortization because these items vary from company to company – for reasons which generally do not impact value – making them harder to compare on a consistent basis 

Interest is a function of capital structure



Taxes are a function of incorporation and tax structure



Depreciation is a function of depreciation policy / asset lives



Amortization is a function of how acquisitive a company has been

EBITDA = Earnings before Interest, Taxes, Depreciation and Amortization 

We place emphasis on Enterprise Value / EBITDA because this metric excludes most variables which do not affect value (or can be easily changed) making companies more comparable for valuation purposes

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Let’s Recap 



The absolute value of a business is expressed by its Enterprise and Equity Value 

Enterprise Value is the total value of all ownership interests in a business



Equity Value is the value of the equity in a business

The relative value of a business is expressed by a “multiple” of its absolute value to its operating results 





“GE is trading at 22x its 2006E projected EBITDA” – Translation: The ratio of GE’s Enterprise Value to its forecasted 2006E EBITDA is 22 “Walmart’s 2006E P/E multiple is 18x” – Translation: The ratio of Walmart’s equity value to its forecasted 2006 net income is 18

Enterprise Value / EBITDA is an important metric because it eliminates non-value impacting variables which otherwise make companies less comparable Enterprise Value Multiples

Equity Value Multiples

Enterprise Value / Sales

Equity Value / Net Inco me

Enterp rise Value / EBITDA

Price / Earnings

Enterprise Value / EBIT

Equity Value / Tangible Book Value

Industry Specific Metrics (EV / Fiber Miles)

Other Industry Specific Metrics

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CONFIDENTIAL

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

Financial



Industry



Seasonality



Size



Products



Cyclicality



Growth Profile (Sales, EBITDA, Earnings)



Distribution Channels



Strategy



Margins (Gross Profit, EBIT, Net Income)



Markets



Customers



Leverage

Sources to check to init ially select comparables: 

Your colleagues (before you start, make sure someone hasn’t done it already!)



Associates and Officers – most of the time they will pick them for you



Proxy Statements



Equity research reports and analysts



SIC code searches – FactSet, OneSource, Library



S&P Tearsheets



Value Line



Trade publications



IPO or other prospectuses



10K – Competition section

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

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CONFIDENTIAL

Collecting The Data – What Do I Need? 

Most recent financial statements – LTM financials 

10-K, 20-F or Annual Report (available 90 days after end of period)



10-Q quarterly or interim report (available 45 days after end of period)











Earnings Releases (typically available 2-3 weeks after the end of the quarter) – Don’t miss these – they are the most updated information available – Often have complete income statements and balance sheets Other Press Releases

EPS Forecasts – Be Consistent! 

First Call



I/B/E/S

Operating Projections 

CS Equity Research



Equity Research from other firm



I/B/E/S

Stock Price Information 

Current / 52 week high-low

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CONFIDENTIAL

Why Do I Need It and Where Do I Get It? Why Do I Need It? 

10-Ks, 10-Qs, 8-Ks





10-K / Annual Report 

LTM Income Statement Information



Options/Convertible Data

10-Q / Quarterly Report





Thomson Research (from InfoCentral – IBD Internal website)



FactSet on your PC



OneSource on your PC

LTM Income Statement Information



SEC Edgar Archives (www.sec.gov)



Balance Sheet Information



Disclosure workstations (in library)



Basic Shares Outstanding



Sedar.com (for Canadian companies)

8-Ks / Report of a Material Event



Documents Library on EMA 28 at x5-4000 (use library as a last resort – they will always take longer to pull docs than you will)



FactSet (First Call, I/B/E/S) on your PC



First Call website (InfoCentral)



Detailed First Call reports (6th Floor)



Bloomberg terminals (Nelson's)



EPS Forecasts









Where Do I Get It?

Pro Forma Information for Acquisitions or Other Transactions Earnings Announcements

Research analysts submit their EPS estimates to publicly available centralized databases (First Call, I/B/E/S) The mean or “consensus” estimate represents the Street view of a Company’s expected performance We use Street view to calculate P/E multiples

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CONFIDENTIAL

Why Do I Need It and Where Do I Get It? Why Do I Need It? 

Operating Projections

Research analysts project what a Company’s income statement will look like in the future



We use these models to calculate projected EBITDA



The research report you select is VERY important and will influence your valuation multiples



CS Research & Analytics



Call CS Research Analyst for updated model



Research Bank Web (Info Central) – for non-CS research



Multex.com – for non-CS research



Research Bank workstations (older reports)



You should always select a research report which has an EPS forecast close to the consensus



Library request at x5-4000 (for older or hard to find research reports)



To calculate equity and enterprise value



FactSet on your PC



Investment Banking Workstation on your PC



Bloomberg terminals



FactSet on your PC



Investment Banking Workstation on your PC



Bloomberg terminals

Stock Price Information



Other Information

Where Do I Get It?

To calculate equity and enterprise value

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CONFIDENTIAL

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

Keep a Record 



Leave a Trail / Be Organized 





Supply your Associate with all source documents, a printout of the equity comps and an electronic copy for all companies to be checked Work sequentially through companies, so that your Associate can start checking while you continue working

Be a Thinker 



Use “Comments” function in Excel to footnote items that need explanation (i.e., approximations, assumptions, calculations and unusual items)

Be Efficient 



Highlight data and tab pages used from source documents and use folders for each company

Be Complete 



Print out hardcopies of all source documents (10-Ks, 10-Qs, EPS Projections, Analyst Reports)

Check your results. If something looks wrong, it probably is

Never assume FactSet downloads or other people’s comps are correct

43

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

CHRW 12/31/04 3/31/05 10-Q 3/31/05 10-Q 12/31/05 0.0%



The ticker identifies the company you are creating a comp file for and is used by Factset to select data to download



The financial statement dates identify which historical and projected years you are generating multiples for. These dates drive the model’s column headings 

Research

Research Source Analyst Date of Research Recommendation Target Price

Morgan Stanley James Valentine 5/01/05

Note: The dates do not drive which data FactSet downloads; FactSet defaults to the most recently available data

–

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

kjackso3 62714 T_Bushey 65888



It is important to fill out the user information so that other people using your model can call you with questions

44

CONFIDENTIAL


2. Diluted Share Calculation / Options and Convertible Debt Schedules 

In general, Equity Value = Current Stock Price x Basic Shares Outstanding



However, most companies have securities which represent contingent shares – meaning they are not shares today, but can become shares if certain conditions are met – and as a result, we need to make adjustments to basic shares outstanding



The most common of these securities are options / warrants 





Management profits if the market price of the stock exceeds the strike price when they exercise the options. Hence, Management is only likely to exercise his/her options under these circumstances

Options are reported in the 10-K. Companies typically disclose the number of options that are outstanding and exercisable 



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

Exercisable options are vested and can be used to purchase shares today. Exercisable options, NOT outstanding, are relevant for equity comp purposes

The method we use for calculating the impact on basic shares outstanding of options is called the Treasury Stock Method

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CONFIDENTIAL


Calculating Diluted Shares Outstanding Using the Treasury Stock Method Scenario:

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

Translation:

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

Treasury Method Calculations:

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

($14.02 x 8.2) / $17.74

Less: Shares Repurchased with Proceeds Diluted Shares Outstanding

197.3 8.2 205.5 (6.5) 199.0

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CONFIDENTIAL


What About Convertible Debt and Preferred? 

Investment Bankers have created hybrid securities which pay interest like straight debt, but become common stock if certain conditions are met 

Convertible Debt



Convertible Preferred



Other Equity-Linked Securities



Convertible securities are NOT evaluated using the Treasury Stock Method



Most important thing to remember: Convertible Securities are treated as either debt or equity for valuation purposes – NOT both

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CONFIDENTIAL

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

Current Price < $18.00 

Income Statement Effect 



Current Price > $18.00 

None





None

Net Debt Effect





Debt: Interest backed out Preferred: Dividend backed out ($1,114 x 6.5% = $72.4)

Equity Value Effect 

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

Treated as Equity

Income Statement Effect 

Equity Value Effect 



Treated as Debt

Additional shares outstanding from conversion (add $1,114/$18 = 61.9 to shares outstanding)

Net Debt Effect 

Debt does NOT include face value of converted debt/preferred

48


CONFIDENTIAL

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

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

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

Schedule A - Convertible Debt ANNUAL INTEREST

MATURITY

Debt Series 1

1/00/00

0.00%

BOOK VALUE

TRADING VALUE

0.0

0.0

BOOK VALUE

TRADING VALUE

0.0

0.0

# SHARES CONV INTO

0.0

IMPLIED CONV PR

DEBT CONVTD

SHARES ISSUED

0.00

0.0

0.0

IMPLIED CONV PR

PREF CONVTD

SHARES ISSUED

0.00

0.0

0.0

Schedule B - Convertible Preferred ANNUAL INTEREST

MATURITY

Preferred Series 1

1/00/00

0.00%

# SHARES CONV INTO

Schedule C - Options/Warrants usin g Outstanding PRICE

Options/Warrants 1 Options/Warrants 2 Options/Warrants 3 Options/Warrants 4

# EXER 6.760 7.970 21.340 12.590

LOW 21.29 53.27 71.03 79.44

PRICE HIGH 21.29 56.14 71.93 77.90

# OUTS 6.760 21.370 31.510 23.170

LOW 21.29 56.14 71.93 77.90

HIGH 21.29 56.14 71.93 77.90

WEIGHTED AVERAGE PRICE 21.29 56.14 71.93 77.90

# EXERCISED 6.8 21.4 31.5 0.0

Note: Option Schedule Includes all series.

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3. Debt & Preferred Schedule Debt & Preferred Schedule



($ in millions)

DESCRIPTION

VALUE

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

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

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

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

5,310.7 0.0 0.0 0.0

5,310.7 0.0 0.0 0.0

Debt can be listed on the balance sheet under a variety of names 

Notes



Commercial Paper (CP)



Current Portion of LT debt



Credit Facility



Revolver



Loans



The ABACUS model allows you to calculate the net debt based on book or market values



If the Company issued additional debt or convertible securities since its latest filing, input these securities in adjustment rows (additional equity securities would increase shares outstanding and book equity)



For Credit Stats identify Seniority of the outstanding debt 

1 = Senior Debt



2 = Sub. Debt

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

50

CONFIDENTIAL


4. Historical / LTM Income Statement Step 1 

FactSet downloads the historicals automatically. Check downloaded FactSet information and make changes as required



Fill in Last Fiscal Year column exactly as shown on financial statement (we’ll get to adjustments later)



You will find all the line items on the income statement, except Depreciation & Amortization, which are on typically the cashflow statement



If the latest fiscal year end is the most recent quarter, you can ignore the other two columns

Step 2 

Fill in the most current quarter and prior corresponding quarter to get to LTM



Make sure you use cumulative amounts (i.e. if the fiscal year end is 12/31 and you are looking at 9/30 10-Q, use “nine months ended” data)

Step 3 

The model automatically calculates LTM for you. Make sure you set CS as the LTM source under settings/options so the output picks up your hard work

51

CONFIDENTIAL


Great, But What’s LTM? 

LTM = Last Twelve Months



Companies report financial results on a quarterly basis (every 3 months)



LTM represents the sum of the last four quarters’ results



LTM is important because it shows what the company’s reported performance has been over the last year (though not necessarily a calendar year)

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5. Income Statement Adjustments – Unusual and Non-Recurring Items Companies often report o ne-time gains or extraordinary ch arges in accordance with GAAP. As fi nanc ial analysts , we do n ot view th ese charg es as related to operatio ns and thus exclude them. 

Typical “non-operating” charges include gains/losses on sale of assets, inventory write-downs and restructuring charges



It is important to remember that not all unusual or non-recurring items will be broken out on the financial statements. This is the result of: 





Accountants will not always allow companies to break-out certain charges on the financial statements because they are not unusual in the strictest sense Some companies may not want to highlight that they “made their numbers” as a result of an extraordinary gain

Charges or gains not broken out in the financials can always be found in the MD&A – that’s why you need to read it!

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6. Projected and Calendarized Income Statement 

Projected income statement data comes from the research report you have selected



This data generates your projected EBITDA



It is important to make sure your projected data is presented on the same basis as your historical data



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

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A Note On Calendarizing Estimates Some companies do not have December 31 fisc al year ends. As a result, the earnings of these companies are not c omparable to the earnings of companies with a December 31 year end. Therefore: 

EPS estimates must be adjusted to a December year end to make companies with different fiscal year ends comparable on a P/E basis 



First Call and I/B/E/S generally download a CYEPS (Calendar Year EPS)

This is intuitively clear when considering two companies – one with a fiscal year ending September 30, 2005 and the other with a fiscal year ending December 31, 2005 

The 2005 earnings estimates associated with the “September” company have a higher degree of certainty than the “December” company and thus should receive a higher multiple than an identical “December” company



Our objective is to eliminate this artificial valuation differential by “calendarizing” the estimates



If you choose not to calendarize it, please set calendarization date equal to last fiscal year end

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

55

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Calendarizing EPS Estimates Example #1: “ Fiscal year ends September 30” What does this mean? It means that 9 months (or ¾) of the Company’s fis cal 2004 resul ts (Jan. 2004 – Sept. 2004) are included in the 2004 calendar year with the remaining 3 months (or ¼) of the calendar year estimated in t he fisc al 2005 results. Illustration: FISCAL YEAR ENDED SEPT. 30, 2004A 2005E 2006E

Sales

$1,000

$1,010

FACTOR 75.0%

CALENDAR YEAR ENDED DEC. 31, 2004A 2005E

25% $1,020

$1,002.5

$1,012.5

75%

EBITDA

150

200

250

162.5

212.5

EPS

1.00

1.10

1.20

1.03

1.13

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The Sanity Check How to avoid the dreaded, “ This doesn’t look right” response 

Take 5 minutes to look at the output when you’re done – the team will wait



Look for outliers in the data 

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



Likewise, the relationship between Enterprise Value / EBITDA and P/E should be roughly the same across companies – Not always true, but be prepared to explain why it’s not



Check your multiples against research to be sure you’re in the right ballpark



If the business is showing momentum and estimated annual operating statistics are improving over current year figures, your consecutive multiples should be declining (e.g., 16.5x 2005E P/E vs. 14.6x 2006E P/E) 

If the multiples are increasing, make sure you understand why

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Great Equity Comp Mysteries 

What do I do with Minority Interests? 





Include if it is a “normal” part of the business

How do I know if a company has “done something” recently? 







Include with net income if it appears to be a “normal” part of business

What do I do with Equity Earnings when I am calculating Net Income? 



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

“Something’s not right” Common “light bulbs” – dramatic change in stock price or shares outstanding, jump in sales or margins Look in News Runs, SDC, Documents Library

What if a company has done something recently? 

Pro forma the event, e.g., for equity or debt offerings, use the prospectus



Make sure your forecasts (EPS and operating) reflect the event



Footnote!

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Great Equity Comp Mysteries 

What do I do with all those weird “extraordinary” charges? 





Most common are Environmental Charges, Restructuring, Gain/Losses on Sales, Changes in Accounting



Get rid of it – don’t forget tax effects



Don’t forget to adjust historical EPS

Can I trust FactSet (FDS) codes? 



Is it really extraordinary?

In general, no (exception is security prices)

Do I do anything different with options in an M&A situation? 

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

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Great Equity Comp Mysteries What do I do if a company has had a stoc k split? 

Look in the Stock Guide, footnotes to financial statements, Bloomberg



Make sure historical and forecast EPS reflect the split



Example:

BEFORE SPLIT

Stock Price EPS P/E

AFTER SPLIT: CORRECT

AFTER SPLIT: INCORRECT

$100

$50

$50

$10.00

$5.00

$10.00

10x

10x

5x

2:1 Stock Split

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Definitions 

Equity Value (also referred to as Market Value) 







The market value of a company’s equity: (Number of fully diluted shares x current stock price) - option/warrant proceeds Number of fully diluted shares = “What the market thinks is outstanding” = Primary shares + “in the money” exercisable options/warrants + shares from the conversion of “in the money” convertible debt/convertible preferred stock What to do with option/warrant proceeds – Subtract from market value

Enterprise Value (also referred to as Adjusted Market Value, or AMV) 

The market value of the total enterprise



Market value of equity + net debt



Net Debt = Long-term debt (including current portion) + short-term debt + “out of the money” convertible debt + minority interest + capitalized leases – (cash + equivalents)

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Interpreting the Results – A Few General Themes 

A larger business is viewed as less risky than a smaller business. However, smaller entrepreneurial companies may get a premium valuation if they are growing quickly



Higher projected earnings growth implies faster stock appreciation potential and will positively impact valuation



Higher leverage implies less financial flexibility and will negatively impact valuation



Higher profitability margins imply better expense controls and better ability to stay price competitive and will positively impact valuation



The higher the economic cyclicality or seasonality of earnings, the riskier the stock



Dividend payments positively impact valuation. Dividends are usually paid by mature companies that need further incentives for investors. High growth companies do not need a dividend to get a high valuation



Higher trading multiples (e.g., price/earnings ratio) make the stock less attractive than a similar company with lower statistics

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Your Enterprise Value Is Not Correct 

You forgot Minority Interest 

Should be included in total capital for enterprise value calculation



Is not included in total capital when calculating credit stats



You missed a debt instrument on the balance sheet



You missed a cash equivalent on the balance sheet



The Company may have done a debt offering after the balance sheet date 





You can find out in the “subsequent events” section of the 10-K or 10-Q, from a company news run or Bloomberg Make sure that you check what the proceeds were used for – if they were used to pay down other debt, then you should not change anything

Your Equity Value is not correct

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Your Equity Value Is Not Correct 

The Company has done a stock split



The Company has issued or repurchased shares after the 10-K or 10-Q date



The Company has additional classes of common stock outstanding



You forgot to include the stock options



You forgot to include convertible debt or convertible preferred stock

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Your LTM Data Is Incorrect 

You forgot to pro forma for all the charges – make sure to thoroughly read the MD&A and financial notes



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



You forgot to adjust your income statement for acquisitions/divestitures



You forgot to check for press releases and are not using the most up-to-date data



You assume D&A is included in operating expenses but it isn’t

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Your Projected Data Is Incorrect 

Your research report is outdated – make sure that the research report you are using has EPS estimates in line with I/B/E/S or First Call



You did not calendarize



You did calendarize but used the wrong ratios



Your research report had a mistake you did not catch



Your research report currency does not match the rest of your input currency

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Comparable Company Analysis ($ in millions)

COMPANY

SHARE PRICE

% OF 52-WEEK

EQUITY

ENTERPRISE

02/04/05

HIGH

VALUE

VALUE

ENTERPRISE VALUE AS A MULTIPLE OF SALES MULTIPLE OF EBITDA 2004E

2005E

2004E

2005E

P/E 2004E

2005E

LONG-TERM EPS

LTM OPERATING

GROWTH

RATIO

Truck Load JB Hunt Transportation

$45.00

97.7%

$3,682

$3,697

1.3x

1.2x

8.2x

7.2x

17.5x

15.5x

15.8%

92.9%

22.61

99.4%

1,671

2,265

0.8x

0.7x

6.2x

5.9x

14.8x

12.6x

12.6%

93.6%

Werner Enterprises

20.94

90.1%

1,679

1,570

0.9x

0.9x

5.5x

4.9x

19.6x

16.1x

15.3%

91.6%

Heartland Express(1)

20.93

90.2%

1,570

1,311

2.9x

2.6x

10.8x

9.7x

25.2x

22.0x

13.8%

79.6%

Knight Transportation

25.71

99.3%

1,460

1,434

3.5x

2.9x

11.9x

10.1x

29.4x

23.1x

16.6%

80.7%

Covenant Transportation

20.86

97.8%

312

372

0.6x

0.6x

4.8x

4.1x

18.9x

15.8x

12.0%

(1)

Swift Transportation

(1)

(1)

Mean Median

1.7x 1.1x

1.5x 1.0x

7.9x 7.2x

7.0x 6.5x

20.9x 19.3x

17.5x 16.0x

14.4% 14.6%

94.0% 88.7% 92.3%

Less Than Truckload (1)

CNF Inc

(1)

Overnite Corp

(1)

Arkansas Best Corp

(1)

Old Dominion Freight

(1)

SCS Transportation

(1)

Yellow Roadway Corp

$46.49

91.2%

$2,457

$2,400

0.6x

0.6x

6.2x

5.3x

17.8x

14.3x

14.1%

92.3%

30.35

78.5%

850

925

0.6x

0.5x

5.3x

4.6x

13.2x

11.0x

15.5%

82.8%

41.77

89.5%

1,069

1,000

0.6x

0.5x

4.9x

4.7x

13.0x

11.2x

12.5%

92.8%

35.60

97.5%

885

961

1.2x

0.9x

7.9x

6.6x

21.6x

16.9x

17.5%

91.4%

22.55

81.6%

354

470

0.5x

0.4x

5.2x

4.6x

17.8x

13.0x

15.0%

95.6%

56.31

97.8%

2,769

3,320

0.5x

0.5x

6.3x

5.0x

14.2x

10.9x

10.5%

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

$51.38 71.88 9.40 31.18 35.25 22.19 43.33 56.46 8.62

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

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

0.7x 0.6x $4,201 2,297 1,165 1,475 1,113 1,007 840 529 436

Mean Median USF Corp(1)

$32.44

83.6%

$916

1.0x 1.5x 1.1x 0.5x 0.6x 2.6x 3.0x 0.4x 0.7x 1.3x 1.0x

$1,015

0.4x

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

6.0x 5.8x

5.2x 4.9x

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

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

14.0x 11.2x 6.0x

10.2x 9.8x 4.0x

16.3x 16.0x 32.9x 27.9x 11.1x 27.7x 29.0x 16.2x 27.7x 25.3x 12.3x 23.3x 27.7x 38.2x

12.9x 12.1x 28.4x 21.6x 7.4x 23.1x 23.8x 13.7x 23.1x 22.6x 8.5x 19.1x 22.6x 13.1x

14.2% 14.5% 14.5% 20.0% 20.0% 17.4% 17.0% 14.6% 14.5% 25.0% NA 17.9% 17.2% 10.2%

94.6% 91.6% 92.6% 94.9% 94.0% 94.6% 97.2% 94.1% 94.8% 81.1% 96.6% 93.9% 93.5% 94.6% 97.3%

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

67

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3. Weekly Assignments and Resources D.

M&A Comps

68


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Summer Assignment – M&A Comps Assig nmen t 

For the following two acquisitions, create a deal list similar to that on the sample page Date Jan-05 Jun-00



Acquiror Lee Enterprises Gannett

Target Pulitzer Central Newspapers

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

EV / LTM sales



EV / LTM EBIT



EV / LTM EBITDA

Key Takeaways 

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

69

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Agenda 

What are M&A Comps and Why Do We Do Them?



Finding Comparable Transactions



Practical Guidelines



M&A related SEC filings



USF Corporation: Sample M&A comps

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CONFIDENTIAL


Comparable Acquisitions Analysis 

Comparable acquisit ions analysis values a company by reference to other sale transactions of similar businesses. Comparable acquisit ions analysis i s based on t he same multiples as those used in comparable companies analysis 

Enterprise Value / EBITDA



Equity Value / Net Income



Enterprise Value / Sales (usually less relevant)



Enterprise Value / EBIT (usually less relevant)



The trick is to find the right comparable transactions and to ferret out the relevant information required



As in comparable company analyses, look for acquisitions of companies with comparable operational and financial characteristics



Recent transactions are a more accurate reflection of the values buyers are currently willing to pay than are acquisitions completed in the dist ant past. This is because market fundamentals are subject to dramatic change over periods of time. In additio n, cyclical businesses will trade at widely dif ferent valuation s at the peak and ebb of a cycle



Multiples should be based on the latest public financial information available to the Acquiror at the time of the acquisition

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

CONFIDENTIAL


Finding Comparable Acquisitions Sources to check for comparable acquisitions include: 

Other comparable acquisitions schedules



Previous presentations/valuation analyses



SDC database (Securities Data Corporation)



News runs



Equity analysts



Public tender offer documents and merger proxies



Colleagues

Never rely on the multiples of a schedule with an unknown author or wit h an author who is not su re that the multiples are corr ect.

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


CONFIDENTIAL

Calculation of Transaction Value Total Transaction Value

Equity Value

=

Equity Value

+

Total Debt

=

Fully Diluted Shares Outstanding

x

Purchase Price

+

Preferred Stock

+

Minority Interest

-

Cash and Equivalents

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

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


CONFIDENTIAL

Calculation of Shares Outstanding Fully Diluted Shares Outstanding

=

Basic Shares Outstanding

+

Option/ Warrant Shares



Basic Shares Outstanding are taken from the cover of the most recent 10-K or 10-Q.



Option/Warrant Shares are calculated using the treasury method, which assumes that all in-the-money options/warrants are exercised and the proceeds are used to repurchase shares at today’s market price



For example: Basic Shares

Option /Warrant Shares

20 million shares

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

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

1. Outstanding versus Exercisable 2. “In-the-money” versus “out-of-the-money” 

In an acquisition context, all outstanding and “in-the-money” options/warrants get converted. In a market value (equity comp) context, only those options that are both exercisable and “in-the-money” convert



Options/warrants “out-of-the-money” never convert

To calculate equity value, we must always us e fully dil uted shares outstandi ng. 74

CONFIDENTIAL


Calculation of Shares Outstanding (Cont’d) 



In-The-Money Option/Warrant Shares: 

Step 1: 500,000 x $25 = $12.5 million



Step 2: $12.5 million / $35 = 357,143 shares



Step 3: 500,000 - 357,143 = 142,857

Finally . . . To Calculate Fully Diluted Shares Outstanding. Fully Diluted Shares Outstanding



=

20,000,000

+

142,857

=

20,142,857

Now You Can Solve For The Equity Value

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CONFIDENTIAL

Determination of Purchase Price per Share 

Cash consideration is straightforward



Common stock issued by an acquiror is valued using the acquiror’s stock price on the day prior to announcement of the transaction



Other securities are valued at market 



Existing publicly traded securities should be valued at market on the day prior to announcement New classes of securities should be valued at market value on the first day of trading

Calcul ating the purchase price per share is not always as sim ple as it may first appear 76

CONFIDENTIAL


Enterprise Value vs. Equity Value General Overview 

There are typically two stakeholders in any firm, the Debt Holders and the Equity Holders. The concept of Enterprise Value contemplates that the earnings of the Company are allocated to both the Debt Holders (through interest payments) and the Equity Holders (through dividends and appreciation in stock price)

When You Use Enterprise Value 

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

When You Use Equity Value 

Typically, you will use Equity Value in circumstances when the financial statistic being utilized is flowing only to the equity holders. In general, this means that any financial statistic that is postinterest expense will use an Equity Value concept to determine valuation



Public market valuations tend to use earnings multiples (typically forward earnings multiples) because the investment decision is being made based upon a capital structure that is already in place and cannot be influenced by the common stock holder

When do you use what? 77


CONFIDENTIAL

Stock Price Premiums

% Premium = Paid

[

Purchase Price ______________ -1 Historical Price

]

* 100



Often calculated from day prior to announcement of transaction



Often news and rumors of a potential transaction often leak to the market and affect the stock price prior to announcement. We also look at premiums over the stock price at other points in time relative to announcement including: 

One Day



One Week



One Month

For public comp anies, we often look at the percent premium paid to sh areholders. 78

CONFIDENTIAL


Practical Guidelines 1)

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

2)

Make sure the announ cement date is corr ect by checking Bloomberg

3)

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

4)

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

5)

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

79

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Practical Guidelines (Cont’d) 6)

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

7)

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

8)

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

9)

Calculate equity value using fu lly dil uted shares outstandin g and the offer price per share. This sounds straightforward, but it is often easy to get tripped up here. Things to consider:

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Practical Guidelines (Cont’d) a) For a stock-for-stock deal, the price per share is implied. Some terms to get familiar with: 

The exchange ratio is simply the number of shares of the acquiror being offered for every share of the target. So if Target Corp. received one share of Acquisition Corp. stock for every five of its shares, then the exchange ratio would be 1/5, or 0.2.



If you read the summary of the terms, you will either get a fixed ratio or a fixed price. In the case of a fixed price, the exchange ratio adjusts to fit the price. For example, if Acquisition Corp. knows it wants to pay $5 per share for Target Corp., then the number of shares it must offer to get to that $5 will depend on its own stock price. If its price were $2 per share, then it would have to offer 2.5 of its own shares, and 2.5 would be the exchange ratio. In other cases, the exchange ratio is fixed. So if Acquisition Corp. offered 2.5 of its shares for every Target share, then the implied value of the Target share is (2.5 x Acquisition Corp. share price). Therefore, the implied price will fluctuate over time. So you can see, either you hold the exchange ratio constant and vary the implied purchase price, or you have a fixed price and vary the exchange ratio



For our purposes, what we care about is what the shares were valued at prior to the announcement. So if the Acquiror’s share price was $10 on the day prior to the announcement and the exchange ratio was 2, then the implied price per Target share would be $20. Often the merger proxy will state that the actual exchange ratio at the closing will depend on “the average closing price of the twenty trading days prior to the three days before the Effective Date...” Ignore it, unless for some reason this language is related to the announcement date somehow, because this is the actual price to be paid. Remember, our job is to determine how the transaction is valued as of the announcement, so just assume that such a price is whatever it was on the day prior to the announcement 81

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Practical Guidelines (Cont’d) b) Check the capitalization of the company to see if they have any convertible securities (debt and preferred stock). Often such securities have takeover provisions which allow them to convert upon a merger, in which case you want to include their value in the equity purchase price (of course, you will have to back out their value later when calculating the enterprise value) c) Options. Generally, upon a change of control in a company, the options are bought out by the acquiror. We need to account for this in the equity purchase price, so there are columns which will calculate this value for you. You can get this info either from the 10-K , or if available, from the merger proxy (you generally wont find this info in a 14D-1). Since we will usually not have a detailed breakout of what each individual option is, it is sufficient to take the average exercise price. When doing so, you should never get to a negative purchase price for the options because when the exercise price is less than the offer price, the options are worthless (“out of the money”)

10) Calculate the enterprise value by entering the appropriate debt and cash figures. Remember, include marketable securities in the cash figure, and if you converted some pieces of debt or preferred in calculating them in the equity purchase price, do not include them here. Otherwise, that would be double counting 11) For LTM figures, make sure the numbers you input d o no t in clu de unusual or nonrecurring items. Simply subtract them out from EBITDA and EBIT. For the net income line, make sure you take these out tax-affected. This means that for a net income calculation you would back out the unusual multiplied by (1-tax rate)

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

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

14D-9

DOCUMENT NAME

Tender Offer/Offer to Purchase

Target’s Recommendation to Tender Offer

DESCRIPTION 

Filed by the acquiror when launching a tender offer



Has to be opened for a minimum of 20 days



Must be amended for changes in deal/material events



Some information disclosed in document: 

Price per share



Number of shares sought



Conditions to closing



Source of financing



Background and purpose of offer



Financial data on acquiror



Information on acquiror’s investment banker and fees



Filed by the target within 10 business days of the commencement of a tender offer



Contains a recommendation from the target’s Board of Directors about how to respond to the Tender Offer, along with reasons for such recommendation



Also contains other disclosures 

Background of transaction



Agreements involving management



Fairness opinion for target’s shareholders



Information on target’s investment banker and fees

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

Proxy/S-4 (if securities involved)

DOCUMENT NAME –

Merger Proxy; Joint Proxy/Prospectus

DESCRIPTION 

Filed by any person or group which has acquired 5% of a public company within 10 days of such acquisition



Required disclosures include: 

Identity and background of acquiror



Amount and source of funds



Purpose/intent of purchase



Number of shares owned



Must be amended for material charges



Filed by target and/or acquiror



Comprehensive document used to solicit votes to approve transaction



Serves as a registration statement if securities are to be issued as consideration (versus all cash)



Selected disclosures include:





Vote required for approval



Terms of transaction



Recommendation of board



Fairness opinions for target’s (and possibly acquiror’s) shareholders



May describe analysis supporting fairness opinions



Summary financial data, including pro formas



May have full financial statements as an exhibit

Form F-4 (versus S-4) is used by foreign acquirors

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M&A – Related SEC Filings (Cont’d)

SEC FORM/ SCHEDULE 8K

10K, 10Q

13E-3

DOCUMENT NAME

–

Annual, Quarterly Filings ”Ks” and “Qs” Going Private Filing

DESCRIPTION 

Filed for material corporate events or disclosures; not only used for M&A deals



In M&A context, filed to announce a material acquisition and/or sale of a division/subsidiary



Filed by either seller or acquiror if the transaction is material to such party



Typically gives the key terms of a transaction, with the sale/purchase contract filed as an exhibit



Financial statements and/or pro forma financials are often filed as an amendment on Form 8 as companies are given time to include financials on the filing



Contain required financial statements and MD&A filings



May also contain M&A-related disclosures which could have been made on Form 8K



Used in connection with a significant affiliated party M&A transaction (i.e., LBO or Minority Buyout)



Discloses fairness of transaction to such minority shareholders, usually determined by Special Committee



Often contains filing of actual Board presentation by financial advisor to Special Committee

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Discounted Cash Flow Analysis

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Summer Assignment – DCF 

Project Knight Ridder’s income statement for five years 



From these projections, calculate Knight Ridder’s annual free cash flows 





Using your equity comps, find the terminal EBITDA multiple and calculate the terminal value

Using your comps, calculate the proper WACC that should be used to discount Knight Ridder’s cash flows 



Make note of what assumptions you use to grow the income statement

Unlever the Beta for each comp and re-lever at Knight Ridder’s leverage

Discount the Free Cash Flows and terminal multiple at the WACC 

Use the terminal multiple and WACC to calculate an implied perpetuity growth rate



Calculate the equity value per share and compare to Knight Ridder’s current price

Create a sensitivity table showing the changes in enterprise value and equity value per share as impacted by the WACC and terminal multiple

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

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Summer Assignment – DCF (Cont’d) Key Takeaways 

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

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Agenda 

What is a DCF and why do we do it?



Projections



Terminal Value



Weighted Average Cost of Capital (“WACC”)



Present Value



Sample Discounted Cash Flow Analysis



Sample WACC Schedule

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Discounted Cash Flow Analysis 

Comparable company and comparable acquisition analyses are often used as confirming methodologies



Specific asset values are sometimes used if other methodologies are inapplicable

Ap pli cat io ns of valuation analys is in clu de: 

Acquisitions: How much should we pay to buy the company / division?



Divestitures: How much could we sell our company / division for?



Defense: Is our company undervalued / vulnerable to a raider?



Fairness Opinions: Is the price offered for our company / division fair from a financial point of view?



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



New Business Presentations: Various applications

Discoun ted Cash Flow analysis is typ ically the primary valuation methodol ogy used by CS in M&A and certain capital markets transactions . 92


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DCF Versus Other Valuation Methodologies Discounted Cash Flow Analysi s

Comparable Company Analysis

Comparable Ac qu isit ion An aly si s

Methodology:



Present value of projected unlevered free cash flows  “Inherent” value  Best captures business in transition  Sensitivity analysis  Synergies analysis  Buy vs. build



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



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

Issues:



Financial forecasts developed with management  Discount rate  Terminal value method



Market environment Quality of comparables  Public data  Consistent accounting treatment  Less meaningful benchmark for assets with unique cash flow patterns







Market environment Quality of comparables  Availability of data  Consistent accounting treatment  Less meaningful benchmark for assets with unique cash flow patterns

Of the three princi pal valuation method olog ies used on Wall Street, DCF analysis frequently carries significant weight. 93

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Discounted Cash Flow Analysis Components Valuation Steps

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

Forecast of Unlevered FCFs

Calculate Termi nal Value



Exit multiples, perpetuity formula, other approaches

Cost of equity  Cost of debt  Theoretical optimal capital structure 

Calculate WACC

Discoun t FCFs

FCF for periods 1 to n  Terminal value 



Enterpris e Value

Less net debt

Equity Value



Adjustment for non-operating items ( e.g., extraordinary items, cash flow from unconsolidated subsidiaries, hidden assets, contingent liabilities, etc.) Take market value of financial debt, plus minority interests plus other non-working capital liabilities less excess cash and marketable securities (sometimes referred to as “corporate adjustments”)

Interpret results  Compare findings with other valuation methods 

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Valuation: Enterprise Value Versus Equity Value 

Enterprise Value = market value of operating assets



Equity Value = market value of shareholders’ equity



Equity Value = Enterprise Value – Net Debt(1) Liabilities and Shareholders’ Equity

Net Assets

Net Debt

Enterprise Value

Enterprise Value Equity Value

(1)

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

We use discounted cash flow analysis to calculate the enterprise value of the firm, whic h then allows us to calculate its equit y value. 95


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DFC Analysis: The Process

Step 1

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

Projections

Step 2

Termi nal Value

Step 3

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

WACC

Present Value

Step 4

Step 5

Ad ju st men ts

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

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Step 1: Projections 

DCF analysis is an attempt to look at the company’s pure operating results, free and clear of financial leverage, extraordinary items, discontinued operations, etc.



Many times, we are given financial projections from the management of a particular company; however, there are situations in which we must develop our own forecast for a particular company or business – It is extremely important to look at the historical performance of a company or business to understand how future cash flows relate to past performance



A company’s unlevered free cash flows represent the cash generating ability of that particular company, without regard to its present or prospective capital structure – As a result, unlevered free cash flows are projected before subtracting interest and financing expenses or related tax shields



DCF projections should be based on:





Historical performance



Company projections (when available)



Equity research analyst estimates



Industry data



Common sense

The forecast horizon should be long enough so that the company reaches “steady state” by the end of the forecast period – Typically, forecasts of 5 - 10 years are used for DCF analyses of maturing or mature firms

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


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Step 1: Projections Extract h istorical financials 

Sales



Operating cash flow



Depreciation & amortization



Deferred taxes



Capital expenditures



Working capital (receivables, inventories and prepaid expenses less current payables and other current operating liabilities)



Analyze numbers



How relevant are historical figures?







Major changes in business or industry



Management’s discussion of results

Are numbers “clean”? 

Extraordinary items



Acquisitions / divestitures

Is anything excluded? 

Compare to cash flow statement 98


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Step 1: Projections – Sales Sales Build up 

Build a separate schedule for sales analysis which will feed through to consolidated statement



Breakdown by market segment (different prevailing market dynamics), product type/class, etc.



Assumptions on volumes and unit prices



Base assumptions on: – Research reports – Management or client forecasts (if available) – Overall industry trends



Sales growth is usually an input; aggregate sales are derived from this input

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Step 1: Projections – Operating Expenses, Depreciation Expenses and Taxes Operating Expenses 

Build a separate schedule for cost analysis: 

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



Understand cost behavior/sensitivity to changes in sales level



Understand key cost drivers (e.g., price of raw materials, inflation, etc.)



Estimate as a percentage of sales

Depreciation Expense 

Usually expressed as a percentage of sales, comparing to historical trend or hardcoded and set relatively flat throughout the period

Tax 

(1)

Tax charge that the Company would pay if it had no debt – Assess tax rate based on previous marginal tax rate (composite local and corporate tax rates) as well as current and future tax regulation – Reflect operating loss carry forwards, if any

Exclude land because it is not depreciable.

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Step 1: Projections – Capital Expenditures 

Capital expenditures (“Capex”) are the investments necessary to maintain the required capital intensity, which includes expenditures on new as well as replacement property plant and equipment (“PP&E”)



Base assumptions on: – Company forecasts – Industry levels – Research reports – Percentage of sales, percentage of PP&E



Build a CapEx schedule breaking down expenditures by type of asset (buildings, machinery and equipment, other assets) and between new and replacement CapEx – Show beginning and ending PP&E by type of asset



At the end of forecast period, the CapEx level should be in line (equal or slightly higher) with depreciation (i.e., assume that capital intensity is maintained going forward)



For a given year, CapEx is equal to end of year net PP&E less beginning of year net PP&E plus depreciation expense for the year

(1)

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

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Step 1: Projections – Working Capital 



Working capital is defined as the sum of accounts receivable, inventories, pre-paid expenses and other current assets, less the sum of accounts payable, accrued expenses and other current liabilities – This definition can change slightly for companies in different industries Exclude excess cash and marketable securities and short-term debt – We often use the term “net working capital” to distinguish the investment banking concept from the accountant’s definition of working capital



Build a working capital schedule breaking down the main components of working capital – Estimate balances for the components of working capital as a percentage of sales, cost of goods sold or other appropriate metrics (or using year-on-year growth rates) for each projection year – Calculate the net increase/decrease in working capital for each year



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



Increases in net working capital are a use of cash and decreases in net working capital are a source of cash – Remember that increases in assets and decreases in liabilities are uses of cash and decreases in assets and increases in liabilities are sources of cash 102

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Step 1: Projections – Deferred Taxes Deferred Taxes 

For valuation purposes, taxes should be stated on a cash basis



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



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

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Step 1: Projections – Reality Check 

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



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



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



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



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

As always, it is impo rt ant to perf or m a “ Reality Chec k” on the main comp onen ts of FCF 104

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Step 1: Projections Unlevered Free Cash Flow 

Unlevered Free Cash Flow is the unlevered after-tax cash flow generated by the Company (including the impact of any reinvestment)



Unlevered Free Cash Flow is available to all providers of the Company’s capital, both creditors and shareholders



Unlevered Free Cash Flow is best determined by considering sources and uses of cash: METHOD 1

METHOD 2

Net Income

EBIT

(+) After-Tax Interest Expense

Note: (1) (2)

(1)

(2)

(-) Tax Effect

= Unlevered Net Income

= Unlevered Net Income

(+) Increase in net Deferred Tax Liability

(+) Increase in net Deferred Tax Liability

(+) Depreciation and Amortization

(+) Depreciation and Amortization

(-) Increase in Net Working Capital

(-) Increase in Net Working Capital

(-) Capital Expenditures

(-) Capital Expenditures

= Unlevered Free Cash Flo w

= Unlevered Free Cash Fl ow

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

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Step 2: Determinati termi nation on of Termin rm ina al Value lu e 

Firm value, based on free cash flows, can be separated into two components:

Company Value

=

PV of FCF during explicit forecast period

+

PV of FCF after explicit forecast period



Since DCF analysis is based on a limited forecast period, a terminal value must be used to capture the value of the business at the end of the projection period



The terminal value is usually added to the free cash flow in the final year of the projections and then discounted back to the valuation date, or it can be discounted separately to the valuation date



The terminal value typically constitutes a substantial portion of the total enterprise value. Critical thinking about prospects of the business, and therefore the terminal value, results in a more meaningful, accurate and defensible DCF analysis



Note that the terminal year free cash flow has to be normalized to ensure that the company has reached a steady state – Normalized operating assumptions: sales and profitability assumptions for the final year should reflect a “steady state” year, not a peak or trough in the business cycle; and depreciation and capex should be within the same range



Terminal value is determined through either application of a valuation multiple (the “terminal multiple”) or the perpetuity growth method

The terminal value captures the value of the bus iness at the end of t he projection projectio n period, period , which is based on the free cash cash flo ws of the business beyond the explicit explicit foreca forecast st period. 106

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Step 2: Termin rm ina al Va Value lu e – Terminal rmi nal Multi ul tipl ple e Method th od 

Terminal Value = Statistic x Multiple – Statistic: Operating statistic used (e.g., EBITDA in year 10) – Multiple: Selected multiple (e.g., 10.0x)



Multiple is based on the most appropriate multiple for the company’s industry (e.g., EBIT versus EBITDA versus EBITDAR)



The multiple applied should reflect the long-term market valuation of the company/industry, rather than a current multiple that may be distorted by industry or economic cycles



When applying the multiple it is important to distinguish between: 

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





LTM and forward multiples

Always show a range of multiples

Terminal value based on assumed trading o r acquis itio ition n multiple mult iple at the end end of the projection period. 107


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Step 2: Terminal rmi nal Value lu e – Perpe rp etuity tui ty Gro Growth wth Me Method tho d 

The Gordon Growth formula: Termi Terminal nal Valuen = Unlevered FCFn+1 (r - g) 





r: Discount rate (based on weighted average cost of capital)



g: Perpetuity growth rate

The perpetuity growth rate used must be realistic 





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

Reference point should be nominal GDP growth Expected long-term growth rate of the industry (e.g., utility industry growth rate versus cable TV industry growth rate)

Always show a range of perpetuity growth rates

Terminal value based based on busin b usin ess operating into in to perpetuity, grow growing ing free cash cash flow f low at some constant con stant rate. 108


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Step 2: Terminal Value – Cross Referencing 

Check the reasonableness of the terminal value by linking the terminal multiple and perpetuity growth rate – Calculate the implied perpetuity growth rate for a range of terminal multiples or, conversely check how the perpetuity growth rate translates into terminal multiples. For example, the terminal multiple you used may imply too high a perpetuity growth rate for the industry, or vice versa



The formula below demonstrates how to ‘reverse’ into the implied terminal multiple from the perpetuity growth method Implied terminal multiple = PV TV x (1+r)n Statistic

– – – – – 

=

FV TV Statistic

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

The formula below demonstrates how to ‘reverse’ into the implied perpetuity growth rate from the terminal multiple method (assuming FCFn+1 = FCFn x (1+g) ) Implied perpetuity growth rate = (r x Statistic x Multiple) – Unlevered FCFn (Statistic x Multiple) + Unlevered FCFn – Multiple: Selected valuation multiple (e.g., 10.0x) – Unlevered FCF n: Unlevered free cash flow in last year of the projection

Does the terminal value make sense? 109

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Step 3: WACC – Discount Rate Overview The Weighted Average Cost Capital (“ WACC” ) is the recommended di scount rate to be used in the unlevered disc ounted cash flo w valuation of an asset. 

The WACC should be thought of as the opportunity cost of capital, the long-term return an investor expects to earn in an alternative investment of equivalent risk



The WACC to be used in a DCF analysis is specific to the business or asset being valued. It does not necessarily depend on the buyer’s or seller’s overall cost of capital



WACC is used by firms as the hurdle rate for a project or division, as a performance benchmark for return on capital calculations, to determine desirability of stock repurchases or issuance, or for valuation purposes



Mathematically, WACC is expressed as: After-tax Cost of Debt

x

Cost of = Equity (2)

Risk-Free Rate

+

Levered Beta

Levered Beta (3) =

Unlevered Beta

x

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

(1)

(1) (2) (3)

Cost of Equity

WACC =

Proportion of Debt in Capital Structure

x

+

x

Equity Market Risk Premium

Proportion of Equity in Capital Structure

;

;

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

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Step 3: WACC – Target Capital Structure 

The “weights” applied to the costs of equity and debt used in computing WACC for an asset represent the theoretical “optimal” capital structure for that asset



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

Weighted Average Cost of Capital (WACC)

Cost of Debt

Debt as a % of Enterpris e Value

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

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Calculate the current market value-based capital structure for the company

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

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Review the capital structures of comparable companies – Assess the average market capital structure prevailing in the company’s sector



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

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Step 3: WACC – Cost of Equity 

Typically, the Capital Asset Pricing Model (CAPM) is used to estimate the cost of equity; there are other approaches that are occasionally used in valuation, including: 

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



Arbitrage Pricing Theory



Fama-French three factor model



An investor may obtain a risk-free rate by investing in governmental bonds. By purchasing equities, he or she assumes general market risk and therefore will expect a certain premium for doing so. CAPM quantifies the relationship between risk and return in a well functioning market



To implement the CAPM approach, you need to estimate three factors that determine the Security Market Line: the risk-free rate, the market risk premium and the levered beta Security Market Lin e 20 ) t n e c 15 r e p Market n Return i ( n r u 10 t e R dRisk-free e t cRate e 5 p x E

M

Risk Premium

0 0.0

0.5

1.0 Beta

1.5

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Step 3: WACC – The Risk-Free Rate 

Finance theory recommends using a “true” risk-free rate that has the same term as the cash flows projected



Since long term bond rates have intrinsic interest rate risk factored in, some theorists have suggested making a “liquidity” adjustment to the long bond rate representing the term premium implicit in those rates – However, this is rarely done in practice by Wall Street professionals



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



To access current yields to maturity on U.S. Government bills, notes and bonds on Bloomberg, type “T” and the “Government” key and hit GO

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Step 3: WACC – The Equity Risk Premium 

The equity risk premium (ERP) is the difference between the expected rate of return on the market portfolio and the risk-free rate



Proper methodology for estimating the equity risk premium is the subject of much debate in academia – Equity premia ranging from as low as 3% to as high as 8% are used on Wall Street



CS IBD uses estimates for ERP from Ibbotson Associates; the current ERP figure is 7.1% – This figure is calculated by looking at stock market returns relative to returns on long-term government bonds from 1926 through 2005 – Some argue that use of this period over-estimates the risk premium, and that data over a more recent period would suggest a lower premium – Also, some argue that using historical data presents a conundrum - equity returns over the last 20 years have been significantly higher than returns on government bonds, however the performance of the equity markets may have been, in part, driven by a reduction in the equity risk premium – Nevertheless, most (if not all) major Wall Street firms rely on the Ibbotson data for their cost of capital analyses



Where applicable, the WACC must be adjusted to reflect fact that betas for small companies do not account for all of the risks faced by investors in those companies. The following size premia (Ibbotson, 2006) should be added to the cost of equity calculation where appropriate:

Mid-Cap ($1,729 million to $7,187 million) = 1.02% Low-Cap ($587 million to $1,729 million) = 1.81% Micro-Cap (Below $586 million) = 3.95%

The equity risk premium is a critical element of WACC and DCF analysis that is o ften the subject of in tense debate. 116

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Step 3: WACC – Beta 

CAPM holds that investors are only rewarded for bearing systematic risk and are not rewarded for bearing unique or unsystematic risk. It is assumed that investors can eliminate unsystematic risk on their own through portfolio diversification



Beta represents a measure of the systematic risk that exists in an asset, and is central to CAPM Beta = COV[Rasset, Rmarket] / VAR[Rmarket], or equivalently = CORR[Rasset, Rmarket] x STDasset / STDmarket – High volatility is not necessarily an indication of high beta



Historical betas of publicly traded equity securities can be calculated based on an analysis of the actual returns on the security vs. the actual market returns over the same period – Unfortunately, historical betas can be poor predictors of expected beta, which is what we need in our analysis – BARRA, a financial research firm, computes predicted betas for most public companies



Use a portfolio or average of peer company betas where available because significant error can exist in individual betas – R-Squared (R2) measures the “goodness of fit” of the regression line, and describes the percentage of variation in the dependent variable that is explained by the independent variable. R2 may vary from 0 to 1 with 1 meaning that the independent variable explains 100% of the variation of the dependent variable, although R2 for individual equity betas seldom rise above 0.2



Observed betas reflect both the business and financial risk of the company. Betas are unlevered to measure only the business risk of a company and then relevered to the target capital structure of the company that is being valued to reflect both business and financial risk – Increasing leverage will, according to theory, increase the beta of a firm’s equity and hence its cost of equity ßU =

ßL

D (1-T) 1+ E

ßL = ßU [ 1 + D E

(1-T) ]

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Step 3: WACC – Cost of Debt 

The cost of debt is measured as the expected return on the company’s long-term debt securities – The cost of debt is dependent on both the general interest rate environment in the economy and the credit quality of the business or asset being valued



The cost of debt is measured on an after-tax basis because interest payments are tax deductible in the U.S. – The tax rate to be used is the company’s marginal tax rate, typically 40% in the U.S.



The cost of debt can be measured in several ways:

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

Risk-free rate + current corporate spread over treasuries of selected comparable credits – Must either use the bond rating given to the company by Standard & Poors or Moody’s, or estimate the company’s bond rating by comparing the company’s financial ratios (i.e., Debt / EBITDA, EBITDA / Interest) to those of its peers who have such ratings



Be wary of debt securities that have options attached (e.g., convertible bonds or callable bonds) that affect the overall yield to maturity and thus may not reflect the true cost of straight debt securities

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Step 3: WACC – Cost of Capital Build-up

Corporate Bonds

Treasury Bills

Long-Term Treasury Bonds

Default Premium

Long Horizon Premium

Long Horizon Premium

Inflation

Inflation

Inflation

Real Riskless Rate

Real Riskless Rate

Real Riskless Rate

Small Cap Stocks

Foreign Stocks

Size Premium

Foreign Stock Premium

Equity Risk Premium

Equity Risk Premium

Equity Risk Premium

Inflation

Inflation

Inflation

Large Cap Stocks

Real Riskless Rate

Real Riskless Rate

Real Riskless Rate

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Step 3: CS U.S. WACC Methodology 

In practice, we typically make the following assumptions at CS:

Target Capital Structure Risk Free Rate: Tax Rate: Equity Market Risk Premium: Beta: Cost of Debt:



Average of ratio of debt and equity market capitalization of selected comparable companies 20 year US Treasury coupon bond yield (Bloomberg: ICUR20)  Estimated future marginal tax rate (usually 40%)  Ibbotson equity market premium (currently 7.1%), calculated based on historical (arithmetic) return of equity market relative to 20 year treasury bond  Take predicted levered betas of comparable companies (use Barra predicted betas), unlever them according to capital structure, average the unlevered betas, and re-lever the average to the target capital structure of the company being valued  Risk-free rate + current corporate spread over treasury for comparable credits  

In general, WACC calculation is not a science; there are no exact answers, judgment and reality checks are essential – Typically, discount rate ranges centered around a best estimate for WACC are used in DCF valuations – Small differences in WACC/discount rate can have huge impacts on value

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Step 4: Present Value Time Value of Money

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

2003

2004

2005

2006

2007

$10 1 1 1 /1.10 0.9091 $9

$15 2 1 2 /1.10 0.8264 $12

$20 3 1 3 /1.10 0.7513 $15

$24 4 1 4 /1.10 0.6830 $16

$89 5 1 5 /1.10 0.6209 $55

The total present value at December 31, 2002 is equal to the sum of the present values of the individual cash flows ($108)

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

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Step 4: Present Value Valuation 

To calculate the value of a business using DCF analysis, the projected free cash flows over the forecast period are discounted to the present over the appropriate range of discount rates



A range of terminal values for the business is added to the cash flows in the last year of projections and discounted to a present value



The resulting values represent the total or “enterprise” value of the business, including both debt and equity. To calculate the value of a company’s equity, subtract the company’s net debt from its enterprise value



In addition, the enterprise value should be adjusted by adding other unusual assets or subtracting liabilities to reflect the company’s fair equity value

DCF pointers 

Assumption Summaries: Write up summaries of the key assumptions underlying your cash flow projections



Sensitivity Analysis: It is useful to vary some of the important assumptions (e.g., sales growth rate, margins) to determine how sensitive your value range is to key determinants of future results



Calculator Check: Always check Excel numbers with a calculator

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Step 5: Corporate Adjustments 

DCF analysis calculates the Enterprise Value (also known as Adjusted Market Value) of a company – The Equity Value of a company is equal to its Enterprise Value less Corporate Adjustments



Corporate Adjustments include the company’s net debt plus other obligations, less other assets not included in the DCF analysis or financial forecasts Long term debt (including current portion) Short term debt  Minority interest  Capitalized leases

Contingent liabilities Excess Cash  Value of other assets not in DCF











The Equity Value per diluted share is equal to the Equity Value divided by the number of net fully-diluted shares outstanding – Number of net fully diluted shares = Basic shares + net shares underlying “in the money” options / warrants + net shares from the conversion of “in the money” convertible debt and convertible preferred stock



Incremental common-equivalent shares are typically calculated using the treasury stock method – Note that this is a circular calculation – the treasury stock calculation depends on an assumed share repurchase price, which is dependent upon the number of net fully-diluted shares outstanding – Outstanding vs. exercisable options

(1)

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

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Sample Discounted Cash Flow Valuation ($ in millions)

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

2005E

2006E

2007E

2008E

2009E

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

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

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

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

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

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

Discount Rate

4.50x

Terminal Value EBITDA Multip le 5.00x 5.50x

6.00x

9.0%

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

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

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

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


10.0%

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

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

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

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


11.0%

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

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

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

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

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

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

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3. Weekl kly y Ass Assig ignm nme ents and and Resources F.

Merger Consequences Analysis

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Summer ummer Assignme Assignm ent – Accretion Accretion / Dilution iluti on 

Evaluate the transaction consequences of McClatchy buying Knight Ridder: 100% Cash, 0% Stock 50% Cash, 50% Stock 0% Cash, 100% Stock   



What are the Income Statement consequences? Accretion / Dilution impact 



What are the Balance Sheet consequences? Total Debt / Total Capitalization Total Debt / EBITDA EBITDA / Interest   



Other consequences? Ownership 

Helpfu Helpfu l Hint: We use all outstanding and exercisable shares due to change of control. If you properly filled in the option schedule on the input tab, this should be a quick manual fix. 

Key Takeaways 

At the end of this section, you should be able to answer the following: 1. Is an acquisition accretive or dilutive 2. How do premiums paid, financing and level of synergies affect accretion / dilution 3. How is accretion / dilution tied to the relative P/E multiples of the acquiror and target 4. Can an accretive deal be achieved given the DCF and comp valuations?

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

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Mergers and Acquisitions: What’s the Difference?

Asset Acquisitio n



Acquiring company purchases a part or all of the assets of the Target company



Target remains in existence post-transaction, as does Target ownership structure



Requires that each asset and liability acquired be separately conveyed contractually 



Stock Acquisition

Acquiring company buys the stock of the Target company from stockholder(s) 

Statutor y Merger

More complicated and time consuming than transfer of stock

Stockholders’ may be a parent company or individuals



Corporate shell of Target survives in Acquiror’s hands



Two or more corporations combine such that one of the combining corporations remains in existence while the other participating corporation(s) disappear 

Frequently follows a stock acquisition

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What are the Consequences of a Merger? Income Statement Consequences 

Corporate performance yardstick impacting stock price 



Earnings per share impact of a transaction Quality of earnings – growth, volatility, customer concentration, etc.

Balance Sheet Consequences 

Leverage & Coverage ratios





Stock options / “Golden Parachutes”

Debt/Total Cap



Debt/EBITDA



Management/Board composition



EBITDA/Interest



Pro Forma Ownership

Does the combined firm have market power in any particular market? 





An ti trust Conseq uenc es 

Social Consequences

Evaluate stand-alone and pro forma market shares in all affected markets Must some business units be sold?

Regulatory Consequences 

Would a variety of regulators (e.g. FCC, FAA, state insurance commissioners) permit the merger to take place? 



Market power concerns similar to FTC Other regulatory concerns

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

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Accounting Treatments Old Purchase Accounting 

Excess of purchase price over fair market value (FMV) of identifiable assets less liabilities is recorded as goodwill



Goodwill amortized by the straight line method over a period not exceeding 40 years

New Purchase Accounting 

Excess of purchase price over FMV of identifiable assets and liabilities is recorded as goodwill



Goodwill not systematically amortized. Instead, subject to an impairment test at least once per year and on an interim basis as warranted 



No more systematic income statement “hit”

Because goodwill is not amortized but most other intangible assets will be, FASB wants companies to separately identify more intangible assets rather than simply allocating such amounts to goodwill

The Financial Acco unting Standards Bo ard (FASB) has modifi ed the existing purc hase accounting rules and has eliminated the way we treat Goodwil l. 131


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Earnings Per Share 

Corporate Performance yardstick – –

Growth Stability

– –

Stock price Executive compensation



Cornerstone in merger consequences



2 Earnings per share (“EPS”) measures: – Basic EPS – Diluted EPS

Basic EPS



Net Income ÷ Shares Outstanding

Diluted EPS



Accounting concept only



Factors in impact of options and convertible securities, if dilutive

–

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

–

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



Options – Treasury Method



Convertible Securities – “If-Converted” Method



Shares outstanding calculated via Treasury Method frequently used to calculate equity market value of a company 132


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Earnings Per Share – The Treasury Method Key Information

Stock Price (P)

=

$10.00

Basic Shares (B)

=

20.00

Options (N)

=

3.00

Strike Price (K)

=

$8.00

Net Income (NI)

=

$50.0

1. Basic EPS

=

NI B

=

NI Diluted Shares

=

B

=

20 +

=

20 + 0.60

=

20.60 shares

=

$50.0 20.60



Standalone EPS calculations - Use Options Exercisable from 10-K



Acquisition Target - Options Outstanding from 10-K 

=

$50.0 20.00

=

$2.50

Change of Control usually leads to accelerated vesting for all options

Single Option “intrinsic value” Intuition:

2. Diluted EPS

Diluted Shares

Diluted EPS

+

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

=

$2.43

1. Company issues one share for each option = 3.00 shares 2. Company collects strike price of 3.00 X $8.00 = $24.00 3. Company uses $24.00 to repurchase shares at market price of $10.00 Shares repurchased: $24.00 = 2.40 $10.00 

4. Incremental shares = Shares Issued - Shares Repurchased 3.00 - 2.40 = 0.60 Accounting Convention – Diluted shares not ACTUALLY outstanding – Allows for consistent treatment of options and computing EPS 

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Earnings rni ngs Per Share hare – Conve onv ertible rti ble Se Securiti cur itie es 

Convertible Bonds and convertible preferred securities are bonds and preferred shares from an economic perspective as well as in terms of their impact on financial statements until holder exercises his option to convert into common shares



Diluted EPS calculation follows a different different logic – the “If-Converted” method 

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

If converted test:

Convertible Bond s If converted test:



Add back preferred dividend to net income





Add the number of common shares the convertible converts into to the basic share count

Add back after-tax interest to net income [I x (1-t)]



Add the number of common shares the convertible converts into to the basic share count



Compute EPS



Is EPS lower than Basic EPS?



Compute EPS



Is EPS lower than Basic EPS?

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Ac A c c o u n t i n g f o r Inv In v est es t m ent en t i n Equ Eq u i t y Secu Sec u r i t i es METHOD OF ACCOUNTING

Cost Method

(less than 20% in a nonmarketable security) Fair Fair Value Value

(less than 20% ownership in a marketable security)

Equity Method

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

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

BALA BA LA NCE SHEET

INCOME STATEMENT

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

Dividends received from target are shown as dividend income

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

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

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

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

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

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

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Purchase Accounting Account ing – Frame ramework work

Ac A c qu i ro r Income Statement

NewCo

Ad j us t men ts

Target

1. Synergies

Income Statement

Pro Forma Income Statement

2. Transaction expenses Balance Sheet Cashflow Statement

Balance Sheet

+

Cashflow Statement

3. Capital Structure

+









Acquisition Debt Common shares issued Refinancing existing debt

=

Pro Forma Balance Sheet Pro Forma Cashflow Statement

Other

4. Goodwill & Depreciation 5. Date acquisition closes

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Purchase Accounting 

Determine buyer 







If no definitive share count, other factors are: – Board of Directors – Management – Relative size

Determine acquisition cost 

Valuation of securities



Earnings contingency



Share price contingency

Closing date 



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

Target financials combined with Acquiror financials as of the closing date

Allocation of Purchase Price 

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



Include any newly identified intangible assets



Excess of cost of acquired company over the FMV is recorded as goodwill 137

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Purchase Accounting – Balance Sheet Impact      

 

Accounting: Acquisition of stock (Carryover basis) Purchase Price – $100MM 50% stock, 45% debt, 5% cash on hand Closing Date: December 31, 20XX $5MM in synergies Question to class: Why is there a deferred tax liability? Asset step-up: $30MM Step-up amortization: 15 years

Goodwill GOODWILL

$100.0 5.0

Purchase Price Less: Book Value

95.0 30.0

Excess Purchase Price Less: Asset Write-ups

$65.0

Goodwill

($ in millions)

Cash Other Assets Goodwill Total Assets

ACQUIROR

TARGET

$30.0

$5.0

10.0

5.0

0.0

0.0

ACCOUNTING ADJUSTMENT

FINANCING ADJUSTMENT

$(5.0)

PRO FORMA

$30.0 20.0

65.0

92.0

$40.0

$10.0

Debt

0.0

0.0

Other Liabilities

5.0

5.0

10.0

Deferred Tax Liability

0.0

0.0

2.0

Total Liabi lit ies

$5.0

$5.0

$57.0

Equity

35.0

5.0

$40.0

$10.0

Total Liabil iti es & Equit y

$142.0

45.0

(5.0)

50.0

45.0

=

85.0 $142.0

138

CONFIDENTIAL


Purchase Accounting – Income Statement Impact ($ in millions)

ACQUIROR

Sales EBITDA

ACCOUNTING ADJUSTMENT

FINANCING ADJUSTMENT

PRO FORMA

$150.0

$100.0

30.0

21.0

5.0

56.0

5.0

1.0

2.0

6.3

0.0

0.0

0.0

25.0

20.0

Depreciation Amortization EBIT

TARGET

$250.0

0.0 49.7

Net Interest Expense (Income)

(1.5)

(0.3)

PBT

26.5

20.3

46.7

Tax

10.6

8.1

18.7

Net Income

15.9

12.2

28.0

Tax – %

40%

Diluted Shares

10.00

EPS

$1.59

3.0

40%

2.50

40%

(2.50)

0.67

10.67 $2.62

EPS Accretion / (Dilution) – $ Stock Price

4.8

$1.03 $75.00

$40.00

?

Implied Cost of Funds Cost of Cash

5% x

$5.0

Cost of Debt

10% x $45.0

Total Interest

$4.8

Shares Issued = $50.0MM ÷ $75.00 = 0.67

139


CONFIDENTIAL

The P/E Ratio Shortcut 

If the P/E of your acquisition currency is higher than the P/E of the stock of the Target at the price you propose to pay, the acquisition will likely be accretive, and vice-versa



Robust rule of thumb in the absence of goodwill amortization / impairment KEY DATA ACQUIRER $10.00 $1.00 10.0x 1 10% 40.0%

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

TARGET $5.00 $1.00 5.0x 1

Example 1 – Acquir er pays for Target wit h Acquir er Stock 1. Target Purchase Price 2. Acquirer Shares Issued

=

$5.00 x 1 share = $5.00 Purchase Price

=

Acquirer Stock Price

3. Combined Net Income

=

$1.00 + $1.00 = $2.00

4. New Share Count

=

1 + 0.5 = 1.5

5. Earnings per Share

=

$2.00 / 1.5 = $1.33

$5.00

=

$10.00

0.50 shares

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

Example 2 – Acquir er pays for Target wit h Bor rowed Money P/E of Cash

=

Pro forma EPS

=

1 Rate x (1 – t)

=

1 10% (1 – 40%)

= 16.7x

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

=

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

= $1.70

140


CONFIDENTIAL

The Incremental Method Useful fo r 

Preliminary Analysis



Limited Information



Multiple Companies / Permutations

Purchase Price: $100MM; Book Value: $80MM 50% Stoc k / 50% Debt Financ ing

+ – – – =

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

2002

}

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



AcquirCo and TargetCo Debt is not refinanced



Transaction closes 12/01



No Synergies



Purchase Price – Book value = Excess Purchase Price



FMV adjustment: $10.0



Deferred Tax Liability = $4.0



Goodwill = $14.0



Tax deductible or non-deductible



Asset vs. stock transaction



New Debt x int. x (1 – tax) 50.0 x 10% x (1 – 40%) = 3.0



Per Treasury Method



Shares issued = Equity issued AcquirCo Stock Price = $50.0 / 10.00 = 5.00 141


CONFIDENTIAL

Merger Consequences: Yellow Roadways Buys USF 

For Knight Ridder project show: 

3 Considerations (100% Cash, 50%/50% Cash Stock and 100% Stock)



3 Premiums (10%, 20% and 30%)

($ in millions)

–

Premium to Share Price Price Per Share

5.0%

10.0%

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

35.0%

40.0%

$32.44

$34.06

$35.68

$37.31

$38.93

$40.55

$42.17

$43.79

$45.42

Equity Value (1) Net Debt

$918 99

$966 99

$1,014 99

$1,062 99

$1,111 99

$1,160 99

$1,210 99

$1,259 99

$1,309 99

Enterprise Value

1,017

1,065

1,114

1,162

1,210

1,259

1,309

1,358

1,408

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

4.1x 3.7x

4.2x 3.8x

4.4x 4.0x

4.6x 4.2x

4.8x 4.3x

5.0x 4.5x

5.2x 4.7x

5.4x 4.9x

5.6x 5.1x

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

13.3x 11.4x

14.0x 12.0x

14.7x 12.6x

15.4x 13.2x

16.1x 13.8x

16.9x 14.4x

17.6x 15.0x

18.3x 15.6x

19.0x 16.2x

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

$5.25 5.59

$5.25 5.53

$5.25 5.48

$5.25 5.43

$5.25 5.38

$5.25 5.33

$5.25 5.28

$5.25 5.24

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

$0.34 6.4% –

$0.28 5.4% –

$0.23 4.4% –

$0.18 3.5% –

$0.13 2.6% –

$0.08 1.6% –

$0.03 0.7% –

($0.01) (0.3%) $1.3

($0.06) (1.2%) $6.1

1.6x 45.28%

1.7x 45.36%

1.7x 45.45%

1.7x 45.53%

1.8x 45.61%

1.8x 45.69%

1.8x 45.76%

1.9x 45.83%

1.9x 45.91%

14.2% 85.8%

14.9% 85.1%

15.5% 84.5%

16.1% 83.9%

16.7% 83.3%

17.3% 82.7%

17.9% 82.1%

18.5% 81.5%

19.1% 80.9%

(2)

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

$5.25 5.19

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

142

Credit Suisse Analyst Valuation Book.pdf

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