Management Buyouts Sandra Lister – KPMG Corporate Finance

CORPORATE FINANCE

October 2008

ADVISORY Key Topics

z Introduction to management buyouts z Principle of a management buyout z Private Equity requirements z The management buyout process z Current conditions in the market z Key steps for management

This document is CONFIDENTIAL and its circulation and use are RESTRICTED. © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. 1 Introduction to management buyout’s

A management buyout is a form of acquisition where a company’s existing managers acquire a significant equity share in the Company

Management Buyout

Advantages Disadvantages z Management own the business and are incentivised to z Loss of autonomy drive it forward z Additional reporting requirements including cash z Potential for significant financial reward management and forecasting z Provides access to the commercial skills and resources z Debt burden to service and restrictive financial controls of an investor to meet bank covenants z PE house may provide cash to further develop the z Potential risk to personal investment business either through organic growth or bolt on z PE House will want a clear exit route, typically in a acquisitions three - five year time frame

High risk but with the opportunity for high reward

Composition of Enterprise value throughout the life of a buyout

£m

Management Equity

Private Equity Enterprise value

PE Loan Notes

Debt

0 123 4 5 Entry Exit Exit

Example of a management buyout at entry

Entry Value Equity

£m %

Management 0.6 30%

Private Equity Equity 1.4 70% Loan notes 24.0

Debt Senior 16.0 Mezzanine 8.0

Total Enterprise Value 50.0 100%

• Management provide funding of £0.6m (1.2%) of the Enterprise Value • Private Equity provide funding of £25.4m (51%) of the Enterprise Value

Example of a management buyout exit

Entry Value Exit Value Exit Value

£m £m £m

Management 0.6 4.8 7.1

Private Equity Equity 1.4 11.2 16.4 Loan notes 24.0 24.0 24.0

Debt 24.0 20.0 20.0

Total enterprise value 50.0 60.0 67.5

EBITDA £6.25m £7.5m £7.5m

Exit EBITDA/enterprise 8x 8x 9x value multiple

BWA Water Bodycote Additives Testing Group The Original Factory Shop Group Corporate Finance Corporate Finance KPMG Corporate Finance acting as financial advisor to acting as financial advisor to acted as financial adviser to the Close Brothers Private Equity Bodycote plc on the disposal shareholders of The Original Factory on the disposal of BWA of its Bodycote Testing Group Shop Group on the disposal of its department store business to Duke (BTG) division Street Capital Value not disclosed c.£417 million £68.5m September 2008 Announced August 2008 December 2007

z Investment held for 2 years z Sold to Clayton Dubilier & z Investment held for 3 years Rice (US Private Equity) z 3.5x return on exit z 2.4x return on exit (35% IRR) z Sold to United International z Sold to Duke Street Capital Bank (Bahrain Private Equity)

z Key issues for a private equity buyer will be: − growth strategy − sector dynamics − financial dynamics − cash generation − exit − quality of management z Key requirements for a private equity buyer will be − Board representation via non-executive director and non executive chairman − Key personnel incentivisation − Representations, warranties and indemnities from vendor and management (Investment agreement) − Regular detailed management information − Swamping rights

Initial assessment of viability

Appointment of Seek funding support Opportunity financial adviser

Business Plan

Negotiations and legal agreements Negotiations with Vendors and Financial Heads of Approach vendor Completion Institutions Agreement

Due diligence

The business plan is the foundation for a successful fund Questions investors will need to be convinced about raising z Primarily a business plan - but also a selling document z Quality and breadth of experience of the management team z Management need to z Market position of the business and the market dynamics − present the business in its best light z Achievability of plan − address the key issues for funders z What are the likely exit strategies? − present the management team as united, dynamic and capable of delivering growth z An integrated three - five year set of financial projections including profit and loss, balance sheet and cash flow will be required Key issues for management to consider z What is the realistic business plan for the next three - five Issues to be covered in the business plan years z Have all costs been reflected? i.e separation costs? z Background to the business and prospects z What is the potential upside to the plan? z Markets, customers and competitors The ‘base case’ business plan z Services and suppliers z Should be challenging yet achievable z Management and employees z Needs to balance demonstrating upside with the equity risk for z Financial information and forecasts management associated with ‘stretched targets’ z Exit routes z Risk factors

Due diligence can encompasses the following elements

z Accountants’ financial investigation (financial due diligence) z Independent market reviews (commercial due diligence) z Regulatory issues z References on management z Pensions, property valuations, taxation and environmental issues z Detailed legal review

z “All transactions completed between May 2007 and April 2008 with an enterprise value between £5m and £15m, 18 deals completed in Manchester and Leeds compared to 13 in London and 8 in the South of England” Source: Corporate Finance Worldwide z “The total value of regional transactions was £210m in the second quarter to June 2008, less than half the £535m achieved in quarter one and the current quarterly figure since the fourth quarter in 2005” Source: The Centre for Management buyout research z The equity market is getting tougher as Private Equity Houses seek quality investments. But Private Equity Houses still have cash to invest as recent deal activity shows: − Crown Paints backed by Endless in August 2008 − Advanced Travel Partner backed by Barclays Private Equity in July 2008 − Bodycote Testing Group backed by Clayton Dubilier and Rice and August 2008 − BWA Water Additives backed by United International Bank in September 2008

...

z The “credit crunch” emerged primarily as a liquidity issue Western Europe leveraged loan volume by quarter z Signs of strain are now appearing amongst highly leveraged borrowers and companies most affected by the downturn in 160 160 consumer confidence Number of of Deals Number z Bank appetite for cash flow lending is experiencing a notable 120 120 retraction with underwriting appetite significantly reduced and an increase in the prevalence of club deals 80 80

Volume ($bn) 40 40 Implications for borrowers of this retrenchment in bank appetite include: 0 0 z ‘Flight to quality’ as market issuance falls 1Q00 1Q01 1Q02 1Q03 1Q04 1Q05 1Q06 1Q07 1Q08 z Higher margins z Reduced leverage available Volume Number of deals z More ‘lender-friendly’ documentation, including tighter covenants z Increase in importance of established banking relationships Western Europe leveraged transactions pricing and leverage multiples z Less certainty over banks’ internal credit approval processes, 7x 270 and therefore greater execution risk

6x 260 Margin (bps) z More onerous due diligence and information requirements Total leverage

5x 250

4x 240 Debt/EBITDA ratio Margin

3x 230 1Q02 1Q03 1Q04 1Q05 1Q06 1Q07 1Q08

Note: Pricing shown is average margin in new MBO transactions Source: LPC

The first steps for management are as follows: z Agree management’s position/priorities z Consideration of business plan z Approach financial advisors

Sandra Lister KPMG LLP +44 (0) 161 246 4901 [email protected] www.kpmg.co.uk