Deals, Dollars, and Disputes

MAXIMIZING VALUE MINIMIZING RISK

A Summary of Transactions for the Quarter Ended September 30, 2013

Burgundy Navy Cream Gray PMS 202 C PMS 295 C PMS 7499 C PMS Cool Gray 11 C

R138 R0 R242 R84 G36 G40 G229 G86 B50 B86 B179 B91 CONTENTS

Our Process and Methodology...... 1 Summary of Q3 2013 PE Firm Transaction Activity...... 2 Volume of PE Deals Announced and Completed...... 2 Top 25 PE Firm Transactions by Deal Value Completed During Q3 2013...... 3 Volume of PE Deals by Deal Type...... 4 Number of Completed PE Deals by Acquisition Type for Q3 2013...... 4 Average Deal Value for PE Firm Transactions During Q3 2013...... 4 Industry Sector Transaction Analysis...... 5 Purchase Price Premium for Transactions Involving Public Companies Taken Private...... 5

Featured Transactions and Insights...... 6 Risks and Rewards in a Competitive Bidding Process...... 6 Structuring Earn-Outs and Special Considerations to Avoid Pitfalls...... 8

Introduction We are pleased to present you with our Deals, Dollars, and Disputes report for the quarter ended September 30, 2013. Our analysis involves a study of the merger and and acquisition transactions involving private equity firms (“PE firms”) during the Our Objective recent quarter.

Our objective in preparing this report is to provide a general overview of the volume and value of transactions during the quarter, along with an analysis of trends when compared to prior quarters. We also hope to present useful information on select topics related to valuation concepts and recent acquisition disputes in our Featured Transactions and Insights section.

As an independent consulting firm offering financial and accounting expertise in areas of business strategy, transaction analysis, and valuation matters, we are committed to contributing thought leadership and relevant research to assist our clients in today’s fast-paced and demanding market. This report is just one example of how we intend to fulfill this commitment.

We appreciate your comments and feedback and welcome requests for any additional analysis that you might find helpful.

Floyd Advisory NOVEMBER 2013 “In theory, the M&A market is the true reflection of current interaction between willing sellers and willing buyers. In Our Process the real world, however, this is rarely the case. Corporations and Methodology are not yellow pencils, quickly stacked and easily matched; it is difficult to make true We studied financial data for transactions involving PE firms, both as buyers and as comparisons of complex sellers, during the most recent quarter for companies headquartered in North America. situations—in one way or another virtually every M&A As part of our review, we gathered and analyzed relevant transaction information sale can be considered special and data such as industry sector, equity interest, and deal structure, among others, or extraordinary.” DEALS, DOLLARS, AND DISPUTES and created a database for our further analyses. From this information, we analyzed market trends by industry, by common attributes, by valuation premiums, and by other Kuhn, Mergers, Acquisitions, characteristics. Applying our professional judgment to these observations, we have and Leveraged , p. 61 prepared this report. Within our Featured Transactions and Insights section, we have highlighted two transactions as recommended reading.

For the purposes of this report, the transaction data we have analyzed is limited to publicly available information.

NOVEMBER 2013 | Page 1 Summary of Q3 2013 PE Q3 2013 marked a reversal in a downward trend with a 5% increase in the number Firm Transaction Activity of announced deals and a 6% increase in the number of completed deals as compared Volume of PE Deals Announced and Completed to the previous quarter.

NORTH AMERICAN PE DEAL LANDSCAPE For the One Year Period Ended Q3 2013 450 ■ No. of Announced Deals ■ No. of Completed Deals 400 419 405

371 350 348 349 331 339 319 300 NO. OF DEALS

250

200 Q4/2012 Q1/2013 Q2/2013 Q3/2013

Source: Zephyr Note: Includes data for which transaction details were reported and publicly available.

From Q4 2012 through the end of Q2 2013, we note a constant downward trend in the volume of PE deal activity. However, Q3 2013 marked the reversal of this decline with a 5% increase in the number of announced deals and a 6% increase in the number of completed deals as compared to the previous quarter.

Page 2 | NOVEMBER 2013 Top 25 PE Firm Transactions by Deal Value Completed During Q3 2013

Deal Value USD Acquirer/Advisor - Deal Type Target Acquiring Entity Target Primary US SIC Description (in millions) Private Equity/ 1 $6,800 GIC Special Investments Pte Ltd Institutional Bmc Software Inc. Boxer Parent Company Inc. Computer Golden Gate Capital LP buy-out programming services Bain Capital LLC Insight Venture Partners 2 $3,900 Kohlberg Kravis Roberts & Institutional Gardner Denver Inc. Renaissance Parent Corporation Air and gas compressors Company LP buy-out 3 $1,400 General Atlantic LLC Acquisition Knight Capital Kcg Holdings Inc. Security brokers, dealers, 100% Group Inc. and flotation companies 4 $1,350 BC Partners Ltd Institutional Allflex Holdings Bc Partners Ltd Electronic components, buy-out not elsewhere specified 5 $1,300 Madison Dearborn Partners LLC Institutional National Financial Madison Dearborn Partners LLC Investment advice buy-out Partners Corporation 6 $1,025 Thoma Bravo LLC Institutional Intuit Financial Services Thoma Bravo LLC Computer processing and buy-out data preparation and processing services 7 $835 TowerBrook Capital Partners LP Institutional True Religion Towerbrook Capital Partners Lp Women's, misses' and buy-out Apparel Inc. juniors' outerwear not elsewhere classified 8 $667 MidOcean US Advisor LP Institutional Water Pik Technologies Midocean Us Advisor Lp Electric housewares buy-out Inc. Vulcan Capital Management Inc. and fans Investors 9 $640 Vulcan Capital Management Inc. Institutional Multi Packaging Madison Dearborn Partners LLC Packaging paper and buy-out Solutions Inc. plastics film, coated and laminated manufacturing 10 $489 Madison Dearborn Partners LLC Management American Greetings Century Intermediate Holding Greeting cards buy-out Corporation Company 11 $465 Koch AG Investment LLC Institutional Synagro Technologies Eqt Partners Ab Refuse systems buy-out Inc. 12 $413 Genstar CapitalLLC Institutional Genworth Wealth Genstar Capital LLC Investment advice Aquiline Capital Partners LLC buy-out Management Inc. Aquiline Capital Partners LLC 13 $395 Thoma BravoLLC Institutional Keynote Thoma Bravo LLC Computer processing and buy-out Systems Inc. data preparation and processing services 14 $315 Roark Capital Group Institutional Miller's Ale Roark Capital Group Eating places buy-out House Inc. 15 $300 Riverstone Holdings LLC Minority Bridger LLC Riverstone Holdings LLC Local trucking stake ≤ 50% Management without storage 16 $278 TPG Capital LP Institutional Assisted Living Aid Holdings LLC Residential care buy-out Concepts Inc. 17 $258 TPG Capital LP Minority Uber Tpg Capital Lp Computer processing Google Ventures stake ≤ 50% Technologies Inc. Google Ventures and data preparation and processing services 18 $246 Crestview Advisors LLC Institutional Victory Capital Management Crestview Advisors Investment advice buy-out Management Inc. LLC Employees 19 $219 Blackstone Group LP, The Minority Landmark Apartment Blackstone Group Lp Real estate investment trusts stake ≤ 50% Trust Of America Inc. The Istar Financial Inc. 20 $174 Kelso & Company LP Institutional Eacom Timber Et Acquisition Corporation Sawmills and planning buy-out Corporation mills, general 21 $168 Axel Johnson Inc. Minority Conformis Inc. Axel Johnson Inc. Orthopedic, prosthetic AGC Equity Partners Ltd stake ≤ 50% Agc Equity Partners Ltd and surgical appliances Undisclosed Funds and supplies 22 $150 T Rowe Price Associates Inc. Minority Pure Storage Inc. T Rowe Price Associates Inc. Computer storage devices Redpoint Management LLC stake ≤ 50% Redpoint Management LLC Greylock Management Corporation Greylock Management Corporation Sutter Hill Ventures Sutter Hill Ventures Samsung Ventures America Samsung Ventures America Tiger Global Management LLC Tiger Global Management LLC Index Venture Management LLP Index Venture Management LLP 23 $150 EnCap Flatrock Midstream Minority Isis Energy LLC Encap Flatrock Midstream Crude petroleum pipelines stake ≤ 50% 24 $108 GE Energy Financial Services Inc. Minority Jackalope Gas Crestwood Niobrara LLC Crude petroleum and stake ≤ 50% Gathering Services LLC natural gas 25 $105 Prospect Capital Corporation Institutional Cp Energy Investors Electric services buy-out Services Inc. Prospect Capital Corporation Source: Zephyr NOVEMBER 2013 | Page 3 Volume of PE Deals by Deal Type

We broke down the transactions by the following categories based on characteristics of the acquirer and the stake acquired:

Deal Type Definition

Acquisition 100% A company acquires 100% of another company and uses funding from a PE investor to support the transaction.

Acquisition 51% - 99% A company acquires a majority stake (between 51% and 99%) using funding from a PE investor to support the transaction.

Minority stake ≤ 50% A transaction where one or more PE firms have provided equity funding for a company and the resulting stake held is less or equal to 50%.

Institutional buy-out A transactions where a PE firm, its affiliate, or a newly- formed vehicle company has taken a 50% or greater stake in the target company or is the parent of the acquirer.

Management buy-out A company is acquired by its management with financial support from a PE firm. “The same acquisition target will have different values to different buyers, due both to perception and reality.” Number of Completed PE Deals by Acquisition Type for Q3 2013

8 11 William D. Rifkin, Valuing and Pricing I: Concepts and Mechanisms, Chapter 3 in Mergers, ■ Minority Stake ≤ 50% Acquisitions, and Leveraged Buyouts, 102 ■ Robert Lawrence Kuhn, ed. Institutional Buy-Out (New York: McGraw-Hill, 1990), p. 39. ■ Acquisition 100% ■ Management Buy-Out ■ 227 Acquisition 51%–99%

Source: Zephyr

Average Deal Value for PE Firm Transactions During Q3 2013

$800

$728

$600

$489 $400 USD (in Millions)

$200 $221

$16 $0 Minority Stake Institutional Management Acquisition ≤ 50% Buy-Out Buy-Out 100% Source: Zephyr Note: Average deal value based on transactions for which values were publicly available.

Page 4 | NOVEMBER 2013 Industry Sector Transaction Analysis

NUMBER AND VALUE OF DEALS BY INDUSTRY For Q3 2013 $700  [A] “Financial Services” includes Security & Commodity Brokers – 7 / $675 non-depository credit institutions, as well as holding and other $600 investments offices.

The following industries had no $500 disclosed deal values therefore are not displayed on the chart to the left: Food Products (7 deals), Agriculture, $400 Forestry, and Fishing (1 deal), and Mining – 9 / $35 Wholesale Trade (7 deals).

$300 Manufacturing – 19 / $288 Note: Average deal value based on transactions for which values Electronics – 49 / $247 Utilities – 6 / $240 were publicly available.

AVERAGE DEAL VALUE (in Millions) VALUE DEAL AVERAGE $200 Transportation & Communication 4 / $120 Financial Services[A] Computer Programming

8 / $60 64 / $158 $100 Retail Trade – 14 / $77 Chemical & Metal Data Processing Services – 39 / $26 Products – 16 / $21 82 / $36 $0 Construction – 4 / $22 Public Administration – 3 / $14

0 10 20 30 40 50 60 70 80 90 During Q3 2013, the industry NUMBER OF COMPLETED DEALS with the largest reported Source: Zephyr average deal value was the During Q3 2013, the industry with the largest reported average deal value was the Security & Commodity Brokers sector with seven Security & Commodity Brokers sector with seven transactions averaging $674.7 million. transactions averaging Two transactions dominated this sector, namely (1) Knight Capital Group acquired $674.7 million in size. by KCG Holdings, Inc. for approximately $1.4 billion (General Atlantic LLC acted as advisor to the buyer) and (2) National Financial Partners Corporation acquired by Madison Dearborn Partners for approximately $1.3 billion.

Purchase Price Premium for Transactions Involving Public Companies Taken Private DEALS, DOLLARS, AND DISPUTES

MEDIAN PURCHASE PRICE PREMIUMS For the Previous 4 Quarters 30% ■ 30 days Prior to Announcement 28.1% ■ 60 days Prior to Announcement

22.6% 22.7% 22.7% 20% 21.0%

14.3% 13.7% 10% PERCENTAGE PREMIUM PERCENTAGE 8.0%

0% Q4/2012 Q1/2013 Q2/2013 Q3/2013 Source: Zephyr Note: Purchase price premiums based on transactions for which values were publicly available.

The median purchase price premium over share price 30 days prior to announcement for the trailing four quarters was equal to 17.4%.

The median purchase price premium over share price 60 days prior to announcement for the trailing four quarters was equal to 22.7%.

NOVEMBER 2013 | Page 5 Featured Transactions and Insights

Among the transaction activity and related events in the quarter, we select certain deals that present information we consider especially worthy of further review and analysis by those involved in structuring and negotiating deals. For balance, we select one transaction to highlight a valuation topic and one transaction to highlight a disputed item, each featured in the interest of sharing information and insights that we hope will be useful. This quarter, our valuation selection relates to control premiums, risks, and rewards arising from a competitive bidding process. Our dispute selection relates to structuring earn-outs and special considerations to avoid pitfalls.

Risks and Rewards from a Competitive Bidding Process

“Acquisitions that reduce On July 1, 2013, a controlled affiliate of Madison Dearborn Partners, LLC, a private excess capacity or put equity investment firm, acquired National Financial Partners Corporation (“NFP”), companies in the hands a former NYSE-listed company and a leading provider of benefits, , and of better owners or wealth-management services. managers typically create substantial value both for the economy as a whole Under the terms of the agreement, NFP shareholders will receive $25.35 in cash for and for investors.” each share of NFP common stock they own in a transaction with an equity value of

approximately $1.3 billion, a figure which includes the full value of the company’s convertible debt. The purchase price represents a premium of approximately 26% over McKinsey & Company, Tim Koller, Marc Goedhart, NFP’s closing share price of $20.05 on March 12, 2013, the last day of trading prior to David Wessels, Valuation Measuring and Managing the press reports that NFP was considering a possible sale of the company. Value of Companies. To oversee the sales process, NFP’s Board of Directors formed a special committee of independent directors to engage legal and financial advisors to assist in the bidding process which included private equity firms. The special committee selected Madison Dearborn’s offer and the transaction was unanimously approved by the Board. Per Jessica M. Bibliowicz, chairman and chief executive officer of NFP, “this compelling transaction provides shareholders with substantial value, and is a successful outcome of the thorough process undertaken by our Board.”

The NFP press release on the transaction raises several fascinating valuation topics, all geared around assessing risks and rewards. These topics include: what causes a premium to be paid over the trading value for a public company’s stock in the first place, what concerns arise for buyers in a competitive bidding process, and how do current shareholders benefit from such a competitive bidding process?

Page 6 | NOVEMBER 2013 First, while the stated control premium was 26%, if one considers the increase in NSF’s share price during the 30- and 60-day windows prior to the rumor date of the deal, March 12, 2013, the premium is actually quite larger. In fact, the transaction price was 36.5% greater than the closing price 30 days prior to the deal rumor date and 47.1% greater than the closing price 60 days prior to the deal rumor date. Notably, the share price on the exchange reflects a minority interest that has no power over company directions or actions and is burdened with a discount from the total value for the company to reflect its lack-of-control position. However, a takeover buyer for the company possesses such power and, therefore, the price paid for the entirety of the company with control reflects what is generally referred to as a control premium over the daily trading price per share of minority shares. On average, control premiums are priced at approximately 20% to 30% over share price, although that percentage varies based on a specific company’s circumstances and the enhanced shareholder valuation opportunities that control may avail to the buyer.

For targets pursued by multiple acquirers in a competitive bidding process, control premiums can rise dramatically, thus creating incremental risks for the winning bidder and concerns that they may have overpaid for the transaction. The key differentiator between buyers will be the level of synergies and efficiencies they Overestimating assume they may realize once in control of the target company. Overestimating synergies and/or synergies and/or efficiencies is a common cause of over-paying for an acquisition efficiencies is a common and can destroy the expected returns on the investment. Theoretically, if several cause of over-paying buyers evaluate a company and all identify similar synergies and efficiencies, the for an acquisition bidder who overestimates potential synergies the most will offer the highest price. and can destroy the Complicating this assessment for all parties involved is the determination of whether expected returns on the foundational price for the share price in the market is fairly stated or whether the the investment. market has under- or over-valued the company.

Finally, selling shareholders can benefit greatly from the competitive bidding process, in part through the same concerns and risks described above for bidders on the company. Of note, Ms. Bibliowicz’s comments that the transaction provides shareholders with “substantial value” and is a successful outcome of the “thorough process” undertaken by the Board may send the message that she feels the process produced a result exceeding fair value, the legal standard required to approve such a market transaction.

NFP STOCK PRICE $27

$25

$23

$21 ■ 3/12/13 – $20.05 U.S. DOLLARS $19

$17

$15 1/2/13 1/9/13 1/16/13 1/23/13 1/30/13 2/6/13 2/13/13 2/20/13 2/27/13 3/6/13 3/13/13 3/20/13 3/27/13 4/3/13 4/10/13

Source: Google Finance

NOVEMBER 2013 | Page 7 NFP PREMIUM 50%

40%

40%

■ 3/12/13 – 24.7%

20% PERCENTAGE

10%

0% 1/2/13 1/9/13 1/16/13 1/23/13 1/30/13 2/6/13 2/13/13 2/20/13 2/27/13 3/6/13 3/13/13 3/20/13 3/27/13 4/3/13 4/10/13

Source: Google Finance

Structuring Earn-Outs and Special Considerations to Avoid Pitfalls

An earn-out is an In 2007, Nuance Communication, Inc. (“Nuance”), a multinational computer software agreement for additional corporation traded on the NASDAQ exchange, acquired Vocada, Inc. (“Vocada”), consideration to be paid a medical software firm, from Murchison Capital Partners, Inc. (“Murchison”) in a to the seller based on transaction with aggregate consideration totaling $45 million. Under the terms of the future performance of agreement, Nuance acquired 100% of Vocada’s stock in exchange for the following: the acquired business, $20 million in cash or stock at closing, $4 million for employee retention payments generally in the form of a and management bonuses, and $21 million in earn-out consideration contingent on percentage of revenues Vocada’s flagship product, the Veriphy critical test result management system, meeting or profits. certain revenue goals over a three-year period.

Per news stories, Vocada’s board members valued the company at no less than $40 million prior to the sale, approximately equal to the $20 million paid at closing plus the full value of the earn-out of $21 million. From this information, assuming the company was worth $40 million as of the closing, it appears that the sellers essentially provided a type of unsecured financing to the buyers in the form of an earn-out, leaving the sellers with a significant amount of risk for the future success of the business. An earn-out is an agreement for additional consideration to be paid to the seller based on future performance of the acquired business, generally in the form of a percentage of revenues or profits.

A dispute arose when Nuance refused to pay Vocada any earn-out consideration because they claimed that Veriphy never reached the required revenue targets. In December 2010, Vocada shareholders filed a demand for arbitration seeking damages tied to the earn-out consideration and Nuance’s allegedly fraudulent conduct in the merger process. The panel found that Nuance fraudulently induced Vocada’s board and shareholders to enter into the merger agreement, however it ruled that Vocada wasn’t entitled to damages because the panel was “reasonably certain” Veriphy wouldn’t have achieved the revenue threshold necessary to include the $21 million earn-out payment. Strangely, Murchison “won” but received nothing in return for its earn-out.

Page 8 | NOVEMBER 2013 Murchison filed an application to vacate and remand the arbitration award in Texas State Court in November 2012, saying the panel failed to issue findings of fact and conclusions of law on Vocada’s request for out-of-pocket damages. The Judge refused to vacate the arbitration award and, instead, remanded the award to the panel for further consideration. The result for the selling shareholder, Murchison, is that it will never realize the expected earn-out of $21 million, representing approximately 50% of the value the Vocada board estimated for the company.

The publicly-available information on this transaction raises many important subjects related to structuring an earn-out and the financial motivations for buyers and sellers to enter into earn-out arrangements when involved in a business transaction.

• For a buyer, examples of when it makes sense to agree to an earn-out are as follows: when a buyer wants to motivate the selling shareholders to continue to grow the business, when there are new products or services with little history and the parties can’t agree on the expected future results for the not-yet-established products and services, or when financing the purchase is difficult and the earn-out essentially provides a form of seller financing. The financial reporting • For sellers, examples of when it makes sense to agree to an earn-out are as follows: rules for business when a seller decides to cooperate with a buyer in structuring a transaction while combinations provide hoping to achieve incremental value for assuming the risks of future payments, or important insight into the when a seller wants to capture synergies realized for the merger, such as matching buyer’s expectations to the seller’s products or services with the buyer’s distribution channels. pay additional amounts under an earn-out. Several common problems arise with earn-outs that, unfortunately, result in frequent Under ASC 805-30-25-5, disputes. These disputes often arise from ambiguous accounting terms in the the buyer must determine agreement that lack standalone reporting for the acquisition such that earn-out the fair value of the future reports are incomplete or burdened by unrelated costs as well as from buyer earn-out payments and mismanagement and failures to meet expectations. record the contingent consideration as part of The financial reporting rules for business combinations provide important insight the goodwill arising from into the buyer’s expectations to pay additional amounts under an earn-out. Under the acquisition. ASC 805-30-25-5, the buyer must determine the fair value of the future earn-out payments and record the contingent consideration as part of the goodwill arising from the acquisition. Underlying this determination would be financial projections and discount factors reflecting the buyer’s perceived risk-worthiness of achieving the forward-looking financial results. Certainly, if a dispute arises, the seller will want to carefully review these schedules, the buyer’s auditor’s assessment of the information, and all related financial statement disclosures. With regard to Nuance, it never recorded any contingent consideration for the acquisition of Vocada, leading one to believe that from the date of the acquisition, Nuance did not anticipate ever paying the selling shareholders anything under the earn-out arrangement.

NOVEMBER 2013 | Page 9 www.floydadvisory.com

ACKNOWLEDGEMENT We wish to acknowledge the valuable contribution to this analysis by Michael C. Gordon, Liz Klyuchnikova, Genevieve S. Snow, and Timothy E. Steinmetz.

For more information, please contact George Ives at 646.449.7275.

ABOUT Floyd Advisory Floyd Advisory is an independent consulting firm offering financial and accounting expertise in areas of business strategy, transaction analysis, and valuation matters. With offices in Boston and New York City, we provide services related to financial reporting problems, fraud investigations, SEC reporting issues, white collar defense matters, post-acquisition disputes, business damages, financial analysis, and decision making.

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