Marketing Fundamentals - BUAD 307 s8

Private Equity: Venture Capital & Leveraged Buyouts

523– Spring 2014

Professor: Gordon Phillips Office: HOH 714 Office Phone: (213) 740-0598 (email contact however is best). E-mail: [email protected]

Lecture Class Wed. evening 6:30 – 9:30 JKP 112

Office Hours Wednesday 4:00 – 6:00 Thursday 1:30 – 2:30

Introduction and Course Objective

FBE 523 uses a combination of lectures and the case method to introduce you to private equity. Private equity is a broad designation that includes venture capital and also leveraged buyouts of existing private and public companies. This course is time-consuming and challenging. Do not take this course if you are not willing to participate fully in class. The class periods will be a mixture of lectures and case discussion. Assigned readings must be completed prior to class.

The major emphasis is how financiers (venture capitalists, investment banks and private equity partnerships) help growing firms using different types of securities at different points in the industry's and firm's life. We will study venture capitalists on the finance side, young start-ups and more mature firms that go private on the firm side. We will also study preferred stock, private financing arrangements, Initial Public Offerings (IPOs) as this is how entrepreneurs cash out, private equity funds and raising private equity during the recent financial crisis.

Learning Objectives

 Global Objectives: The objectives of this course are two-fold:

1. Provide an understanding of the institutions and economics of private equity. 2. To understand how to raise money for a businesses at different stages of their life.

 Detailed Objectives o Understanding fundamental private equity terms, concepts, principals, and theories. o Understand the securities used in private equity. o Developing critical thinking and communication skills related to private equity. o Evaluate a new company from a financial perspective. 1 o Understand a financing term sheet.

Required Materials

1) Chapters from: Metrick and Yasuda (MY), Venture Capital and the Finance of Innovation, Wiley 2010 (VCFI), available at the bookstore but frequently cheaper on Amazon. Print ISBN-10: 0470454709 Print ISBN-13: 978-0470454701

2) CASES in case package (Harvard and Darden and my own case). First case, “Yale Investments Office” is just a “reading case” no analysis. Of the remaining 7 cases, you will be responsible for analyzing six of eight (you will have 1 additional free "pass"). Also note 2 of the cases are split into 2 parts for ease of exposition – both parts count as 1 case together.

3) Course packet will also consist of the following articles.

1. Note on the Financial Perspective: What Should Entrepreneurs Know? Harvard Business School Note #9-285-087. 2. How Venture Capitalists Evaluate Potential Venture Opportunities 9-085-019 4 interviews with venture capitalists. 3. New Venture Financing #9-802-131 4. Note on the Valuation of VC deals. (Stanford Case E-95) 5. Method for Valuing High-Risk, Long-Term Investments Harvard Business School Note #9-288-006. 6. Deal Structure and Deal Terms 9-806-085 (includes venture capital term sheet)

4) Other articles I will post on blackboard including: 1) Kaplan, Steven N. and Per Stromberg, 2003, Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts, Review of Economic Studies (Blackboard). 2) Ibbotson, I., J. Sindelar, J. Ritter, Initial Public Offerings, Journal of Applied Corporate Finance, VOLUME 1 NUMBER 2 SUMMER 1988, pp. 38-45, (Blackboard). 3) Klein, Zenner, Shivdasani, ”The Private Equity Revolution: Are You Ready?”, Citicorp corporate and investment banking group, (Blackboard).

4) Kohlbert, Kravis, Roberts, Leveraged Buyouts, Journal of Applied Corporate Finance, VOLUME 2 NUMBER 1 SPRING 1989, pp. 64-72, (Blackboard). 5) Inselberg, I. and H. Kaufold, How to Value Recapitalizations and Leveraged Buyouts, Journal of Applied Corporate Finance, VOLUME 2 NUMBER 2 SUMMER 1989, pp. 87-96, (Blackboard).

2 5) Subscription to the Wall Street Journal online. For the Wall Street Journal: You can subscribe online and get the student rate (70% off and online WSJ included, about $30 for 15 weeks) at the following URL: https://buy.wsj.com/shopandbuy/order/subscribe.jsp?trackCode=aap1hybd

Prerequisites: Corporate Finance

Course Notes: Copies of lecture slides and other class information will be available through your Blackboard account.

COURSE READINGS/CLASS SESSIONS Daily Activities Tasks, Readings, and Due Dates

Week 1 Introduction / Overview of Venture Capital Readings: (1.) MY Chapter 1-3, + (2.) Jan 15 and Private Equity

Week 2 Case 1: Yale Investments Office Case discussion: Yale Investments 1/22 Review of Valuation Office Lecture on Security Issuance and Design Read Class lecture notes + HBS Note: “Note on the Financial Perspective: What Should Entrepreneurs Know?” Week 3 Case 2: Dynatronics case Do Dynatronics case: Part 1, 1/29 Lecture on External Funds Needed (EFN) No case handin, just discussion in class Lecture notes on EFN Week 4 Dynatronics case: Part 2 Turn in Dynatroncs case: Part 2 2/5 / Lecture on VC Strategy Case handin or presentation (1.) MY Chapter 7 + (2.)HBS note: "How Venture Capitalists Evaluate Potential Venture Opportunities ” (3.) HBS Note: "New Venture Financing". Week 5 Lectures on VC Securities Tu/Th Read (1.) MY, Chapter 8-10 2/12 (2. )HBS Note: "Method for Valuing High-Risk, Long-Term Investments" (3.) Stanford "A Note on the Valuation of VC deals"

Week 6 Lectures on VC continued Turn in Valhalla case or presentation 2/19 Case 3: Valhalla Partners Read MY Chapter 13-14 Week 7 More on VC Preferred Stock Read (1.) MY Chapter 15-16 2/26 Case 4: Metapath Case HBS NOTE (2.) “ Deal Structure and Deal Terms” Turn in Metapath case handin or presentation Week 8 Lecture on scenario analysis and Do Crystal Ball tutorial 3/5 simulation / Review Crystal Ball Read MY, Chapter 21, 24

3 Week 9 Midterm 3/12 Sp. Brk ENJOY YOUR SPRING BREAK!!! Week 10 Simulation / scenario continued Turn or present Genzyme Geltex case 3/26 Case 5: Genzyme-Geltex case Week 11 Lecture on Initial Public Offerings Read: "Initial Public Offerings" 4/2 Case 6: Netflix Case Part 1 (blackboard) Do Netflix I case (no turnin on this part) Week 12 Case 6 continued: Netflix Case Part 2 Turn in or present Netflix II case 4/9 Lecture on private equity and LBOs Read: (1.) ”The Private Equity Revolution: Are You Ready?”, (blackboard) (2.) "Leveraged Buyouts" (blackboard) Week 13 Lecture on LBO valuation Turn in or present Brazos case 4/16 Case 7: Brazos Partners: The Co-Mark Read: " How to Value LBO / Recapitalizations and Leveraged Buyouts Possible Industry Speaker Week 14 Lectures on Convertible bonds and warrants 4/23 Week 15 Case 8: Warren Buffet GE or Goldman Turn in or present Warren Buffet case. 4/30 + Course Overview. FINAL

Grading Summary:

Case writeups (5): 35% (5 written cases, 7% each) Case presentation (1): 15% (1 case presentation, different case than the ones written up). Given there are 8 cases this means that you will not turn in 2 of them. We will just discuss as a class the case: Yale Investments Office, the 2nd one you will not turn in is your choice. Midterm exam: 20% Final or project: 20% Participation: 10%

I evaluate participation by the quality of your course comments on our case discussions and will keep track of participation. You are required to bring your name card to class.

Attendance is not part of the course grade but missing more than 2 classes will result in a loss of 5% of the participation grade and of course missing classes may affect your test performance.

Final grades represent how you perform in the class relative to other students. Your grade will not be based on a mandated target, but on your performance. The average grade will conform to Marshall MBA standards and it will be about a 3.5 – ranging from 3.4 to 3.6 depending on overall class performance. Three items are considered when assigning final grades:

1. Your average weighted score as a percentage of the available points for all assignments (the points you receive divided by the number of points possible). 2. The overall average percentage score within the class.

4 3. Your ranking among all students in the class.

CLASS PROCEDURES AND ASSIGNMENTS DETAIL

Case Studies:

We will study 8 cases during the semester. While you will read them all, you will not have to analyze fully all of them as you will only do 6 cases (5 with written case memos and 1 group presentation). The first case “Yale Investments Office” will not have a "turn-in" - you will just read it and think about the discussion questions. You will have 1 "pass" on the subsequent cases and thus you will only be responsible to turn in 6 cases from cases 2 to 8 below (5 with written case memos, including Dynatronics, and 1 with require a group presentation). NOTE 2 cases are split up into 2 parts – however both parts count as 1 case. I just split the case into 2 to make sure you don’t get “lost” halfway through. Thus if you skip one of these cases, you should skip both parts – you can’t just skip ½ of these cases. (Not recommended as these are two cases in which you will learn a lot.) Case 1: Yale University Investments Office (An introduction to venture capital and private equity - just a discussion, but read the case and think about the discussion questions). Case 2: Dynatronics ( covered in two parts, turn in just part 2) (IT case, bank and other financing) Case 3: Valhalla Partners, 9-805-033 (Venture Capital – IT case). Case4: Metapath Software, 9-899-160 (Venture Capital – IT case). Case 5: Genzyme – Geltex (biotechnology case). Case 6: NetFlix (covered in 2 parts, turn in just part 2). (famous IPO) Case 7: Brazos Partners: The Co-Mark LBO Case 8: One of my private equity cases. The cases will deal with venture capital, initial public offerings and private equity used in buyouts. Finally, the last “case” also has another different dimension. We will be analyzing a recent private equity deal from the recent financial crisis using online data. The objective in using case studies is to provide examples of companies or individuals that have faced the topic at hand and to apply theoretical tools to real problems. I will distribute questions and ideas that you may use as guidelines for analyzing the case. In addition, for each case, I will assign study questions concerning the case. For most of the class period, we will consider these questions and the material in the case. You are allowed and encouraged, but not required, to meet in your groups outside of class to discuss and analyze the cases. I expect that these groups will complement class discussion well. In addition, you may discuss and analyze the cases with anyone you choose.

Each student will submit a two-page memorandum of analysis and recommendations at the beginning of each case discussion. If you are working in a group, I will accept one memorandum from the group and count it for all students in the group. If you choose to do this, the group cannot exceed 5 students. Each memorandum should be typed and double-spaced. Do NOT write up the memo as answers to the study questions. Write these as if you were writing a executive memo with your recommendation to the major decision-maker in the case. The two-page limit is for text only. You may attach up to 4 pages of additional excel exhibits or graphs.

5 Memoranda will not be accepted after the class has met. You can email the case hand-ins to: [email protected] . Faxed memoranda will not be accepted.

In your memoranda, you should argue as if you are in a funding meeting rather than in a class. The process of arriving at the answer is as important as getting the answer.

Students sometimes ask that instructors’ case analyses be handed out after the class has discussed the case. I will not do this, because there are usually no absolute right answers. The best cases are deliberately written to be ambiguous. While there are no right answers, there are good arguments and bad arguments. Among other things, this course is designed to help you learn to distinguish between sensible and senseless arguments. Handing out my analyses would reduce the ambiguity in the cases and partially defeat the purpose of doing cases. Handouts also tend to circulate which is a problem when I teach the case in another semester. If you are uncomfortable with ambiguity, do not take this class.

Finally, if your name is on the report as part of the group, it means you participated in the analysis. You are on the honor code to observe this requirement. If for some reason you are not able to participate in the case write-up with the group, you can turn in a write-up on that case or a different case on your own.

The content of the case memorandum is as follows:

1. Write up your analysis as an executive memo to the major decision maker in the case. Use an executive memo format with an introductory paragraph containing your executive summary and recommendation. Do not answer the questions with a 1. 2. 3. Format. The questions are merely designed to get you start thinking. 2. The case questions are designed to help you streamline the issues to be addressed. If you believe that these questions do not effectively address the problems in the case, feel free to go outside the parameters of the questions. 3. It is not necessary to rehash the case situation in your write-up. Do not, however, assume that I know every single number and detail. Use your best judgment on how much of the case to include in your write-up. 4. Most importantly, you must take a position regarding the problem in the case and make specific recommendations on how to solve it. Support your recommendation as succinctly and as effectively as you can. 5. The case write-up to be a double-spaced two-page (maximum) report with up to an additional 4 pages of exhibits – for a maximum total of 6 pages. The case write-up should be double spaced, in 12 point type with 1 inch margins.

*** I do not expect that you “kill the case” – but rather that you show a thoughtful, well-reasoned approach. I am looking for well-structured arguments – some mistakes are fine and will of course occur. ***

Case Presentation: Each team will be assigned to present one case. For each case, one to two teams will present their case presentation with their analysis to the class. Note case teams will have a maximum of 5 members. The presentation should consist of 20 powerpoint slides MAXIMUM with 30 minutes maximum presentation time. These guidelines are strictly enforced. Your grade will be based on

6 both presentation skills (25%) and also content (75%). Each team member is required to speak and be responsible for covering a minimum of 4 slides. Please come early to class the day of your presentation so you can load your slides onto the computer. You are also required to bring a printed copy of your slides for me. CLASS GUIDELINES

Add/Drop Process

The class will remain open enrollment (R-clearance) for the first two weeks of the semester. If the class is full, students will need to continue checking Web Registration to see if a seat becomes available. There are no wait lists for these courses, and professors cannot add students.

If you do not attend the first two class sessions or the first class session of the semester for a once- a-week class, I may drop you from the course without any notification. This procedure is so that students from any wait list can be accommodated and to ensure the class forms teams and works constructively together. In addition, if you are absent two or more times (for the weekly class) prior to the last date to withdraw from the course, I may ask you to withdraw by that date. These policies maintain professionalism and ensure a system that is fair to all students.

Retention of Graded Coursework:

Final exams and all other graded work which affect the course grade will be retained for 1 year after the end of the course if the graded work has not been returned to the student; i.e., if I returned a graded paper to you, it is your responsibility to file it, not mine.

523 Technology Policy

Laptop / tablet use is not permitted during academic or professional sessions unless we are working on a case and then the use is solely for analyzing the case and no internet browsing is permitted. Use of other personal communication devices, such as cell phones, is considered unprofessional and is not permitted during academic or professional sessions. ANY e-devices (cell phones, PDAs, I-Phones, Blackberries, other texting devices, laptops, I-pods) must be completely turned off during class time. Upon request, you must comply and put your device on the table in off mode and FACE DOWN. Videotaping faculty lectures is not permitted, due to copyright infringement regulations. Audiotaping is permitted. Use of any recorded material is reserved exclusively for USC Marshall students.

Statement for Students with Disabilities

Any student requesting academic accommodations based on a disability is required to register with Disability Services and Programs (DSP) each semester. A letter of verification for approved accommodations can be obtained from DSP. Please be sure the letter is delivered to me (or to TA) as early in the semester as possible. DSP is located in STU 301 and is open 8:30 a.m.–5:00 p.m., Monday through Friday. The phone number for DSP is (213) 740-0776.

Statement on Academic Integrity

7 USC seeks to maintain an optimal learning environment. General principles of academic honesty include the concept of respect for the intellectual property of others, the expectation that individual work will be submitted unless otherwise allowed by an instructor, and the obligations both to protect one’s own academic work from misuse by others as well as to avoid using another’s work as one’s own. All students are expected to understand and abide by these principles. SCampus, the Student Guidebook, contains the Student Conduct Code in Section 11.00, while the recommended sanctions are located in Appendix A. http://www.usc.edu/dept/publications/SCAMPUS/gov/

Students will be referred to the Office of Student Judicial Affairs and Community Standards for further review, should there be any suspicion of academic dishonesty. The Review process can be found at: http://www.usc.edu/student-affairs/SJACS/ Failure to adhere to the academic conduct standards set forth by these guidelines and our programs will not be tolerated by the USC Marshall community and can lead to dismissal.

Emergency Preparedness/Course Continuity

In case of emergency, and travel to campus is difficult, USC executive leadership will announce an electronic way for instructors to teach students in their residence halls or homes using a combination of Blackboard, teleconferencing, and other technologies. Instructors should be prepared to assign students a "Plan B" project that can be completed at a distance. For additional information about maintaining your classes in an emergency please access: http://cst.usc.edu/services/emergencyprep.html

Please activate your course in Blackboard with access to the course syllabus. Whether or not you use Blackboard regularly, these preparations will be crucial in an emergency. USC's Blackboard learning management system and support information is available at blackboard.usc.edu.

Incomplete Grades Explanation:

In incomplete (IN) grade may be assigned due to an “emergency” that occurs after the 12th week of classes. An “emergency” is defined as a serious documented illness, or an unforeseen situation that is beyond the student’s control, that prevents a student from completing the semester. Prior to the 12th week, the student still has the option of dropping the class. Arrangements for completing an IN course should be initiated by the student, and negotiated with the instructor. Class work to complete the course should be completed within one calendar year from the date the IN was assigned. The IN mark will be converted to an F grade should the course not be completed.

Assignment Submission Policy

Assignments must be turned in on the due date/time electronically via Blackboard. Any assignment turned in late, by more than 15 minutes, will receive a grade deduction (for example, if your work is a B+ grade, you will be given a C+ grade). If your internet breaks down on the due date, you must deliver a hard copy at the beginning of class on that day. If you are unable to attend class on that day, make arrangements for it to be delivered to the classroom or to my box by the start of class. Late or not, however, you must complete all required assignments to pass this course.

8 Evaluation of Your Work

You may regard each of your submissions as an “exam” in which you apply what you’ve learned according to the assignment. I will do my best to make my expectations for the various assignments clear and to evaluate them as fairly and objectively as I can. If, however, you feel that an error has occurred in the grading of any assignment, you may, within one week of the date the assignment is returned to you, write me a memo in which you request that I re-evaluate the assignment. Attach the original assignment to the memo, and explain fully and carefully why you think the assignment should be re-graded. Be aware that the re-evaluation process can result in three types of grade adjustments: positive, none, or negative.

All grades assigned by faculty members are final. Students have the right to seek explanation, guidance, counsel and reasons for the assignment of a grade. Students may appeal a grade according to university policy as set forth in SCampus. Faculty may initiate a change in grade if there is an error in the calculation of a grade. However, a faculty member may not change a disputed grade outside the formal appeals process. In response to a disputed academic evaluation by an instructor, a student is entitled to two levels of appeal after review by the instructor: first to the chairperson of the department and then to the appropriate dean of the school. The full university policy can be found on page 125 of SCampus and at: http://www.usc.edu/dept/publications/SCAMPUS/gov/disputed_academic_evaluation_procedures. html

9 Case Guidance Questions

These are guidance questions: Top cases frequently do not just answer the questions. Think beyond these basic guidance questions.

IMPT: Use an Executive Memo Style, with an executive summary. Remember to NOT to write up your memo in 1. 2. 3. format.

Dynatronics Case Guidance Questions:

Case Guidance Questions:

Part 1:

1. Why is the bank tightening the requirements on Dynatronics? In particular why is the bank referring this growing firm to their factoring high-risk division? 2. What are the cash flows for the new product line? Clearly state your assumptions on the first page of your case write up. 3. What is the company’s weighted average cost of capital (WACC) – assume that the company does issue 400,000 shares of stock using an IPO and issues equity at $6.5 per share – which nets the company $5 per share. Assume the amount of existing debt stays the same. 4. Is the new product line worth introducing? Calculate the NPV of the new product line. 5. Is it worth it to increase the stocks of finished goods? Try several different levels of inventory and try to see which level is the best. Try a yearly IRR analysis here. 6. What would you say as the bank about financing new product lines? What covenants would you include?

Part 2:

1. As the bank, what is an appropriate set of base case (i.e. no new product or inventory policies) pro forma financial statements for Dynatronics for the next 3 years? 2. Using these pro forma statements, estimate the company’s external financing requirements for the 3 years 1989, 1990, and 1991. What financing would you recommend as a financier for the current business? 3. If you do either or both of the new investment alternatives, what is the company’s external financing requirements?

10 4. As an outside financing advisor, present a financing plan that details both the source (debt vs. equity), and the amounts of external finance that is needed.

11 Case: Valhalla Partners

Case Guidance Questions: 1. Should Art Monks vote to make an investment in Telco Exchange? What valuation do you think is appropriate? What would be the deal terms? You will have to make lots of assumptions but do your best to justify them and the deal terms you would require in order to invest. 2. Based on the information in the investment memo, what are the top 3 risks you see in Telco Exchange? 3. What is your assessment of Valhalla’s due diligence process? In your opinion, what is the most significant benefit of the process? What set of risks does it present?

Case: Metapath Software

Case Guidance Questions: 1. Describe the past financing strategy of Metapath. 2. What are the pros and cons of the two financing options? The VC option vs. selling out to Celltech? 3. Why are the venture capitalists choosing to offer preferred stock with the particular terms and conditions outlined in the case to Metapath? Describe the pros and cons of this particular preferred stock. 4. What do you think the participating convertible feature is worth? How much should Hanson be willing to accept as a sale price per share to the venture capitalists to remove it? 5. What is your final recommendation?

Case: Genzyme/Geltex Pharmaceuticals Joint Venture

1. What is the strategic importance of this project? How should we evaluate the attractiveness of this opportunity? 2. Does anything worry you about this project? What could happen? 3. What is the meaning of “probability”? What are the relevant probabilities in this case? How might we incorporate them into our analysis? 4. What does the output of the monte-carlo simulation show? 5. How does this opportunity look to you now? (pre monto-carlo vs. post monte-carlo) 6. How can we make it better? How can we improve the deal?

12 NetFlix.com:

PART 1:

1. How would you assess NetFlix’s performance to date as an outsider financier?

2. What is NetFlix’s long-run objective? How does NetFlix plan to achieve its long-run objective?

3. As an outside investor, construct an annual subscriber model that can be used to forecast cash flows per subscriber for the next 5 years. What is the value of a new subscriber using a discount rate of 20%.

PART 2 1. How much cash (External Funds Needed) does NetFlix need in order to remain viable over the next 5 years? You will have to project subscriber growth rates for the next 5 years. Assume total subscribers (of all 3 types, trail, 6 months, and permanent) ends year 2000 at 250,000 initially.

2. Assuming that NetFlix does not change its business model, come up with a value for NetFlix- both total value pre-IPO and a value post-IPO using discounted cash flow? Come up with total firm values both pre- IPO and post-IPO.

3. Using the data from your answer in question #5, Calculate the per share fundamental price pre-IPO and post-IPO. To calculate a per-share price, the following data will be helpful. There will be 25,651,415 (see pro forma capitalization in attached table) shares of stock issued and outstanding upon conversion of the preferred stock BEFORE any additional shares are issued. (These data are from the capitalization of the firm as of Dec 31, 1999 from their statements filed with the SEC (Securities and Exchange Commission).

4. What changes, if any, would you suggest as an outsider investor to its business model? What are the value implications of these changes?

5. Should NetFlix go public? If not, what would you recommend?

13 Case Analysis: Brazos Partners

Case Questions: 1. What is the Brazos’ private equity funds investment strategy? Does it seem well suited for a first time fund? How do you assess the merits of the GTT transaction? 2. How has the recessionary climate affected the Brazos’ investment strategy, in both favorable and unfavorable ways? 3. Is Co-Mark an attractive investment? How attractive is the purchase price? Conduct your own valuation of the firm. 4. The Brazos partners claim that structuring the deal as an asset purchase rather than a stock purchase is beneficial, not just to Brazos, but also to the management team. Assess this claim

Case Analysis: Sun Microsystems, ticker SUNW (one of the final cases, you will pick just 1 of these real time cases):

See blackboard for full assignment details. The data for this real-time case can be found online from two sources. 1. Main source: SEC EDGAR at http://www.sec.gov/Archives/edgar/data/709519/000118143107006432/000118 1431-07-006432-index.htm 2. You will also need daily stock price data from a site that has stock price data like the wall street journal or Nasdaq web site.

Case Questions: 1. Analyze why the company has chosen to issue a $750 million convertible bond issue. What factors led them to choose this security? Use historical cash flow data to understand these factors. 2. How does the company's option to call the convertible affect the decision to issue and the convertible's value? 3. Determine both the value of the convertible bond and the effect its issuance will have on the company's cost of capital. 4. How should the company's basic business risk and strategy affect its long- term capital structure policy?

14 Case Analysis: Countrywide Financial, ticker CFC (one of the final cases, you will pick just 1 of these cases):

See blackboard for full assignment details. The data for this real-time case can be found online from two sources. 1. SEC EDGAR at http://www.sec.gov/Archives/edgar/data/25191/000089882207001085/0000898 822-07-001085-index.htm 2. You will also need daily stock price data from a site that has stock price data like the wall street journal or Nasdaq web site. Case Questions: 1. Analyze why the company choose to issue a $2 billion convertible preferred stock issue. What factors led them to choose this security? Use historical cash flow data to understand these factors. 2. What is the value of the preferred stock under reasonable assumptions? 3. What affect will its issuance will have on the company's cost of capital? 4. Does this issuance affect the value of CFC stock? If so how? Try to come up with some reasonable scenarios and analyze some cash flow data. 5. How should the company's basic business risk affect its long-term capital structure policy? 5. .

The data for this real-time case can be found on blackboard and from SEC Edgar. Please consult the document and data on blackboard.

Case Questions: 1. Analyze why the company has chosen to issue 5 Billion Preferred stock + warrants to Warren Buffet. What factors led them to choose this security? Use historical cash flow data to understand these factors. 2. Determine both the value of the preferred stock and the warrants and the effect its issuance will have on the company's cost of capital. 3. How should the company's basic business risk and strategy affect its long-term capital structure policy?

15 Assignment: 1. Analyze why the company has chosen to issue 5 Billion Preferred stock + warrants to Warren Buffet. What factors led them to choose this security? Use historical cash flow data to understand these factors. 2. Determine both the value of the warrants and the effect its issuance will have on the company's cost of capital. If the required return on the preferred stock is 10%, also consider the value of the preferred stock. 3. How should the company's basic business risk and strategy affect its long-term capital structure policy?

More specific details can be found online (see blackboard) and at: http://biz.yahoo.com/e/081020/ge8-k.html and details of the warrants are at: http://www.sec.gov/Archives/edgar/data/40545/000090951808000768/mm10- 1608_8ke4a.htm

16 Final Project

You may do a project instead of the “appointed” final case. If so you can do the project with a teammate. Otherwise the final case is an individual effort. The reports can vary in length but should be LESS than 20 pages including exhibits (15 pages is fine). Reports should be double spaced with normal margins. If you can it may also be a good idea to talk directly to the company’s executives when possible. Many companies in the area are willing to talk to MBAs and it will give you some direct (hopefully high level) exposure as well as improve your analysis.

The following represent potential topics for projects: Venture Capital Investment, Leveraged Buyouts, and Initial Public Offerings.

It should be on a firm that has tapped the VC market or plans to tap it, an IPO or LBO/Bankruptcy in the past 12 months. If it is an IPO company, the company should have already gone public in the last 12 months or has filed statements with the SEC to go public.

I. Venture Capital Investment

Put yourself in the position of a venture capitalist and analyze a small to medium sized firm for a potential investment. Analyze an existing firm and talk to a venture capitalist.

Your project should have the following components:

1. A term sheet for the proposed investment. What securities will you offer? What will be the terms and covenants? Over what items will you be willing to bargain?

2. What performance orientated items will you include as part of the terms and covenants?

3. If you are not the first investor, how do past rounds of financing affect your terms?

4. A plan for due diligence for the investment.

5. An analysis of the company’s projected cash flows. What are the strengths, weaknesses, critical factors.

6. An evaluation of the management team.

17 II. Going Public: Analyze the performance of Initial Public Offerings after going public to determine whether you should continue to invest in initial public offerings. Consider the perspective of the investor and the firm. Is the price set "right"? What factors are important for this firm.

Examples of Industries:

A. The Computer Industry: AOL, Google etc.

B. The Biotechnology Industry: Focus on Genetic, Amgen and others -

C. The Medical Technology Industry:

Your Analysis should include (again not merely comprise) the following issues:

1. A discussion and analysis of annual financial statements for the company and its competitors. Discuss industry and competitor's ratios, identifying financial strengths and weaknesses. What made the company decide to go public?

2. Has the company done "well" following the IPO? Investment/market share relative to its competitors?

3. Cost of Capital: Estimate the required rate of return for stock, bonds for at least one company in the industry using stock market data from the Daily Stock Price Record or from the Wall Street Journal.

4. Given information in the prospectus and other competitors what should be the offering price?

5. Discuss the price set by the investment banker vs. the closing price after the first day of trading. Is there any difference? If so, should management be “upset”? Was the company priced incorrectly? If so, why?

6. Your Suggestions: Do you recommend the company for an investment - What are the risks, potential rewards?

III. Leveraged Buyout

Pick a company that recently went private using a leveraged buyout (LBO). Analyze the following questions:

1. A discussion of the company’s performance and debt and capital structures over time – what were the factors that led to the company’s LBO?

2. What is the company’s capital structure and value pre-LBO?

3. What securities did the buyout firm issue at the time of the LBO? What changes were forecasted in the company’s capital structure in the future?

18 4. What is the company’s capital structure and value post-LBO?

5. What happens to required rates of return for stocks, bonds, post-LBO?

6. What was the company’s “performance” after the LBO? How did the firm's cash flows and business risk affect its "performance" after the LBO?