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LBO Overview The Art of the LBO November 2004 Agenda I. An Overview of Leveraged Buyouts II. The Building Blocks III. Putting It All Together IV. How It Happens in Reality 2 1 I. An Overview of Leveraged Buyouts What Are LBOs? What Is an LBO? A Leveraged BuyOut is the acquisition of an entire Company or division n Buyer (the “Sponsor”) raises debt and equity to acquire Target ¾ Borrows majority of purchase price ¾ Contributes proportionately small equity investment n Buyer grows Company, improves performance ¾ Relies on Company’s free cash flow and asset sales to repay debt ¾ Potentially makes add-on acquisitions ¾ Later sells or IPOs all or a portion of the Company to exit investment 4 2 What Is An LBO? Typical Leveraged Buyout Structure Current Acquiror Owners Purchase Equity (LBO Firm) Price Investment NewCo High Yield Bank Bondholders (Merged Into Banks Bonds Target) Loan Target 5 More Common Than You Think… Some prominent LBOs: Company Sponsor Size Silver Lake $2.0bn TPG, Bain & GS $1.6bn Madison Dearborn Partners $1.5bn KKR $1.5bn THLee $1.1bn Bain $1.0bn Blackstone $700mm 6 3 Value of LBO Activity: 1997-2003 100 $86 $86 $81 $85 80 $60 60 $43 $39 40 ($ Billions) 20 Global Announced Volume 0 1997 1998 1999 2000 2001 2002 2003 Source: GS F&P, Securities Data Co., Buyouts, Thompson Financial Securities Data 7 LBO Analysis – An Important Banker Tool n M&A valuation ¾ Complements other valuation techniques n Acquisition financing ¾ LBO ¾ Corporate acquisition ¾ “Staple-on” financing n Dividend recapitalization n Straight debt financings n Complex merger plan analysis ¾ Cash flow impact vs. EPS 8 4 II. The Building Blocks How Are LBOs Financed? The Building Blocks Types of Acquisition Financing Bank Debt (Senior) ~ 45% High Yield Debt ~ 25% (Subordinated) Private Equity ~ 30% 100% 10 5 How Are LBOs Financed? Hypothetical Example Cum. Multiple % of of LTM ($ in millions) 12/31/2003 Capitalization EBITDA Revolving Credit Facility - 6 Years $ 0.0 Tranche A Senior Term Loan - 6 Years 150.0 Tranche B Senior Term Loan - 8 Years 200.0 Total Senior Secured Debt 350.0 43.8% 2.9x Senior Subordinated Notes due 2014 200.0 Total Debt 550.0 68.8% 4.6x Management Rollover Equity 50.0 Sponsor Cash Equity 200.0 Total Equity 250.0 31.3% — Total Capitalization $800.0 100.0% 6.7x LTM EBITDA = $120.0 million. 11 Comparing the Building Blocks How the Pieces Differ Ranking in Capital Structure Cost Structure of Coupon or Dividend Maturity and Amortization Callability and Prepayment Fees to Underwriters Ratings Covenants and Legal Restrictions Marketing and the Capital-Raising Process Investor Base 12 6 Private Equity Terminology n Most junior money in the capital structure n Typically no dividends n Voting control at all times n Co-investing with other sponsors n Raised in the “alternative investment market” ¾ Portion from Sponsor – “put your money where your mouth is” ¾ Pension funds, endowments, investment portfolios, investment banks, commercial banks, “fund of funds ” ¾ Represents 5% to 10% of investors’ portfolios n Net IRRs to LPs are generally 15-25% 13 Size of the Private Equity Market US Fund Raising Activity 80 $63.3 60 $55.4 $36.9 40 $34.5 $34.6 ($ Billions) $23.2 $24.0 $18.4 20 $17.0 $11.6 $9.9 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 YTD Source: Buyouts Magazine 14 7 Average LBO Equity Contribution 45% 16% 40.6% 40.0% 39.4% 40 37.8% 14 35.7% 35 31.6% 12 30.0% 30 B Default Rates (%) 26.2% 10 Historical Single 22.0%25.2% 25 23.7% 22.9% 20.7% 8 20 to LBOs (%) 6 15 13.4% Average Equity Contribution 9.7% 4 10 7.0% 5 2 0 0 1987 1988 1989 19901991(a)1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 (a) No data for 1991 Source: Portfolio Management Data and Standard & Poor’s 15 ...But Equity Alone Is Not Enough Using Leverage to Turbo-Charge Returns 10 8.8x 9 8 7.2x 7 6.7x 5.8x 6 5.7x 5.3x 5.2x 5.3x 5.2x 5.3x 5.0x 5 4.5x 4.5x 4.0x 4.0x 3.8x 4 3.7x 3 1987 — Second Quarter 2004 2 1 0 Average Debt Multiples of Highly Leveraged Loans (a) 1987 1988 1989 1990 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 YTD Total Debt/EBITDA (a) Criteria: Pre-1996: L+250 and higher; 1996 to date: L+225 and higher; Media and Telecom loans excluded; there were too few details in 1991 to form a meaningful sample. Source: Portfolio Management Data. 16 8 How Are LBOs Financed? Hypothetical Example Cum. Multiple % of of LTM ($ in millions) 12/31/2003 Capitalization EBITDA Revolving Credit Facility - 6 Years $ 0.0 Tranche A Senior Term Loan - 6 Years 150.0 Tranche B Senior Term Loan - 8 Years 200.0 Total Senior Secured Debt 350.0 43.8% 2.9x Senior Subordinated Notes due 2014 200.0 Total Debt 550.0 68.8% 4.6x Management Rollover Equity 50.0 Sponsor Cash Equity 200.0 Total Equity 250.0 31.3% — Total Capitalization $800.0 100.0% 6.7x LTM EBITDA = $120.0 million. 17 Leveraged Bank Debt Terminology Ranking Senior secured, most senior debt in the capital structure Interest Rate Floating, typically LIBOR + 250 bps and higher, quarterly payments Maturity Varies with credit profile, typically 5-8 years, but before more junior debt Callability Typically prepayable at par Fees to 1.75% to 2.25% Underwriters Ratings Usually BB+ to B+ (rating agencies now rate bank loans) Covenants Maintenance covenants, set out in “Credit Agreement” Sold via syndication process and confidential offering memorandum Marketing (“bank book”) Process Diligence, commitment, launch, syndicate, fund 18 9 Leveraged Bank Debt Terminology n Revolving Credit Facilities vs. Term Loans ¾ Revolvers allow multiple drawings (like a credit card) ¾ Term Loans are funded at closing n Pro Rata Facilities ¾ Consist of Revolvers and “A” Term Loans (“Term Loan A”) ¾ Sold to traditional commercial banks ¾ Same LIBOR spread, 5-6 year maturities, even amortization n Institutional Tranches ¾ Consist of “B”, “C” or “D” Term Loans ¾ Sold to over 100 institutions and funds ¾ Progressively higher spreads, 6-8 year maturities, minimal front-end amortization 19 Leveraged Bank Debt Only a Subset of the Broader Loan Market $930 B Total Loan Market $329 B Leveraged Loan Market $73 B Sponsored Loan Source: Loan Pricing Gold Sheets, Buyouts Magazine, Standard & P oor ’s - 2003 20 10 Leveraged Bank Debt Historical Growth in the Market 350 $329 $300 $265 $256 $243 250 $220 $216 200 $185 $ billions 150 100 $71 $50 $49 50 $16 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Source: Portfolio Management Data 1993 -2000; Loan Pricing Corporation 2001-2003 21 How Are LBOs Financed? Hypothetical Example Cum. Multiple % of of LTM ($ in millions) 12/31/2003 Capitalization EBITDA Revolving Credit Facility - 6 Years $ 0.0 Tranche A Senior Term Loan - 6 Years 150.0 Tranche B Senior Term Loan - 8 Years 200.0 Total Senior Secured Debt 350.0 43.8% 2.9x Senior Subordinated Notes due 2014 200.0 Total Debt 550.0 68.8% 4.6x Management Rollover Equity 50.0 Sponsor Cash Equity 200.0 Total Equity 250.0 31.3% — Total Capitalization $800.0 100.0% 6.7x LTM EBITDA = $120.0 million. 22 11 High Yield Debt Terminology Ranking Usually subordinated and/or unsecured Fixed, expressed as a coupon, varies with credit quality, semiannual Interest Rate payments Maturity “Bullet” maturity in 10 years Callability “10NC5” and 35% “Equity Clawback” now standard Fees to 2.5% to 3.0% Underwriters Ratings Usually B+ to CCC+ Covenants Incurrence covenants, governed by the “Indenture” Marketing Sold via SEC Prospectus / 144A Offering Circular Process Diligence, documentation, roadshow, price, fund 23 Mezzanine Financing Terminology n Structure ¾ Rank / Return / Equity / “All-In” n Investors ¾ “Mezz” buyers in the market ¾ Banks / Other financial institutions n Issuer’s Perspective ¾ Leverage equity more; push risk / return profile ¾ Fill hole in cap structure ¾ Disclosure / Size 24 12 LBO Market Activity n LBO activity continues to be very strong n Extremely receptive financing markets ¾ Large amount of bank loan refinancings and new CLOs ¾ Substantial cash positions of high yield mutual funds n Large corporations divesting assets to reduce debt n Return of the jumbo LBO $7.05 B $4.75 B $4.3 B n Financial sponsors creating consortiums to cover large equity investments and diversify risk n Although the LBO market is back, sponsors remain disciplined 25 III. Putting It All Together The Analysis 13 The Five Simple Steps of LBO Analysis n Step #1: Evaluate the Story ¾ Is this a good debt story? ¾ What are the risks? ¾ What is the “real” EBITDA? n Step #2: Construct Sources & Uses n Step #3: Run the IRRs n Step #4: Does the LBO work? 27 Step #1 – Understand the Story Dig a Little Deeper n Is this a good debt story? ¾ Stability of revenues: Cyclicality? Contracts? Customers? Organic growth? ¾ Margins: Commodity risk? Supplier reliance? Pricing? ¾ Capex: Maintenance vs. discretionary? ¾ Working capital: Seasonality? Overall management? ¾ Management team: Track record? Acquisitions? n What are potential risks and mitigants? n Projections ¾ Are they realistic? ¾ How do they compare to historical? 28 14 Step #1 – Understand the Story EBITDA Revisited n What is the right time period to use? n Don’t take EBITDA at face value – look for adjustments n Common add-backs ¾ “Restructuring” charges ¾ Non-cash compensation ¾ Asset impairments ¾ Sponsor fees ¾ Money-losing businesses n Are adjustments really non-recurring? ¾ Look at historical financials ¾ Use common sense 29 Step #2 – Construct Sources and Uses Sources Uses Revolving Credit Facility $ 0.0 Purchase Target Equity $ 250.0 Term Loan A 150.0 Refinance Existing Debt 525.0 Term Loan B 200.0 Transaction Costs 25.0 Total Senior Debt 350.0 Senior Subordinated Notes 200.0 Total Debt 550.0 Management Rollover Equity 50.0 Sponsor Cash Equity 200.0 Total Sources $800.0 Total Uses $800.0 30 15 Step #2 – Construct Sources and Uses The Typical “Sources” of Funds n Bank debt (“Senior” debt) ¾ Start with 2.5x senior leverage ¾ Price term loan @ LIBOR + 3.00% ¾ Use 100% excess cash flow sweep n Total debt ¾ Start with 4.5x total leverage ¾ Difference between total and bank is high yield debt ¾ Minimum high yield size of $150mm ¾ Price high yield @ 10.00% n Equity contribution ¾ Minimum 30% contribution ¾ New sponsor cash equity vs.
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