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

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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

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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

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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

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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

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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%

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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.

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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

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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%

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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

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1987 — Second Quarter 2004 2

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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.

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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

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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

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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.

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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

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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

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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

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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?

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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?

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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

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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

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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. management rollover

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Step #2 – Construct Sources and Uses The Typical “Uses” of Funds n Retire existing debt ¾ Existing covenants will typically prohibit post-LBO debt levels ¾ Don’t forget tender/call premiums n Pay transaction fees & expenses ¾ Bank debt fees: 1.75% to 2.25% ¾ High yield fees: 2.50% to 3.00% ¾ Don’t forget legal expenses n Purchase target equity ¾ Make this the “plug” to balance Sources & Uses for now

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16 Step #3 – Run the IRRs n Calculate returns depending on future “exit strategy” in Years 3–5 n Typical exit analysis contemplates outright sale of company ¾ Make base case exit EBITDA multiple = entry multiple n Deduct net debt in exit year to compute future equity value n Allocate equity to owners based on ownership ¾ Financial sponsor vs. management ¾ Exercise of warrants if appropriate

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Step #4 – Does the LBO Work? Ask yourself the following questions: n Do the senior and total debt multiples “make sense” in the context of the overall purchase price multiple? n Are the coverage ratios adequate? ¾ EBITDA / Interest Expense > 2.00x ¾ (EBITDA - Capex) / Interest Expense > 1.50x n How is the bank debt amortizing? ¾ Is the bank debt completely repaid by year 7? n What are the results after running more realistic and downside cases? n What are the expected credit ratings?

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17 Step #4 – Does the LBO Work? Iterate Until The LBO Works For All Constituencies

Debt Holders: Equity Holders: Feasibility Attractiveness

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Step #4 – Does the LBO Work? How Does the Implied Valuation Compare? n Triangulate with Other Enterprise Valuation Techniques ¾ Deal Comps ¾ Common Stock Comps ¾ Other Recent LBOs n Can a financial sponsor beat a strategic? ¾ Synergy opportunities ¾ Merger plan analysis

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18 IV. How It Happens In Reality The Tension between Buyer and Seller

The Scenario n An attractive business is up for auction n Your client is a large private equity player n Tomorrow is the final bid deadline n You believe your client is competing vs. a large corporation and other financial sponsors n The corporate can pay tomorrow in cash n The seller wants to know you’re good for the money n Your client wants guidance from you on: ¾ Maximum leverage ¾ Certainty of funds ¾ Financing conditions

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19 What Does the Seller Want? n Seller generally wants to maximize selling price n But not all bids are created equal — seller also wants certainty ¾ How long between signing and closing? ¾ Sponsor generally needs to raise the debt in this period ¾ Compare with corporate buyer with available stock/cash n Mere promise by buyer to raise the debt is insufficient n Seller wants legal commitment n Although Sponsor has committed financing, the letters typically have “outs” that weaken the commitment

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What Can the Buyer Do?

n Buyer must make seller comfortable that the financing risk is minimal by providing committed financing n Committed financing is usually comprised of a bank commitment and a bridge commitment

¾ The bank commitment typically represents the senior secured portion of the capital structure (i.e., “Bank Debt”)

¾ The bridge commitment typically represents the subordinated portion of the capital structure (i.e., “High Yield”) n Sponsor typically has access from its own funds but check absolute dollar size of equity needed

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20 The Commitment Letters n The bank and bridge commitments are comprised of four letters ¾ Commitment letter that covers both facilities ¾ Fee letter for the bank facility ¾ Separate fee letter for the bridge facility ¾ Engagement letter for the take-out of the bridge facility

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