O C T O B E R 2 0 0 4 I N T R O D U C T I O N T O V A L U A T I O N M E T H O D S U S E D I N I N V E S T M E N T B A N K I N G T L Y PRIVATE A ND CONFID E NTIAL
This presentation was prepared exclusively for the benefit and internal use of the JPMorgan client to whom it is directly addressed and delivered (including such client’s subsidiaries, the “Company”) in order to assist the Company in evaluating, on a preliminary basis, the feasibility of a possible transaction or transactions and does not carry any right of publication or disclosure, in whole or in part, to any other party. This presentation is for discussion purposes only and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this presentation nor any of its contents may be used for any other purpose without the prior written consent of JPMorgan.
The information in this presentation may be based upon any management forecasts provided to us and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of the Company or which was otherwise reviewed by us. In addition, our analyses are not and do not purport to be appraisals of the assets, stock, or business of the Company or any other entity. JPMorgan makes no representations as to the actual value which may be received in connection with a transaction nor the legal, tax or accounting effects of consummating a transaction.
Notwithstanding the foregoing (but subject to any applicable federal or state securities laws), JPMorgan and the Company may disclose to any and all persons, without limitation, the tax treatment and tax structure of any transaction contemplated hereby and all materials (including opinions or other tax analyses) relating thereto, so long as such disclosure is not made prior to the earlier of (x) public announcement of discussions relating to the transaction or of the transaction itself and (y) the execution of an agreement to enter into the transaction.
JPMorgan’s policies prohibit employees from offering, directly or indirectly, a favorable research rating or specific price target, or offering to change a rating or price target, to a subject company as consideration or inducement for the receipt of business or for compensation. JPMorgan also prohibits its research analysts from being compensated for involvement in investment banking transactions except to the extent that such participation is intended to benefit investors.
JPMorgan is a marketing name for investment banking businesses of J.P. Morgan Chase & Co. and its subsidiaries worldwide. Securities, syndicated loan arranging, financial advisory and other investment banking activities are performed by J.P. Morgan Securities Inc. and its banking affiliates. JPMorgan deal team members may be employees of any of the foregoing entities.
CONFIDENTIAL, FOR TRAINING PURPOSES ONLY
I ON T O V A L U A T ION M ET H O DS US ED IN I N VESTMENT BAN K ING
Agenda
Additional valuation materials LBO analysis
Comparable transactions analysis
Publicly traded comparable company analysis Discounted cash flow
Valuation overview 1 8 17 23 28 36 I ON T O V A L U A T ION M ET H O DS US ED IN I N VESTMENT BAN K ING
Research
Should our clients buy, sell or hold positions in a
given security? Research Should our clients buy, sell or hold positions in a
given security?
Acquisitions
How much should we pay to buy the
company? Acquisitions How much should we
pay to buy the company? New business presentations Various applications New business presentations Various applications Fairness opinions
Is the price offered for company/division fair (from a financial point of
view)? Fairness opinions Is the price offered for
company/division fair (from a financial point of
view)? Divestitures
How much should we sell our company/division for?
Divestitures How much should we
sell our company/division for? Hostile defense Is our company undervalued/ vulnerable to a raider? Hostile defense Is our company undervalued/ vulnerable to a raider?
Public equity offerings
For how much should we sell our company/division
in the public market? Public equity offerings For how much should we sell our company/division
in the public market?
Debt offerings
What is the underlying value of the business/
assets against which debt is being issued?
Debt offerings What is the underlying value of the business/
assets against which debt is being issued?
Valuation
Applications
O N O V E R V I E WValuation methodologies
“Intrinsic” value of business Present value of projected free cash flows to all providers of capital “Public market valuation” Value based on multiples for comparable companies in sale transactions Includes control premium “Public market valuation” Value based on market trading multiples of comparable companies How does a firm’s financial performance match to market value? Value based on debt repayment and return on investment Value to a financial/LBO buyer Liquidation analysis Break-up analysis Historical trading performance Private company valuation Expected IPO valuation Premiums paid analysis Valuation methodologies Discounted cash flow analysis Publicly traded comparable companies analysis Comparable acquisitions analysis Leveraged buyout/recap analysis Other O N O V E R V I E WApproach to valuation
In arriving at a preliminary valuation for its clients, JPMorgan utilizes several methodologies that are consistent with industry practices
In arriving at a preliminary valuation for its clients, JPMorgan utilizes several methodologies that are consistent with industry practices
(3) Comparable acquisition transactions
Utilizes data from M&A transactions involving similar companies (1) Discounted cash flow Analyzes the present value of a company’s free cash flow
(2) Publicly traded comparable companies
Utilizes market trading multiples from publicly traded companies to derive value (4) Leveraged buy out Used to determine range of potential value for a company based on maximum leverage capacity O N O V E R V I E W
Equity value versus enterprise value
Enterprise value = Market value of all capital invested in a business1 (often referred to as “transaction value”)
The value of the total enterprise: market value of equity + net debt
Equity value = Market value of the shareholders’ equity (often referred to as “offer value”)
The market value of a company’s equity (shares outstanding x current stock price)
Equity value = Enterprise value - net debt2
Liabilities and shareholders’ equity Assets Enterprise value Net debt Equity value
Enterprise
value
1Assume book value of debt approximates market value of debt
2Net debt equals total debt + minority interest + capitalized leases + short-term debt - cash and cash equivalents
O N O V E R V I E W
Equity value versus enterprise value (cont’d)
Value for owners of business
Multiples of
Net income
After tax cash flow
Book value
Equity value or offer value Equity value or offer value
Value available to all providers of capital
Multiples of
Sales
EBITDA
EBIT
Enterprise value or transaction value Enterprise value or transaction value
O N O V E R V I E W
Application example: Valuation summary
$60.00 $45.00 $64.60 $50.50 $34.75 $55.50 $54.70 $55.00 $47.10 $37.60 $37.30 $38.00 $50.40 $19.25 10.00 20.00 30.00 40.00 50.00 $60.00 7.0x—9.0x 2004E EBITDA 7.0x—9.0x 2008E EBITDA 8.0%—11.0% discount rate 1.6x LTM sales 9.8x LTM EBITDA 13.3x LTM EBIT Public market comparables 2 Precedent comparable transactions 52-week trading range1Share prices are based on 157.6 million diluted shares outstanding 2Forecasts are based on JPMorgan research
3Synergies assumed to be 6.0% of sales, capitalized at 8.0x
DCF analysis Analyst price target With synergies of $1,500mm 3 Current stock price = $34.20 7.0x—9.0x 25% IRR LTM EBITDA LBO Implied share price
Implied share price
O N O V E R V I E W
Agenda
Additional valuation materials LBO analysis
Comparable transactions analysis
Publicly traded comparable company analysis
Discounted cash flow
Valuation overview 1 8 17 23 28 36 I ON T O V A L U A T ION M ET H O DS US ED IN I N VESTMENT BAN K ING
DCF analysis: the process
Project the operating results and free cash flows of a business over the forecast period. The typical forecast period is 10 years. However, the range can vary from five to 20 years depending on the profitability horizon.
Estimate the value of the business at the end of the forecast period.
Adjust your valuation for all assets and liabilities not accounted for in cash flow projections.
Discount rate
Present value Determine a range of values for the enterprise by discounting the projected free cash flows and terminal value to the present.
Adjustments Projections
Terminal value
Use the weighted average cost of capital (WACC) to determine the appropriate discount rate range.
Step 1 Step 1 Step 2 Step 2 Step 3 Step 3 Step 4 Step 4 Step 5 Step 5 I SCOU N T ED CASH FLO W
The first step in DCF analysis is projection of unlevered
free cash flows
Calculation of unlevered free cash flow begins with financial projections
Comprehensive projections (i.e., fully-integrated income statement, balance
sheet and statement of cash flows) typically provide all the necessary elements
Quality of DCF analysis is a function of the quality of projections
Often required to “fill in the gaps”
Confirm and validate key assumptions underlying projections
Sensitize variables that drive projections
Sources of projections include
Target company’s management
Acquiring company’s management
Research analysts Bankers N T ED CASH FLO W
Free cash flow is cash available to creditors and owners
after taxes and reinvestment
Unlevered free cash flows can be forecast from a firm’s financial projections, even if
those projections include the effects of debt
Start your calculation with EBIT (earnings before interest and taxes)
EBIT (from the income statement)
Plus: Non-tax-deductible goodwill amortization Less: Taxes (at the marginal tax rate)
Equals: Tax-effected EBITA
Plus: Deferred taxes1
Plus: Depreciation and any tax-deductible amortization Less: Capital expenditures
Plus/(less): Decrease/(increase) in net working investment
Equals: Unlevered free cash flow
1Although beyond the scope of our current discussions, you should only include actual cash taxes paid in the DCF. Depending on the firm and industry, you may want to adjust for the non-cash (or deferred) portion of a firm’s tax provision. The tax footnote in the financial statements will give you a good idea of whether this is a meaningful issue for your analysis
I SCOU N T ED CASH FLO W
Projections
Key assumptions:
Deal/valuation date = 12/31/04 Marginal tax rate = 40% Discount rate = 10%
Fiscal year ending December 31,
2001 2002 2003 2004E 2005E 2006E 2007E 2008E Net sales $400.0 $440.0 $484.0 $532.4 $585.6 $644.2 $708.6 $779.5
EBITDA 80.0 88.0 96.8 106.5 117.1 128.8 141.7 155.9
Less: Depreciation 12.0 13.2 14.5 16.0 17.6 19.3 21.3 23.4
EBITA 68.0 74.8 82.3 90.5 99.6 109.5 120.5 132.5
Less: Taxes at marginal rate 27.2 29.9 32.9 36.2 39.8 43.8 48.2 53.0 Tax-effected EBITA $40.8 $44.9 $49.4 $54.3 $59.7 $65.7 $72.3 $79.5
Plus: Depreciation 16.0 17.6 19.3 21.3 23.4
Plus: Deferred taxes — — — — —
Less: Capital expenditures 20.0 22.0 24.2 26.6 29.3
Less: Incr./(decr.) in working capital 10.0 8.5 7.0 5.5 4.0 Unlevered free cash flow 40.3 46.8 53.8 61.4 69.6
Adjustment for deal date (40.3) — — — —
Unlevered FCF to acquirer $0.0 $46.8 $53.8 $61.4 $69.6
Memo: Discounting factor 0.0 0.5 1.5 2.5 3.5
Discounted value of unlevered FCF $0.0 $44.6 $46.7 $48.4 $49.9 Discounted value of FCF 2004P—2008P $189.6
Stand-alone projections for Company X ($ millions) Stand-alone projections for Company X ($ millions)
JPMorgan convention is to use the “mid-year” convention—which assumes cash flows happen midway during the year
N T ED CASH FLO W
Weighted average cost of capital (WACC) formula
Most firms use a combination of debt and equity to fund their operations. The overall cost of
capital is the weighted average of the cost of debt and the cost of equity WACC = rd * (Total debt) + re * (Total equity)
(Total cap) (Total cap) More accurately stated the formula is:
WACC = rd * [D *(1-T)] + re * E D+E D+E E = market value of equity
D = market value of debt T = marginal tax rate
re = return on equity (from CAPM)
rd = return on debt (assumed to be weighted average cost of debt¹)
Because interest is tax deductible, the true cost of debt is the after tax rate due to the ability
of interest expense to shield taxes. The tax rate used should be the marginal tax rate for each specific company
¹ In order to be more accurate, the analyst should try to estimate the current market cost of debt by looking at the market cost of debt of comparable companies (with similar credit ratings) I SCOU N T ED CASH FLO W
A + B = C
Discounted Discounted terminal value Firm value Terminal value as percent
FCF at 2008P EBITDA multiple of at 2008P EBITDA multiple of of total firm value Discount rate 2004–2008 6.0x 7.0x 8.0x 6.0x 7.0x 8.0x 6.0x 7.0x 8.0x 8% $196.8 $687.5 $802.1 $916.7 $884.4 $999.0 $1,113.6 78% 80% 82% 9% 193.1 662.6 773.1 883.5 855.8 966.2 1,076.7 77 80 82 10% 189.6 638.9 745.4 851.8 828.4 934.9 1,041.4 77 80 82 11% 186.1 616.2 718.9 821.6 802.3 904.9 1,007.6 77 79 82 12% 182.7 594.5 693.5 792.6 777.2 876.3 975.3 76 79 81 - D = E
Equity value Equity value per share1 Implied perpetuity growth rate Net debt at 2008P EBITDA multiple of at 2008P EBITDA multiple of at 2008P EBITDA multiple of Discount rate 12/31/04 6.0x 7.0x 8.0x 6.0X 7.0X 8.0X 6.0x 7.0x 8.0x 8% $100.0 $784.4 $899.0 $1,013.6 $19.17 $21.97 $24.77 0.2% 1.3% 2.1% 9% 100.0 755.8 866.2 976.7 18.47 21.17 23.87 1.1 2.2 3.0 10% 100.0 728.4 834.9 941.4 17.80 20.41 23.01 2.0 3.1 3.9 11% 100.0 702.3 804.9 907.6 17.16 19.67 22.18 2.9 4.0 4.8 12% 100.0 677.2 776.3 875.3 16.55 18.97 21.39 3.8 4.9 5.8
Terminal values: The exit multiple method
Note: DCF value as of 12/31/04 based on mid-year convention
1Based on 40.0 million basic shares outstanding and 2.0 million options with a weighted exercise price of $8.13 calculated using the treasury method
In the EBITDA exit multiple method, a multiple is applied to the final year’s EBITDA to determine a terminal value in the final year. This terminal value is discounted to the present and added to the PV of the cash flows
A review of the terminal value and implied perpetuity is useful to help understand the drivers of the DCF value
N T ED CASH FLO W
Terminal values: The perpetuity method
A + B = C
Discounted Discounted terminal value Firm value Terminal value as percent FCF at perpetuity growth rate of at perpetuity growth rate of of total firm value Discount rate 2004–2008 2.5% 3.0% 3.5% 2.5% 3.0% 3.5% 2.5% 3.0% 3.5% 8% $196.8 $991.0 $1,095.4 $1,223.0 $1,187.8 $1,292.2 $1,419.8 83% 85% 86% 9% 193.1 811.9 883.8 968.9 1,005.0 1,077.0 1,162.0 81 82 83 10% 189.6 681.5 733.7 794.0 871.1 923.3 983.6 78 79 81 11% 186.1 582.6 622.0 666.7 768.7 808.1 852.8 76 77 78 12% 182.7 505.1 535.8 570.1 687.9 718.5 752.8 73 75 76 - D = E
Equity value Equity value per share1 Implied EBITDA exit multiple
Net debt at perpetuity growth rate of at perpetuity growth rate of at perpetuity growth rate of Discount rate 12/31/04 2.5% 3.0% 3.5% 2.5% 3.0% 3.5% 2.5% 3.0% 3.5% 8% $100.0 $1,087.8 $1,192.2 $1,319.8 $26.59 $29.14 $32.26 8.6x 9.6x 10.7x 9% 100.0 905.0 977.0 1,062.0 22.12 23.88 25.96 7.4 8.0 8.8 10% 100.0 771.1 823.3 883.6 18.84 20.12 21.59 6.4 6.9 7.5 11% 100.0 668.7 708.1 752.8 16.34 17.31 18.40 5.7 6.1 6.5 12% 100.0 587.9 618.5 652.8 14.37 15.12 15.95 5.1 5.4 5.8
Note: DCF value as of 12/31/04 based on mid-year convention
1Based on 40.0 million basic shares outstanding and 2.0 million options with a weighted exercise price of $8.13 calculated using the treasury method
In the perpetuity method the final year cash flow is used to determine the terminal value of the cash flows
The PV of a growing perpetuity in year 5 is: FCF * (1+g)
(r - g)
Thus, this PV 5 years forward must then be discounted back to the valuation date
I SCOU N T ED CASH FLO W
Concluding DCF remarks
DCF analysis is a key valuation methodology
Three key variables
Projections/relevant and incremental cash flows (unlevered free cash flow)
Weighted average cost of capital (discount rate)
Residual value at end of the projection period (terminal value)
Remember
Validate and test projection assumptions
Determine appropriate cash flow stream
Utilize appropriate cost of capital approach
Carefully consider all variables in the calculation of the discount rate
Thoughtfully consider terminal value methodology
Sensitize appropriately (base projection variables, synergies, discount rates,
terminal values, etc.)
Footnote assumptions in detail
Think about other value enhancers and detractors
— NOLs
— Options, warrants, etc.
Check it with a calculator!
N T ED CASH FLO W
Agenda
Additional valuation materials LBO analysis
Comparable transactions analysis
Publicly traded comparable company analysis
Discounted cash flow
Valuation overview 1 8 17 23 28 36 I ON T O V A L U A T ION M ET H O DS US ED IN I N VESTMENT BAN K ING
Overview
Comparable company analysis values a company by reference to other
publicly-traded companies with similar operating and financial characteristics. It compares the public company value with operating statistics to calculate the valuation
multiple
Comparable companies values do not incorporate the “control” premiums reflected
in comparable acquisitions. Depending on market conditions, the comparable companies' multiples may or may not be higher than comparable acquisitions’ multiples
The trick to comparable company analysis is to find good comparables
The bad news: no two companies are really comparable
The good news: it doesn't matter, because everybody else (equity research
analysts, traders, arbs, etc.) has to deal with the same problem
Once you have chosen the comparable companies, calculate the implied value of
your company by multiplying the company’s historical and projected sales, EBIT, EBITDA, net income, book value and other key operating statistics by the respective comparable company multiples
LY T R AD E D C O M P ARA B L E C O M P ANY A NALY SI S
Identifying the right peer group
The key to compiling a trading comparables analysis is to identify companies that are considered comparable and that closely resemble the composition and function of the Company you are evaluating
SIC code search
Research reports
10K
To find comparable companies, look for companies with similar characteristics to those of the business being valued Industry Product Markets Distribution channels Customers Seasonality Cyclicality Size Leverage Margins Growth prospects Shareholder base Operational Financial U BLIC LY T R AD E D C O M P ARA B L E C O M P ANY A NALY SI S
Choosing the right metric
Even with standard metrics, certain multiples are more relevant for some industries than others
For many industries, FV/EBITDA multiples are the most common trading metric (e.g.
Industrials, Transportation, Distribution, etc.)
For other industries, P/E multiples are more widely followed (Pharmaceuticals, Restaurants,
Biotech, etc.)
Reading analyst reports will help you understand the metrics analysts use to value the sector
and the industry
Certain sectors have unique metrics
Telecommunications Natural resources Retail/Real estate
Enterprise value to
— Run rate revenue (LQA) — 2000 to 2002 revenue — Net PPE (Latest 10-Q) — Route miles (Latest 10-Q) — Fiber miles (Latest 10-Q) — Access lines (Latest 10-Q
and 1-year forward)
Enterprise value to — Pretax Sec10 — EBITDAX — Reserves — Production Equity value
— Discretionary cash flow
Enterprise value — Square footage — EBITDAR LY T R AD E D C O M P ARA B L E C O M P ANY A NALY SI S
FV/EBITDA4 P/E5
Company
Share
price1 52-wk. high % of Equity value2 Firm value3 2004E 2005E 2004E 2005E LTGR5 2004E PEG
Large capitalization WellPoint $111.05 94.0% $17,926 $19,164 8.9x 7.8x 15.6x 13.6x 15.0% 1.04x Aetna 87.40 91.9% 14,598 16,211 8.7x 7.8x 12.9x 11.3x 15.0% 0.86x Anthem 87.35 92.0% 12,264 13,927 7.4x 6.8x 14.0x 12.2x 15.0% 0.94x Cigna 65.22 92.5% 9,273 10,773 7.7x 7.4x 11.3x 10.2x 10.0% 1.13x Mean 92.6% 8.2x 7.5x 13.5x 11.8x 13.8% 0.99x Median 92.2% 8.2x 7.6x 13.5x 11.7x 15.0% 0.99x Mid c apitalization Oxford $53.62 88.1% $4,561 $4,965 7.8x 7.3x 12.0x 10.9x 12.0% 1.00x PacifiCare 38.25 89.5% 3,752 4,372 7.4x 6.5x 12.5x 10.5x 13.0% 0.96x Coventry 42.63 90.2% 3,979 4,149 8.9x 7.7x 13.1x 11.4x 15.0% 0.87x Humana 18.10 75.4% 2,973 3,616 6.8x 6.1x 11.1x 10.1x 13.5% 0.82x Health Net 26.05 72.8% 3,028 3,427 5.4x 4.8x 9.3x 8.1x 13.5% 0.69x WellChoice 36.75 94.5% 3,079 3,128 7.3x 6.4x 13.1x 11.5x 15.0% 0.88x Mean 85.1% 7.3x 6.5x 11.9x 10.4x 13.7% 0.87x Median 88.8% 7.3x 6.5x 12.3x 10.7x 13.5% 0.87x Small c apitalization Sierra $35.98 92.7% $1,322 $1,324 8.0x 7.7x 13.3x 11.8x 15.0% 0.89x
American Medical Security 25.74 92.3% 397 427 7.1x 6.5x 12.0x 11.0x 15.0% 0.80x
Median 92.5% 7.5x 7.1x 12.6x 11.4x 15.0% 0.84x
Blended mean 90.3% 7.6x 6.9x 12.7x 11.2x 14.2% 0.90x
Blended median 92.4% 7.6x 7.1x 13.0x 11.4x 15.0% 0.88x
UnitedHealth Group $65.41 95.5% $43,979 $46,379 11.2x 9.9x 17.4x 15.0x 17.0% 1.02x
$ millions, except for per share data $ millions, except for per share data
1As of 4/16/04
2Based on diluted shares outstanding using the treasury stock method 3Calculated using equity value plus debt
4Based on equity analyst research reports; includes investment income 5Based on I/B/E/S
Managed care trading comparables
U BLIC LY T R AD E D C O M P ARA B L E C O M P ANY A NALY SI S
Concluding remarks on comparable companies
Trading comps are an important valuation metric for a number of reasons
Benchmark of how the equity market is valuing the company stand alone and relative to its peers
Every CEO knows his own multiples and those of his peers
Key steps for comps
Choose the right comparable companies and valuation metrics to focus on
Spread the comps correctly
Use the comps to determine a valuation range
Getting the comps correct
Ensure you have correctly captured the equity and net debt components
— Diluted shares (includes options using the treasury method and convertibles if in the money) — Net debt includes preferreds, out of the money converts, capital leases, etc.
Ensure your income statement projections are uniform across your comps — Adjust for extraordinary items and one time charges
— Calendarize so that projections reflect the same time periods
— Check analyst projections to make sure they are treating all expense components the same across the comps (e.g., amortization of intangibles)
Determining a value range
Thoughtfully consider the multiple range—using the mean/median is not thoughtful Calculate the value correctly (Firm value versus Equity value issue)
LY T R AD E D C O M P ARA B L E C O M P ANY A NALY SI S
Agenda
Additional valuation materials LBO analysis
Comparable transactions analysis
Publicly traded comparable company analysis Discounted cash flow
Valuation overview 1 8 17 23 28 36 I ON T O V A L U A T ION M ET H O DS US ED IN I N VESTMENT BAN K ING
Overview of comparable transactions analysis
Comparable transactions analysis values a company by reference to other private market sales of similar businesses.
The trick is to find the right comparable transactions and to ferret out the information required to do the math. As in comparable companies analysis, look for acquisitions of companies in similar industry spaces, with comparable operational and financial characteristics
Recent transactions are a more accurate reflection of the values buyers are currently willing to pay than acquisitions completed in the further in the past because market fundamentals are subject to dramatic change over the periods of time
Establish relative values of various component businesses i.e., break-up analysis)
Multiples should be based on the latest public financial information available to the acquiror at the time of the acquisition
Develop understanding of M&A activity in industry
Relative activity
Who is buying?
What are they buying (market share, technology, etc.)?
How much are buyers paying?
Deal technicals (e.g., termination fees, lock-up options, etc.)
MP AR ABL E T R A N SAC T I O N S ANALY S I S
Overview of comparable transactions analysis (cont’d)
Comparable transaction analysis contains information about selected
acquisition transactions in the same industry as the company being
evaluated or in similar situations, e.g. LBO, hostile, reverse acquisitions
Purpose is similar to that of public comparables analysis except that by
looking at prior acquisitions, insight can be gained as to the premium paid
to gain control (i.e., control premium) of the target company, valuation
multiples, social issues, and technical transaction elements
In addition, “private market” values sometimes differ from public market
values
Measure private market value, including control value, strategic
benefits and synergies
O MP AR ABL E T R A N SAC T I O N S ANALY S I S
Date
announced Acquiror/ target
Transaction value ($mm) 10-day premium paid (offer/
average) Transaction value/ LTM EBITDA Equity value/ net income
Transaction value/ adjusted members2 LTM EBIT / adjusted
members2 growth rateLong term 3
4/26/04 UnitedHealth /Oxford $4,999 7.8%4 10/27/03 Anthem/ WellPoint 17,529 20.4 10/27/03 UnitedHealth /MAMSI 2,695 16.0 6/3/03 WellPoint/ Cobalt 930 13.8 4/29/02 Anthem/ Trigon 4,326 24.7 11/21/01 WellPoint/ CareFirst 1,300 NA 10/18/01 WellPoint/ RightCHOICE 1,358 45.1 LTM/1-year forward Mean5 11.9% 9.7x 15.3x/14.2x $2,984 $310 13.8% Offer6 43.8% 9.8x 16.1x/13.8x $1,724 $154 10.0%
Selected precedent managed care transactions
1Forward estimates based on equity research at the time of the transaction
2Adjusted members calculated using 100% of risk members and 20% of non-risk members, as of most recent filing prior to announcement 3I/B/E/S long term growth rate prior to announcement
4Premium paid to the 10-day average stock price prior to the news of the rumored Wellchoice/Oxford transaction was 18.9% 5Based on highlighted transactions
6 LTM EBITDA based on Company financials as of 6/30/04
LTM 1-year forward¹ 8.7x 10.6x 12.1x 19.8x 11.3x 11.6x 19.0x 17.2x 16.5x 33.7x 26.1x 22.6x 15.9x 15.2x 13.7x 20.8x 23.3x 20.2x 10.6x 13.3x 13.1x $1,792 $2,254 $1,813 $2,828 $1,506 $698 $51 $3,714 $152 $202 $125 $125 $106 $417 NA 15.0% 16.0% 20.0% 15.0% NA 11.5% MP AR ABL E T R A N SAC T I O N S ANALY S I S
Calculating the LTM (latest twelve months)
Fiscal year Most recentperiod
Period ending one year prior to
most recent
+
–
Q1 Q2 Q3 Q4 Q1 Q2Annual
QT-1 QT Annual(12/03)
+
10-Q (6/04) Six months–
10-Q (6/03) Six months=
(6/04) LTMTotal revenue $2,292.2 $1,480.4 $1,447.0 $2,325.6
Example: Terra Industries LTM = 6/30/04 Example: Terra Industries LTM = 6/30/04
Note: If the third quarter Form 10-Q is being used, revenues for nine monthsshould be used when calculating LTM results, not three months
O MP AR ABL E T R A N SAC T I O N S ANALY S I S
Agenda
Additional valuation materials
LBO analysis
Comparable transactions analysis
Publicly traded comparable company analysis Discounted cash flow
Valuation overview 1 8 17 23 28 36 I ON T O V A L U A T ION M ET H O DS US ED IN I N VESTMENT BAN K ING
LBO analysis provides another perspective on M&A transactions
A leveraged buyout is an acquisition transaction in which much of the purchase price is funded with debt; usually done by financial sponsors
This type of capital structure provides the ability to “leverage” returns on a relatively small equity investment, as cash flows generated during the investment period are used to pay down debt
Financial sponsors profit by exiting three to five years after the transaction Sell the target to another buyer
Take the target public
Recapitalize the target
Assumptions regarding the investment transaction, the exit and the period between the acquisition and the exit are critical to determining an appropriate capital structure and potential returns to equity
M&A clients include both financial sponsors and strategic players
Financial sponsors typically pursue M&A transactions with different perspectives and objectives (e.g., a shorter investment horizon)
Strategic buyers sometimes behave like financial investors (i.e., acquiring with the expectation of selling in several years)
Financial sponsors generally analyze a transaction using LBO methodologies in the first instance (and DCF, comparable companies/transactions analyses thereafter)
LBO valuation may be useful from a competitive point of view, as strategic players vie with financial sponsors for the same assets
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NALYSI
The process of LBO analysis
Projections Projections Adjustments Adjustments Terminal value Terminal value IRR IRR Pro forma capitalization Pro forma capitalizationDevelop an integrated model of the business that projects EBITDA and cash available for debt repayment over the investment horizon
(typically three to five years)
Estimate the multiple at which the sponsor can be expected to exit the investment at the end of the investment period
Determine a transaction structure and a pro forma capital structure that result in realistic financial coverage
Calculate returns (IRR) to the equity sponsor
Tweak the transaction/capital structure as needed to achieve harmony (if possible) between IRR, leverage and valuation
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NALYSI
The initial steps in an LBO analysis are identical to those
in a DCF analysis
The same financial projections developed for a DCF analysis can be used to build a
basic LBO model
Free cash flows are expected to be used to service debt, with positive flows to
equity typically coming at exit
Amount and predictability of free cash flows dictate whether a company is an
attractive or viable LBO target
Cash flows are not discounted
Terminal value drives valuation, and is calculated on the basis of multiples
Multiple of exit-year EBITDA is generally used to bound the valuation of the
enterprise in any possible exit scenario
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NALYSI
Pro forma capitalization and transaction structure are set
forth in “sources and uses”
Sources should show the entire pro forma capitalization of the company, including
New debt
New equity
Rolled-over debt and equity
Uses of funds should address all parts of the target’s existing capital structure, as
well as transaction-related leakage
Refinancing existing debt
Transaction expenses
Equity purchase price
Debt and equity to be rolled-over
Sources must equal uses
Any debt or equity that is rolled-over shows up under both sources and uses
Always depict every part of the capitalization, whether it changes pro forma or
not
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NALYSI
LBO models are driven by the characteristics of the
sources of capital for the transaction
Typically supplied by an investment or commercial bank
Usually secured/most restrictive covenants
Amortizing 5- to 8-year tenor
First in line at liquidation
Lowest coupon
Typically supplied by an investment or commercial bank or a mezzanine fund
Riskier debt/typically unsecured
Primarily bullet structures
Typical tenor is 10-year
High coupon
Typically supplied by an investment or commercial bank or a mezzanine fund (often sponsor-affiliated)
Multiple forms: Convertible debt, exchangeable debt, convertible preferred stock, PIK securities and warrants
Expected IRR in the 15—20% range
Typically supplied by a financial sponsor
Highest risk/cost of capital
Sometimes “stapled” to high-yield paper to attract broader investor group
Minimum annual returns >20% Mezzanine securities Mezzanine securities Subordinated debt Subordinated debt Common equity Common equity Senior debt Senior debt Revolving Term 30%–50% of total capital LIBOR + 200-400 5–8years Senior/sub notes Discount notes 25%–35% of total capital T + 350–650 7–10 years
Sub. debt (conv.) Preferred stock PIK Warrants 0%–35% total capital High teens/low 20s 7–10+ years 20%–40% of total capital 20%-30% IRR 5–7 year horizon Sample inputs Sample inputs Sample inputs Sample inputs Components of capital Components of capital A NALYSI S
Exit multiple 6.5x 7.0x 7.5x
2008 projected EBITDA $556 $556 $556
Implied 2008 firm value 3,613 $3,891 $4,169
Plus: 2008 cash 36 $36 $36
Less: 2008 total debt (1,154) (1,154) (1,154)
Implied 2008 total equity value $2,496 $2,774 $3,052
Implied 2008 sponsor equity value1 $2,371 $2,635 $2,899
Required return 25% 30% 35% 25% 30% 35% 25% 30% 35%
Implied max. equity contribution $869 $728 $614 $965 $809 $683 $1,062 $890 $751 Plus: Maximum transaction debt
(@ 5.0x LTM EBITDA) $1,550 $1,550 $1,550 $1,550 $1,550 $1,550 $1,550 $1,550 $1,550
Implied firm value2 $2,419 $2,278 $2,164 $2,515 $2,359 $2,233 $2,612 $2,440 $2,301
Implied LTM EBITDA multiple 8.0x 7.5x 7.1x 8.3x 7.8x 7.4x 8.7x 8.1x 7.6x
Value sensitivity analysis 25% returns 30% returns 35% returns
Exit multiple Exit multiple Exit multiple
6.5x 7.0x 7.5x 6.5x 7.0x 7.5x 6.5x 7.0x 7.5x Maximum leverage3 4.50x $2,336 $2,433 $2,530 $2,185 $2,266 $2,347 $2,062 $2,131 $2,199
4.75x 2,378 2,475 2,571 2,232 2,313 2,394 2,114 2,182 2,250 5.00x 2,419 2,515 2,612 2,278 2,359 2,440 2,164 2,233 2,301
Sample LBO valuation analysis
1Assumes management promote of 5% 2Valuation as at 12/31/01
3Leverage based on bank/bond case $ millions
$ millions
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NALYSI
At purchase No operating improvement/ No arbitrage Operating improvement/ No arbitrage Operating improvement and arbitrage EBITDA purchase multiple 7.0x
EBITDA on purchase date $100 Firm value at purchase date $700 Debt at purchase (5x EBITDA) 500
Equity value invested 200
EBITDA exit multiple 7.0x 7.0x 8.0x
EBITDA at exit $100 $128 $128
Firm value at exit 700 896 1,024
Debt (after paydown of $75 per yr.) 125 125 125
Equity value at exit 575 771 899
IRR (5-year exit) 23.5% 31.0% 35.1%
IRR drivers
Three important factors drive IRRs:
1) De-levering
2) Operating improvement, and
3) Multiple expansion (arbitrage)
$ millions $ millions
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NALYSI
Agenda
Additional valuation materials
LBO analysis
Comparable transactions analysis
Publicly traded comparable company analysis Discounted cash flow
Valuation overview 1 8 17 23 28 36 I ON T O V A L U A T ION M ET H O DS US ED IN I N VESTMENT BAN K ING
Several other types of analysis are common in
M&A transactions
Pro forma analysis—what is the impact on the company of this merger/acquisition?
Earnings impact (accretion/dilution)
Growth impact
Multiple impact
Premiums paid analysis—how does the premium to be paid compare with prior
transactions?
Analysis at various prices (AVP)—At different prices what are the implied premiums
and multiples?
Contribution analysis (stock for stock deals)
Shareholders of each company receive shares in the merged entity—contribution
analysis looks at what each company gives versus what it gets
Shares traded analysis
Attempts to establish cost basis in shares
Interloper analysis
On the buyside, tactically it is important to determine which other companies
may be interested in the target
Once other potential bidders have been identified it is important to analyze their
capacity to pay and the pro forma impact on their earnings
O N AL VALUA T I O N M AT E R IA LS
Purpose of pro forma analysis
Evaluate the impact of a merger or acquisition on the income statement and
balance sheet of a potential buyer
Pro forma analysis is used to determine
Pricing capacity of Acquirer to pay for Target based on certain key measures
Optimal form of consideration (cash, stock, other securities, combination)
Key measures
Dilution in earnings per share
Pretax synergies required to break even
Leverage/capitalization Interest coverage Post-transaction ownership O N AL VALUA T I O N M AT E R IA LS
Accretion/(dilution)
Acquiror standalone EPS xxx
Acquiror NI xx
Target NI xx
Combined NI XX A
Transaction adjustments:
Amortization of identifiable intangibles (xx) Incremental interest expense from transaction debt (xx)
Foregone interest income on cash (xx)
Amortization of transaction fees (xx)
Tax rate differential (xx)
Total transaction adjustments (XX) B
Pro forma net income A — B
Total shares outstanding xxx
Pro forma EPS xxx
Proforma calculation Proforma calculation O N AL VALUA T I O N M AT E R IA LS
Premium to Target
0% 20% 25% 30%
Implied offer price per share $22.67 $27.20 $28.34 $29.47 Implied exchange ratio2 0.39x 0.47x 0.49x 0.51x
Implied transaction value3 $373 $446 $465 $483
Implied Acquiror ownership 89.7% 87.9% 87.5% 87.1% Target 2004E transaction P/E 10.4x 12.5x 13.0x 13.5x Target 2005E transaction P/E 9.3x 11.2x 11.7x 12.1x
100% stock
2004E $—EPS ($0.08) ($0.24) ($0.27) ($0.31)
2004E %—EPS (1.3%) (4.0%) (4.7%) (5.3%)
Add’l pre-tax synergies to break even $5.8 $18.4 $21.5 $24.6
2005E $—EPS ($0.13) ($0.30) ($0.35) ($0.39)
2005E %—EPS (1.9%) (4.5%) (5.2%) (5.8%)
Add’l pre-tax synergies to break even $9.7 $23.8 $27.4 $30.9
Pro forma debt $735.5 $735.6 $735.7 $735.7
Pro forma capitalization 2,586.5 2,660.0 2,678.4 2,696.8 Pro forma debt/pro forma 2003E EBITDA 1.3x 1.4x 1.4x 1.4x Pro forma debt/pro forma total cap 28.4% 27.7% 27.5% 27.3%
75% stock/ 25% cash
2004E $—EPS $0.03 ($0.11) ($0.15) ($0.18)
2004E %—EPS 0.6% (1.9%) (2.5%) (3.1%)
Add’l pre-tax synergies to break even NM $8.3 $11.0 $13.7
2005E $—EPS $0.03 ($0.13) ($0.17) ($0.21)
2005E %—EPS 0.4% (2.0%) (2.5%) (3.1%)
Add’l pre-tax synergies to break even NM $9.9 $12.9 $15.9
Pro forma debt $820.5 $839.0 $843.6 $848.2
Pro forma capitalization 2,586.6 2,660.1 2,678.5 2,696.9 Pro forma debt/pro forma 2003E EBITDA 1.5x 1.5x 1.5x 1.6x Pro forma debt/pro forma total cap 31.7% 31.5% 31.5% 31.5%
EPS accretion/dilution summary
EPS1 P/E
Current price 9/27/04 % 52-wk high 2004E 2005E 2004E 2005E
Target $22.67 99.3% $2.18 $2.43 10.4x 9.3x
Acquiror $57.99 97.9% $5.87 $6.70 9.9x 8.7x
$ millions, except per share data $ millions, except per share data
$ millions, except per share data $ millions, except per share data
Note: Target estimates based on equity research, expect EPS, which is based on I/B/E/S; Acquiror estimates based on JPMorgan equity research; Assumes transaction date of 12/31/03, tax rate of 37.0%, 10.0% of excess purchase price allocated to non-goodwill intangibles and amortized over 10 years, transaction expenses of 0.20% and financing fees of 0.10% for illustrative purposes; Assumes interest expense of 6.5%, existing Target debt is refinanced at this rate 1Based on I/B/E/S O N AL VALUA T I O N M AT E R IA LS
Bootstrapping
Potentially increasing your P/E by acquiring a company with a lower P/E and “bootstrapping”
Acquiror’s P/E
FC acquires CC for stock. It takes 1/2 of FC stock to acquire CC
Finance club (FC) Consulting club (CC)
P/E multiple 20x 10x Stock price $20.00 $10.00 EPS 1.00 1.00 Shares outstanding 1 1 Earnings 2.00 Shares outstanding 1.5 EPS $1.33
Stock Price $26.66 Accretive, assuming multiple stays the same
O N AL VALUA T I O N M AT E R IA LS
1 day prior to announcement (median %; 2004YTD)
1 day prior to announcement (median %; 2004YTD) 1 month prior to announcement (median %; 2004YTD)1 month prior to announcement (median %; 2004YTD)
22% 22% 24%
30%
Premiums paid analysis for US targets
Source: Thomson Financial
Note: Includes all transactions with US targets (friendly and hostile) from 1/1/99 to 7/31/04
1Cash transaction if cash is greater than 40%
15% 24% 10% 25% $0.5-$1bn $1-$5bn $5-$10bn $10bn+ # of transactions 27 32 4 5 $0.5-$1bn $1-$5bn $5-$10bn $10bn+ Median: 20% Median: 23% # of transactions 27 32 4 5
1 day prior to announcement: $0.5bn+
1 day prior to announcement: $0.5bn+ 1 month prior to announcement: $0.5bn+1 month prior to announcement: $0.5bn+
27% 26% 32% 29% 27% 25% 20% 20% 18% 19% 15% 27% 1999 2000 2001 2002 2003 2004YTD Stock Cash 40% 13% 30% 44% 38% 31% 22% 36% 34% 28% 25% 52% 1999 2000 2001 2002 2003 2004YTD Stock Cash 1 1 O N AL VALUA T I O N M AT E R IA LS
Current Offer
Price per share $23.39 $30.00 $32.75 $33.00 $34.00 $35.00 $36.00
Implied premium/(discount) to:
Current price (9/10/04) $23.39 - 28.3% 40.0% 41.1% 45.4% 49.6% 53.9% 52-week high $27.76 (15.7%) 8.1% 18.0% 18.9% 22.5% 26.1% 29.7% One month prior average price $22.60 3.5% 32.8% 44.9% 46.0% 50.5% 54.9% 59.3% Three month prior average price $24.61 (5.0%) 21.9% 33.1% 34.1% 38.1% 42.2% 46.3% Six month prior average price $25.20 (7.2%) 19.0% 30.0% 31.0% 34.9% 38.9% 42.9% One year prior average price $23.83 (1.9%) 25.9% 37.4% 38.5% 42.7% 46.8% 51.0%
Implied equity value1 $377 $483 $527 $531 $547 $564 $580
Add: Total debt2
30 30 30 30 30 30 30 Implied firm value $407 $513 $558 $562 $578 $594 $610 Implied firm value multiples
Operating Metrics3 LTM revenue2 $740 0.55x 0.69x 0.75x 0.76x 0.78x 0.80x 0.82x 2004E revenue $744 0.55x 0.69 0.75 0.75 0.78 0.80 0.82 2005E revenue $799 0.51x 0.64 0.70 0.70 0.72 0.74 0.76 LTM EBITDA2 $57 7.2x 9.0x 9.8x 9.9x 10.2x 10.4x 10.7x 2004E EBITDA $58 7.1x 8.9 9.7 9.7 10.0 10.3 10.6 2005E EBITDA $62 6.6x 8.3 9.0 9.1 9.3 9.6 9.9
Implied P/E multiples
LTM EPS2 $2.04 11.5x 14.7x 16.1x 16.2x 16.7x 17.2x 17.6x
2004E EPS $2.15 10.9x 14.0 15.2 15.4 15.8 16.3 16.8 2005E EPS $2.37 9.9x 12.7 13.8 13.9 14.3 14.8 15.2
$ millions, except per share data $ millions, except per share data
1Based on 16.1mm fully diluted shares outstanding as of 9/5/04 provided by management 2As of 6/30/04
3Based on management estimates
Analysis at various prices
O N AL VALUA T I O N M AT E R IA LS
14.1% 13.7% 14.0% 13.7% 14.1% 13.8% 8.9% 10.1% 85.9% 86.3% 86.0% 86.3% 85.9% 86.2% 91.1% 89.9% Revenue - 2004E Revenue - 2005E EBITDA - 2004E EBITDA - 2005E Net income - 2004E Net income - 2005E
Current equity value Transaction equity value
London Umbrella
Contribution analysis
Contribution Total ($mm) $40,940 $46,126 $4,868 $3,195 $48,695Note: Estimates for London and Umbrella based on projections prepared by Umbrella management; analysis excludes transaction adjustments
$5,542 $2,850 $49,360 O N AL VALUA T I O N M AT E R IA LS
44% 25% 7% 24% $22.00—23.50 $23.50—25.00 $25.00—26.50 $26.50—28.00 21% 24% 27% 28% $22.00—23.50 $23.50—25.00 $25.00—26.50 $26.50—28.00 Cum: 21% 45% 72% 100% 8% 18% 7% 42% 25% $19—21 $21—23 $23—25 $25—27 $27—29 One-month
One-month Three-monthThree-month
Six-month
Six-month 1 year1 year
Shares traded analysis
Avg. daily trading vol (’000s) 56 Total shares traded (’000s) 7,132
Peak daily volume (’000s) 266
VWAP $25.17
High price $27.76
Low price $22.07
Avg. daily trading vol (’000s) 61 Total shares traded (’000s) 15,420
Peak daily volume (’000s) 266
VWAP $23.57
High price $27.76
Low price $19.75
Avg. daily trading vol (’000s) 53 Total shares traded (’000s) 3,320
Peak daily volume (’000s) 180
VWAP $24.60 High price $27.25 Low price $22.07 45% 6% 14% 6% 29% $22.00—22.25 $22.25—22.50 $22.50—22.75 $22.75—23.00 $23.25—23.50
Avg. daily trading vol (’000s) 53 Total shares traded (’000s) 1,167
Peak daily volume (’000s) 180
VWAP $22.51 High price $23.38 Low price $22.07 Cum: 8% 50% 75% 93% 100% Note: As of 9/10/04 Source: Tradeline Cum: 44% 51% 75% 100% Cum: 29% 35% 80% 94% 100% O N AL VALUA T I O N M AT E R IA LS
Interloper analysis
Potential acquirors
Apogent Applied BioSystems Mettler-Toledo Thermo-Electron Waters
2003 cash EPS $1.36 $1.07 $2.53 $1.19 $1.60
Accretion/dilution - $ (0.07) 0.01 (0.11) (0.02) (0.08)
Accretion/dilution - % (5.0)% 1.3% (4.1)% (1.6)% (4.8)%
Incremental pretax synergies to break even 15.0 NA 9.5 6.2 20.4
% of target S,G&A 19% NA 12% 8% 26%
2004 cash EPS $1.66 $1.35 $3.26 $1.41 $2.00
Accretion/dilution - $ 0.04 0.08 0.13 0.06 (0.01)
Accretion/dilution - % 2.4% 6.0% 4.3% 4.2% (0.4)%
Incremental pretax synergies to break even NA NA NA NA 2.0
% of target S,G&A NA NA NA NA 2%
Ownership
PBSC 21% 11% 24% 13% 16%
Acquiror 79% 89% 76% 87% 84%
2003 Break even price $6.45 $9.41 $7.06 $7.48 $5.94 2004 Break even price $9.44 $12.96 $9.89 $11.08 $8.24
1Based on Pedro offer of 0.311 shares per Pablo share, implying a price per share of $8.46 based on Pedro closing price of $27.19 on 7/12/03 2Assumes synergies of $30 million with 50% realized in 2003
O N AL VALUA T I O N M AT E R IA LS
