2007 summer analyst valuation book

VALUATION PROJECT WORKBOOK

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SUMMER ANALYST PROGRAM – 2007

PRELIMINARY | SUBJECT TO FURTHER REVIEW AND EVALUATIONTHESE MATERIALS MAY NOT BE USED OR RELIED UPON FOR ANY PURPOSE OTHER THAN AS SPECIFICALLY CONTEMPLATED BY A WRITTEN AGREEMENT WITH CREDIT SUISSE.

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If you have any questions regarding materials in this book, or the valuation project in general, don’t hesitate to call us:

Anna Golynskaya Phil KohnTraining Leader Training [email protected] [email protected] (212) 538-5442 (212) 538-0558

Miriam Roshan Jeff VollingTraining Leader Training Leader (212) 325-1822 (212) 325-5529 [email protected] [email protected]

Table of Contents

1 Overview of Valuation Project

2 Sample Project

3 Weekly Assignments and ResourcesA Public Information Book (PIB)B Company ProfileC Equity Comps / M&A CompsD DCF and WACC AnalysisE Merger Consequences Analysis

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1. Overview of Valuation Project

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Overview of Valuation ProjectWelcome to Credit Suisse! In addition to meeting a ton of new people and having fun for the next 10 weeks, we figured it would be helpful for you to return to college your senior year having learned something about what Investment Bankers do

Several analysts, associates, and Vice Presidents from across the division have worked hard to put the following materials together as your “one-stop shop” for banking how to’s

In addition to your group staffing assignments over the next two months, you will also be asked to complete a group valuation project to be submitted by Week 9 of your program. The submission will include the following: A company profile Equity comps and M&A comps DCF valuation Merger consequences analysis

At the end of the summer, August 2nd, your team will be asked to present, in a short session, your analyses and conclusions to a team of bankers

This project will be completed gradually over the course of the summer and we will be holding 4 sessions (1 every week) to cover each of the topics or analysis we will be asking you to do

You will be required to turn in you work for the topic covered each week at the following weeks session (i.e., you will go over profiles in first session and turn them in at the second session) We plan to return your assignment within one week so you can see if you are on the right track and

where you may need to improve

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Project Schedule and Key Dates

Date Session Details Next Steps

Session 1 June 29 10 am & 2 pm

Finding public information and creating a PIB Creating a company profile

Create Knight Ridder PIB Create Knight Ridder profile

Session 2 July 6

10 am & 2 pm

Equity Comps and Acquisition Comp Analysis Find Knight Ridder trading comparables Find important average trading stats

For given comparable acquisitions, find key multiples

Session 3 July 13

10 am & 2 pm

Discounted Cash Flow Create projected Knight Ridder income statement

Determine WACC based on comps Project free cash flows and discount at WACC

Session 4 July 27

10 am & 2 pm

Merger Consequences Evaluate transaction consequences including EPS accretion/dilution, pro forma credit stats, pro forma ownership

Create premiums paid and synergies sensitivity tables

PRESENTATION August 6 Present final projects Good Luck!!

This schedule provides a set of guidelines to help you plan your final project.

Note: Due to the fact that the deal was announced on 3/13/06, for all valuations, please use all public information available as of then (latest filing would be the 12/25/05 10-K) and stock prices and research as of 3/10/06.


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2. Sample Project

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Provides comprehensive supply chain management services in four business segments: “Less-than-truckload” segment, carriers provide regional and inter-

regional delivery throughout the United States “Truckload” segment offers premium regional and national truckload

services “Logistics” segment provides dedicated fleet, cross-dock operations,

supply chain management, contractual warehousing, domestic ocean freight forwarding and reverse logistics services

“Information Technology” segment provides support activities including corporate sales and various financial management functions

USF provide services to a wide variety of customers, with no single customer accounting for more than 3.3% of revenue

Management and Board of DirectorsCompany Overview

USF Corporation – Company Profile

1/28/2005: USF Corporation reported fourth quarter and full year 2004 results, missed Wall Street earnings

12/13/2004: Announced opening of two new terminals serving the Southern Minnesota and Decatur, Alabama areas

11/2/2004: Richard P. DiStasio stepped down as CEO, Paul Liska was named interim CEO

10/22/2004: Reported third quarter 2004 results, missed Wall Street earnings

9/9/2004: USF Holland announced the opening of eight (8) Northeast terminals, service city includes: Baltimore, MD Albany, NY, Allentown, PA, Harrisburg, PA, Philadelphia, PA, Wilkes Barre, PA, Syracuse, NY, and Richmond, VA

Recent News Ownership

Status: Public (Nasdaq: USFC) Headquarters: Chicago, ILWebsite: www.usfc.com Employees: 21,000

Source: Company filings, and website.

Name Position and Affiliation Thomas E. Bergmann Interim CEO, CFO

Steven Caddy President and CEO, USF Holland

Edward R. Fitzgerald President and CEO, USF Reddaway

Douglas R. Waggoner President and CEO, USF Bestway

Paul J. Liska Chairman of the Board

Morley Koffman Director Stephen W. Lilienthal Director Anthony J. Paoni Director Glenn R. Richter Director Neil A. Springer Director Michael L. Thompson Director

HOLDERS SHARES % OF TOTAL Citigroup Inc. 2,595,871 9.9% Fidelity Management & Research 2,410,515 9.2% Dimensional Fd Advisors, Inc. 1,831,607 7.0% Barclays Bank 1,567,377 6.0% Allianz Dresdner Asset Mgmt. 1,234,140 4.7% Top 5 Institutions 9,639,510 36.8% Other Institutions 15,892,218 60.7% Total Institutions 25,531,728 97.4% Insiders 473,040 1.8% Other 196,072 0.7% Total 26,200,840 100.0%

Source: Company filings and Capital IQ. Source: Company filings and FactSet.

Source: Company filings and ShareWorld.

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Stock Price Performance

Financial Overview

$25

$28

$31

$34

$37

$40

2/4/04 4/5/04 6/5/04 8/5/04 10/5/04 12/5/04 2/4/05

Stoc

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500

1,000

1,500

2,000

Volume in Thousands

USF Corp. Volume USF Corp. Stock Price

Stock Price (2/4/05) $32.44

% of 52-Week High 83.6%

52-Week High / Low $38.80 / $27.51

Diluted Shares 28.2

Equity Market Value 916.0

(+) Debt 250.1

(–) Cash & Equivalents 150.8

Enterprise Value $1,015.3

Enterprise Value to:

2004E Revenue $2,516.9 / 0.4x

2005E Revenue $2,658.8 / 0.4x

2004E EBITDA $169.2 / 6.0x

2005E EBITDA $253.7 / 4.0x

EPS Estimates / P/E Ratio

2004E EPS $0.85 / 38.2x

2005E EPS $2.48 / 13.1x

Source: Company filings and Wall Street equity research.Note: EPS projections based on I/B/E/S consensus.

USF Corporation (Cont’d)

Market and Trading Data

Source: Company filings and Wall Street equity research.

($ in millions)December 31,

2004A 2005E 2006ERevenues $2,394.6 $2,516.9 $2,658.8

% Growth 4.5% 5.1% 5.6%EBIT $112.1 $130.0 $150.1

% Margin 4.7% 5.2% 5.6%EBITDA $169.2 $253.7 $273.1

% Margin 7.1% 10.1% 10.3%Net Income $55.8 $66.5 $78.8

% Margin 2.3% 2.6% 3.0%EPS $0.85 $2.48 $2.82Capex 145.0 185.0 190.0

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Comparable Company Analysis($ in millions)

SHARE % OF ENTERPRISE VALUE AS A LONG-TERM LTMPRICE 52-WEEK EQUITY ENTERPRISE MULTIPLE OF SALES MULTIPLE OF EBITDA EPS OPERATING

COMPANY 02/04/05 HIGH VALUE VALUE 2004E 2005E 2004E 2005E 2004E 2005E GROWTH RATIO

Truck Load

JB Hunt Transportation $45.00 97.7% $3,682 $3,697 1.3x 1.2x 8.2x 7.2x 17.5x 15.5x 15.8% 92.9%Swift Transportation(1) 22.61 99.4% 1,671 2,265 0.8x 0.7x 6.2x 5.9x 14.8x 12.6x 12.6% 93.6%Werner Enterprises(1) 20.94 90.1% 1,679 1,570 0.9x 0.9x 5.5x 4.9x 19.6x 16.1x 15.3% 91.6%Heartland Express(1) 20.93 90.2% 1,570 1,311 2.9x 2.6x 10.8x 9.7x 25.2x 22.0x 13.8% 79.6%Knight Transportation(1) 25.71 99.3% 1,460 1,434 3.5x 2.9x 11.9x 10.1x 29.4x 23.1x 16.6% 80.7%

Covenant Transportation 20.86 97.8% 312 372 0.6x 0.6x 4.8x 4.1x 18.9x 15.8x 12.0% 94.0%

Mean 1.7x 1.5x 7.9x 7.0x 20.9x 17.5x 14.4% 88.7%Median 1.1x 1.0x 7.2x 6.5x 19.3x 16.0x 14.6% 92.3%

Less Than TruckloadCNF Inc(1) $46.49 91.2% $2,457 $2,400 0.6x 0.6x 6.2x 5.3x 17.8x 14.3x 14.1% 92.3%Overnite Corp(1) 30.35 78.5% 850 925 0.6x 0.5x 5.3x 4.6x 13.2x 11.0x 15.5% 82.8%Arkansas Best Corp(1) 41.77 89.5% 1,069 1,000 0.6x 0.5x 4.9x 4.7x 13.0x 11.2x 12.5% 92.8%Old Dominion Freight(1) 35.60 97.5% 885 961 1.2x 0.9x 7.9x 6.6x 21.6x 16.9x 17.5% 91.4%SCS Transportation(1) 22.55 81.6% 354 470 0.5x 0.4x 5.2x 4.6x 17.8x 13.0x 15.0% 95.6%

Yellow Roadway Corp(1) 56.31 97.8% 2,769 3,320 0.5x 0.5x 6.3x 5.0x 14.2x 10.9x 10.5% 94.6%


LogisticsC.H. Robinson Worldwide $51.38 91.1% $4,435 $4,201 1.0x 0.9x 18.5x 16.1x 32.9x 28.4x 14.5% 94.9%UTi Worldwide Inc 71.88 98.5% 2,307 2,297 1.5x 1.1x 30.8x 13.0x 27.9x 21.6x 20.0% 94.0%Sirva Inc 9.40 36.2% 693 1,165 1.1x 1.0x 6.9x 5.2x 11.1x 7.4x 20.0% 94.6%EGL Inc 31.18 89.1% 1,461 1,475 0.5x 0.5x 19.1x 14.7x 27.7x 23.1x 17.4% 97.2%Landstar System Inc(1) 35.25 91.4% 1,083 1,113 0.6x 0.5x 8.3x 7.2x 29.0x 23.8x 17.0% 94.1%Pacer International 22.19 91.0% 837 1,007 2.6x 2.4x 11.2x 9.8x 16.2x 13.7x 14.6% 94.8%Forward Air Corp 43.33 91.7% 944 840 3.0x 2.6x 13.9x 11.5x 27.7x 23.1x 14.5% 81.1%Hub Group 56.46 96.6% 529 529 0.4x 0.4x 10.2x 8.9x 25.3x 22.6x 25.0% 96.6%Quality Distribution Inc 8.62 53.4% 164 436 0.7x 0.6x 6.6x 5.5x 12.3x 8.5x NA 93.9%


USF Corp(1) $32.44 83.6% $916 $1,015 0.4x 0.4x 6.0x 4.0x 38.2x 13.1x 10.2% 97.3%

Source: Public filings and Wall Street research reports.(1) Based on 4Q '04 earnings releases.

P/E

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Selected Precedent Transactions ($ in millions)

EQUITY ENTERPRISE ENTERPRISE

VALUE/

TARGET DATE TARGET TARGET DESCRIPTION ACQUIROR VALUE VALUE (1) EBITDA (2) UNIONIZED

Jul-03 Roadway Corporation (US)

LTL carrier providing freight services on major city-to-city routes in North America

Yellow Corporation $966 $1231 6.7x NA

Nov-01 Motor Cargo Industries Provides regional less-than truckload services in the western U.S.

Union Pacific Corp. 83 78 4.0 No

Nov-01 Arnold Industries Provides regional less-than-truckload services in northeastern states and also provides truckload and logistics services

Roadway Corp. 558 510 5.7 Yes

Aug-01 Arnold Industries (US) N/A Roadway Corporation 539 510 5.4 No Aug-01 G.I. Trucking Company Provides regional less-than-truckload services

in western and southwestern states Investor Group (Estes) 40 40 5.0 No

Nov-00 American Freightways Corporation

Operates as a scheduled common and contract carrier transporting primarily less-than-truckload shipments of general commodities.

FedEx Corp. 934 1,196 6.3 No

Jun-99 Jevic Transportation Inc.

Provides regional and interregional transportation of general commodity freight

Yellow Corp. 158 197 5.9 No

Jun-98 Preston Trucking Provides les-than-truckload transportation of general commodity freight

Management Group NM NA NA Yes

Oct-97 Caliber System, Inc.

Provides transportation, logistics and related information services through its five subsidiaries

FedEx Corp. 2,489 2,681 10.3 No

Jul-95 Worldway Corp. Transporter of freight throughout United States; also provides truckload services and driver leasing services through its subsidiaries

Arkansas Best Corp. 82 153 9.0 Yes

Nov-92 Central Freight Lines Inc.

Carrier of intrastate and foreign commerce within Texas, Arizona, and New Mexico

Roadway Services Inc. 102 148 6.8 No

Nov-92 Preston Trucking Provides less-than-truckload transportation of general commodity freight

Yellow Freight Systems 24 146 5.8 Yes

Jul-88 Viking Freight Inc. Provides regional carrier services in California and 9 other Western States


Jun-88 Arkansas Best Corp. LTL and TL carriage, furniture manufacturing and tire retreading

Kelso & Co. 317 472 6.2 Yes

Median 6.1x Average 6.5x High 10.3x Low 4.0x

Source: Securities Data Corporation, public filings and news reports.(1) Enterprise Value = Value of Common + Total Debt – Cash.(2) EBITDA, EBIT and Net Income exclude extraordinary items and accounting changes.

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WACC ScheduleIndustry Statistics(in millions)

Total Mkt Debt / Tax Levering Unlevered

Company Beta (1) Debt Equity Mkt Equity Rate (2) Factor (3) Beta (4) AssumptionsArkansas Best Corp 0.83 15 1,069 1.4% 40.1% 1.01 0.82 Target Marginal Tax Rate 38.0%Cnf Inc 0.89 714 2,457 29.1% 41.0% 1.17 0.76 Risk Free Rate (5) 4.330%Old Dominion Freight 0.62 81 885 9.2% 39.1% 1.06 0.59 Equity Risk Premium (6) 7.20%Overnite Corp 0.95 127 850 14.9% 40.0% 1.09 0.87 Size Premia ("Sp") (7) 1.59%Scs Transportation Inc 0.63 123 354 34.7% 37.6% 1.22 0.52Yellow Roadway Corp 1.00 728 2,769 26.3% 39.1% 1.16 0.86

Mean 0.82 19.3% 39.5% 1.12 0.74Median 0.86 20.6% 39.6% 1.12 0.79

Schedule A (Sensitivity of Capital Structure)Weighted Average Cost of Capital (10)

Debt / Debt / Average Levering Levered Cost of Pre-tax Cost of DebtCapital Mkt Equity Unlev'd Beta Factor Beta (8) Equity (9) 5.0% 6.0% 7.0% 8.0% 9.0% 10.0%

0.0% 0.0% 0.74 1.00 0.74 11% 11.2% 11.2% 11.2% 11.2% 11.2% 11.2%10.0% 11.1% 0.74 1.07 0.79 12% 10.7% 10.8% 10.9% 10.9% 11.0% 11.1%20.0% 25.0% 0.74 1.16 0.85 12% 10.3% 10.4% 10.5% 10.6% 10.8% 10.9%30.0% 42.9% 0.74 1.27 0.93 13% 9.8% 10.0% 10.1% 10.3% 10.5% 10.7%40.0% 66.7% 0.74 1.41 1.04 13% 9.3% 9.5% 9.8% 10.0% 10.3% 10.5%50.0% 100.0% 0.74 1.62 1.19 15% 8.8% 9.1% 9.4% 9.7% 10.0% 10.4%

Schedule B (Sensitivity of Unlevered Beta)Weighted Average Cost of Capital (10)

Debt / Debt / Levering Unlevered Pre-tax Cost of DebtCapital Mkt Equity Factor Beta 5.0% 6.0% 7.0% 8.0% 9.0% 10.0%

0.0% 0.0% 1.00 0.65 10.6% 10.6% 10.6% 10.6% 10.6% 10.6%10.0% 11.1% 1.07 0.70 10.5% 10.5% 10.6% 10.7% 10.7% 10.8%20.0% 25.0% 1.16 0.75 10.3% 10.5% 10.6% 10.7% 10.8% 11.0%30.0% 42.9% 1.27 0.80 10.2% 10.4% 10.5% 10.7% 10.9% 11.1%40.0% 66.7% 1.41 0.85 10.0% 10.2% 10.5% 10.7% 11.0% 11.2%50.0% 100.0% 1.62 0.90 9.8% 10.1% 10.4% 10.7% 11.0% 11.3%

(1) Barra US equity Book predictions (7) Cost of equity premia based on equity market capitalization.(2) Based on marginal tax rate low-cap ($797mm - $1,167mm) = 1.59%. Amounts per 2004 Ibbotson.(3) Levering Factor: 1 + [ ( 1 - Tax Rate ) * ( Debt / Equity ratio ) ] (8) Levered Beta: (Beta * Levering Factor)(4) Unlevered Beta: ( Beta / Levering Factor ) (9) Cost of Equity: Rf + B * ( Rm - Rf ) + Sp, or the risk-free rate plus the beta * the eq(5) Yield on Interpolated 20-Year US treasury Bonds which corresponds to Ibbotson's long-term equity (10) WACC: Rd = Return on Debt; Re = Return on Equityrisk premium (as of 2/04/05). Source: Bloomberg. [ Rd * (1 - tax rate) * (D / (D + E) ) ] + [ Re * (E / (D + E) ) ](6) The average historic period between the return on stocks and L-T bonds (2004 Ibbotson Associates).

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Discounted Cash Flow Analysis($ in millions)

2005E 2006E 2007E 2008E 2009EEBITDA $250.7 $278.5 $307.2 $317.6 $328.2

Less: D&A (113.6) (121.6) (130.3) (134.2) (138.2)EBIT $137.1 $156.9 $176.9 $183.4 $190.0

Less: Tax Effect (52.1) (59.6) (67.2) (69.7) (72.2)Unlevered Net Income $85.0 $97.3 $109.7 $113.7 $117.8

Plus: D&A 113.6 121.6 130.3 134.2 138.2Less: Capex (103.2) (110.5) (118.4) (122.0) (125.7)Plus: Changes in WC (13.7) (7.2) (7.7) (3.2) (3.2)

Unlevered Free Cash Flow $81.7 $101.1 $113.9 $122.7 $127.1Source: Wall Street research projections and Credit Suisse estimates.

($ in millions, except per share data)

Terminal Value EBITDA MultipleDiscount Rate 4.50x 5.00x 5.50x 6.00x

9.0% $417.5 $417.5 $417.5 $417.5 Present Value of Free Cash Flows960.0 1,066.7 1,173.3 1,280.0 Present Value of Terminal Value

$1,377.5 $1,484.2 $1,590.9 $1,697.5 Enterprise Value(99.3) (99.3) (99.3) (99.3) Less: Net Debt

$1,278.2 $1,384.9 $1,491.6 $1,598.2 Equity Value$44.42 $47.92 $51.42 $54.92 Equity Value per Share

36.9% 47.7% 58.5% 69.3% Implied Premium / (Discount) to Current (1)

0.4% 1.2% 1.8% 2.4% Implied Perpetuity Growth Rate10.0% $406.1 $406.1 $406.1 $406.1 Present Value of Free Cash Flows

917.1 1,019.1 1,121.0 1,222.9 Present Value of Terminal Value$1,323.3 $1,425.2 $1,527.1 $1,629.0 Enterprise Value

(99.3) (99.3) (99.3) (99.3) Less: Net Debt$1,224.0 $1,325.9 $1,427.8 $1,529.7 Equity Value

$42.64 $45.98 $49.33 $52.67 Equity Value per Share31.4% 41.8% 52.1% 62.4% Implied Premium / (Discount) to Current (1)


876.6 974.0 1,071.4 1,168.8 Present Value of Terminal Value$1,271.8 $1,369.2 $1,466.6 $1,564.0 Enterprise Value



2.2% 3.0% 3.7% 4.3% Implied Perpetuity Growth Rate(1) Based on share price of $32.44 as of 02/04/05.

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Projections USF Corporation and Yellow Roadway projections based on Wall Street equity research; estimated marginal tax rate of 38%

Prospective acquiror net income based on Wall Street equity research

Financing 50% Stock – 50% Cash Consideration assumed; financed by 100% bank debt at 3-Months LIBOR plus 100 basis points

Purchase Price Range of $1,015 – $1,410 mm, corresponding to 4.0x – 5.6x 2005E EBITDA

FMV Adjustments Fair market value adjustment estimated at 12% of book value; depreciated over 20 years

Goodwill Goodwill not amortized

Timing Assumed to gain full 2005 earnings

Fees M&A Fees of 0.5% of transaction value

Financing fees of 2.5% of debt raised

Synergies None assumed; pre-tax synergies required to achieve acquiror break-even EPS inferred

Potential Merger AssumptionsKey Assumptions

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Merger Consequences AnalysisYellow Roadway Acquisition of USF Corporation($ in millions)

50% Cash / 50% Stock ConsiderationPremium to Share Price – 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0%

Price Per Share $32.44 $34.06 $35.68 $37.31 $38.93 $40.55 $42.17 $43.79 $45.42

Equity Value $918 $966 $1,014 $1,062 $1,111 $1,160 $1,210 $1,259 $1,309Net Debt (1) 99 99 99 99 99 99 99 99 99Enterprise Value 1,017 1,065 1,114 1,162 1,210 1,259 1,309 1,358 1,408

Enterprise Value / 2005E EBITDA 4.1x 4.2x 4.4x 4.6x 4.8x 5.0x 5.2x 5.4x 5.6xEnterprise Value / 2006E EBITDA 3.7x 3.8x 4.0x 4.2x 4.3x 4.5x 4.7x 4.9x 5.1x

Equity Value / 2005E Net Income 13.3x 14.0x 14.7x 15.4x 16.1x 16.9x 17.6x 18.3x 19.0xEquity Value / 2006E Net Income 11.4x 12.0x 12.6x 13.2x 13.8x 14.4x 15.0x 15.6x 16.2x

2005E Stand Alone Diluted EPS $5.25 $5.25 $5.25 $5.25 $5.25 $5.25 $5.25 $5.25 $5.252005E Pro Forma Diluted EPS 5.59 5.53 5.48 5.43 5.38 5.33 5.28 5.24 5.19

2005E Accretion / (Dilution) Acc / (Dil) – $ $0.34 $0.28 $0.23 $0.18 $0.13 $0.08 $0.03 ($0.01) ($0.06)Acc / (Dil) – % 6.4% 5.4% 4.4% 3.5% 2.6% 1.6% 0.7% (0.3%) (1.2%)Pre-Tax Breakeven Synergies – – – – – – – $1.3 $6.1

Pro-Forma Debt / LTM EBITDA (2) 1.6x 1.7x 1.7x 1.7x 1.8x 1.8x 1.8x 1.9x 1.9xDebt-to-Capitalization (at closing) 45.28% 45.36% 45.45% 45.53% 45.61% 45.69% 45.76% 45.83% 45.91%

% Shares issued as currency 14.2% 14.9% 15.5% 16.1% 16.7% 17.3% 17.9% 18.5% 19.1%ProForma Ownership% 85.8% 85.1% 84.5% 83.9% 83.3% 82.7% 82.1% 81.5% 80.9%Source: Wall Street Projections, Credit Suisse Estimates.(1) Net Debt numbers as of 12/31/04.(2) Based on LTM EBITDA of $697mm.


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3. Weekly Assignments andResources

A. Public Information Book (PIB)

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Summer Assignment – PIBAssignment

Prior to the June 30th training session, please assemble a PIB on Knight Ridder

Make sure that your PIB has all the sections outlined on the next page

Insert numbered tabs between each section “blue sheets” between each item in the same tab, if multiple items exist. For example, put a blue sheet between each research report

Have the Copy Center make a double-sided bound copy of your PIB

Key Takeaways

After completing this section, you should be familiar with most of the tools that are available to access public information

Research reports are expensive!!! Purchase only those that are appropriate

Be prepared to answer questions like:

1. Where do I go to get the latest SEC filing?

2. Where do I go to get an ownership run?

3. Have any major events occurred at the Company in the recent quarter?

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Public Information Book Resources

1. General Public Information – S&P Stock Report – Bloomberg Data – Price/Volume – Web Site

Company Website

2. Prospectus – Usually follows a major event (M&A, Equity offering, Debt offering)

3. Annual Report Company Website

4. Form 10-K – Annual filing with the SEC, similar to an annual report

5. Form 10-Q – Quarterly filing with the SEC

6. Proxy Statement – Covers information about company shares and shareholders

7. Research Report – Include CS if available – Look for longer, more recent research

CS Research & Analytics

8. News Run – Back two – six months is standard

Company Website

9. Ownership Run – Tracks ownership structure of company

Sample Table of Contents Where to Get the Material


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3. Weekly Assignments and Resources

B. Company Profile

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Summer Assignment – Company ProfileAssignment In the format shown on the sample pages, create a two page company profile for Knight Ridder

Corporation Make sure you include: Company Overview Market Statistics (download from FactSet) Financial Overview Stock Price Performance Directors and Officers Products Current Ownership

Helpful Hint: The financial overview summary sheet in your Abacus shell (see Tab C) is a good template from which to copy and paste market stats and financial overviewsKey Takeaways At the end of this section, you should be able to answer the following:

1. What are Knight Ridder Corporation’s primary business segments?2. How has Knight Ridder Corporation performed in the last year with respect to:

– Earnings?– Stock price?– Any relationship between the two?

3. Any important events occur at the Company over the past year?

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Agenda

Creating a general two page company profile

Keys to a successful acquisition ideas presentation

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Keys to a Successful Acquisition Ideas Presentation Know Your Audience

Use a Systematic Approach

Remember the Formula: Strategic Fit + Availability = A Good Idea

Demonstrate Industry Knowledge

Revisit “Old” Ideas Selectively

Stimulate Discussion and Ask Questions

Summarize Conclusions and Develop Follow-up Plan

A successful acquisition ideas presentation delivers a focused set of ideas with a point of view and a rationale.

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Considerations in Determining Fit

Client specified Size Industry Technology Geographic scope

(international vs. domestic)

Product synergies Markets Customers Distribution Manufacturing

Operating synergies Corporate cost savings S,G & A cost savings Other

Strategic Organic growth prospects of

target

Management talent

Technology or other proprietary assets

General Leverage

Accretion / dilution

Market perception

Financial

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Parent is a LBO sponsor

Filed equity offering with large secondary component

Previous failed attempt to sell (“busted auction”) or spin-off (“busted IPO”)

Takeover speculation

Undervalued, depressed or declining stock price

Shareholder activism

Potential odd man out in rapidly consolidating industry or segment

Changes in senior management or aging senior management with no obvious successor

Dramatic revisions in corporate strategy

Need to expand internationally or to retrench

Need for capital

Failure or inability to grow new products organically

Parent reorganizing or realigning businesses, possibly in preparation for a sale

Division with no logical strategic fit with the parent (“corporate orphan”)

Division underperforming or less profitable than core business

Insiders control a meaningful percent of the stock and have no evident need for liquidity

Family-owned with the next generation preparing or prepared to assume leadership

Majority owned by another company that has obvious reason to hold onto the business

Strong and consistent stock performance

The current parent is the most obvious best owner for the business

The current parent has identified the business as a core business and/or the equity market is in favor of current parent owning the business

Consider the target’s defensive posture vis-a-vis a hostile offer, but remember … the valuation/rationale must be even more compelling to justify an unsolicited approach

Note: It is also important to review the valuation multiples of the publicly-traded Parent Company which owns the “target” subsidiary. If sale proceeds (after tax) imply lower valuation multiples (EBITDA, EBITA and Net Income) than those at which the parent stock is selling, the transaction would be dilutive to overall value and thus would probably be a non-starter as a sale candidate today

Signals of Availability / Lack Thereof

Signs of Availability Signs of Lack of Availability

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Acquisition Screening – Information Sources SIC code lists

Equity analyst research

“Competition” sections of prospectuses and 10-Ks of comparable companies

Research reports relating to the Client and its core industry group competitors

Value Line for Client and its competitors

S&P Tear Sheets (with word search)

OneSource (U.S. Public, U.S. Private, and U.K. Public SIC Code Summary Analyses)

Industry trade association lists

Trade publications

WorldScope database (Global Buyers List)

FactSet “comp builder”

SDC M&A summaries

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Creating a General Company Profile

Business Description

The Boeing Company is an aerospace firm. The Company operates in principal areas that include commercial airplanes, military aircraft, missile systems, space and communications and customer and commercial financing.

Business Segments

The Commercial Airplanes segment is involved in development, production and marketing of commercial jet aircraft and providing related support services, principally to the commercial airline industry worldwide.

The Military Aircraft and Missile Systems segment is involved in the research, development, production, modification and support of military aircraft including fighter, transport and attack aircraft, as well as helicopters and missiles.

The Space and Communications segment is involved in the research, development, production, modification and support of space systems, missile defense systems, satellites and satellite launching vehicles, rocket engines and information and battle management systems.

The Customer and Commercial Financing segment is primarily engaged in the financing of commercial and private aircraft and commercial equipment.

Competitors

The Company competes with Lockheed Martin, Raytheon, BAE Systems, Northrop Grumman, Matra BAe Dynamics Alenia and The European Aeronautics Defense & Space Corporation.

Company Overview Business section of 10K / Annual Report

finance.yahoo.com business profile

Research reports

Company Web site

VentureSource (private companies)

Your PIB can be a great resource (See Tab A)

10K / Annual Report

Research reports

Company Web site

PIB

10K / Annual Report

Research reports

finance.yahoo.com business profile

Company Web site

PIB

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Financial Overview

Therapeutic Focus – 2003

CNS$5.4 BN

Diabetes/ Metabolic$2.1 BN

Osteoporosis$1.0 BN

Sexual Dysfunction

$0.2 BN

Oncology$1.0 BN

Antibiotics$0.7 BN

Cardiology$0.5 BN

You can find the historical information from company filings

The projections will come from research

PIB

Highlight product mix or any particularasset that might be of interest to your Audience

Company Web site

Research reports

10K / Annual report

($ in millions)December 31,

2004A 2005E 2006ERevenues $2,394.6 $2,516.9 $2,658.8

% Growth 4.5% 5.1% 5.6%EBIT $112.1 $130.0 $150.1

% Margin 4.7% 5.2% 5.6%EBITDA $169.2 $253.7 $273.1

% Margin 7.1% 10.1% 10.3%Net Income $55.8 $66.5 $78.8

% Margin 2.3% 2.6% 3.0%EPS $0.85 $2.48 $2.82Capex 145.0 185.0 190.0

Note: Currently there is no similar pie graph in USF profile but it is a possibility for your Knight Ridder profile (or other profiles you will be expected to do in your respective groups).

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Market and Trading Data This should come from your equity

comp shell (See Tab C)

Keep in mind, you may update this profile often (e.g. latest stock price or estimates) so keeping your comps flexible is key

Stock Price (2/4/05) $32.44

% of 52-Week High 83.6%

52-Week High / Low $38.80 / $27.51

Diluted Shares 28.2

Equity Market Value 916.0

(+) Debt 250.1

(–) Cash & Equivalents 150.8

Enterprise Value $1,015.3

Enterprise Value to:

2004E Revenue $2,516.9 / 0.4x

2005E Revenue $2,658.8 / 0.4x

2004E EBITDA $169.2 / 6.0x

2005E EBITDA $253.7 / 4.0x

EPS Estimates / P/E Ratio

2004E EPS $0.85 / 38.2x

2005E EPS $2.48 / 13.1x

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Stock Price Performance

ActiveGraph made from Excel and FactSet

Keep in mind, you may update this often

Plot either standalone or against peer group. If showing peer group, use the companies in your equity comps (see Tab C) but exclude the company you are profiling

$25

$28

$31

$34

$37

$40

2/4/04 4/5/04 6/5/04 8/5/04 10/5/04 12/5/04 2/4/05

Stoc

k Pr

ice

0

500

1,000

1,500

2,000

Volume in Thousands

USF Corp. Volume USF Corp. Stock Price

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Ownership

Recent News

ShareWorld

Proxy (for insider ownership)

FactSet

Company news releases

Factiva

Equity research

1/28/2005: USF Corporation reported fourth quarter and full year 2004 results, missed Wall Street earnings

12/13/2004: Announced opening of two new terminals serving the Southern Minnesota and Decatur, Alabama areas

11/2/2004: Richard P. DiStasio stepped down as CEO, Paul Liska was named interim CEO

10/22/2004: Reported third quarter 2004 results, missed Wall Street earnings

9/9/2004: USF Holland announced the opening of eight (8) Northeast terminals, service city includes: Baltimore, MD Albany, NY, Allentown, PA, Harrisburg, PA, Philadelphia, PA, Wilkes Barre, PA, Syracuse, NY, and Richmond, VA

HOLDERS SHARES % OF TOTAL Citigroup Inc. 2,595,871 9.9% Fidelity Management & Research 2,410,515 9.2% Dimensional Fd Advisors, Inc. 1,831,607 7.0% Barclays Bank 1,567,377 6.0% Allianz Dresdner Asset Mgmt. 1,234,140 4.7% Top 5 Institutions 9,639,510 36.8% Other Institutions 15,892,218 60.7% Total Institutions 25,531,728 97.4% Insiders 473,040 1.8% Other 196,072 0.7% Total 26,200,840 100.0%

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Management and Board

Proxy

finance.yahoo.com

Company Web site

Sometimes you will see profiles with a brief biography of the directors and officers

Name Position and Affiliation Thomas E. Bergmann Interim CEO, CFO

Steven Caddy President and CEO, USF Holland

Edward R. Fitzgerald President and CEO, USF Reddaway

Douglas R. Waggoner President and CEO, USF Bestway

Paul J. Liska Chairman of the Board

Morley Koffman Director Stephen W. Lilienthal Director Anthony J. Paoni Director Glenn R. Richter Director Neil A. Springer Director Michael L. Thompson Director


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C. Equity Comps

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Summer Assignment – Equity Comps For your assignment, you are to submit an Equity Comp output page for Knight Ridder AS OF THE

DATE OF THE ACQUISITION (3/10/06)

You must first find comparable companies. For this project, you need only Knight Ridder Corporation and three comparable companies

Include McClatchy Company and New York Times Co as comps and find one comp on your own

Input ABACUS shells for these comps using FactSet, the companies’ financials and Wall Street research to find the following multiples: 2006E and 2007EV/revenue 2006E and 2007E EV/EBITDA 2006E and 2007E EV/EBIT 2006E and 2007E P/E 2006E and 2007E EBITDA margins

When necessary, make sure to calendarize the financials

Make sure to check your output and see if something looks abnormal If so, you’ve likely made a mistake

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Summer Assignment – Equity Comps (Cont’d)Helpful Hint #1: If you’ve inserted your data properly into the input pages, ABACUS will generate a formatted and linked output page for you: Go to ABACUS / New Summary Sheet / Forward Multiple Analysis

Helpful Hint #2: The output page converts all currencies to US$. If you are using a foreign company, make sure you input the proper exchange rate in the appropriate section of the shell

Key Takeaways

At the end of this section, you should be able to answer the following: 1. On what basis did you choose your one other comparable? 2. In retrospect, are they “good” comps? Why or why not? 3. How is Knight Ridder trading relative to its peer group? 4. Can you explain its relative valuation? Why does it trade at a premium or discount to its

peers? Think of its relative earnings, margins, market share, size, etc. 5. What does this mean to a potential buyer?

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Agenda What are Equity Comps and Why Do We Do Them?

Finding Comparable Companies

Collecting the Data

Using the Compco Model

Common Pitfalls

Interpreting the Results

USF Corporation: sample equity comps

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What Are Equity Comps and Why Do We Do Them? A big part of an investment banker’s job is to value companies

More than anything else, clients want to know what their companies areworth – especially relative to their peers

One way to value companies is to infer (or compare) their value based on the public trading values of other companies with similar characteristics

Because not all companies are the same size or have the same capital structure, we need to establish universal metrics that can apply to all companies within a group

These metrics almost always take the form of a ratio or “multiple”, where the numerator is a measure of trading value (Enterprise Value; Market Value) and the denominator is an operating statistic (EBITDA, Net Income)

The most common metrics are Enterprise Value / EBITDA and Market Value / Net Income (or P/E)

The calculation and interpretation of these metrics is a Comparable Company Analysis, or Compco Analysis

Helpful Hint: The right terminology for this analysis is the Comparable Company Analysis, but since bankers like to complicate matters, this analysis is referred to differently by each group. Don’t get confused if you’re asked to do equity comps, compcos, comps, and a comparable company analysis all in one night: They all mean the same thing!

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OK, So What Are Enterprise and Equity Value? Enterprise Value is the total dollar value of a business, represented by the sum of all of the

ownership interests in the business

Note: Enterprise Value is sometimes referred to as Adjusted Market Value, Firm Value or (in early-stage biotech) Technology Value

In broad terms, there are two types of ownership interests in a business – Debt and Equity

The public market value of a business’ equity is referred to as its equity value, market value or market capitalization

We calculate a business’ Enterprise Value by summing the public market values of its debt and equity

Caveat: Because the trading value of debt securities is less volatile than equity securities, we typically use the book value of debt rather than the market value to save time

Enterprise Value is an important measure because it makes companies with different capital structures more comparable

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OK, So What Are Enterprise and Equity Value?

Enterprise Value = Value of All Business’ Assets = Equity Value + Net Debt(1)

Equity Value = Value of the Shareholders’ Equity = Current Stock Price x Shares Outstanding(2)

(1) Net Debt equals long-term debt + short-term debt + “out of the money” convertible debt + minority interest + preferred stock + capitalized leases – cash and cash equivalents.

(2) The proper way to calculate Equity Value is to use the diluted number of shares outstanding, which includes all “in the money” and exercisable stock options.

Enterprise ValueNet Debt

Equity Value

Enterprise Value

AssetsLiabilities and

Shareholders’ Equity

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Fair Enough, But Help Me With This EBITDA Thing EBITDA is an accounting measure of how much cash flow a business generates from its

operations

EBITDA excludes interest, taxes and depreciation and amortization because these items vary from company to company – for reasons which generally do not impact value – making them harder to compare on a consistent basis

Interest is a function of capital structure

Taxes are a function of incorporation and tax structure

Depreciation is a function of depreciation policy / asset lives

Amortization is a function of how acquisitive a company has been

EBITDA = Earnings before Interest, Taxes, Depreciation and Amortization

We place emphasis on Enterprise Value / EBITDA because this metric excludes most variables which do not affect value (or can be easily changed) making companies more comparable for valuation purposes

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Let’s Recap The absolute value of a business is expressed by its Enterprise and Equity Value Enterprise Value is the total value of all ownership interests in a business Equity Value is the value of the equity in a business

The relative value of a business is expressed by a “multiple” of its absolute value to its operating results “GE is trading at 22x its 2006E projected EBITDA” – Translation: The ratio of GE’s

Enterprise Value to its forecasted 2006E EBITDA is 22 “Walmart’s 2006E P/E multiple is 18x” – Translation: The ratio of Walmart’s equity value to

its forecasted 2006 net income is 18

Enterprise Value / EBITDA is an important metric because it eliminates non-value impacting variables which otherwise make companies less comparable

Enterprise Value / Sales

Enterprise Value / EBITDA

Enterprise Value / EBIT

Industry Specific Metrics (EV / Fiber Miles)

Equity Value / Net Income

Price / Earnings

Equity Value / Tangible Book Value

Other Industry Specific Metrics

Enterprise Value Multiples Equity Value Multiples

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Finding Comparable Companies

Sources to check to initially select comparables:

Your colleagues (before you start, make sure someone hasn’t done it already!)

Associates and Officers – most of the time they will pick them for you

Proxy Statements

Equity research reports and analysts

SIC code searches – FactSet, OneSource, Library

S&P Tearsheets

Value Line

Trade publications

IPO or other prospectuses

10K – Competition section

Industry

Products

Distribution Channels

Markets

Size

Growth Profile (Sales, EBITDA, Earnings)

Margins (Gross Profit, EBIT, Net Income)

Leverage

Operational Financial

Look for companies with characteristics similar to those of the business being valued:

Note: This rule does not apply to your summer valuation project –sorry guys!

Seasonality

Cyclicality

Strategy

Customers

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Collecting The Data – What Do I Need? Most recent financial statements – LTM financials 10-K, 20-F or Annual Report (available 90 days after end of period) 10-Q quarterly or interim report (available 45 days after end of period) Earnings Releases (typically available 2-3 weeks after the end of the quarter)

– Don’t miss these – they are the most updated information available– Often have complete income statements and balance sheets

Other Press Releases

EPS Forecasts – Be Consistent! First Call I/B/E/S

Operating Projections CS Equity Research Equity Research from other firm I/B/E/S

Stock Price Information Current / 52 week high-low

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Research analysts submit their EPS estimates to publicly available centralized databases (First Call, I/B/E/S)

The mean or “consensus” estimate represents the Street view of a Company’s expected performance

We use Street view to calculate P/E multiples

FactSet (First Call, I/B/E/S) on your PC

First Call website (InfoCentral)

Detailed First Call reports (6th Floor)

Bloomberg terminals (Nelson's)

Why Do I Need It and Where Do I Get It?

10-K / Annual Report LTM Income Statement Information Options/Convertible Data

10-Q / Quarterly Report LTM Income Statement Information Balance Sheet Information Basic Shares Outstanding

8-Ks / Report of a Material Event Pro Forma Information for Acquisitions or

Other Transactions Earnings Announcements

Why Do I Need It? Thomson Research (from InfoCentral – IBD

Internal website)

FactSet on your PC

OneSource on your PC

SEC Edgar Archives (www.sec.gov)

Disclosure workstations (in library)

Sedar.com (for Canadian companies)

Documents Library on EMA 28 at x5-4000 (use library as a last resort – they will always take longer to pull docs than you will)

Where Do I Get It?

10-Ks, 10-Qs, 8-Ks

EPS Forecasts

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To calculate equity and enterprise value FactSet on your PC

Investment Banking Workstation on your PC

Bloomberg terminals

Why Do I Need It and Where Do I Get It?

Research analysts project what a Company’s income statement will look like in the future

We use these models to calculate projected EBITDA

The research report you select is VERY important and will influence your valuation multiples

You should always select a research report which has an EPS forecast close to the consensus

Why Do I Need It? CS Research & Analytics

Call CS Research Analyst for updated model

Research Bank Web (Info Central) – for non-CS research

Multex.com – for non-CS research

Research Bank workstations (older reports)

Library request at x5-4000 (for older or hard to find research reports)

Where Do I Get It?

Operating Projections

Stock Price Information

To calculate equity and enterprise value FactSet on your PC

Investment Banking Workstation on your PC

Bloomberg terminalsOther

Information

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Data Collection Best Practices (How To Keep My Associate Happy and Get a Big Bonus) Keep a Record Print out hardcopies of all source documents (10-Ks, 10-Qs, EPS Projections, Analyst

Reports)

Leave a Trail / Be Organized Highlight data and tab pages used from source documents and use folders for each company Use “Comments” function in Excel to footnote items that need explanation (i.e.,

approximations, assumptions, calculations and unusual items)

Be Complete Supply your Associate with all source documents, a printout of the equity comps and an

electronic copy for all companies to be checked

Be Efficient Work sequentially through companies, so that your Associate can start checking while you

continue working

Be a Thinker Check your results. If something looks wrong, it probably is

Never assume FactSet downloads or other people’s comps are correct

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1. General Company Information / User

The ticker identifies the company you are creating a comp file for and is used by Factset to select data to download

The financial statement dates identify which historical and projected years you are generating multiples for. These dates drive the model’s column headings Note: The dates do not drive which data

FactSet downloads; FactSet defaults to the most recently available data

It is important to fill out the user information so that other people using your model can call you with questions

General Company Information

User Information

Primary Company Ticker CHRWLast Fiscal Year Ended 12/31/04Latest Balance Sheet as of 3/31/05Source of Latest Balance Sheet 10-QLTM Earnings as of 3/31/05Source of LTM Earnings 10-QFirst Projected Calendar Year End: 12/31/05Calendarization Factor 0.0%

ResearchResearch Source Morgan StanleyAnalyst James ValentineDate of Research 5/01/05RecommendationTarget Price –

Analysis Prepared by kjackso3Preparer Phone Number 62714Analysis Checked by T_BusheyChecker Phone Number 65888

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2. Diluted Share Calculation / Options and Convertible Debt Schedules In general, Equity Value = Current Stock Price x Basic Shares Outstanding

However, most companies have securities which represent contingent shares – meaning they are not shares today, but can become shares if certain conditions are met – and as a result, we need to make adjustments to basic shares outstanding

The most common of these securities are options / warrants

Options are a price right or option granted to management to purchase their company’s stock at a pre-specified or strike price

Management profits if the market price of the stock exceeds the strike price when they exercise the options. Hence, Management is only likely to exercise his/her options under these circumstances

Options are reported in the 10-K. Companies typically disclose the number of options that are outstanding and exercisable

Exercisable options are vested and can be used to purchase shares today. Exercisable options, NOT outstanding, are relevant for equity comp purposes

The method we use for calculating the impact on basic shares outstanding of options is called the Treasury Stock Method

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Scenario: 197.3 million basic shares outstanding 8.2 million exercisable options with a weighted average strike price of $14.02 Current stock price is $17.74.

Translation: 8.2 million options are “in the money,” meaning they are exercisable at a lower price than the current market price. This means the owner of these options has the right to buy stock from the Company at $14.02 and could sell it in today’s market at $17.74. If the owner of the options did this, he would pay the Company $14.02 for each share, sell it in the market for $17.74 and pocket the $3.72 spread.

Treasury Method Calculations:

The treasury stock method assumes the above transaction occurs and that the Company uses the $14.02 they receive to repurchase shares in the market at $17.74, thus:

Basic Shares Outstanding 197.3 Plus: Shares Issued to Options Holder 8.2 205.5 Less: Shares Repurchased with Proceeds (6.5) Diluted Shares Outstanding 199.0

Calculating Diluted Shares Outstanding Using the Treasury Stock Method

($14.02 x 8.2) / $17.74

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What About Convertible Debt and Preferred? Investment Bankers have created hybrid securities which pay interest like straight debt, but

become common stock if certain conditions are met

Convertible Debt

Convertible Preferred

Other Equity-Linked Securities

Convertible securities are NOT evaluated using the Treasury Stock Method

Most important thing to remember: Convertible Securities are treated as either debt or equity for valuation purposes – NOT both

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What About Convertible Debt and Preferred?

Example: A company has a convertible preferred security with a face value of $1,114 million that pays a dividend of 6.5% and has a conversion price of $18.00

Income Statement Effect None

Equity Value Effect None

Net Debt Effect Should include full amount of convertibles

($1,114)

Income Statement Effect Debt: Interest backed out Preferred: Dividend backed out ($1,114 x 6.5%

= $72.4)

Equity Value Effect Additional shares outstanding from conversion

(add $1,114/$18 = 61.9 to shares outstanding)

Net Debt Effect Debt does NOT include face value of converted

debt/preferred

Current Price < $18.00 Treated as Debt Current Price > $18.00 Treated as Equity

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2. Treasury Method Diluted Share Calculation / Options and Convertible Debt SchedulesTreasury Method Fully Diluted Share Calculation($ in millions, except per share data)

CLASS SHS. OUT. PRICEA 1,129.5 74.36B 0.0 0.00C 0.0 0.00D 0.0 0.00E 0.0 0.00

Total Primary Shares Outstanding 1,129.5 74.36New Shares Issued 0.0Converted Debt shares (Schedule A) 0.0Converted Preferred Shares (Schedule B) 0.0Converted Options/Warrants (Schedule C) 59.6Shares Buy-Back from Options/Warrants exercise proceeds (48.5)

Fully Diluted Shares Outstanding 1,140.6

Schedule A - Convertible DebtANNUAL BOOK TRADING # SHARES IMPLIED DEBT SHARES

MATURITY INTEREST VALUE VALUE CONV INTO CONV PR CONVTD ISSUEDDebt Series 1 1/00/00 0.00% 0.0 0.0 0.0 0.00 0.0 0.0

Schedule B - Convertible PreferredANNUAL BOOK TRADING # SHARES IMPLIED PREF SHARES

MATURITY INTEREST VALUE VALUE CONV INTO CONV PR CONVTD ISSUEDPreferred Series 1 1/00/00 0.00% 0.0 0.0 0.00 0.0 0.0

Schedule C - Options/Warrants using Outstanding

PRICE PRICE WEIGHTED# EXER LOW HIGH # OUTS LOW HIGH AVERAGE PRICE # EXERCISED

Options/Warrants 1 6.760 21.29 21.29 6.760 21.29 21.29 21.29 6.8Options/Warrants 2 7.970 53.27 56.14 21.370 56.14 56.14 56.14 21.4Options/Warrants 3 21.340 71.03 71.93 31.510 71.93 71.93 71.93 31.5Options/Warrants 4 12.590 79.44 77.90 23.170 77.90 77.90 77.90 0.0Note: Option Schedule Includes all series.

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3. Debt & Preferred Schedule Debt can be listed on the balance sheet

under a variety of names Notes Commercial Paper (CP) Current Portion of LT debt Credit Facility Revolver Loans

The ABACUS model allows you to calculate the net debt based on book or market values

If the Company issued additional debt or convertible securities since its latest filing, input these securities in adjustment rows (additional equity securities would increase shares outstanding and book equity)

For Credit Stats identify Seniority of the outstanding debt 1 = Senior Debt 2 = Sub. Debt

Debt & Preferred Schedule($ in millions)

DESCRIPTION VALUENAME RATE SENIORITY BOOK MARKETLong-Term 0.0% Sen 4,503.6 4,503.6Long-Term 0.0% Sen 0.0 0.0Long-Term 0.0% Sub 0.0 0.0Long-Term 0.0% Sub 0.0 0.0Long-Term 0.0% Sen 0.0 0.0LT Debt Adj 0.0% Sen 0.0 0.0

Total Long-Term Debt 4,503.6 4,503.6Out-of-the-Money Convertible Sub 0.0 0.0Short-Term 0.0% Sen 807.1 807.1Short-Term 0.0% Sub 0.0 0.0ST Debt Adj 0.0% Sen 0.0 0.0

Total Short-Term Debt 807.1 807.1Capital Leases 0.0% Sub 0.0 0.0Capital Leases 0.0% Sub 0.0 0.0Cap. L. Adj. 0.0% Sub 0.0 0.0

Total Capital Leases 0.0 0.0Other 0.0% Sen 0.0 0.0Other Adj. 0.0% Sen 0.0 0.0

Total Other Debt 0.0 0.0Out-of-the-Money Convertible Preferred 0.0 0.0Preferred 0.0% 0.0 0.0Preferred 0.0% 0.0 0.0Pref. Adj. 0.0% 0.0 0.0

Total Preferred 0.0 0.0Total Debt & Preferred 5,310.7 5,310.7

Total Senior Debt 5,310.7 5,310.7Total Subordinated Debt 0.0 0.0Total Convertible Debt (assumes no conversion 0.0 0.0Total Convertible Preferred (assumes no conve 0.0 0.0Note: 1=Senior Debt, 2=Subordinated Debt.

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4. Historical / LTM Income StatementStep 1

FactSet downloads the historicals automatically. Check downloaded FactSet information and make changes as required

Fill in Last Fiscal Year column exactly as shown on financial statement (we’ll get to adjustments later)

You will find all the line items on the income statement, except Depreciation & Amortization, which are on typically the cashflow statement

If the latest fiscal year end is the most recent quarter, you can ignore the other two columns

Step 2

Fill in the most current quarter and prior corresponding quarter to get to LTM

Make sure you use cumulative amounts (i.e. if the fiscal year end is 12/31 and you are looking at 9/30 10-Q, use “nine months ended” data)

Step 3

The model automatically calculates LTM for you. Make sure you set CS as the LTM source under settings/options so the output picks up your hard work

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Great, But What’s LTM? LTM = Last Twelve Months

Companies report financial results on a quarterly basis (every 3 months)

LTM represents the sum of the last four quarters’ results

LTM is important because it shows what the company’s reported performance has been over the last year (though not necessarily a calendar year)

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5. Income Statement Adjustments –Unusual and Non-Recurring ItemsCompanies often report one-time gains or extraordinary charges in accordance with GAAP. As financial analysts, we do not view these charges as related to operations and thus exclude them.

Typical “non-operating” charges include gains/losses on sale of assets, inventory write-downs and restructuring charges

It is important to remember that not all unusual or non-recurring items will be broken out on the financial statements. This is the result of:

Accountants will not always allow companies to break-out certain charges on the financial statements because they are not unusual in the strictest sense

Some companies may not want to highlight that they “made their numbers” as a result of an extraordinary gain

Charges or gains not broken out in the financials can always be found in the MD&A – that’s why you need to read it!

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6. Projected and Calendarized Income Statement Projected income statement data comes from the research report you have selected

This data generates your projected EBITDA

It is important to make sure your projected data is presented on the same basis as your historical data

Completing the equity comp projected data is similar to the historical / LTM data

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A Note On Calendarizing EstimatesSome companies do not have December 31 fiscal year ends. As a result, the earnings of these companies are not comparable to the earnings of companies with a December 31 year end. Therefore:

EPS estimates must be adjusted to a December year end to make companies with different fiscal year ends comparable on a P/E basis

First Call and I/B/E/S generally download a CYEPS (Calendar Year EPS)

This is intuitively clear when considering two companies – one with a fiscal year ending September 30, 2005 and the other with a fiscal year ending December 31, 2005

The 2005 earnings estimates associated with the “September” company have a higher degree of certainty than the “December” company and thus should receive a higher multiple than an identical “December” company

Our objective is to eliminate this artificial valuation differential by “calendarizing” the estimates

If you choose not to calendarize it, please set calendarization date equal to last fiscal year end

Helpful Hint: In the top right corner of your ABACUS shell, you have the option to calendarize manually (meaning you do all the work) or by formula (meaning FactSet generates the formula for you). In most cases, use the Formula option, but make sure you know how it is deriving its ratio.

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Calendarizing EPS EstimatesExample #1: “Fiscal year ends September 30”

What does this mean?

It means that 9 months (or ¾) of the Company’s fiscal 2004 results (Jan. 2004 – Sept. 2004) are included in the 2004 calendar year with the remaining 3 months (or ¼) of the calendar year estimated in the fiscal 2005 results.

Illustration:

FACTOR2004A 2005E 2006E 75.0% 2004A 2005E

Sales $1,000 $1,010 $1,020 $1,002.5 $1,012.5

EBITDA 150 200 250 162.5 212.5

EPS 1.00 1.10 1.20 1.03 1.13

ENDED DEC. 31,FISCAL YEAR ENDED SEPT. 30,CALENDAR YEAR

25%75%

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The Sanity CheckHow to avoid the dreaded, “This doesn’t look right” response

Take 5 minutes to look at the output when you’re done – the team will wait

Look for outliers in the data

Comparable companies usually have comparable multiples

– If 9 out of 10 companies in your equity comps are trading between 8x and 10x EBITDA, and one is trading at 20x, you might have a problem

– Possible explanations: 1. You’ve made a mistake, 2. This isn’t a good comp, or 3. There is something unusual about this company

– In the unlikely event of Case 3, be sure you can explain the situation

Likewise, the relationship between Enterprise Value / EBITDA and P/E should be roughly the same across companies

– Not always true, but be prepared to explain why it’s not

Check your multiples against research to be sure you’re in the right ballpark

If the business is showing momentum and estimated annual operating statistics are improving over current year figures, your consecutive multiples should be declining (e.g., 16.5x 2005E P/E vs. 14.6x 2006E P/E)

If the multiples are increasing, make sure you understand why

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Great Equity Comp Mysteries What do I do with Minority Interests?

Include with total capital for Enterprise Value calculation, exclude from debt for credit statistics

Include with net income if it appears to be a “normal” part of business

What do I do with Equity Earnings when I am calculating Net Income?

Include if it is a “normal” part of the business

How do I know if a company has “done something” recently?

“Something’s not right”

Common “light bulbs” – dramatic change in stock price or shares outstanding, jump in sales or margins

Look in News Runs, SDC, Documents Library

What if a company has done something recently?

Pro forma the event, e.g., for equity or debt offerings, use the prospectus

Make sure your forecasts (EPS and operating) reflect the event

Footnote!

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What do I do with all those weird “extraordinary” charges?

Is it really extraordinary?

Most common are Environmental Charges, Restructuring, Gain/Losses on Sales, Changes in Accounting

Get rid of it – don’t forget tax effects

Don’t forget to adjust historical EPS

Can I trust FactSet (FDS) codes?

In general, no (exception is security prices)

Do I do anything different with options in an M&A situation?

Assume all in-the-money options are exercisable (change of control provisions)

Great Equity Comp Mysteries

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What do I do if a company has had a stock split?

Look in the Stock Guide, footnotes to financial statements, Bloomberg

Make sure historical and forecast EPS reflect the split

Example:

BEFORE SPLIT

AFTER SPLIT: CORRECT

AFTER SPLIT: INCORRECT

Stock Price $100 $50 $50 EPS $10.00 $5.00 $10.00 P/E 10x 10x 5x

2:1 Stock Split

Great Equity Comp Mysteries

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Definitions Equity Value (also referred to as Market Value)

The market value of a company’s equity: (Number of fully diluted shares x current stock price) - option/warrant proceeds

Number of fully diluted shares = “What the market thinks is outstanding”= Primary shares + “in the money” exercisable options/warrants + shares from the conversion of “in the money” convertible debt/convertible preferred stock

What to do with option/warrant proceeds – Subtract from market value

Enterprise Value (also referred to as Adjusted Market Value, or AMV)

The market value of the total enterprise

Market value of equity + net debt

Net Debt =Long-term debt (including current portion) + short-term debt + “out of the money” convertible debt + minority interest + capitalized leases – (cash + equivalents)

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Interpreting the Results – A Few General Themes A larger business is viewed as less risky than a smaller business. However, smaller

entrepreneurial companies may get a premium valuation if they are growing quickly

Higher projected earnings growth implies faster stock appreciation potential and will positively impact valuation

Higher leverage implies less financial flexibility and will negatively impact valuation

Higher profitability margins imply better expense controls and better ability to stay price competitive and will positively impact valuation

The higher the economic cyclicality or seasonality of earnings, the riskier the stock

Dividend payments positively impact valuation. Dividends are usually paid by mature companies that need further incentives for investors. High growth companies do not need a dividend to get a high valuation

Higher trading multiples (e.g., price/earnings ratio) make the stock less attractive than a similar company with lower statistics

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Your Enterprise Value Is Not Correct You forgot Minority Interest

Should be included in total capital for enterprise value calculation

Is not included in total capital when calculating credit stats

You missed a debt instrument on the balance sheet

You missed a cash equivalent on the balance sheet

The Company may have done a debt offering after the balance sheet date

You can find out in the “subsequent events” section of the 10-K or 10-Q, from a company news run or Bloomberg

Make sure that you check what the proceeds were used for – if they were used to pay down other debt, then you should not change anything

Your Equity Value is not correct

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Your Equity Value Is Not Correct The Company has done a stock split

The Company has issued or repurchased shares after the 10-K or 10-Q date

The Company has additional classes of common stock outstanding

You forgot to include the stock options

You forgot to include convertible debt or convertible preferred stock

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Your LTM Data Is Incorrect You forgot to pro forma for all the charges – make sure to thoroughly read the MD&A and

financial notes

You forgot to use cumulative quarterly data (i.e. “three months ended” 9/30 vs. “nine months ended” 9/30)

You forgot to adjust your income statement for acquisitions/divestitures

You forgot to check for press releases and are not using the most up-to-date data

You assume D&A is included in operating expenses but it isn’t

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Your Projected Data Is Incorrect Your research report is outdated – make sure that the research report you are using has EPS

estimates in line with I/B/E/S or First Call

You did not calendarize

You did calendarize but used the wrong ratios

Your research report had a mistake you did not catch

Your research report currency does not match the rest of your input currency

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Comparable Company Analysis($ in millions)

SHARE % OF ENTERPRISE VALUE AS A LONG-TERM LTMPRICE 52-WEEK EQUITY ENTERPRISE MULTIPLE OF SALES MULTIPLE OF EBITDA EPS OPERATING

COMPANY 02/04/05 HIGH VALUE VALUE 2004E 2005E 2004E 2005E 2004E 2005E GROWTH RATIO

Truck Load

JB Hunt Transportation $45.00 97.7% $3,682 $3,697 1.3x 1.2x 8.2x 7.2x 17.5x 15.5x 15.8% 92.9%Swift Transportation(1) 22.61 99.4% 1,671 2,265 0.8x 0.7x 6.2x 5.9x 14.8x 12.6x 12.6% 93.6%Werner Enterprises(1) 20.94 90.1% 1,679 1,570 0.9x 0.9x 5.5x 4.9x 19.6x 16.1x 15.3% 91.6%Heartland Express(1) 20.93 90.2% 1,570 1,311 2.9x 2.6x 10.8x 9.7x 25.2x 22.0x 13.8% 79.6%Knight Transportation(1) 25.71 99.3% 1,460 1,434 3.5x 2.9x 11.9x 10.1x 29.4x 23.1x 16.6% 80.7%

Covenant Transportation 20.86 97.8% 312 372 0.6x 0.6x 4.8x 4.1x 18.9x 15.8x 12.0% 94.0%


Less Than TruckloadCNF Inc(1) $46.49 91.2% $2,457 $2,400 0.6x 0.6x 6.2x 5.3x 17.8x 14.3x 14.1% 92.3%Overnite Corp(1) 30.35 78.5% 850 925 0.6x 0.5x 5.3x 4.6x 13.2x 11.0x 15.5% 82.8%Arkansas Best Corp(1) 41.77 89.5% 1,069 1,000 0.6x 0.5x 4.9x 4.7x 13.0x 11.2x 12.5% 92.8%Old Dominion Freight(1) 35.60 97.5% 885 961 1.2x 0.9x 7.9x 6.6x 21.6x 16.9x 17.5% 91.4%SCS Transportation(1) 22.55 81.6% 354 470 0.5x 0.4x 5.2x 4.6x 17.8x 13.0x 15.0% 95.6%Yellow Roadway Corp(1) 56.31 97.8% 2,769 3,320 0.5x 0.5x 6.3x 5.0x 14.2x 10.9x 10.5% 94.6%


LogisticsC.H. Robinson Worldwide $51.38 91.1% $4,435 $4,201 1.0x 0.9x 18.5x 16.1x 32.9x 28.4x 14.5% 94.9%UTi Worldwide Inc 71.88 98.5% 2,307 2,297 1.5x 1.1x 30.8x 13.0x 27.9x 21.6x 20.0% 94.0%Sirva Inc 9.40 36.2% 693 1,165 1.1x 1.0x 6.9x 5.2x 11.1x 7.4x 20.0% 94.6%EGL Inc 31.18 89.1% 1,461 1,475 0.5x 0.5x 19.1x 14.7x 27.7x 23.1x 17.4% 97.2%Landstar System Inc(1) 35.25 91.4% 1,083 1,113 0.6x 0.5x 8.3x 7.2x 29.0x 23.8x 17.0% 94.1%Pacer International 22.19 91.0% 837 1,007 2.6x 2.4x 11.2x 9.8x 16.2x 13.7x 14.6% 94.8%Forward Air Corp 43.33 91.7% 944 840 3.0x 2.6x 13.9x 11.5x 27.7x 23.1x 14.5% 81.1%Hub Group 56.46 96.6% 529 529 0.4x 0.4x 10.2x 8.9x 25.3x 22.6x 25.0% 96.6%Quality Distribution Inc 8.62 53.4% 164 436 0.7x 0.6x 6.6x 5.5x 12.3x 8.5x NA 93.9%


USF Corp(1) $32.44 83.6% $916 $1,015 0.4x 0.4x 6.0x 4.0x 38.2x 13.1x 10.2% 97.3%

Source: Public filings and Wall Street research reports.(1) Based on 4Q '04 earnings releases.

P/E


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D. M&A Comps

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Summer Assignment – M&A Comps Assignment

For the following two acquisitions, create a deal list similar to that on the sample page

Include target business description, as well as the the following statistics: EV / LTM sales EV / LTM EBIT EV / LTM EBITDA

Key Takeaways

At the end of this section you should be able to answer the following:1. At what multiples have similar transactions been closed in the past?2. What valuation (approximately) does this imply for Knight Ridder?3. Is this valuation different than what was implied from the equity comp analysis, can you

explain the difference?

Date Acquiror TargetJan-05 Lee Enterprises PulitzerJun-00 Gannett Central Newspapers

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Agenda What are M&A Comps and Why Do We Do Them?

Finding Comparable Transactions

Practical Guidelines

M&A related SEC filings

USF Corporation: Sample M&A comps

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Comparable Acquisitions Analysis Comparable acquisitions analysis values a company by reference to other sale transactions of similar

businesses. Comparable acquisitions analysis is based on the same multiples as those used in comparable companies analysis

Enterprise Value / EBITDA

Equity Value / Net Income

Enterprise Value / Sales (usually less relevant)

Enterprise Value / EBIT (usually less relevant)

The trick is to find the right comparable transactions and to ferret out the relevant information required

As in comparable company analyses, look for acquisitions of companies with comparable operational and financial characteristics

Recent transactions are a more accurate reflection of the values buyers are currently willing to pay than are acquisitions completed in the distant past. This is because market fundamentals are subject to dramatic change over periods of time. In addition, cyclical businesses will trade at widely different valuations at the peak and ebb of a cycle

Multiples should be based on the latest public financial information available to the Acquiror at the time of the acquisition

Helpful Hint #1: Unlike Equity Comps, which value companies off of forward looking estimates, M&A Comps are historical looking

Helpful Hint #2: Comparable acquisition multiples include consideration which is paid for "control" of the Target. Since this "control premium" is not reflected in the comparable company valuation, comparable acquisition multiples tend to be higher and more indicative of the value of a company in a sale context

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Finding Comparable AcquisitionsSources to check for comparable acquisitions include:

Other comparable acquisitions schedules

Previous presentations/valuation analyses

SDC database (Securities Data Corporation)

News runs

Equity analysts

Public tender offer documents and merger proxies

Colleagues

Never rely on the multiples of a schedule with an unknown author or with an author who is not sure that the multiples are correct.

Look for recent acquisitions of companies with operational and financial characteristics similar to those of the business being valued.

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Total Transaction Value of an M&A deal is similar to Enterprise Value used in Comparable Companies Analysis.

Calculation of Transaction Value

Total Transaction

Value

Equity Value

Total Debt

Preferred Stock

Minority Interest

Cash and Equivalents

EquityValue

Fully DilutedShares

Outstanding

PurchasePrice

+ + + -=

= x

Helpful Hint: The major difference between a Transaction Value and an Enterprise Value lies in the share count. In any “Change of Control,” all outstanding and “in-the-money” options, regardless of whether they are exercisable or not , get converted at the weighted average strike price. This differs from the Enterprise Value calculation, where only those options that are exercisable get converted

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Calculation of Shares Outstanding

Basic Shares Outstanding are taken from the cover of the most recent 10-K or 10-Q.

Option/Warrant Shares are calculated using the treasury method, which assumes that all in-the-money options/warrants are exercised and the proceeds are used to repurchase shares at today’s market price

For example:

To calculate equity value, we must always use fully diluted shares outstanding.

Basic Shares Option/Warrant Shares 20 million shares 500,000 in-the-money options $25 is the average strike price $35 is today’s stock price

Fully DilutedShares

Outstanding

BasicShares

Outstanding

Option/WarrantShares

= +

Helpful Hint: There are two independent concepts regarding option/warrants that tend to confuse people:

1. Outstanding versus Exercisable

2. “In-the-money” versus “out-of-the-money”

In an acquisition context, all outstanding and “in-the-money” options/warrants get converted. In a market value (equity comp) context, only those options that are both exercisable and “in-the-money” convert

Options/warrants “out-of-the-money” never convert

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Calculation of Shares Outstanding (Cont’d) In-The-Money Option/Warrant Shares: Step 1: 500,000 x $25 = $12.5 million Step 2: $12.5 million / $35 = 357,143 shares Step 3: 500,000 - 357,143 = 142,857

Finally . . . To Calculate Fully Diluted Shares Outstanding.

Now You Can Solve For The Equity Value

Fully Diluted Shares Outstanding = 20,000,000 + 142,857 = 20,142,857

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Determination of Purchase Price per Share Cash consideration is straightforward

Common stock issued by an acquiror is valued using the acquiror’s stock price on the day prior to announcement of the transaction

Other securities are valued at market Existing publicly traded securities should be valued at market on the day prior to

announcement New classes of securities should be valued at market value on the first day of trading

Calculating the purchase price per share is not always as simple as it may first appear

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Enterprise Value vs. Equity ValueGeneral Overview

There are typically two stakeholders in any firm, the Debt Holders and the Equity Holders. The concept of Enterprise Value contemplates that the earnings of the Company are allocated to both the Debt Holders (through interest payments) and the Equity Holders (through dividends and appreciation in stock price)

When You Use Enterprise Value

Typically, you will use Enterprise Value in circumstances when the financial statistic being utilized is flowing to the debt and equity holders. In general, this means that any financial statistic that is pre-interest expense will use an Enterprise Value concept to determine valuation

When You Use Equity Value

Typically, you will use Equity Value in circumstances when the financial statistic being utilized is flowing only to the equity holders. In general, this means that any financial statistic that is post-interest expense will use an Equity Value concept to determine valuation

Public market valuations tend to use earnings multiples (typically forward earnings multiples) because the investment decision is being made based upon a capital structure that is already in place and cannot be influenced by the common stock holder

When do you use what?

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Stock Price Premiums

Often calculated from day prior to announcement of transaction

Often news and rumors of a potential transaction often leak to the market and affect the stock price prior to announcement. We also look at premiums over the stock price at other points in time relative to announcement including: One Day One Week One Month

For public companies, we often look at the percent premium paid to shareholders.

% PremiumPaid

Purchase PriceHistorical Price= 100[ ]______________ - 1 *

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Practical Guidelines1) Obtain SDC run to get general information regarding announcement dates, target/acquirors,

structure of transactions, etc. When doing an SDC run, you typically search by industry SIC codes to find M&A deals for certain industries. If a deal has just been announced, you'll need to get a news run done on the deal

2) Make sure the announcement date is correct by checking Bloomberg

3) Retrieve appropriate documents from SEC. You will need a merger document and 10-K and 10-Q. Make sure that the 10-K and 10-Q are for the target company financials for the LTM period before the announcement date. M&A comps are usually done on an LTM basis. At some point you may have to do an M&A comp on a forward basis, but this is uncommon

4) Read a summary of the terms of the transaction in the merger doc. This is especially true for stock-for-stock transactions. Understand whether the transaction was a stock-for-stock, cash tender offer, asset sale, minority interest investment, etc. This will help you determine the purchase price later on

5) Scan the notes of the 10-K and the 10-Q for any significant items not reflected in the statements. Sometimes the target has been involved in other significant mergers, divestitures, or other consequential events. If so, then read the appropriate 8-K or other document in order to pro forma the financials. Also, do a quick Bloomberg scan to see if anything has happened after the filing of the last financial statement and the announcement of the merger, which could also affect the valuation

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Practical Guidelines (Cont’d)6) Once you have checked SDC’s announcement date, enter this and the effective date.

Generally, you can trust SDC on the effective date

7) Get the business description from the Bloomberg or from the 10-K. Be brief but not vague

8) The type of merger doc you get will tell you what the structure of the deal is. If you’ve got a stock deal, then you will have a merger proxy S-4. If you have a cash tender offer, then you will have a 14D-1. Attitude (friendly vs. hostile) can be obtained from SDC. For the type of consideration offered, read the summary of the terms of the merger. You may not always need to show this in your comps

9) Calculate equity value using fully diluted shares outstanding and the offer price per share. This sounds straightforward, but it is often easy to get tripped up here. Things to consider:

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Practical Guidelines (Cont’d)a) For a stock-for-stock deal, the price per share is implied. Some terms to get familiar with: The exchange ratio is simply the number of shares of the acquiror being offered for every

share of the target. So if Target Corp. received one share of Acquisition Corp. stock for every five of its shares, then the exchange ratio would be 1/5, or 0.2.

If you read the summary of the terms, you will either get a fixed ratio or a fixed price. In the case of a fixed price, the exchange ratio adjusts to fit the price. For example, if Acquisition Corp. knows it wants to pay $5 per share for Target Corp., then the number of shares it must offer to get to that $5 will depend on its own stock price. If its price were $2 per share, then it would have to offer 2.5 of its own shares, and 2.5 would be the exchange ratio. In other cases, the exchange ratio is fixed. So if Acquisition Corp. offered 2.5 of its shares for every Target share, then the implied value of the Target share is (2.5 x Acquisition Corp. share price). Therefore, the implied price will fluctuate over time. So you can see, either you hold the exchange ratio constant and vary the implied purchase price, or you have a fixed price and vary the exchange ratio

For our purposes, what we care about is what the shares were valued at prior to the announcement. So if the Acquiror’s share price was $10 on the day prior to the announcement and the exchange ratio was 2, then the implied price per Target share would be $20. Often the merger proxy will state that the actual exchange ratio at the closing will depend on “the average closing price of the twenty trading days prior to the three days before the Effective Date...” Ignore it, unless for some reason this language is related to the announcement date somehow, because this is the actual price to be paid. Remember, our job is to determine how the transaction is valued as of the announcement, so just assume that such a price is whatever it was on the day prior to the announcement

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Practical Guidelines (Cont’d)b) Check the capitalization of the company to see if they have any convertible securities

(debt and preferred stock). Often such securities have takeover provisions which allow them to convert upon a merger, in which case you want to include their value in the equity purchase price (of course, you will have to back out their value later when calculating the enterprise value)

c) Options. Generally, upon a change of control in a company, the options are bought out by the acquiror. We need to account for this in the equity purchase price, so there are columns which will calculate this value for you. You can get this info either from the 10-K, or if available, from the merger proxy (you generally wont find this info in a 14D-1). Since we will usually not have a detailed breakout of what each individual option is, it is sufficient to take the average exercise price. When doing so, you should never get to a negative purchase price for the options because when the exercise price is less than the offer price, the options are worthless (“out of the money”)

10) Calculate the enterprise value by entering the appropriate debt and cash figures. Remember, include marketable securities in the cash figure, and if you converted some pieces of debt or preferred in calculating them in the equity purchase price, do not include them here. Otherwise, that would be double counting

11) For LTM figures, make sure the numbers you input do not include unusual or nonrecurring items. Simply subtract them out from EBITDA and EBIT. For the net income line, make sure you take these out tax-affected. This means that for a net income calculation you would back out the unusual multiplied by (1-tax rate)

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Practical Guidelines (Cont’d)12) There might have been significant events for which you did not pro forma the numbers. Did

the target purchase another company prior to being acquired that is not reflected in the numbers? Did the target sell off assets or spin off a division? Use your judgment. Companies in high-growth industries can trade at high multiples (for example, technology deals can be done at 4x revenues, 15–20x EBITDA). Slow, prodding industries should not have such multiples. Also, if it is a hostile deal, then you may have pretty high multiples since the acquiror has to pay a big premium to get the deal done

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M&A – Related SEC Filings

SEC FORM/ SCHEDULE

DOCUMENT NAME

DESCRIPTION

14D-1 Tender Offer/Offer to Purchase

Filed by the acquiror when launching a tender offer

Has to be opened for a minimum of 20 days

Must be amended for changes in deal/material events

Some information disclosed in document:

Price per share Number of shares sought Conditions to closing Source of financing Background and purpose of offer Financial data on acquiror Information on acquiror’s investment banker and fees

14D-9 Target’s Recommendation to Tender Offer

Filed by the target within 10 business days of the commencement of a tender offer

Contains a recommendation from the target’s Board of Directors about how to respond to the Tender Offer, along with reasons for such recommendation

Also contains other disclosures

Background of transaction Agreements involving management Fairness opinion for target’s shareholders Information on target’s investment banker and fees

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M&A – Related SEC Filings (Cont’d)

SEC FORM/ SCHEDULE

DOCUMENT NAME

DESCRIPTION

13D – Filed by any person or group which has acquired 5% of a public company within 10 days of such acquisition

Required disclosures include:

Identity and background of acquiror Amount and source of funds Purpose/intent of purchase Number of shares owned

Must be amended for material charges

Proxy/S-4 (if securities involved)

Merger Proxy; Joint Proxy/Prospectus

Filed by target and/or acquiror

Comprehensive document used to solicit votes to approve transaction

Serves as a registration statement if securities are to be issued as consideration (versus all cash)

Selected disclosures include:

Vote required for approval Terms of transaction Recommendation of board Fairness opinions for target’s (and possibly acquiror’s) shareholders May describe analysis supporting fairness opinions Summary financial data, including pro formas May have full financial statements as an exhibit

Form F-4 (versus S-4) is used by foreign acquirors

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M&A – Related SEC Filings (Cont’d)

SEC FORM/ SCHEDULE

DOCUMENT NAME

DESCRIPTION

8K – Filed for material corporate events or disclosures; not only used for M&A deals

In M&A context, filed to announce a material acquisition and/or sale of a division/subsidiary

Filed by either seller or acquiror if the transaction is material to such party

Typically gives the key terms of a transaction, with the sale/purchase contract filed as an exhibit

Financial statements and/or pro forma financials are often filed as an amendment on Form 8 as companies are given time to include financials on the filing

10K, 10Q Annual, Quarterly Filings ”Ks” and “Qs”

Contain required financial statements and MD&A filings

May also contain M&A-related disclosures which could have been made on Form 8K

13E-3 Going Private Filing Used in connection with a significant affiliated party M&A transaction (i.e., LBO or Minority Buyout)

Discloses fairness of transaction to such minority shareholders, usually determined by Special Committee

Often contains filing of actual Board presentation by financial advisor to Special Committee

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Comparable Acquisition Analysis($ in millions)

EQUITY ENTERPRISE ENTERPRISE

VALUE/

TARGET DATE TARGET TARGET DESCRIPTION ACQUIROR VALUE VALUE (1) EBITDA (2) UNIONIZED

Jul-03 Roadway Corporation (US)

LTL carrier providing freight services on major city-to-city routes in North America

Yellow Corporation $966 $1231 6.7x NA

Nov-01 Motor Cargo Industries Provides regional less-than truckload services in the western U.S.

Union Pacific Corp. 83 78 4.0 No

Nov-01 Arnold Industries Provides regional less-than-truckload services in northeastern states and also provides truckload and logistics services

Roadway Corp. 558 510 5.7 Yes

Aug-01 Arnold Industries (US) N/A Roadway Corporation 539 510 5.4 No Aug-01 G.I. Trucking Company Provides regional less-than-truckload services

in western and southwestern states Investor Group (Estes) 40 40 5.0 No

Nov-00 American Freightways Corporation

Operates as a scheduled common and contract carrier transporting primarily less-than-truckload shipments of general commodities.

FedEx Corp. 934 1,196 6.3 No

Jun-99 Jevic Transportation Inc.

Provides regional and interregional transportation of general commodity freight

Yellow Corp. 158 197 5.9 No

Jun-98 Preston Trucking Provides les-than-truckload transportation of general commodity freight

Management Group NM NA NA Yes

Oct-97 Caliber System, Inc.

Provides transportation, logistics and related information services through its five subsidiaries

FedEx Corp. 2,489 2,681 10.3 No

Jul-95 Worldway Corp. Transporter of freight throughout United States; also provides truckload services and driver leasing services through its subsidiaries

Arkansas Best Corp. 82 153 9.0 Yes

Nov-92 Central Freight Lines Inc.

Carrier of intrastate and foreign commerce within Texas, Arizona, and New Mexico


Nov-92 Preston Trucking Provides less-than-truckload transportation of general commodity freight

Yellow Freight Systems 24 146 5.8 Yes

Jul-88 Viking Freight Inc. Provides regional carrier services in California and 9 other Western States


Jun-88 Arkansas Best Corp. LTL and TL carriage, furniture manufacturing and tire retreading

Kelso & Co. 317 472 6.2 Yes

Median 6.1x Average 6.5x High 10.3x Low 4.0x

Source: Securities Data Corporation, public filings and news reports.(1) Enterprise Value = Value of Common + Total Debt – Cash.(2) EBITDA, EBIT and Net Income exclude extraordinary items and accounting changes.


88

Discounted Cash Flow Analysis

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Project Knight Ridder’s income statement for five years Make note of what assumptions you use to grow the income statement

From these projections, calculate Knight Ridder’s annual free cash flows Using your equity comps, find the terminal EBITDA multiple and calculate the terminal value

Using your comps, calculate the proper WACC that should be used to discount Knight Ridder’s cash flows Unlever the Beta for each comp and re-lever at Knight Ridder’s leverage

Discount the Free Cash Flows and terminal multiple at the WACC Use the terminal multiple and WACC to calculate an implied perpetuity growth rate Calculate the equity value per share and compare to Knight Ridder’s current price

Create a sensitivity table showing the changes in enterprise value and equity value per share as impacted by the WACC and terminal multiple

Helpful Hint #1: ABACUS has a WACC summary sheet that unlevers and relevers the betas for you. This schedule can be very helpful, but make sure you understand how it works. You will have to input company betas, the risk-free rate, market risk premiums and tax rates manually

Summer Assignment – DCF

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Summer Assignment – DCF (Cont’d)Key Takeaways

At the end of this section, you should be able to answer the following:1. What projected income statement assumptions did you use and why?2. How do you calculate a WACC? Why is it important to unlever and then re-lever your

beta?3. What risk-free rate, equity risk premium and size premium did you use and where do

these numbers come from?4. Explain how you determined your Terminal Multiple5. What value range does your DCF imply for Knight Ridder?6. Given this valuation, is Knight Ridder currently under- or over-valued in the marketplace?7. What does this mean for a potential buyer?

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Agenda

What is a DCF and why do we do it?

Projections

Terminal Value

Weighted Average Cost of Capital (“WACC”)

Present Value

Sample Discounted Cash Flow Analysis

Sample WACC Schedule

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Discounted Cash Flow Analysis Comparable company and comparable acquisition analyses are often used as confirming

methodologies

Specific asset values are sometimes used if other methodologies are inapplicable

Applications of valuation analysis include:

Acquisitions: How much should we pay to buy the company / division?

Divestitures: How much could we sell our company / division for?

Defense: Is our company undervalued / vulnerable to a raider?

Fairness Opinions: Is the price offered for our company / division fair from a financial point of view?

Public Equity Offerings: For how much could we sell our company / division in the public market?

New Business Presentations: Various applications

Discounted Cash Flow analysis is typically the primary valuation methodology used by CS in M&A and certain capital markets transactions.

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DCF Versus Other Valuation Methodologies

Of the three principal valuation methodologies used on Wall Street, DCF analysis frequently carries significant weight.

Discounted

Cash Flow Analysis Comparable

Company Analysis Comparable

Acquisition Analysis

Methodology: Present value of projected unlevered free cash flows

“Inherent” value Best captures business in

transition Sensitivity analysis Synergies analysis Buy vs. build

Value based on market trading multiples of comparable companies·

Implied value in public securities markets (IPO analysis); fully-distributed value

Usually focus on forward looking EBITDA, earnings and cash flow

Value based on multiples paid for comparable companies/assets in sale transactions

Implied value in private market Focuses mainly on multiples of

historical EBITDA, earnings and cash flow

Issues: Financial forecasts developed with management

Discount rate Terminal value method

Market environment Quality of comparables Public data Consistent accounting treatment Less meaningful benchmark for

assets with unique cash flow patterns

Market environment Quality of comparables Availability of data Consistent accounting

treatment Less meaningful benchmark for

assets with unique cash flow patterns

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Discounted Cash Flow Analysis Components

Define components of free cash flow (“FCF”) Develop historical perspective Produce financial forecasts and sensitivity analysis Step back and interpret the results

Exit multiples, perpetuity formula, other approaches

Cost of equity Cost of debt Theoretical optimal capital structure

FCF for periods 1 to n Terminal value

Adjustment for non-operating items (e.g., extraordinary items, cash

flow from unconsolidated subsidiaries, hidden assets, contingent liabilities, etc.)

Take market value of financial debt, plus minority interests plus other

non-working capital liabilities less excess cash and marketable securities (sometimes referred to as “corporate adjustments”)

Interpret results Compare findings with other valuation methods

RemarksValuation Steps

Forecast of Unlevered FCFs

Calculate Terminal Value

Calculate WACC

Discount FCFs

Enterprise Value

Less net debt

Equity Value

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Valuation: Enterprise Value Versus Equity Value

We use discounted cash flow analysis to calculate the enterprise value of the firm, which then allows us to calculate its equity value.

Enterprise Value = market value of operating assets

Equity Value = market value of shareholders’ equity

Equity Value = Enterprise Value – Net Debt(1)

Enterprise Value

Equity Value

Net Debt

Enterprise Value

Net AssetsLiabilities and

Shareholders’ Equity

(1) Net Debt (Corporate Adjustments) is equal to total debt + minority interest + preferred stock + capitalized leases - excess cash and cash equivalents.

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DFC Analysis: The Process

Projections Project the operating results and free cash flows of a business over a particular forecast period.

Terminal Value Estimate the terminal value of the business, often by using terminal multiples, at the end of the forecast period.

WACC Use the weighted average cost of capital to determine the appropriate discount rate range.

Present Value Determine a range of values for the enterprise by discounting the projected free cash flows and terminal value to the present.

Adjustments Adjust your valuation for all assets and liabilities not accounted for in the cash flow projections.

Step 1

Step 2

Step 3

Step 4

Step 5

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Step 1: Projections DCF analysis is an attempt to look at the company’s pure operating results, free and clear of financial leverage,

extraordinary items, discontinued operations, etc.

Many times, we are given financial projections from the management of a particular company; however, there are situations in which we must develop our own forecast for a particular company or business

– It is extremely important to look at the historical performance of a company or business to understand how future cash flows relate to past performance

A company’s unlevered free cash flows represent the cash generating ability of that particular company, without regard to its present or prospective capital structure

– As a result, unlevered free cash flows are projected before subtracting interest and financing expenses or related tax shields

DCF projections should be based on: Historical performance Company projections (when available) Equity research analyst estimates Industry data Common sense

The forecast horizon should be long enough so that the company reaches “steady state” by the end of the forecast period

– Typically, forecasts of 5 - 10 years are used for DCF analyses of maturing or mature firms

The free cash flows from a business can be projected using information about the industry in which the business operates and information specific to the business.

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Step 1: ProjectionsExtract historical financials

Sales

Operating cash flow

Depreciation & amortization

Deferred taxes

Capital expenditures

Working capital (receivables, inventories and prepaid expenses less current payables and other current operating liabilities)

Analyze numbers

How relevant are historical figures? Major changes in business or industry Management’s discussion of results

Are numbers “clean”? Extraordinary items Acquisitions / divestitures

Is anything excluded? Compare to cash flow statement

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Step 1: Projections – SalesSales Buildup

Build a separate schedule for sales analysis which will feed through to consolidated statement

Breakdown by market segment (different prevailing market dynamics), product type/class, etc.

Assumptions on volumes and unit prices

Base assumptions on:

– Research reports

– Management or client forecasts (if available)

– Overall industry trends

Sales growth is usually an input; aggregate sales are derived from this input

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Step 1: Projections – Operating Expenses, Depreciation Expenses and TaxesOperating Expenses

Build a separate schedule for cost analysis: Breakdown by main category of costs

– Cost of goods sold, personnel costs, SG&A expenses– Fixed vs. variable costs

Understand cost behavior/sensitivity to changes in sales level Understand key cost drivers (e.g., price of raw materials, inflation, etc.) Estimate as a percentage of sales

Depreciation Expense

Usually expressed as a percentage of sales, comparing to historical trend or hardcoded and set relatively flat throughout the period

Tax

Tax charge that the Company would pay if it had no debt– Assess tax rate based on previous marginal tax rate (composite local and corporate tax

rates) as well as current and future tax regulation– Reflect operating loss carry forwards, if any

(1) Exclude land because it is not depreciable.

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Step 1: Projections – Capital Expenditures Capital expenditures (“Capex”) are the investments necessary to maintain the required capital

intensity, which includes expenditures on new as well as replacement property plant and equipment (“PP&E”)

Base assumptions on:

– Company forecasts

– Industry levels

– Research reports

– Percentage of sales, percentage of PP&E

Build a CapEx schedule breaking down expenditures by type of asset (buildings, machinery and equipment, other assets) and between new and replacement CapEx

– Show beginning and ending PP&E by type of asset

At the end of forecast period, the CapEx level should be in line (equal or slightly higher) with depreciation (i.e., assume that capital intensity is maintained going forward)

For a given year, CapEx is equal to end of year net PP&E less beginning of year net PP&E plus depreciation expense for the year

(1) Net PP&E is equal to gross PP&E less accumulated depreciation.

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Step 1: Projections – Working Capital Working capital is defined as the sum of accounts receivable, inventories, pre-paid expenses

and other current assets, less the sum of accounts payable, accrued expenses and other current liabilities

– This definition can change slightly for companies in different industries Exclude excess cash and marketable securities and short-term debt

– We often use the term “net working capital” to distinguish the investment banking concept from the accountant’s definition of working capital

Build a working capital schedule breaking down the main components of working capital– Estimate balances for the components of working capital as a percentage of sales, cost of

goods sold or other appropriate metrics (or using year-on-year growth rates) for each projection year

– Calculate the net increase/decrease in working capital for each year When forecasting working capital, consider whether the company’s changing mix of business

affects its need for working capital– Any action to squeeze cash from working capital by operating more efficiently (e.g.,

reducing working capital as a percentage of sales, for instance via implementation of a just-in-time inventory system, a change in receivable/payable policy, etc.); whether there is a discernible trend in working capital, and if so, whether the improvement/deterioration will continue or stabilize?

Increases in net working capital are a use of cash and decreases in net working capital are a source of cash

– Remember that increases in assets and decreases in liabilities are uses of cash and decreases in assets and increases in liabilities are sources of cash

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Step 1: Projections – Deferred TaxesDeferred Taxes

For valuation purposes, taxes should be stated on a cash basis

Deferred tax assets and liabilities arise due to differences between financial (book) accounting and tax accounting

– The most significant differences in book and tax accounting typically arise with regard to the depreciation of assets. In the U.S., assets often can be depreciated on an accelerated basis for tax purposes, lowering taxable income in the current period and thus lowering actual cash taxes paid.

– On a book basis, however, often times the same assets cannot be depreciated on such an accelerated basis, thus taxable income is higher, as are book taxes per the income tax provision. The increase in deferred tax liabilities accounts for the difference between book taxes and the actual taxes paid to the government

Increases in deferred tax liabilities (net of deferred tax assets) are a source of a cash and should be added in calculating free cash flow (and alternatively, decreases in deferred tax liabilities are a use of cash and should be subtracted in calculating free cash flow)

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Step 1: Projections – Reality Check Confront sales growth assumptions with underlying market dynamics

– Be skeptical of projected sales growth curves that look show dramatic improvements versus recent actual performance. Does the increase in sales reflect a constant market share in an expanding market? If so, why is the market expanding? Does that assumption agree with industry projections? If it is an expanding market, why will the company be able to maintain a constant market share? Or does the increase reflect a rising market share in a stagnant market? If yes, why? Are some firms leaving the industry? Why?

Check reasonableness of margins– Avoid margin “hockey sticks”. Be clear on the actions and/or events needed to trigger improvements in margins

(or reasons for decreases in margins). Are the margin levels consistent with the structure of competition in the industry? Any risk of new entrants/substitute products that will drive margins down?

Capital Expenditures– Watch out for step-up of production capacity required as sales increase. Is the CapEx level sufficient to support

the forecasted increase in sales? Factor in the impact of industry trends on CapEx (e.g., increased environmental expenditures, technology changes, etc.)

Working Capital– Are inventory and other working capital forecasts consistent with the sales increase? What is the pattern of

accounts receivable collection? How is it practically achieved? Assess bargaining power of customers (receivables terms) and suppliers (account payable terms). Are your assumptions in line with industry standards?

Be Critical About Buyer’s and Seller’s Projections– Use due diligence/access to seller's management to gain in-depth understanding of company's assumptions and

challenge them (if and when appropriate). Where possible, compare the company's past record of actual versus budgeted results

– Add value/ “manage” client's expectations (both on buy and sell sides) by thoroughly understanding the company's market dynamics and competitive positioning

As always, it is important to perform a “Reality Check” on the main components of FCF

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Step 1: ProjectionsUnlevered Free Cash Flow

Unlevered Free Cash Flow is the unlevered after-tax cash flow generated by the Company (including the impact of any reinvestment)

Unlevered Free Cash Flow is available to all providers of the Company’s capital, both creditors and shareholders

Unlevered Free Cash Flow is best determined by considering sources and uses of cash:

METHOD 1 METHOD 2 Net Income EBIT

(+) After-Tax Interest Expense(1) (-) Tax Effect(2)

= Unlevered Net Income = Unlevered Net Income

(+) Increase in net Deferred Tax Liability (+) Increase in net Deferred Tax Liability

(+) Depreciation and Amortization (+) Depreciation and Amortization

(-) Increase in Net Working Capital (-) Increase in Net Working Capital

(-) Capital Expenditures (-) Capital Expenditures

= Unlevered Free Cash Flow = Unlevered Free Cash Flow

Note: Changes in other long term assets/liabilities may affect Unlevered Free Cash Flow.(1) After-Tax Interest Expense is defined as interest expense less the applicable interest tax shield.(2) In most cases, amortization expense is not tax-deductible.

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Step 2: Determination of Terminal Value Firm value, based on free cash flows, can be separated into two components:

Since DCF analysis is based on a limited forecast period, a terminal value must be used to capture the value of the business at the end of the projection period

The terminal value is usually added to the free cash flow in the final year of the projections and then discounted back to the valuation date, or it can be discounted separately to the valuation date

The terminal value typically constitutes a substantial portion of the total enterprise value. Critical thinking about prospects of the business, and therefore the terminal value, results in a more meaningful, accurate and defensible DCF analysis

Note that the terminal year free cash flow has to be normalized to ensure that the company has reached a steady state

– Normalized operating assumptions: sales and profitability assumptions for the final year should reflect a “steady state” year, not a peak or trough in the business cycle; and depreciation and capex should be within the same range

Terminal value is determined through either application of a valuation multiple (the “terminal multiple”) or the perpetuity growth method

The terminal value captures the value of the business at the end of the projection period, which is based on the free cash flows of the business beyond the explicit forecast period.

Company ValuePV of FCF during explicit forecast

period

PV of FCF afterexplicit forecast

period= +

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Step 2: Terminal Value – Terminal Multiple Method Terminal Value = Statistic x Multiple

– Statistic: Operating statistic used (e.g., EBITDA in year 10)

– Multiple: Selected multiple (e.g., 10.0x)

Multiple is based on the most appropriate multiple for the company’s industry (e.g., EBIT versus EBITDA versus EBITDAR)

The multiple applied should reflect the long-term market valuation of the company/industry, rather than a current multiple that may be distorted by industry or economic cycles

When applying the multiple it is important to distinguish between:

Comparable trading company multiples and comparable acquisitions multiples

– It is almost always more appropriate to base terminal multiples on the figures derived via comparable companies analysis, rather than those from comparable transactions analysis

LTM and forward multiples

Always show a range of multiples

Terminal value based on assumed trading or acquisition multiple at the end of the projection period.

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Step 2: Terminal Value – Perpetuity Growth Method The Gordon Growth formula:

Unlevered FCF n+1: Unlevered free cash flow in the first year after the explicit projection period– Note that we often estimate FCF n+1 by taking FCF n and growing it by the growth rate g,

but this is not always appropriate r: Discount rate (based on weighted average cost of capital) g: Perpetuity growth rate

The perpetuity growth rate used must be realistic Reference point should be nominal GDP growth Expected long-term growth rate of the industry (e.g., utility industry growth rate versus cable

TV industry growth rate)

Always show a range of perpetuity growth rates

Terminal value based on business operating into perpetuity, growing free cash flow at some constant rate.

Terminal Valuen = Unlevered FCFn+1(r - g)

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Step 2: Terminal Value – Cross Referencing Check the reasonableness of the terminal value by linking the terminal multiple and perpetuity growth rate

– Calculate the implied perpetuity growth rate for a range of terminal multiples or, conversely check how the perpetuity growth rate translates into terminal multiples. For example, the terminal multiple you used may imply too high a perpetuity growth rate for the industry, or vice versa

The formula below demonstrates how to ‘reverse’ into the implied terminal multiple from the perpetuity growth method

– PV TV: Present Value of Terminal Value– FV TV: Future Value of Terminal Value – r: Discount rate– n: Number of years discounted – Statistic: Operating statistic on which multiple applied (e.g., EBITDA in year 10)

The formula below demonstrates how to ‘reverse’ into the implied perpetuity growth rate from the terminal multiple method (assuming FCFn+1 = FCFn x (1+g) )

– Multiple: Selected valuation multiple (e.g., 10.0x)– Unlevered FCF n: Unlevered free cash flow in last year of the projection

Does the terminal value make sense?

Implied terminal multiple = PV TV x (1+r)n FV TVStatistic Statistic=

Implied perpetuity growth rate = (r x Statistic x Multiple) – Unlevered FCFn

(Statistic x Multiple) + Unlevered FCFn

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Step 3: WACC – Discount Rate Overview

The WACC should be thought of as the opportunity cost of capital, the long-term return an investor expects to earn in an alternative investment of equivalent risk

The WACC to be used in a DCF analysis is specific to the business or asset being valued. It does not necessarily depend on the buyer’s or seller’s overall cost of capital

WACC is used by firms as the hurdle rate for a project or division, as a performance benchmark for return on capital calculations, to determine desirability of stock repurchases or issuance, or for valuation purposes

Mathematically, WACC is expressed as:

The Weighted Average Cost Capital (“WACC”) is the recommended discount rate to be used in the unlevered discounted cash flow valuation of an asset.

(1) Assumes capital structure is only debt and equity. Other sources of capital, such as preferred stock, would need to be included if present.(2) Based on the Capital Asset Pricing Model.(3) Assumes company’s debt is risk-free. In certain limited situations, an adjustment can be made to this formula to account for the riskiness of the company’s debt.

WACC(1)= x Proportion of Debtin Capital Structure + Cost of

Equity xProportion of Equityin Capital Structure

After-taxCost of Debt

Cost ofEquity(2) = Risk-Free

RateLevered

Beta+ x Equity Market Risk Premium

1 + (1 - Tax Rate) x (Debt/Equity Ratio)=

UnleveredBeta xLevered

Beta (3)

;

;

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Step 3: WACC – Target Capital Structure The “weights” applied to the costs of equity and debt used in computing WACC for an asset represent the

theoretical “optimal” capital structure for that asset

Finance theory (Modigliani-Miller’s three propositions) suggests that in the absence of taxes and financial distress/bankruptcy costs, changing leverage has no effect on WACC, and therefore no effect on firm value

– However, in a world with taxes and financial distress, increasing leverage is predicted to result in a decrease in the cost of capital, permitting the determination of a theoretically “optimal” capital structure

– Common applications of WACC do not directly factor in financial distress costs, thus they underestimate WACC at high levels of leverage

– Another shortcoming of WACC is that it assumes capital weights (i.e., leverage) are held constant through time

Prior to calculating the cost of equity and debt for the company you are valuing, you need to define a target capital structure that reflects the debt to equity ratio that is expected to prevail over the life of the business.

(%)Cost of Equity

Weighted Average Cost of Capital (WACC)

Cost of Debt

Debt as a % of Enterprise Value

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Step 3: WACC – Target Capital Structure Calculate the current market value-based capital structure for the company

To estimate the market value of equity (market capitalization), multiply the stock price by the shares outstanding. Exercisable stock options that are “in-the-money” should be included in the equity value to the extent the current stock price exceeds the exercise price. If the company is not public, you can estimate the equity value by some alternative method.

To estimate the market value of debt, look to see if the debt is publicly traded; if so multiply the trading price by the number of securities outstanding. If the debt is not traded, estimate the market value by comparing with similarly rated publicly traded debt. Book value of debt is sometimes used as an approximation if value of bonds is close to par (issue price)

– Typically convertibles that are “out-of-the-money” are treated as debt at book value. Convertibles that are “in-the-money” are converted into shares of common stock at the conversion price and treated as equity. Theoretically, convertibles consist of both equity and debt components, but rarely do Wall Street firms break them into separate parts for WACC analysis

– Include capital leases in the total debt calculation. Operating leases require case-specific judgment - they are frequently converted into capital leases by applying a multiple (typically 6x - 8x) to the annual operating lease payments

– For companies with captive finance subsidiaries, we typically exclude finance company-related debt

You can use a combination of the following three approaches to estimate the appropriate target capital structure.

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Step 3: WACC – Target Capital Structure Review the capital structures of comparable companies

– Assess the average market capital structure prevailing in the company’s sector

Review management’s financing philosophy– When possible, discuss with management of the company that you are valuing their

financing policy and their explicit or implicit target capital structure on a normalized basis. If you don’t have access to management, look for any statements in the press, research reports, annual report, etc. that give hints on the company’s medium to long-term financing objectives

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Step 3: WACC – Cost of Equity Typically, the Capital Asset Pricing Model (CAPM) is used to estimate the cost of equity; there

are other approaches that are occasionally used in valuation, including: Rate of return required by private equity investors in the market (i.e., LBO or venture capital

transactions) Arbitrage Pricing Theory Fama-French three factor model

An investor may obtain a risk-free rate by investing in governmental bonds. By purchasing equities, he or she assumes general market risk and therefore will expect a certain premium for doing so. CAPM quantifies the relationship between risk and return in a well functioning market

To implement the CAPM approach, you need to estimate three factors that determine the Security Market Line: the risk-free rate, the market risk premium and the levered beta

Security Market Line

0

5

10

15

20

0.0 0.5 1.0 1.5

Beta

Expe

cted

Ret

urn

(in p

erce

nt)

Market Return

Risk-free Rate

M

Risk Premium

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Step 3: WACC – The Risk-Free Rate Finance theory recommends using a “true” risk-free rate that has the same term as the cash

flows projected

Since long term bond rates have intrinsic interest rate risk factored in, some theorists have suggested making a “liquidity” adjustment to the long bond rate representing the term premium implicit in those rates

– However, this is rarely done in practice by Wall Street professionals

At CS, we typically use the 20-year treasury bond for the U.S. risk-free rate, as it matches the risk-free rate used in the calculation of the equity risk premium

– Ibbotson uses the 20-year because there has only been a 30-year bond since 1977 and their data analysis goes back to 1926

– There is no longer a 20-year bond issued by the U.S. Government, so you must look for a 30-year bond that has been outstanding for 10 years or use interpolated yields from Bloomberg (type “ICUR20” and hit GO) or another source

– Treasury strips typically are not used but may be appropriate if the asset being valued provides a single payoff at the end of a specified term

To access current yields to maturity on U.S. Government bills, notes and bonds on Bloomberg, type “T” and the “Government” key and hit GO

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Step 3: WACC – The Equity Risk Premium The equity risk premium (ERP) is the difference between the expected rate of return on the market portfolio and

the risk-free rate

Proper methodology for estimating the equity risk premium is the subject of much debate in academia– Equity premia ranging from as low as 3% to as high as 8% are used on Wall Street

CS IBD uses estimates for ERP from Ibbotson Associates; the current ERP figure is 7.1%– This figure is calculated by looking at stock market returns relative to returns on long-term government

bonds from 1926 through 2005– Some argue that use of this period over-estimates the risk premium, and that data over a more recent

period would suggest a lower premium– Also, some argue that using historical data presents a conundrum - equity returns over the last 20 years

have been significantly higher than returns on government bonds, however the performance of the equity markets may have been, in part, driven by a reduction in the equity risk premium

– Nevertheless, most (if not all) major Wall Street firms rely on the Ibbotson data for their cost of capital analyses

Where applicable, the WACC must be adjusted to reflect fact that betas for small companies do not account for all of the risks faced by investors in those companies. The following size premia (Ibbotson, 2006) should be added to the cost of equity calculation where appropriate:

Mid-Cap ($1,729 million to $7,187 million) = 1.02%Low-Cap ($587 million to $1,729 million) = 1.81%Micro-Cap (Below $586 million) = 3.95%

The equity risk premium is a critical element of WACC and DCF analysis that is often the subject of intense debate.

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Step 3: WACC – Beta CAPM holds that investors are only rewarded for bearing systematic risk and are not rewarded for bearing

unique or unsystematic risk. It is assumed that investors can eliminate unsystematic risk on their own through portfolio diversification

Beta represents a measure of the systematic risk that exists in an asset, and is central to CAPMBeta = COV[Rasset, Rmarket] / VAR[Rmarket], or equivalently

= CORR[Rasset, Rmarket] x STDasset / STDmarket– High volatility is not necessarily an indication of high beta

Historical betas of publicly traded equity securities can be calculated based on an analysis of the actual returns on the security vs. the actual market returns over the same period

– Unfortunately, historical betas can be poor predictors of expected beta, which is what we need in our analysis

– BARRA, a financial research firm, computes predicted betas for most public companies

Use a portfolio or average of peer company betas where available because significant error can exist in individual betas

– R-Squared (R2) measures the “goodness of fit” of the regression line, and describes the percentage of variation in the dependent variable that is explained by the independent variable. R2 may vary from 0 to 1 with 1 meaning that the independent variable explains 100% of the variation of the dependent variable, although R2 for individual equity betas seldom rise above 0.2

Observed betas reflect both the business and financial risk of the company. Betas are unlevered to measure only the business risk of a company and then relevered to the target capital structure of the company that is being valued to reflect both business and financial risk

– Increasing leverage will, according to theory, increase the beta of a firm’s equity and hence its cost of equity

ßU =ßL

1 + (1-T)DE

ßL = 1 + (1-T)DE

ßU [ ]

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Step 3: WACC – Cost of Debt The cost of debt is measured as the expected return on the company’s long-term debt securities

– The cost of debt is dependent on both the general interest rate environment in the economy and the credit quality of the business or asset being valued

The cost of debt is measured on an after-tax basis because interest payments are tax deductible in the U.S.– The tax rate to be used is the company’s marginal tax rate, typically 40% in the U.S.

The cost of debt can be measured in several ways:

If the company has public debt outstanding, take the weighted average of current yields to maturity or yields to worst on all issues in the target capital structure

– The yield to maturity (or for callable bonds, the yield to worst) embodies the market’s expectations of future returns on debt and should be used instead of the coupon rate

– Average cost of debt (not marginal) may be more appropriate when the entire enterprise is being valued– Include short-term and medium-term debt (along with long-term debt) if it is expected to be part of the

permanent capital structure going forward– Talk to Debt Capital Markets (DCM) if debt securities are only thinly traded or if it is difficult to obtain a

market price

Risk-free rate + current corporate spread over treasuries of selected comparable credits– Must either use the bond rating given to the company by Standard & Poors or Moody’s, or estimate the

company’s bond rating by comparing the company’s financial ratios (i.e., Debt / EBITDA, EBITDA / Interest) to those of its peers who have such ratings

Be wary of debt securities that have options attached (e.g., convertible bonds or callable bonds) that affect the overall yield to maturity and thus may not reflect the true cost of straight debt securities

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Step 3: WACC – Cost of Capital Build-up

Real RisklessRate

Inflation Inflation Inflation Inflation Inflation Inflation

Long HorizonPremium

EquityRisk

Premium

DefaultPremium

Size Premium Foreign StockPremium

TreasuryBills

Long-TermTreasuryBonds

CorporateBonds

Large CapStocks

Small CapStocks

ForeignStocks

Real RisklessRate

Real RisklessRate

Real RisklessRate

Real RisklessRate

Real RisklessRate

Long HorizonPremium

EquityRisk

Premium

EquityRisk

Premium

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Step 3: CS U.S. WACC Methodology In practice, we typically make the following assumptions at CS:

In general, WACC calculation is not a science; there are no exact answers, judgment and reality checks are essential

– Typically, discount rate ranges centered around a best estimate for WACC are used in DCF valuations

– Small differences in WACC/discount rate can have huge impacts on value

Target Capital Structure Average of ratio of debt and equity market capitalization of selected comparable companies

Risk Free Rate: 20 year US Treasury coupon bond yield (Bloomberg: ICUR20)

Tax Rate: Estimated future marginal tax rate (usually 40%)

Equity Market Risk Premium:

Ibbotson equity market premium (currently 7.1%), calculated based on historical (arithmetic) return of equity market relative to 20 year treasury bond

Beta: Take predicted levered betas of comparable companies (use Barra predicted betas), unlever them according to capital structure, average the unlevered betas, and re-lever the average to the target capital structure of the company being valued

Cost of Debt: Risk-free rate + current corporate spread over treasury for comparable credits

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Step 4: Present ValueTime Value of Money

A dollar today is worth more than a dollar tomorrow.

Discounting– Discounting is the process of finding the present value of a future sum

Very Simple Example– Assumes the discount rate is 10%; uses end of period discounting for all cash flows

The total present value at December 31, 2002 is equal to the sum of the present values of the individual cash flows ($108)

Mid-year Discounting– The above example assumes end of the period discounting, that is it assumes all of the

cash flows come at the end of each period. A more accurate method may be mid-year discounting, which assumes that the cash flows come in the middle of each period (this is essentially equivalent to evenly spreading the cash flows throughout the period)

– When performing mid-year discounting, one must still discount the terminal value from the end of the forecast period

2003 2004 2005 2006 2007 Free Cash Flow $10 $15 $20 $24 $89 Period 1 2 3 4 5 Discount Factor 1/1.10

1 1/1.102 1/1.10

3 1/1.104 1/1.10

5 Discount Factor 0.9091 0.8264 0.7513 0.6830 0.6209 Present Value $9 $12 $15 $16 $55

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Step 4: Present ValueValuation

To calculate the value of a business using DCF analysis, the projected free cash flows over the forecast period are discounted to the present over the appropriate range of discount rates

A range of terminal values for the business is added to the cash flows in the last year of projections and discounted to a present value

The resulting values represent the total or “enterprise” value of the business, including both debt and equity. To calculate the value of a company’s equity, subtract the company’s net debt from its enterprise value

In addition, the enterprise value should be adjusted by adding other unusual assets or subtracting liabilities to reflect the company’s fair equity value

DCF pointers

Assumption Summaries: Write up summaries of the key assumptions underlying your cash flow projections

Sensitivity Analysis: It is useful to vary some of the important assumptions (e.g., sales growth rate, margins) to determine how sensitive your value range is to key determinants of future results

Calculator Check: Always check Excel numbers with a calculator

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Step 5: Corporate Adjustments DCF analysis calculates the Enterprise Value (also known as Adjusted Market Value) of a

company– The Equity Value of a company is equal to its Enterprise Value less Corporate

Adjustments

Corporate Adjustments include the company’s net debt plus other obligations, less other assets not included in the DCF analysis or financial forecasts

The Equity Value per diluted share is equal to the Equity Value divided by the number of net fully-diluted shares outstanding

– Number of net fully diluted shares = Basic shares + net shares underlying “in the money” options / warrants + net shares from the conversion of “in the money” convertible debt and convertible preferred stock

Incremental common-equivalent shares are typically calculated using the treasury stock method– Note that this is a circular calculation – the treasury stock calculation depends on an

assumed share repurchase price, which is dependent upon the number of net fully-diluted shares outstanding

– Outstanding vs. exercisable options

Long term debt (including current portion) Contingent liabilities Short term debt Excess Cash Minority interest Value of other assets not in DCF Capitalized leases

(1) Note that “out of the money” options, while not converted per the treasury stock method, represent a cost that is not captured in the analysis (typically this error is a small one).

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Sample Discounted Cash Flow Valuation($ in millions)

2005E 2006E 2007E 2008E 2009EEBITDA $250.7 $278.5 $307.2 $317.6 $328.2

Less: D&A (113.6) (121.6) (130.3) (134.2) (138.2)EBIT $137.1 $156.9 $176.9 $183.4 $190.0

Less: Tax Effect (52.1) (59.6) (67.2) (69.7) (72.2)Unlevered Net Income $85.0 $97.3 $109.7 $113.7 $117.8

Plus: D&A 113.6 121.6 130.3 134.2 138.2Less: Capex (103.2) (110.5) (118.4) (122.0) (125.7)Plus: Changes in WC (13.7) (7.2) (7.7) (3.2) (3.2)

Unlevered Free Cash Flow $81.7 $101.1 $113.9 $122.7 $127.1Source: Wall Street research projections and Credit Suisse estimates.

($ in millions, except per share data)

Terminal Value EBITDA MultipleDiscount Rate 4.50x 5.00x 5.50x 6.00x

9.0% $417.5 $417.5 $417.5 $417.5 Present Value of Free Cash Flows960.0 1,066.7 1,173.3 1,280.0 Present Value of Terminal Value

$1,377.5 $1,484.2 $1,590.9 $1,697.5 Enterprise Value(99.3) (99.3) (99.3) (99.3) Less: Net Debt

$1,278.2 $1,384.9 $1,491.6 $1,598.2 Equity Value$44.42 $47.92 $51.42 $54.92 Equity Value per Share

36.9% 47.7% 58.5% 69.3% Implied Premium / (Discount) to Current (1)


917.1 1,019.1 1,121.0 1,222.9 Present Value of Terminal Value$1,323.3 $1,425.2 $1,527.1 $1,629.0 Enterprise Value




876.6 974.0 1,071.4 1,168.8 Present Value of Terminal Value$1,271.8 $1,369.2 $1,466.6 $1,564.0 Enterprise Value



2.2% 3.0% 3.7% 4.3% Implied Perpetuity Growth Rate(1) Based on share price of $32.44 as of 02/04/05.

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WACC ScheduleIndustry Statistics(in millions)

Total Mkt Debt / Tax Levering Unlevered

Company Beta (1) Debt Equity Mkt Equity Rate (2) Factor (3) Beta (4) AssumptionsArkansas Best Corp 0.83 15 1,069 1.4% 40.1% 1.01 0.82 Target Marginal Tax Rate 38.0%Cnf Inc 0.89 714 2,457 29.1% 41.0% 1.17 0.76 Risk Free Rate (5) 4.330%Old Dominion Freight 0.62 81 885 9.2% 39.1% 1.06 0.59 Equity Risk Premium (6) 7.20%Overnite Corp 0.95 127 850 14.9% 40.0% 1.09 0.87 Size Premia ("Sp") (7) 1.59%Scs Transportation Inc 0.63 123 354 34.7% 37.6% 1.22 0.52Yellow Roadway Corp 1.00 728 2,769 26.3% 39.1% 1.16 0.86

Mean 0.82 19.3% 39.5% 1.12 0.74Median 0.86 20.6% 39.6% 1.12 0.79

Schedule A (Sensitivity of Capital Structure)Weighted Average Cost of Capital (10)

Debt / Debt / Average Levering Levered Cost of Pre-tax Cost of DebtCapital Mkt Equity Unlev'd Beta Factor Beta (8) Equity (9) 5.0% 6.0% 7.0% 8.0% 9.0% 10.0%

0.0% 0.0% 0.74 1.00 0.74 11% 11.2% 11.2% 11.2% 11.2% 11.2% 11.2%10.0% 11.1% 0.74 1.07 0.79 12% 10.7% 10.8% 10.9% 10.9% 11.0% 11.1%20.0% 25.0% 0.74 1.16 0.85 12% 10.3% 10.4% 10.5% 10.6% 10.8% 10.9%30.0% 42.9% 0.74 1.27 0.93 13% 9.8% 10.0% 10.1% 10.3% 10.5% 10.7%40.0% 66.7% 0.74 1.41 1.04 13% 9.3% 9.5% 9.8% 10.0% 10.3% 10.5%50.0% 100.0% 0.74 1.62 1.19 15% 8.8% 9.1% 9.4% 9.7% 10.0% 10.4%

Schedule B (Sensitivity of Unlevered Beta)Weighted Average Cost of Capital (10)

Debt / Debt / Levering Unlevered Pre-tax Cost of DebtCapital Mkt Equity Factor Beta 5.0% 6.0% 7.0% 8.0% 9.0% 10.0%

0.0% 0.0% 1.00 0.65 10.6% 10.6% 10.6% 10.6% 10.6% 10.6%10.0% 11.1% 1.07 0.70 10.5% 10.5% 10.6% 10.7% 10.7% 10.8%20.0% 25.0% 1.16 0.75 10.3% 10.5% 10.6% 10.7% 10.8% 11.0%30.0% 42.9% 1.27 0.80 10.2% 10.4% 10.5% 10.7% 10.9% 11.1%40.0% 66.7% 1.41 0.85 10.0% 10.2% 10.5% 10.7% 11.0% 11.2%50.0% 100.0% 1.62 0.90 9.8% 10.1% 10.4% 10.7% 11.0% 11.3%

(1) Barra US equity Book predictions (7) Cost of equity premia based on equity market capitalization.(2) Based on marginal tax rate low-cap ($797mm - $1,167mm) = 1.59%. Amounts per 2004 Ibbotson.(3) Levering Factor: 1 + [ ( 1 - Tax Rate ) * ( Debt / Equity ratio ) ] (8) Levered Beta: (Beta * Levering Factor)(4) Unlevered Beta: ( Beta / Levering Factor ) (9) Cost of Equity: Rf + B * ( Rm - Rf ) + Sp, or the risk-free rate plus the beta * the eq(5) Yield on Interpolated 20-Year US treasury Bonds which corresponds to Ibbotson's long-term equity (10) WACC: Rd = Return on Debt; Re = Return on Equityrisk premium (as of 2/04/05). Source: Bloomberg. [ Rd * (1 - tax rate) * (D / (D + E) ) ] + [ Re * (E / (D + E) ) ](6) The average historic period between the return on stocks and L-T bonds (2004 Ibbotson Associates).


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F. Merger Consequences Analysis

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Evaluate the transaction consequences of McClatchy buying Knight Ridder: 100% Cash, 0% Stock 50% Cash, 50% Stock 0% Cash, 100% Stock

What are the Income Statement consequences? Accretion / Dilution impact

What are the Balance Sheet consequences? Total Debt / Total Capitalization Total Debt / EBITDA EBITDA / Interest

Other consequences? Ownership

Helpful Hint: We use all outstanding and exercisable shares due to change of control. If you properly filled in the option schedule on the input tab, this should be a quick manual fix. Key Takeaways At the end of this section, you should be able to answer the following:

1. Is an acquisition accretive or dilutive2. How do premiums paid, financing and level of synergies affect accretion / dilution3. How is accretion / dilution tied to the relative P/E multiples of the acquiror and target4. Can an accretive deal be achieved given the DCF and comp valuations?

Summer Assignment – Accretion / Dilution

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Agenda

1. Overview of Merger Consequences

2. Recent Developments in Merger Accounting

3. Earnings Per Share Defined

4. Introduction to Modeling an Acquisition

USF Corporation: Sample Merger Consequences Yellow Roadway buys USF Corporation

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Mergers and Acquisitions: What’s the Difference?

Acquiring company purchases a part or all of the assets of the Target company

Target remains in existence post-transaction, as does Target ownership structure

Requires that each asset and liability acquired be separately conveyed contractually More complicated and time consuming than transfer of stock

Asset Acquisition

Acquiring company buys the stock of the Target company from stockholder(s) Stockholders’ may be a parent company or individuals

Corporate shell of Target survives in Acquiror’s hands

Stock Acquisition

Two or more corporations combine such that one of the combining corporations remains in existence while the other participating corporation(s) disappear Frequently follows a stock acquisition

Statutory Merger

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What are the Consequences of a Merger?

Corporate performance yardstick impacting stock price Earnings per share impact of

a transaction Quality of earnings – growth,

volatility, customer concentration, etc.

Income Statement Consequences

Leverage & Coverage ratios Debt/Total Cap Debt/EBITDA EBITDA/Interest

Balance Sheet Consequences

Stock options / “Golden Parachutes”

Management/Board composition

Pro Forma Ownership

Social Consequences

Does the combined firm have market power in any particular market? Evaluate stand-alone and

pro forma market shares in all affected markets

Must some business units be sold?

Will the FTC block the merger (e.g., Staples / Office Depot)

Antitrust Consequences Would a variety of regulators

(e.g. FCC, FAA, state insurance commissioners) permit the merger to take place? Market power concerns

similar to FTC Other regulatory concerns

Regulatory Consequences

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Excess of purchase price over fair market value (FMV) of identifiable assets less liabilities is recorded as goodwill

Goodwill amortized by the straight line method over a period not exceeding 40 years

Excess of purchase price over FMV of identifiable assets and liabilities is recorded as goodwill

Goodwill not systematically amortized. Instead, subject to an impairment test at least once per year and on an interim basis as warranted

No more systematic income statement “hit”

Because goodwill is not amortized but most other intangible assets will be, FASB wants companies to separately identify more intangible assets rather than simply allocating such amounts to goodwill

Accounting Treatments

The Financial Accounting Standards Board (FASB) has modified the existing purchase accounting rules and has eliminated the way we treat Goodwill.

Old Purchase Accounting New Purchase Accounting

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Earnings Per Share

Corporate Performance yardstick

Cornerstone in merger consequences

2 Earnings per share (“EPS”) measures:– Basic EPS– Diluted EPS

Basic EPS Net Income ÷ Shares Outstanding

Diluted EPS Accounting concept only Factors in impact of options and convertible securities, if dilutive

– Option: right to buy a share from the Company at a predetermined price – Convertible Security: Preferred Stock or Bond whose owner has right to

surrender security for a certain number of common shares Options – Treasury Method Convertible Securities – “If-Converted” Method Shares outstanding calculated via Treasury Method frequently used to

calculate equity market value of a company

– Growth – Stability

– Stock price – Executive compensation

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Earnings Per Share – The Treasury Method

Key Information

Stock Price (P) = $10.00

Basic Shares (B) = 20.00

Options (N) = 3.00

Strike Price (K) = $8.00

Net Income (NI) = $50.0

1. Basic EPS = NI B

= $50.0 20.00

= $2.50

2. Diluted EPS = NI Diluted Shares

Diluted Shares = B + Max (0, P – K) x N P

= 20 + Max (0, 10.00 – 8.00) x 3.00 10.00

= 20 + 0.60

= 20.60 shares

Diluted EPS = $50.0 20.60

= $2.43

Standalone EPS calculations - Use Options Exercisable from 10-K

Acquisition Target - Options Outstanding from 10-K Change of Control usually leads to accelerated vesting for all

options

Single Option “intrinsic value”

Intuition:

1. Company issues one share for each option = 3.00shares

2. Company collects strike price of 3.00 X $8.00 = $24.00

3. Company uses $24.00 to repurchase shares at market price of $10.00 Shares repurchased: $24.00 = 2.40

$10.00

4. Incremental shares = Shares Issued - SharesRepurchased3.00 - 2.40 = 0.60 Accounting Convention

– Diluted shares not ACTUALLY outstanding– Allows for consistent treatment of options

and computing EPS

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Earnings Per Share – Convertible Securities Convertible Bonds and convertible preferred securities are bonds and preferred shares from an

economic perspective as well as in terms of their impact on financial statements until holder exercises his option to convert into common shares

Diluted EPS calculation follows a different logic – the “If-Converted” method Compare Diluted EPS on a converted and not converted basis, and choose the lower of the

two

If converted test:

Add back preferred dividend to net income

Add the number of common shares the convertible converts into to the basic share count

Compute EPS

Is EPS lower than Basic EPS?

If converted test:

Add back after-tax interest to net income [I x (1-t)]

Add the number of common shares the convertible converts into to the basic share count

Compute EPS

Is EPS lower than Basic EPS?

Convertible Preferred Convertible Bonds

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Accounting for Investment in Equity Securities

METHOD OF ACCOUNTING BALANCE SHEET INCOME STATEMENT

Cost Method (less than 20% in a non-marketable security)

Investment is shown at cost. Changes in value (from original cost) are reported only as realized

Dividends received from target are shown as dividend income

Fair Value (less than 20% ownership in a marketable security)

Investment account is shown at fair value. Changes in fair value are reported as a separate component of shareholders’ equity until realized

Dividends received from target are shown as dividend income. Losses are also realized upon recognition of permanent impairment

Equity Method (generally when voting ownership percentage is at least 20 percent but not more than 50 percent)

Investment account is shown at cost plus share of target’s net income less share of target’s dividends since acquisition

Equity in target’s net income is shown as investment income in period during which target earns income

Consolidation Method (generally when voting ownership percentage is greater than 50 percent). Tax consolidation requires at least 80% voting and value ownership “M&A Purchase Accounting” “Control” If own less than 100%,

recognize minority interest

Consolidate 100% of individual assets and liabilities of subsidiary. Minority interest in subsidiary’s net assets is shown between liabilities and equity

100% revenues and expenses of subsidiary are combined with those of acquiror. Minority interest in subsidiary’s net income is shown as a subtraction

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Purchase Accounting – Framework

Acquiror

Income Statement

Balance Sheet

Cashflow Statement

Target

Income Statement

Balance Sheet

Cashflow Statement

NewCo

Pro Forma Income Statement

Pro Forma Balance Sheet

Pro Forma Cashflow Statement

Adjustments

1. Synergies

2. Transaction expenses

3. Capital Structure Acquisition Debt Common shares

issued Refinancing

existing debt Other

4. Goodwill & Depreciation

5. Date acquisition closes

+ + =

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Purchase Accounting

Determine buyer Group that receives the most voting shares of post merger company is presumed to be the

accounting acquirer; regardless of the legal acquiror If no definitive share count, other factors are:

– Board of Directors– Management– Relative size

Determine acquisition cost Valuation of securities Earnings contingency Share price contingency

Closing date Target financials combined with Acquiror financials as of the closing date

Allocation of Purchase Price Allocate to identifiable assets acquired and liabilities assumed to reflect fair value at date of

acquisition Include any newly identified intangible assets Excess of cost of acquired company over the FMV is recorded as goodwill

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Purchase Accounting – Balance Sheet Impact

Accounting: Acquisition of stock (Carryover basis) Purchase Price – $100MM 50% stock, 45% debt, 5% cash on hand Closing Date: December 31, 20XX $5MM in synergies Question to class: Why is there a deferred tax

liability? Asset step-up: $30MM Step-up amortization: 15 years

Goodwill

GOODWILL

Purchase Price $100.0

Less: Book Value 5.0

Excess Purchase Price 95.0

Less: Asset Write-ups 30.0

Goodwill $65.0

ACQUIROR TARGET

ACCOUNTING ADJUSTMENT

FINANCING ADJUSTMENT PRO FORMA

Cash $30.0 $5.0 $(5.0) $30.0 Other Assets 10.0 5.0 20.0 Goodwill 0.0 0.0 65.0 92.0 Total Assets $40.0 $10.0 $142.0 Debt 0.0 0.0 45.0 45.0 Other Liabilities 5.0 5.0 10.0 Deferred Tax Liability 0.0 0.0 2.0 Total Liabilities $5.0 $5.0 $57.0 Equity 35.0 5.0 (5.0) 50.0 85.0

Total Liabilities & Equity $40.0 $10.0 $142.0

($ in millions)

=

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Purchase Accounting – Income Statement Impact

Implied Cost of Funds

ACQUIROR TARGET ACCOUNTING ADJUSTMENT

FINANCING ADJUSTMENT PRO FORMA

Sales $150.0 $100.0 $250.0 EBITDA 30.0 21.0 5.0 56.0 Depreciation 5.0 1.0 2.0 6.3 Amortization 0.0 0.0 0.0 0.0

EBIT 25.0 20.0 49.7 Net Interest Expense (Income) (1.5) (0.3) 4.8 3.0

PBT 26.5 20.3 46.7 Tax 10.6 8.1 18.7

Net Income 15.9 12.2 28.0 Tax – % 40% 40% 40%

Diluted Shares 10.00 2.50 (2.50) 0.67 10.67 EPS $1.59 $2.62 EPS Accretion / (Dilution) – $ $1.03 Stock Price $75.00 $40.00 ?

Cost of Cash 5% x $5.0

Cost of Debt 10% x $45.0

Total Interest $4.8

Shares Issued = $50.0MM ÷ $75.00 = 0.67

($ in millions)

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The P/E Ratio Shortcut If the P/E of your acquisition currency is higher than the P/E of the stock of the Target at the

price you propose to pay, the acquisition will likely be accretive, and vice-versa

Robust rule of thumb in the absence of goodwill amortization / impairmentKEY DATA

ACQUIRER TARGET

Price $10.00 $5.00 Net Income $1.00 $1.00 P/E 10.0x 5.0x # of Shares 1 1 Int. rate 10% Tax Rate 40.0%

Example 1 – Acquirer pays for Target with Acquirer Stock 1. Target Purchase Price $5.00 x 1 share = $5.00

2. Acquirer Shares Issued = Purchase Price

Acquirer Stock Price =

$5.00

$10.00 = 0.50 shares

3. Combined Net Income = $1.00 + $1.00 = $2.00

4. New Share Count = 1 + 0.5 = 1.5

5. Earnings per Share = $2.00 / 1.5 = $1.33

6. New EPS of $1.33 greater than Acquirer EPS of $1.00 – transaction is accretive

Example 2 – Acquirer pays for Target with Borrowed Money

P/E of Cash = 1

Rate x (1 – t) =

1

10% (1 – 40%) = 16.7x

Pro forma EPS = Acquirer NI + Target NI – After Tax Interest Cost

Acquirer Shares =

$1.00 + $1.00 – [$5.00 x 10% x (1-40%)]

1 = $1.70

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50% Stock / 50% Debt Financing 2002 AcquirCo Net Income $50.0 + TargetCo Net Income 20.0 – Incremental D&A 0.5 – Goodwill Amortization 0.0 – After-Tax Interest Exp. 3.0 = PF Net Income 66.5 Initial AcquirCo Diluted Shares 10.00 Pro forma AcquirCo Diluted Shares 15.00 Stand-alone EPS (Diluted) $5.00 Pro forma EPS (Diluted) $4.43 EPS Accretion (Dilution) – $ $(0.57) EPS Accretion (Dilution) – % (11.4%)

The Incremental MethodUseful for

Preliminary Analysis

Limited Information

Multiple Companies / Permutations

}}}

Purchase Price: $100MM; Book Value: $80MM

AcquirCo and TargetCo Debt is not refinanced

Transaction closes 12/01

No Synergies

Purchase Price – Book value = Excess Purchase Price

FMV adjustment: $10.0

Deferred Tax Liability = $4.0

Goodwill = $14.0

Tax deductible or non-deductible

Asset vs. stock transaction

New Debt x int. x (1 – tax)50.0 x 10% x (1 – 40%) = 3.0

Per Treasury Method

Shares issued = Equity issued AcquirCo

Stock Price= $50.0 / 10.00 = 5.00

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Merger Consequences: Yellow Roadways Buys USF

($ in millions)

50% Cash / 50% Stock ConsiderationPremium to Share Price – 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0%

Price Per Share $32.44 $34.06 $35.68 $37.31 $38.93 $40.55 $42.17 $43.79 $45.42

Equity Value $918 $966 $1,014 $1,062 $1,111 $1,160 $1,210 $1,259 $1,309Net Debt (1) 99 99 99 99 99 99 99 99 99Enterprise Value 1,017 1,065 1,114 1,162 1,210 1,259 1,309 1,358 1,408

Enterprise Value / 2005E EBITDA 4.1x 4.2x 4.4x 4.6x 4.8x 5.0x 5.2x 5.4x 5.6xEnterprise Value / 2006E EBITDA 3.7x 3.8x 4.0x 4.2x 4.3x 4.5x 4.7x 4.9x 5.1x

Equity Value / 2005E Net Income 13.3x 14.0x 14.7x 15.4x 16.1x 16.9x 17.6x 18.3x 19.0xEquity Value / 2006E Net Income 11.4x 12.0x 12.6x 13.2x 13.8x 14.4x 15.0x 15.6x 16.2x

2005E Stand Alone Diluted EPS $5.25 $5.25 $5.25 $5.25 $5.25 $5.25 $5.25 $5.25 $5.252005E Pro Forma Diluted EPS 5.59 5.53 5.48 5.43 5.38 5.33 5.28 5.24 5.19

2005E Accretion / (Dilution) Acc / (Dil) – $ $0.34 $0.28 $0.23 $0.18 $0.13 $0.08 $0.03 ($0.01) ($0.06)Acc / (Dil) – % 6.4% 5.4% 4.4% 3.5% 2.6% 1.6% 0.7% (0.3%) (1.2%)Pre-Tax Breakeven Synergies – – – – – – – $1.3 $6.1

Pro-Forma Debt / LTM EBITDA (2) 1.6x 1.7x 1.7x 1.7x 1.8x 1.8x 1.8x 1.9x 1.9xDebt-to-Capitalization (at closing) 45.28% 45.36% 45.45% 45.53% 45.61% 45.69% 45.76% 45.83% 45.91%

% Shares issued as currency 14.2% 14.9% 15.5% 16.1% 16.7% 17.3% 17.9% 18.5% 19.1%ProForma Ownership% 85.8% 85.1% 84.5% 83.9% 83.3% 82.7% 82.1% 81.5% 80.9%Source: Wall Street Projections, Credit Suisse Estimates.(1) Net Debt numbers as of 12/31/04.(2) Based on LTM EBITDA of $697mm.

For Knight Ridder project show: 3 Considerations (100% Cash, 50%/50% Cash Stock and 100% Stock) 3 Premiums (10%, 20% and 30%)

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These materials have been provided to you by Credit Suisse ("CS") in connection with an actual or potential mandate or engagement and may not be used or relied upon for any purpose other than as specifically contemplated by a written agreement with CS. In addition, these materials may not be disclosed, in whole or in part, or summarized or otherwise referred to except as agreed in writing by CS. The information used in preparing these materials was obtained from or through you or your representatives or from public sources. CS assumes no responsibility for independent verification of such information and has relied on such information being complete and accurate in all material respects. To the extent such information includes estimates and forecasts of future financial performance (including estimates of potential cost savings and synergies) prepared by or reviewed or discussed with the managements of your company and/or other potential transaction participants or obtained from public sources, we have assumed that such estimates and forecasts have been reasonably prepared on bases reflecting the best currently available estimates and judgments of such managements (or, with respect to estimates and forecasts obtained from public sources, represent reasonable estimates). These materials were designed for use by specific persons familiar with the business and the affairs of your company and CS assumes no obligation to update or otherwise revise these materials. Nothing contained herein should be construed as tax, accounting or legal advice. You (and each of your employees, representatives or other agents) may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the transactions contemplated by these materials and all materials of any kind (including opinions or other tax analyses) that are provided to you relating to such tax treatment and structure. For this purpose, the tax treatment of a transaction is the purported or claimed U.S. federal income tax treatment of the transaction and the tax structure of a transaction is any fact that may be relevant to understanding the purported or claimed U.S. federal income tax treatment of the transaction.

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