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Valuation in the Current EconomicEnvironment
March 2011
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Macro Indicators- US
USeconomyisinmidstofacyclicalrecovery
S&Pearningsgrowthontheriseafteradifficult2009
Employmentenvironment
hasbeensteadilyimproving
Inflationholdingfirm
Housingmarketstillweak
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Macro Indicators- US
Goingforward,growthprospectsareonapositivetrajectory
CPIappearstobeincheck
Interestratesshouldremain
low
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Macro Indicators- Canada
CurrentoutlookfortheCanadianeconomyremains
robust
Leadingeconomicindicatorsignalingstronggrowththrough2011
Growthinemploymentunderscoresthestrengthoftheeconomy
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Macro Indicators- Canada
MuchliketheUS,CPIforecastatreasonablelevelsandinterest
rates
remain
low Coreinflationwasaconcern
during2010. Coreinflationhasbeentrendingdown,wellbelowtarget
BankofCanadaresistingraisinginterestrates
SomeconcernoverPersonalSavingsRateandimpacton
growth
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Other Indicators
Canadiandollarhasmovedpastparity
Strength
of
Canadian
fiscal
policyandhighercommodityprices
ExpectCanadiandollartoremainatoraboveparinthe
mediumterm
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Credit Environment
Leverageappearstobe
back 2010setrecordsinboth
leveragedloanandhighyieldissuances
2011shapinguptosurpass2010fromavolumeperspective
Demandforpapercontinuestobedrivenby
lowinterestratesandevidencethatbusinessconditionshaveimprovedsubstantially
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Credit Environment
Thecurrentenvironmentissupportiveforinvestment
Forstrategicbuyers,earningsyieldsversusthecosttoinvestindicateafavorableinvestmentenvironment
For
financial
buyers,
borrowingspreadshavereturnedtoprerecessionlevels
LoangrowthinUSincreasing
Expectthistohaveapositiveimpactondealactivity
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Deal Statistics
AvailabilityofleveragehaspushedupPurchasemultiples
Equitysupportfordeals(asa%
ofdealvalue)arealsostartingtoapproachhistorichighs
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Buyer Universe
Financial
PEismotivatedtotransact
Overweightingof20052007vintagefunds
5yearinvestmentperiod
Managementfeebias
$500mmofdrypowder
Strategic
Management/BoardConfidence
Abilitytopay accumulatedcash,receptivityofdebt/equity
markets
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Debt Multiples of Mid-Market LBO Loans
4.69x 4.72x
5.61x
4.53x
3.25x
4.25x4.12x
0.0 x
1.0 x
2.0 x
3.0 x
4.0 x
5.0 x
6.0 x
2005 2006 2007 2008 2009 2010 4Q10
FLD/EBITDA SLD/EBITDA Other Sr Debt/EBITDA Sub Debt/EBITDA
Source: Standard and Poors Middle Market Lending Review 4Q10
Mid-Market LBO Volume by Quarter
0.0
0.5
1.0
1.5
2.02.5
3.0
3.5
4.0
4.5
2Q05 4Q05 2Q06 4Q06 2Q07 4Q07 2Q08 4Q08 2Q09 4Q09 2Q10 4Q10
U
S$
B
Institutional Pro Rata
Source: Standard and Poors Q410 Middle Market Lending Review
Lever aged Buyout Spreads
L+ 100
L+ 200
L+ 300
L+ 400
L+ 500
L+ 600
L+ 700
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 4Q10
Pro Rata Institutional
Source: Standard and Poors Q410 Middle Market Lending Review
Credit Market Update
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Credit Market Update
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Drawnspreadsandfeeshavecontracted Undrawnfeeshavestabilizedataround25%ofthedrawnspreadPricing
3to5yearcommitmentsforcorporates 5yearcommittedtenorshaveemergedasthemarketnormforsponsortransactions Longertenorsremainpricedatapremium
Tenor
Banksareaggressivelyattemptingtodeploycapital Wellstructuredandwellpriceddealsarebeingoversubscribed Foreignbankscautiouslyreturningtomarket
Lender
Behaviour
Borrower
Behaviour
Borrowersanxioustoaccessbankmarketwithactivitylevelssteadilyincreasing LBO/MBOactivityremainsfragile Following08&09borrowersdemandingmoreaggressivetermsfromlenders
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Representative Metrics(LBO)
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Market Peak
(Mid 2007)
September
2009Today
Representative Senior Metrics
Sr. Debt/Capitalization 40% to 60% 40% to 50% 40% to 50%
Sr. Debt Funding Levels up to 3.75x up to 2.0x to 2.5x up to 3.75x
Pricing (BB/BB-) BAs +275bps BAs +450bps BAs +300bps
Commitment Fee 50 to 70 bps 100 to 150 bps 75 to 100 bps
Min. EBITDA for a cash flow loan $5.0 Million $7.5 Million $5.0 Million
Term 48 to 60 months 36 months 48 to 60 months
Amortization up to 10 years up to 6 years up to 12 years
Representative Sub Metrics
Total Debt/Capitalization 50% to 70% 50% to 60% 50% to 60%
Total Debt Funding Levels up to 4.75x up to 3.0x to 3.5x up to 5.25x
Total Required IRR (incl. warrants) 14% to 16% 16% to 22%+ 14% to 16%
Commitment Fee 200 bps 200 to 300 bps 200 bps
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The Leverage Impact on Value
Financial
FinancialbuyerstypicallyuseIRRindeterminingvalue
multiples PrivateEquityGroups(PEGs)generallytarget25%30%IRR
Typicallyspeaking,higherleverageavailabilityequalshigher
enterprisevalues
Strategic
Strategicbuyersfocusonachievingaminimumhurdlerate
based
on
their
WACC Theacquisitionshouldbeaccretive
Strategicsdontrelyonfinancialengineeringtogeneratereturns
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The Leverage Impact on Value
Theillustrationisbasedonthefollowingassumptions:
TheleverageimpactonvalueforaPEGisasfollows:
TargetIRR 30%EBITDA 10.0GrowthRate 10%SustainingCapex 3.0TaxRate 30%EquityandSeniorDebtFinancingOnlyNoMultipleExpansiononExitSaleoftheBusinessin5YearsAbilitytoRefinanceSeniorDebtontheSameTerms
($Millions)
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MarketPeak(Mid2007) Today
SeniorDebt/EnterpriseValue 60% 47%SeniorDebt/EBITDA 3.6x 2.0xAmortization 10 7
InterestRate 7.3% 4.4%ValueMultiple 6.0x 4.3x
2009
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The Leverage Impact on Value
1) 2)
3) 4)
Yr5EBITDA 16.1EV/EBITDA 6.0xEnterpriseValue 96.6Cash(NetDebt) (6.9)EquityValue 89.8
Assumptions:NoAdvisoryFeesonExit
($Millions)ExitattheendofYr5
($Millions) Closing Yr1 Yr2 Yr3 Yr4 Yr5
EBITDA 10.0 11.0 12.1 13.3 14.6 16.1less:Capex (3.0) (3.0) (3.0) (3.0) (3.0)less:Interest (2.6) (2.4) (2.1) (1.8) (1.6)less:Principal (3.6) (3.6) (3.6) (3.6) (3.6)less:Tax (1.6) (2.0) (2.5) (2.9) (3.5)
FreeCashFlow 0.2 1.1 2.1 3.3 4.5Assumptions:NoDividends Capex=Depreciation Nochangesinworkingcapital
($Millions) Closing Yr5EquityInvestment (24.0)Exit 89.8IRR 30%
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EBITDA 10
EV(1)/EBITDA 6.0x
EnterpriseValue 60Debt/EV 60%SeniorDebt 36Amortization 10InterestRate 7.3%EquityInvestment 24Note: (1)EnterpriseValue
Acquisitionin2007($Millions)
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The Leverage Impact on Value
1) 2)
3) 4)
Yr5EBITDA 16.1EV/EBITDA 4.3xEnterpriseValue 69.3Cash(NetDebt) 14.1EquityValue 83.3
Assumptions:NoAdvisoryFeesonExit
($Millions)ExitattheendofYr5
($Millions) Closing Yr1 Yr2 Yr3 Yr4 Yr5
EBITDA 10.0 11.0 12.1 13.3 14.6 16.1less:Capex (3.0) (3.0) (3.0) (3.0) (3.0)less:
Interest (0.9)
(0.8)
(0.6)
(0.5)
(0.4)less:Principal (2.9) (2.9) (2.9) (2.9) (2.9)less:Tax (2.1) (2.5) (2.9) (3.3) (3.8)
FreeCashFlow 2.1 2.9 3.9 4.9 6.0Assumptions:NoDividends Capex=Depreciation Nochangesinworkingcapital
($Millions) Closing Yr5EquityInvestment (22.8)Exit 83.3IRR 30%
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EBITDA 10
EV(1)/EBITDA 4.3x
EnterpriseValue 43Debt/EV 47%SeniorDebt 20Amortization 7InterestRate 4.4%EquityInvestment 23Note: (1)EnterpriseValue
AcquisitionToday($Millions)
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Impact Of Value Based OnEconomic Uncertainty
Todaysvaluemultiplesaredependenton:
Industrytype
Returnoncapitalemployed
EBITDAmargins
Growth
Size
Typically,
the
larger
the
deal
the
higher
the
multiple Leverageiseasiertoattract
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Impact Of Value Based OnEconomic Uncertainty
1. EBITDASustainability(lowermiddlemarketi.e.EV
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Impact Of Value Based OnEconomic Uncertainty
Diligencemaybeprotracted
lessriskofPEGlosingdealifexclusivityperiodexpires
buyers
waiting
to
see
if
anything
comes
out
of
the
woodwork couldpresentopportunityforpriceadjustment
dealsnotalwaysclosingonletterofintentterms
Strategic
Lessuncertaintyduetoindustryknowledge
MaybeabletosupportEBITDAforecaststhroughsynergies
Wellcapitalizedcompaniespurchasedweakerplayers
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Impact Of Value Based OnEconomic Uncertainty
2. ExitMultipleUncertainty
Financial
Inthepeak,PEGsmayhavemodeledmultipleexpansion
Dependingonindustry,maymodelinmultiplecontraction
Strategic
Noinvestmenttimehorizon
Typicallyusecapitalizedcashflowapproach
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Impact Of Value Based OnEconomic Uncertainty
5. InterestRate
Financial
Cashflowloansaretypicallybasedonfloatinginterestrates
Expectationofrisinginterestratesastheeconomicgrowthreturns
Uncertaintywithrespecttotiming
Impactofrateincreasesoncovenantpackage
Strategic
Lessofanissueifconservativelycapitalized
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CDN Mid-Market M&AThe Way Forward
2009wasadisaster
Veryfewdealsclosed
Leveragewasscarce
Buyerstookawaitandseeapproach
Sellerswaitedforthestormtopass
Lenderswithdistressedcreditswerereluctanttoexerciseontheirsecurityastheirwerenobidsforassets
2010wasayearofrecovery
2011islookingverypositive
Leveragereturningtothemarket
PEGsneedingtogetmoneyout
Valuemultiplesrising(compellingownerstosell)
Distressedassetsfinallycomingtomarket24
Source:Pitchbook Source:ThomsonReutersLPC
PEG Portfolio Exits PEG Lending by Deal Type