Test of New Master

1
Mergers Acquisitions (MA) Strategic Analysis
Series Primer July 2010
2
MA Primer
Introduction
Objectives

• The purpose of this module is to allow new ACs
  and Consultants to
• obtain a background understanding of MA
• understand what XXX does/doesnt do in an MA
  project
• review basic analytical tools required in
  different MA projects at XXX
• develop, through an exercise, an important basic
  analytical skill often used in MA projects

XXX denotes the MA advisor or consulting company
3
MA Primer
Introduction
Agenda

• Trends in MA
• Guiding Principles for Successful MA
• XXX Approach
• Case Examples
• screening
• due diligence
• sale
• Exercise on Synergy Calculation
• Typical Watchouts
• Key Takeaways

XXX denotes the MA advisor or consulting company
4
MA Primer
Introduction
Agenda

• Trends in MA
• Guiding Principles for Successful MA
• XXX Approach
• Case Examples
• screening
• due diligence
• sale
• Exercise on Synergy Calculation
• Typical Watchouts
• Key Takeaways

XXX denotes the MA advisor or consulting company
5
MA Primer

• Trends

Drivers of MA Activity
Strategic
Financial
Other
Macro-economics

• Economy boom or recovery
• Over-capacity in an industry
• Cheap money
• Industry consolidation
• Globalization

• Gain share
• Eliminate competitive threat
• Capture operating opportunities, e.g., scale
  efficiencies
• Leverage existing business systems
• forward/backward integration
• start-up alternative
• Diversify/balance portfolio
• Retire excess industry capacity

• Greed
• Ego

• Improve capital markets evaluation of acquirer
• meet growth targets
• reduce portfolio risk
• Invest idle cash

XXX denotes the MA advisor or consulting company
6
MA Primer

• Trends

MA Activity - U.S. vs. Europe
European and US MA activity is experiencing
similar positive trends.
CAGR (1992-1997)
B
Europe
21
US
41
Note Transaction Value (including Net Debt of
Target). Excludes split-offs. Europe includes 50
major countries
Source SDC
XXX denotes the MA advisor or consulting company
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MA Primer
Trends
MA Activity

• MA activity has grown rapidly in nominal dollar
  terms, peaking in the U.S. in the late 1980s, and
  then matching those levels last year
• The ferocious merger activity of the late 1980s
  was driven in large part by the easy money
  afforded by the junk bond market. This resulted
  in huge, often unsubstantiated, premiums being
  paid for companies without regard to the value
  creation opportunities presented (or not
  presented, as the case may be) by the
  operations/underlying business of the target
• Growth in merger activity since 1992 has
  coincided with the economys recovery from
  recession
• Recent MA activity benefiting from
• extended economic health with little recessionary
  pressure on horizon
• a resulting corporate demand for growth
• increase in international MA activity as
  companies pursuing global strategies
• Since late 1997, U.S. and European markets have
  experienced the resurgence of junk bonds to
  facilitate the execution of deals getting larger
  and larger

XXX denotes the MA advisor or consulting company
8
MA Primer
Trends
MA Activity by Country 1996/97
US market dominates the global MA activity.
Percent change
50
41
110
31
50
14
79
57
Note Represents announced deals Source SDC
XXX denotes the MA advisor or consulting company
9
MA Primer
Trends
US MA Activity by Seller Industry (1992-97)
Value and volume of transactions vary across
industries. For example, in the US, computer
software and service industries tend to do many
small deals. Telecommunications, broadcasting and
leisure and entertainment have high transaction
size.
Source SDC ( March 98)
XXX denotes the MA advisor or consulting company

10
MA Primer
Trends
Multiples Paid for Acquisitions
Over the last five years, the prices paid for
acquisitions have been increasing, and reinforces
the need for in-depth due diligence and analysis
to ensure a fair price.
Average EBIT Multiple
XXX denotes the MA advisor or consulting company
11
MA Primer
Trends
Acquisition Success Rates
The majority of acquisitions have been deemed
failures.
Percent of Acquisitions Failing in First Five
Years
Percent of Total
Harvard Business School
Survey of CFOs
London Business School
XXX Company Study
XXX denotes the MA advisor or consulting company
12
MA Primer
Trends
Common Reasons for Failure

• Poor strategic fit
• combination does not provide competitive
  advantage
• lack of understanding of the business
• Overpay
• imperfect information/wrong valuation
• too optimistic in forecasts/synergies
• unforeseen industry downturn/emerging technology
• auction environment failure to set/stick to
  walk away price
• CEO/management ego
• revenue growth vs. profitability
• emotion vs. analysis
• Poor post acquisition integration
• inadequate planning
• failure to exploit revenue/margin potential
• disrupted relations with customers, employers and
  suppliers
• culture clash failure to involve acquired
  people

Strategic, financial and operating causes

XXX denotes the MA advisor or consulting company
13
MA Primer
Trends
Glossary

• The legal combination of two (or more) formerly
  independent entities
• The acquisition by an independent entity of a
  control stake in another entity. This is usually
  achieved by acquiring more than 50 of shares for
  a public company
• The sale or closure of a particular entity
• Leveraged buy-out An acquisition made possible
  financially by large issuance of debt, making the
  new entity highly leveraged or geared (i.e.,
  with a high ratio of debt to equity)
• Investment firms managing private funds by
  running business portfolios
• Bonds (or debentures, or coupon debt) issued by
  an entity without a credit rating or with
  entities with non-investment grade rating
• Financial markets use the service of credit
  rating firms such as Standard Poors and
  Moodys to determine entities credit worthiness
  (i.e., the ability for an entity to pay back
  their debt). Ratings are allocated from AAA or
  Aaa (highest) to C (lowest)
• Entities with Investment Grade Ratings (AAA down
  to B) are considered stable
• non-investment Grade entities (below B) present
  an investment risk (e.g., third world countries,
  highly leveraged companies)

Merger
Acquisition
Divestiture
LBO
Private Equity Firms
Junk bonds
Credit Rating

XXX denotes the MA advisor or consulting company
14
MA Primer
Introduction
Agenda

• Trends in MA
• Guiding Principles for Successful MA
• XXX Approach
• Case Examples
• screening
• due diligence
• sale
• Exercise on Synergy Calculation
• Typical Watchouts
• Key Takeaways

XXX denotes the MA advisor or consulting company
15
MA Primer
Principles
Guiding Principles (1 of 2)
XXX believes that a clear and disciplined
approach to the acquisition process is vital to
ensure success.
Proactive Strategic Thinking
Screening

• Acquisitions are made to improve the strategic
  position of existing businesses or add to the
  core competencies of the corporation
• Assess impact of acquisitions on long-term
  shareholder value
• Use acquisition as a vehicle to accelerate growth
  in key business units

Principles

• Look for all companies that potentially
  strengthen the corporation
• Don't allow a "transaction" mentality to dominate
  the process

Activities

• Look for targets that present best fit in terms
  of
• relatedness
• impact on market position
• Examine key success factors of potential targets
• Examine competitive position of client vs.
  competitive bidders

• Define business segments
• Diagnose key competencies and any skill gaps
• Analyze market dynamics
• Study cost of acquisition versus organic growth

XXX denotes the MA advisor or consulting company
16
MA Primer
Principles
Guiding Principles (2 of 2)
XXX believes that a clear and disciplined
approach to the acquisition process is vital to
ensure success.
Execution
Capture Full Value
Principles

• Make better decisions upfront through careful due
  diligence
• Strive to identify "deal breaker" issues as early
  as possible
• Use information and insights to provide
  confidence in making a bid

• Clearly communicate corporate vision to target
• Begin integration process as early as possible
• Be objective to ensure a fair decision-making
  process
• Create a set of short-term and long-term
  objectives

• Quantify all potential synergies and cost savings
• Examine margin and revenue forecasts
• Evaluate management of target

Activities

• Provide a blueprint for capturing full potential
  value
• Support managerial integration team

XXX denotes the MA advisor or consulting company
17
MA Primer
Principles
Strategy and MA
Acquisitions at both the corporate and business
unit level need to be thought of as an integral
part of a company's growth strategy.

• Corporate objectives
• growth and financial targets
• competitive arena

• Corporate strategy
• strategic position
• management of resources

Growth throughcorporate acquisitions

• Business unit objectives
• business definition
• growth and financial targets

• Business unit strategy
• strategic position
• key success factors
• sustainable competitive advantage

Growth throughbusiness unit acquisitions
Organic growth
XXX denotes the MA advisor or consulting company
18
MA Primer
Principles
Strategic Framework
The focus of strategic MA activity should be in
areas where there is the highest value creation
opportunity as well as the strongest parenting
advantage.
High
Focus
Value Creation Opportunity
Low
High
Low
Parenting Advantage Is value to our client
higher than value to other parents?
XXX denotes the MA advisor or consulting company
19
MA Primer
Principles
MA Value Creation Opportunities
MA value can arise from generating the full
value of an undervalued entity or by adding value
to under performing assets.
Buy cheap
Add value
Generate synergies
Take advantage of inefficiencies in the market
Spot new market trends early
XXX denotes the MA advisor or consulting company
20
MA Primer
Principles
Critical Issues
XXX assimilates the strategic process with
acquisitions by focusing on four key areas.
(I) Relatedness
(II) Strategic Strength
(III) Market Dynamics

• Market growth
• Technology changes
• Product substitution
• Barriers to exit and entry
• Supplier and buyer power

• Cost sharing
• Customer sharing
• Competitor overlap
• Experience sharing

• Strength of key competitors
• Relative cost position
• Strengths and weaknesses of acquirer

Resolving these issues allows an accurate
evaluation of a company
(IV) Value
XXX denotes the MA advisor or consulting company
21
MA Primer
Principles
Success Criteria - Diagnostic Tool
The ability to improve the strategic position of
the acquirer, and grow or complement its existing
competencies are keys to success.
III) Market Dynamics
RMSgt1.5x
Growth gt 10
RMS1.5-1.0x
Growth 5-10
(II) Strategic Strength(Relative Market Share)
Growth lt5
RMSlt0.5x
Low lt25
Medium 25-50
High gt50
Relatedness (I) (Experience and/or Cost Sharing)
(IV) Value Accurate evaluation based on NPV vs.
Market Price
XXX denotes the MA advisor or consulting company
22
MA Primer
Principles
Success and Market Share
Acquisitions that increased market share
substantially were consistently more successful.
Incidence of success
Incidence of outright failure
Percent
Market Share Bought
Sources Porter (33 Large U.S. Corps.
Management Interviews)
XXX denotes the MA advisor or consulting company
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MA Primer
Principles

Market Impact of Announced Transactions
The stock market rewards companies that make
related and/or focused acquisitions.
Average Percent Price Increases
Definition
Unrelated
Related
Focused

• Minimal cost overlap between acquirer and target

• Medium degree of cost overlap
• Target derives gt70 of revenues from same
  business as acquirer

• Significant amount of activity and cost overlap
  between acquirer and target
• Target complements existing product line and adds
  to core competencies of acquirer

Note Two weeks before compared to one week
after announcement
Source Industry Literature Review,
XXX denotes the MA advisor or consulting company

24
MA Primer
Principles
Examples of Failures (1 of 2)
The MA landscape is littered with unsuccessful
acquisitions which failed to adhere to the core
guiding principles.
Acquisition Thesis
Transaction Value
Reason for Failure
Industry
Acquirer
Target

• Inadequate due diligence
• growth cycle not well understood
• brand strength overestimated

• Leverage distribution channels

Consumer Goods
Quaker Oats
Snapple
1.7B
Entertain-ment
Sony Matsushita
Columbia MCA
4.8B 6.1B

• Own up stream contents for downstream hardware

• Inadequate due diligence
• over valued synergies
• Strategically flawed and poor integration

Sears
DeanWitter
6.7B

• Build a "one-stop" financial supermarket

• Inadequate due diligence
• limited cross-sell potential

Finance
Amex
Shearson
900MM

• Expand distribution capabilities

• Poor integration
• culture clash

XXX denotes the MA advisor or consulting company
Sources Industry literature
25
MA Primer
Principles
Examples of Failures (2 of 2)
The MA landscape is littered with failures which
failed to adhere to the core guiding principles.
Transaction Value
Acquisition Thesis
Reason for Failure
Industry
Acquirer
Target
Retail
Allied
Federated
6.5B

• Expand geographically

• Inadequate due diligence
• overvalued potential synergies and brand value

• Strategically flawed
• few synergies between computer hardware and
  telephony
• Poor integration

ATT
NCR
7.5B
Technology/Telecommu-nications

• Technology/ telephony integration

• New market entry

Novell
WordPerfect

• Poor integration
• culture clash

1.4B
Sources Industry literature
XXX denotes the MA advisor or consulting company
26
MA Primer
Principles
Examples of Successful Acquisitions (1 of 2)
However, many companies have created enormous
value through successful acquisitions.
Transaction Value
Industry
Target
Acquisition Thesis
Acquirer
Reason for Success
Consumer Goods
Cadbury Schweppes
Dr. Pepper/ 7-Up
2.0B

• Expand geographic distribution

• Careful due diligence
• increased scale and presence as a global player

First Financial Management

• Well-managed integration
• integration of credit card processing services of
  consumer and commercial sides

Financial Services
First Data
6.6B

• Obtain scale economies

Wells Fargo
Crocker
1.07B

• Expand geographical reach and leverage back-office

• Careful due diligence and integration
• capture of synergies and cost savings

Food
Tyson
Holly Farms
1.4B

• Extend product line

• Good strategic fit and due diligence
• capture of cost- sharing potential

Sources Industry literature
XXX denotes the MA advisor or consulting company
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MA Primer
Principles
Examples of Successful Acquisitions (2 of 2)
However, many companies have created enormous
value through successful acquisitions.
Transaction Value
Industry
Target
Acquisition Thesis
Acquirer
Reason for Success

• Well-managed integration
• close attention to culture match open
  communication of strategic vision

High Technology
Cisco
Stratacom
4.5B

• New technology

Healthcare
Columbia
HCA

• Build national healthcare group

• Good strategic fit and due diligence
• capture of cost-sharing and scale economies

5.7B

• Expand geographic reach and leverage product
  strengths

• Good strategic fit and due diligence
• strong understanding of market dynamic to improve
  strategic position

Manufacturing
Crown, Cork Seal
Carnaud(French)
3.9B
Transportation
Union Pacific
Chicago North Western Transportation Company
1.1B

• Expand geographically

• Good strategic rationale
• pre-emptive strategic move to maintain strategic
  position

Sources Industry literature
XXX denotes the MA advisor or consulting company
28
MA Primer
Introduction
Agenda

• Trends in MA
• Guiding Principles for Successful MA
• XXX Approach
• Case Examples
• screening
• due diligence
• sale
• Exercise on Synergy Calculation
• Typical Watchouts
• Key Takeaways

XXX denotes the MA advisor or consulting company
29
MA Primer
Approach
Key Activities
Approach to acquisitions follows a series of key
steps.

• Should an acquisition strategy be pursued?

• What sector or region?

Strategy

• The best candidate based on
• attractiveness and availability

Acquisition target screen

• Validate screening assumptions

Due diligence
Bid structure and negotiations

• The right price

Integration pre-planning
Target valuation

• Getting full value

Integration
XXX denotes the MA advisor or consulting company
30
MA Primer
Approach
MA Value Chain
XXX has considerable experience in the different
skill sets needed at different stages in the
acquisition process.
Acquisition Screening
Integration
Valuation
Due Diligence
Objective

• Identify potential candidates which present best
  fit in terms of
• relatedness
• impact on market position

• Understand full strategic value of acquisition
  candidate

• Implement strategic vision for merger that gives
  direction and impetus for change
• Definitive actions and role definitions to speed
  integration process

• Make better decisions upfront
• Provide agenda for post-acquisition change
• Improve success in closing deal

• Business/strategic review
• market trends
• customers and suppliers
• competitors
• costs, technology
• valuation/full potential assessment

• Quantify current operating value, stand alone
  operating improvements, and potential synergies

• Pre-planning
• combined cash flows
• Transition plan
• Cost reduction
• Revenue enhancement

XXX Activities

• Industry profile
• Target screening
• Target approach

• Ignore market dynamics and competitor impact on
  future cash flows
• Taking management projections at face value

• Reluctance to interfere in operations of acquiree

• Non-identification of "deal breaker" issues
• Misunderstanding of cost savings and upside
  opportunities

Common Pitfalls

• Drawing up incomplete list of candidates
• Use of screen process to develop a strategy

XXX denotes the MA advisor or consulting company
31
MA Primer
Approach
XXX and Other Advisors' Role
XXX provides a neutral, third-party view and
analysis on the primary strategic and financial
issues.

• In tandem with accountants, analyze financial
  projections based on managerial input

Investment Banks

• Value based on prices of comparable businesses
  recently bought or sold
• Multiple of earnings/cash flow, assets

• Little or no direct input in post-merger
  activities

• Comb for potential acquisition candidates based
  on availability
• Utilize contacts to build a wide list of
  potential targets

• Limited external research
• largely dependent on managerial projections

Accounting Firms

• Look for potential acquisition candidates based
  on availability
• Use contacts to build list of potential targets

• Value based on prices of comparable businesses
  recently bought or sold
• Construct a basic DCF model

• Little or no direct input in post-merger
  activities

XXX Role

• Analyze quality of customer and supplier base
• Look for potential cost savings and upside
  synergies
• Understand market dynamics to better project
  market and company growth objectives

• Construct a discounted cash flow model that
  values stand alone, operating improvements and
  potential synergies
• Provide a reality check on market valuations

• Active involvement in transition plan, cost
  reduction and revenue enhancement opportunities
• "Hands-on" driver of change process to realize
  full value of merged entity

• Determine targets based on corporate objectives
  and strategies
• Identify acquisitions that enable the acquirer
  to
• penetrate new markets
• acquire capabilities
• gain scale advantage
• improve relative market position

XXX denotes the MA advisor or consulting company
32
MA Primer
Approach
Roles and Responsibilities
XXX is an integral part of a dedicated team of
MA professionals.
100
Investment Banks

• Presentation to board

• Market valuation

• How, what and when to say

• Price
• Terms

• Support as needed

80
XXX

• Prospectus
• Other document- ation

60
Percent of Professional Time

• Support as needed
• Legal Due diligence

40
Lawyers

• Scripts
• Due diligence

• Presentation to both boards

• Non-offer letter
• Terms

• Portfolio
• Norm bands
• Key issues investigation

• Intrinsic cash flow valuation

• How, what and when to say
• Scripts

• Screening study

20

• Letter of comfort
• Due diligence

Accountants

• Pro formas

0
Identify candidate
Due Diligence
Valuation
Development approach
Develop offer and deal structure
Negotiate
Board approvals
Implement
XXX denotes the MA advisor or consulting company
33
MA Primer
Approach
Acquisition Screening
Finding potentially attractive targets is the
critical first step in an MA process.
Acquisition Screening
Integration
Valuation
Due Diligence
Objective

• Identify potential candidates which present best
  fit in terms of
• relatedness
• impact on market position

XXX Activities

• Industry profile
• Target screening
• Target approach

Common Pitfalls

• Drawing up incomplete list of candidates
• Use of screen process to develop a strategy

XXX denotes the MA advisor or consulting company
34
MA Primer
Approach
Acquisition Screening(Common Mistakes)
Inadequate screening of candidates is commonplace.

• Review all potential candidates and determine
  which ones present the best fit in terms of
• relatedness
• impact on market position

Objective

• Drawing up an incomplete list of candidates,
  excluding divisions of large companies and very
  small companies
• Using the screening process to develop the
  strategy
• Saying
• "We can't buy it because..."
• "They have turned us down before"
• "The government won't approve it" or
• "It's family/state/competitor/or big company
  owned"
• Making the wrong contact at the target company
• Being impatient with acquisition process
• Assuming "no" really means "no"

Common pitfalls
XXX denotes the MA advisor or consulting company
35
MA Primer
Approach
Candidate Screening Process
XXX's approach to screening involves careful
analysis of the market, competitors and the
target.
Broad screen
Fine screen
Thorough analysis
Focus of analysis
Market position
Relatedness
Value creation
Screening criteria

• Industry sector
• Company size
• Company growth
• Market share
• Financial performance

• Key success factors
• Competitive position (costs/customers)
• Opportunity for synergies

• Stand-alone value of synergies/ performance
  improvement potential
• Management/cultural considerations

Objective

• Rapidly narrow down universe of companies

• Provide shortlist of candidates

• Detailed assessment of remaining candidates

XXX denotes the MA advisor or consulting company
36
MA Primer
Approach
Screening Criteria
The XXX approach to screening evaluates the
market dynamics and the target's performance and
fit with the acquirer.
Partial examination
Complete examination
Availability of Benefits
XXX denotes the MA advisor or consulting company
37
MA Primer
Approach
Due Diligence
XXX goes beyond financial analysis to assess
fully the competitive position of the target, and
identify "deal breaker" issues .
Acquisition Screening
Integration
Valuation
Due Diligence
Objective

• Make better decisions upfront
• Provide agenda for post-acquisition change
• Improve success in closing deal

• Business/strategic review
• market trends
• customers and suppliers
• competitors
• costs, technology
• valuation/full potential assessment

XXX Activities

• Non-identification of "deal breaker" issues
• Misunderstanding of cost savings and upside
  opportunities

Common Pitfalls
XXX denotes the MA advisor or consulting company
38
MA Primer
Approach
Approach to Due Diligence
XXX minimizes the risks of acquisitions with a
thorough approach to due diligence.

• Provide access to the XXX world network to
  support pre-letter of intent go/no-go decisions
• Conduct exhaustive due diligence study of
  industry and company dynamics
• identify key cash flow drivers
• quantify margin and revenue growth forecasts
• quantify cost reduction potential
• identify "deal breakers" and/or "red flags"
  causing bid adjustments
• identify and quantify all upside opportunities
• Identify and evaluate potential exit options

• Assist in securing financing through development
  and presentation of objective, third-party
  business analysis

• Create blueprint for Full Potential strategy

• Generate enthusiasm and momentum for the deal
  within the target company

XXX denotes the MA advisor or consulting company
39
MA Primer
Approach
Typical Due Diligence Issues (1 of 2)
A well-designed due diligence process involves
answering a series of key questions.
What business is the target in? Who are the
current and potential competitors?
Business Definition
Is this an attractive industry from size, growth,
supplier power, regulatory environment, business
concentration and profitability perspectives? Is
this the right time to buy?
Market Overview
How do you make money in this business today and
in the future?
Key Success Factors
How well positioned is the target company?
(market share, management, products, company
performance, customer stability/defections,
etc...)
Company Overview
What are key purchase criteria and how does our
target perform relative to competitors? How
might this change in the future?
Customer Evaluations
XXX denotes the MA advisor or consulting company
40
MA Primer
Approach
Typical Due Diligence Issues (2 of 2)
XXX denotes the MA advisor or consulting company
41
MA Primer
Approach
Typical Due Diligence Activities
Understanding of market dynamics, strategic fit,
and company performance requires an in-depth
external and internal review.
External Assessment
Internal Assessment

• Interviews with target company's management in
• marketing/sales
• finance/accounting
• operations
• etc.
• Comprehensive review of target company's customer
  base, personnel and operations
• Analysis of above information to determine
• market share projections
• potential margin changes
• relative cost position
• salesforce effectiveness
• potential operational improvements

• Blind interviews with customers, competitors,
  suppliers and market experts conducted by
  experienced, business-minded group members
• Exhaustive review of market research reports,
  company profile information, articles,
  publications and other publicly available sources
• Analysis of above information to determine
• overall market growth potential
• customer segmentation
• relative performance of target company vs.
  competitors based on customer needs
• vulnerability in value chain (including
  distribution channels)

XXX denotes the MA advisor or consulting company
42
MA Primer
Approach
Valuation
XXXs valuation process quantifies the full
strategic value of an acquisition to ensure that
the client can price with comfort and confidence.
Acquisition Screening
Integration
Valuation
Due Diligence
Objective

• Understand full strategic value of acquisition
  candidate

• Quantify current operating value, stand alone
  operating improvements, and potential synergies

XXX Activities

• Ignore market dynamics and competitor impact on
  future cash flows
• Taking management projections at face value

Common Pitfalls
XXX denotes the MA advisor or consulting company
43
MA Primer
Approach
The Value Creation Process
XXXs approach to valuation encompasses three
distinct steps that closely examine the
historical and future financial performance of
the target.

• Investment banking focus
• leverage/gearing
• type of financial products used

Financial deal structure
Percent of Current Market Value (Debt and Equity)

• Integration opportunities
• expanded distribution
• plant consolidation
• eliminate redundant RD
• purchasing leverage

Synergies
Stand alone operating improvement

• Better management of assets
• plant best demonstrated practices
• reduced manufacturing complexity
• outsourcing/move off shore
• reduced working capital

Premium
Current operating value
Market value of debt and equity

• Stand alone cash flow
• domestic demand
• import penetration
• current market share
• price per unit
• variable cost per unit
• fixed costs (RD, advertising, etc.)
• capital expenditures

Current market value
Maximum potential value
Difference between purchase price and
post-integration value to client represents
value creation opportunity
XXX denotes the MA advisor or consulting company
44
MA Primer
Approach
Valuation Roadmap
The valuation process must answer a set of key
questions regarding capabilities, synergies, and
strategic fit.
Value Potential Synergies
Develop RequiredCapital Structure
Value Target as Stand Alone Business
Develop Core Business Expectations
XXX Role
XXX Role
XXX Role
XXX/Investment Bank Role

• Five year cash flow forecast
• Critical areas of sensitivity
• market growth activity
• key customers/ products
• cost reduction
• capital expenditures

• Detailed financial due diligence
• historical financial analysis
• future protections
• DCF analysis
• Comparable analysis
• Other potential buyers
• strategic
• financial
• Other options
• spin-off
• liquidation
• etc.

• Overall fit with strategy
• Cost reduction potential
• fixed
• variable
• Revenue synergies
• positive
• negative
• Customer and competition response
• Non-recurring costs

• Combined cashflow forecasts
• acquirer
• target
• synergies
• Possible financing sources
• equity
• secured debt
• cashflow loans
• seller financing

Investment Bank Role

• Development of conservative case requirements
  provides basis for analyzing debt capacity

• How much is the target worth to the seller?

• How much is the target worth to us?

• Can we afford it?
• Does the increase risk make sense?

• Cash flow
• BDP
• Industry analysis
• 3Cs
• RCP

• Investment appraisal
• Cash flow

Related BVU Modules
XXX denotes the MA advisor or consulting company
45
MA Primer
Approach
Valuation Potential Synergies
A key component in the valuation process is to
quantify, as best as possible, any upside
opportunities on both the revenue and cost side.
Bottom-Line Improvement
Cost Reduction (Hard synergies)
Variable
Fixed
Revenue Enhancement (Soft Synergies)

• Manufacturing
• Sales Marketing
• Distribution
• G A

• Purchasing
• Labor productivity
• Manufacturing efficiency benefits
• Consumer and trade spending efficiencies
• Transportation efficiency

• Examination of sales distribution channels
• Product cross-selling
• Other

Assessed during due diligence
XXX denotes the MA advisor or consulting company
46
MA Primer
Approach
Integration
XXX can assist in the integration process and
maximize the value of the target.
Acquisition Screening
Integration
Valuation
Due Diligence
Objective

• Implement strategic vision for merger that gives
  direction and impetus for change
• Definitive actions and role definitions to speed
  integration process

• Pre-planning
• combined cash flows
• Transition plan
• Cost reduction
• Revenue enhancement

XXX Activities
Common Pitfalls

• Reluctance to interfere in operations of acquiree

XXX denotes the MA advisor or consulting company
47
MA Primer
Approach
Importance of Integration
The ability to successfully integrate acquired
companies is ranked the most important factor
influencing acquisition success.
Degree of Importance
Ability to integrate company
Evaluation of acquisition candidate
Management abilities of company acquired
Prior experience making acquisitions
Compatibility of management styles
Pricepaid
Sample 200 CEO's
Sources Wall Street Journal
XXX denotes the MA advisor or consulting company
48
MA Primer
Approach
Integration - Key Success Factors

• Early planning
• Take control swiftly
• Constant communication
• Ensure retention of key managers
• Aggressive sharing of corporate vision
• Respect for people and culture
• Adopt merger principles
• fact-based and fair decision making
• objectivity
• two-way communication

XXX denotes the MA advisor or consulting company
49
MA Primer
Approach
Integration - Develop Short - and Long-Term
Objectives
Explicit expression of corporate mission/vision
by CEO
Long-term objectives

• Articulate immediately when control is taken
• Gives organization focus for new direction
• Maintains impetus for change

Short-term objectives

• Driven by due diligence and valuation
• Reality check
• Directs Transition Team in first weeks after the
  merger

Top-down consistent approach
XXX denotes the MA advisor or consulting company
50
MA Primer
Approach
Typical Timeline
Integration is a complex process that must be
done quickly to produce tangible results.
2
4
6
8
10
12
14
16
18
20
0
0
(weeks)

• Preplanning
• future cash flows
• industry analysis
• due diligence

1
3
5
7
9
11
13
15
17
19

• Strategy

• Transition Plan

• Communication Plan

• Culture Integration

• Finance Plan
• debt structure
• capex
• compensation

• Cost Reduction
• distribution
• production
• overhead

• purchasing
• sales

• Revenue Enhancement Plan
• cross-selling
• cross-marketing

XXX denotes the MA advisor or consulting company
51
MA Primer
Approach
Integration - Develop Short - and Long-Term
Objectives
The acquisition premium paid can only be
justified by making swift changes. Yet there is a
reluctance to interfere in the management and
operations of the target.
Real/perceived performance shortfall
Acquiree morale declines and attrition increases
Acquirer becomes impatient and storms acquiree
The "hands-off" doom loop
Morale collapse at acquiree
XXX denotes the MA advisor or consulting company
52
MA Primer
Introduction
Agenda

• Trends in MA
• Guiding Principles for Successful MA
• XXX Approach
• Case Examples
• screening
• due diligence
• sale
• Exercise on Synergy Calculation
• Typical Watchouts
• Key Takeaways

XXX denotes the MA advisor or consulting company
53
MA Primer
Case Example - Prepress
Screening/ Due Diligence (1 of 2)
Client

• Prepress's base business is the market leader in
  the high-end electronic imaging market

Situation

• Prepress has historically enjoyed high margins
  and been able to remain market leader

Complication

• Prepress base business is facing price pressure
  from low-end systems.
• With 300MM of cash available, Prepress is
  looking for growth opportunities to sustain
  superior growth rates

Recommendation

• Assess core competencies of Prepress relative to
  the competition and identify potential
  acquisitions

XXX denotes the MA advisor or consulting company
54
MA Primer
Case Example - Prepress
Screening/ Due Diligence (2 of 2)
XXX activities

• Strategic assessment of core competencies
  relative to the competition
• Identify "long list" of industries to discuss
  with client
• Prioritize "long list" in terms of industry
  attractiveness in order to narrow to 3-5
  industries
• Screen for new acquisitions in higher growth
  industries

• From long list" of industries and discussion
  with client, attractive industries were selected.
• Within designated industries, XXX identified
  financially attractive targets that matched
  Prepress's strategic focus.

Result
XXX denotes the MA advisor or consulting company
55
MA Primer
Case Example - Prepress
Search Criteria
Along with the client, XXX developed a set of
criteria with which to evaluate different
industries.
Companies that Purchase Computer Components, Add
Value, and Remarket
Information Capture, and Dissemination
Output Devices
Competitor Industries
Prepress Customers
Another Prepress Industry
Potential Industries
Recording products
X
X
X


Duplication products
X
X
X
X
X
Data enhancement/ manipulation/editing devices
X
X
X
X
X
Data management (storage and retrieval) devices
X

X
X
X
Transmission originators
X

X


Transmission carriers/controllers


X

X




Transmission receivers ("dumb')
X
Intelligent digital processing systems

X
X
X
X

X




Interactive digital systems
Office automation/high potential customers





X
XXX denotes the MA advisor or consulting company
56
MA Primer
Case Example - Prepress
In-depth Screening
After selection of the criteria, each industry
was analyzed to determine its attractiveness and
potential fit with Prepress's existing business.
Is the industry attractive?
Do we offer a value- added proposition?

• Systems orientation
• What other technologies does this industry
  interface with?
• Customers
• Who are they?
• How do they buy? (channels, predictability)
• What do they buy?
• Competitors
• Who are they?
• What is their share of their market?
• How important is this industry to them?
• Industry trends/dynamics
• How cyclical/predictable is the industry?
• How profitable is the industry?
• What is the average selling price per component?
• What is the percent value-added?
• Viable acquisition candidates
• Is one of "top 3" players "buyable"?
• Are they profitable?

• What drives industry's profitability?
• What do we bring to the table? Could our
  capabilities strengthen the industry?
• Could this industry serve as a platform to enter
  other markets?
• Can we create a new system?

XXX denotes the MA advisor or consulting company
57
MA Primer
Case Example - Prepress
Magnetic Resonance Imaging (MRI) (1 of 2)
The MRI industry was selected based on its
attractiveness and potential fit with Prepress.
Industry Attractiveness

• 1.4B, worldwide (second largest medical imaging
  segment)

Market Size
Growth rate

• 9.1 (fastest growing segment)

• Value-added system, but most manufacturers just
  sell component

Systems orientation
Customers

• Medical market

• Fragmented - over 200 equipment suppliers
  worldwide
• Major players in X-ray, CT, SPECT, and PET do not
  dominate MRI
• ROS historically 9, weak 3 now
• Highly competitive with intensified price cutting
• Anticipate industry consolidation and merging of
  manufacturing, product development, and
  distribution functions

Competition
Industry trends/dynamics
Attractive
XXX denotes the MA advisor or consulting company
58
MA Primer
Case Example - Prepress
Magnetic Resonance Imaging (MRI) (2 of 2)
The MRI industry was selected based on its
attractiveness and potential fit with Prepress.
Prepress Value-added Proposition
Similarity to pre-press

• Same workflow
• Similar manufacturing (value-added resale of
  high-technology components linked by proprietary
  software and customer circuit boards or chips)
• Color imaging becoming increasingly valued system
  feature

Linkage to other industries

• Signifies major move into medical imaging market
• Complements current client printer medical market
  strategy
• Entry vehicle to data storage industry
• No linkage to non-medical/other markets

• System similarity (modular design, user-friendly,
  upgradeable, high quality)
• Sales process similarity (system sell, proven ROI
  benefits)
• Customer need similarity (high resolution images,
  low maintenance, strong price-value relationship)

Prepress synergies
Attractive
XXX denotes the MA advisor or consulting company
59
MA Primer
Prepress
MRI Market Segment Competitors
Industry segments were classified and measured to
identify potential targets.
100M
80M
Total 1.4B Players
150M
550M
500M
100
A
Estimated Percent of 1993 Market (1993 Dollars)
B
C
80
I
D
G
E
F
H
I
F
60
E
E
G
H
H
C
G
H
H
40
I
D
G
E
Others
I
B
G
C
D
F
20
C
B
B
A
E
B
A
A
0
Radiology
Cardiology
Other
Peripheral vascular
OB/GYN
XXX denotes the MA advisor or consulting company
60
MA Primer
Case Example - Prepress
MRI Industry Dynamics
The MRI market was then examined further in order
to identify opportunities.

• Dedicated players dominate market
• make money
• increasing sales
• focused RD expenditures

• G had (5.6) ROS
• what's driving losses?

Track record

• Offered by more hospitals (75) than any other
  digital imaging technology
• Majority of hospital CFOs operate MRI profit
  centers

• Increasingly restrictive global government
  regulations for medical spending and reimbursement

Macro-environment

• Ultra high-technology RD
• leverage super-computer advances
• engineer for low cost, compact size, long-term
  reliability
• Shake-out imminent

• Aggressive price-cutting
• Intensive competition

Industry trends
XXX denotes the MA advisor or consulting company
61
MA Primer
Case Example - Prepress
MRI Target Acquisition Candidates
After the creation of a market map, individual
companies were assessed for their viability as an
acquisition.
ViableAcquisitionCandidate
Not Viable
Company
Revenue
Market Value
Medical Imaging Parent
Division of Large Company
Market Share Too Small
170MM
200MM
A

• O
• P
• Q
• R
• S

• H
• K
• L
• M
• N

• D
• E

• I
• G
• C
• J
• K

165MM
100MM
B
150MM
100MM
F
XXX denotes the MA advisor or consulting company
62
MA Primer
Introduction
Agenda

• Trends in MA
• Guiding Principles for Successful MA
• XXX Approach
• Case Examples
• screening
• due diligence
• sale
• Exercise on Synergy Calculation
• Typical Watchouts
• Key Takeaways

XXX denotes the MA advisor or consulting company
63
MA Primer
Case Example - Sand
Due Diligence/Valuation

• A UK-based mining and minerals division of a
  diversified company

Client
Situation

• Acquirer has limited opportunities for internal
  growth and is seeking growth through acquisition

Complication

• Target ("Ferret") purchased a divested division
  from the client several years ago. Initial
  hypothesis is that the target is a good
  acquisition at the right price

Recommendation

• Industrial sand division was divided into 5
  segments by end-user. Based on growth rates in
  individual segments, target firm was valued at
  approximately 100MM

• Market growth projections
• Market share determination
• Assessment of possible synergies with acquiring
  firm
• Competitor analysis
• Analysis of business expansion opportunities
• Independent EBITDA forecast

XXX activities
Result

• A competitor bid was accepted

XXX denotes the MA advisor or consulting company
64
MA Primer
Case Example - Sand
Industry Overview
Every market segment has been volatile. Only the
frac segment has grown significantly, but it is
still below its 1985 peak.
CAGR (1970-1993)
Glass
0.1
Foundry
-1.0
Abrasives
1.3
Frac
8.5
Fillers
-5.6
XXX denotes the MA advisor or consulting company
Sources U.S. Bureau of Mines
65
MA Primer
Case Example - Sand
Value Chain
Regional presence is crucial for both whole grain
segments. The distribution cost is the largest
part of the frac and foundry whole grain segments.
Manufacturers Margin
Distribution
Processing
Extraction
End-User Price
Foundry Whole grain
40
Foundry Resin coated
150-250
Frac Whole Grain
20-25
Frac Resin coated
160-240
Notes In percent of end user price
Sources Ferret's budget Customers Interviews
XXX denotes the MA advisor or consulting company
66
MA Primer
Case Example - Sand
Market Map by Sub-Segment
170M
164M
100M
99M
20M
34M
141M
29M
86M
78M
47M
24M
29M
37M
35M
10M
Others
Total 570M
Other
Others
Ferret
Others
Other
Percent of Total
Others
Ferret
Genstar
Ferret
Others
The Morie Co.
Fairmount Minerals
Norton/Alcoa
FosterDixiez
U.S. Silica
Ferret
Unimin
Other
Ferret
Oglebay Norton
Stanblast
Oglebay Norton
Unimin
The Morie Co.
Other
Borden
Borden
U.S. Silica
Badger Mining


The Morie Co.
U.S. Silica
U.S. Silica
Carbo Ceramics
Reed Minerals
In-House resin coated
Unimin
U.S. Silica
U.S. Silica
Unimin
Ferret
Unimin
Unimin
The Morie Co
Fairmount Minerals
Ferret
Primary Glass
Performance Glass
Whole Grain
Resin-coated
Whole Grain
Other
Resin Coated
Copper Slag
Silica Sand
Coal Slag
Ceramics
Fillers and Extenders
Glass
Foundry
Proppants
Abrasives
Note 1995 estimated figures except for Abrasives
(1992 figures) Ferret Abrasive
share excludes Uniwest
Source Tucker Anthony and U.S. Silica
Information Reports
XXX denotes the MA advisor or consulting company
67
MA Primer
Case Example - Sand
Industrial Sand Market Overview
Summary

• The overall silica sand industry has been notably
  cyclical with flat volume growth over the past
  twenty-five years downturns generally track
  broader economic slowdowns
• Each market segment of the silica sand industry
  is volatile and only frac has shown significant
  long-term volume growth However, frac volume is
  still below its 1985 peak
• Real industry revenues have fallen by 1.6 since
  1980
• Real revenues per ton have fallen by 0.5 since
  1980
• Extraction, manufacturing and distribution should
  be viewed as different businesses with unique
  returns, customers and competitors
• Future environmental and health risks appear to
  be limited - regulations limiting access to and
  use of silica sands are not expected to become
  more burdensome in the near future

XXX denotes the MA advisor or consulting company
68
MA Primer
Case Example - Sand
Ferret's Position
Summary

• Strong historical growth has been due to
  acquisitions and internal growth
• Ferret has focused primarily on the foundry and
  frac segments which account for over 60 of its
  contribution
• Profitability and cash flow (as a percent of
  sales) have recovered from 1993 levels, but are
  still well below 1991 peaks
• Customers generally regard Ferret favorably -
  Ferret has been aggressive in increasing revenues
  per ton and is perceived by customers as being
  higher priced
• Because of high distribution costs, competition
  in most product lines is geographically limited
  and varies across Ferret's locations and market
  segments
• Ferret's key competitors do not own captive
  distributors - the key competitor in resin-coated
  sands, Borden, has no extraction capabilities
• Ferret has significant unutilized manufacturing
  capacity, but extraction capacity will be
  exceeded if the Bridgman permit is not renewed

XXX denotes the MA advisor or consulting company
69
MA Primer
Case Example - Sand
Investment Rationale
Communication to investors regarding the
acquisition of Ferret should focus on five key
points

• Growth in client's existing markets is limited
• products
• geography
• The US market is very large and is about to
  undergo the next phase of change
• out-sourcing of foundry resin-coating processes
• growth in frac sands
• cyclicality provides opportunity to consolidate
  in downturns
• Dramatic change has occurred in the US market
  since client's exit
• consolidation
• shakeout of many competitors
• emergence of Ferret
• Ferret has taken advantage of the industry
  environment to compile a very attractive
  combination of reserves and manufacturing
  capabilities
• Ferret represents an attractive platform for
  future growth
• product synergies (1 worldwide leader in silica
  proppants for the oil gas industry)
• further US acquisitions
• international expansion Mexico, South America,
  Pacific Rim
• diversification across national economic cycles

XXX denotes the MA advisor or consulting company
70
MA Primer
Case Example - Sand
Valuation Summary
Based on different scenarios a 100MM bid was
made.
Worst Case
Base Case
Best Case
CAGR (1995-2000) Sales GP EBIT Operating Cash
Flow
-0.1 -1.4 -7.5 1.4
3.8 3.1 2.7 8.1
8.4 7.9 11.3 14.3
64.9MM
91.3MM
123.0MM
DCF (_at_12)
Notes Assumes no growth perpetuity
Sources XXX model
XXX denotes the MA advisor or consulting company
71
MA Primer
Introduction
Agenda

• Trends in MA
• Guiding Principles for Successful MA
• XXX Approach
• Case Examples
• screening
• due diligence
• sale
• Exercise on Synergy Calculation
• Typical Watchouts
• Key Takeaways

XXX denotes the MA advisor or consulting company
72
MA Primer
Case Example - AMD
Summary (1 of 2)
Situation

• The client, a global asset management company
  with over 50B under management, was losing
  market share across its businesses
• XXX was approached to assist in developing a
  strategy to achieve profitable growth

Approach

• Phase I focused on defining the current state of
  the current business and its environment
• in depth analysis of the clients markets,
  channels and customers established that client
  was losing share in many markets and was being
  out-invested by competitors in core markets
• detailed profitability analysis across products,
  channels and markets identified that only four
  businesses in the clients portfolio of 15 were
  making significant contribution to group profits
• In Phase II, joint XXX/client teams were formed
  in each business to develop detailed five year
  business plans. The plans included required
  investment, potential strategic moves and
  resultant profits, enabling the full potential of
  each business unit to be determined on a
  comparable basis
• The individual business plans were integrated to
  quantify the overall opportunity for the company.
  Corporate-level strategic options were then
  identified, detailed and valued

XXX denotes the MA advisor or consulting company
73
MA Primer
Case Example - AMD
Summary (2 of 2)

• After detailed evaluation of strategic options, a
  decision was made to sell the Asset Management
  Division (AMD) business. The asset management
  company required significant investment in order
  to achieve profitable growth, and the parent
  company was able to achieve higher returns by
  investing in other businesses within its
  portfolio
• XXX continued to support the client through the
  sale process by
• developing the offer memorandum, the business
  forecast and the management presentation
• identifying the best new parent and quantifying
  their full-potential price
• supporting the bid negotiations

Conclusion

• The division was successfully sold, realizing
  500M more in value from the transaction than the
  parent would have been able to extract from the
  business through continued ownership.

Impact
XXX denotes the MA advisor or consulting company
74
MA Primer
Case Example - AMD
Profitability by Business
The clients profits were concentrated in three
businesses.
XXX