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Sponsor Based Leveraged Acquisition Market Overview

Explore the dynamics of acquisition/leveraged finance, global M&A trends, success factors, private equity evolution, PE sector insights, and value creation strategies. Learn about key buyout statistics and the evolving private equity landscape for informed decision-making.

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Sponsor Based Leveraged Acquisition Market Overview

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  1. Sponsor Based Leveraged AcquisitionMarket Overview Joseph V. Rizzi Amsterdam Institute of Finance October, 2014

  2. Acquisition/Leveraged Finance • Transaction: Buyout, Acquisition or Recapitalization • Leverage: Resulting in highly leveraged (i.e., non investment grade) obligor – fD/EBITDA > 3X • Subject to market availability and pricing (function of risk appetite • Deal Types: Acquisition Recapitalization Refinance PTP (Public to Private) STS (Sponsor to Sponsor, aka Pass the Parcel) PE Importance: Provides 1/3 of all I/B Revenues and up to 25% of M&A Amsterdam Institute of Finance October, 2014

  3. Global M&A (1H14) • 7 Year High – 1.77T U.S. - 41% ROW - 59% • Drivers Cash Balances Low Rates Exhausted Cost Cuts and Buybacks Pent-up Demand Positive Response Confidence Rising Stock Prices • Increase in Hostile T/O 20% of total v single digits post crisis • PE: Dog that didn’t bark – Strategic Acquirers crowd-out 20% of total v 27% 4 year average Reflects dearth of larger PTP deals Volume up 6% 2014 v double digit M&A increase • PPX: 14X+ • Drop in cash in favor of stock/stock + cash All cash at lowest level since 2001 • Averages reflect return of the “big deal” Amsterdam Institute of Finance October, 2014

  4. M&A Snapshot 1H14 • Activity 1H141H13 Volume ($B) 1,768 1,023 Size (> 10B) 9 19 • Return of Strategic Acquiror Holcim – LaFarge April, 2014: $39.5B Numericable – SFR March, 2014: $23.3B Facebook – WhatsApp February, 2014: $19.5B Suntory – Beam January, 2014: $15.7B Bayer – Merck Cons May, 2014: $14.2B • Drivers Increased Stock Prices – Management confidence; Stock as Currency Positive Shareholder Reaction: One Day Indexed Buyer Stock Price Reaction 1H14 2.9% 2H13 3.6% 1H13 3.1% 2012 1.8% 2011 .3% 2010 .3% 2009 <1.9%> 2008 <1.3%> Source: S&P Capital IQ Amsterdam Institute of Finance October, 2014

  5. Success Factors Factors Deal Size Timing Price Financing Consideration Buyer Execution Type Tests Best Owner Iron Law Amsterdam Institute of Finance October, 2014

  6. Euro LBO • (Euro/B) 7/31/14 38.8 2013 63.7 2012 29.0 2011 43.9 2010 39.4 2009 9.0 2008 69.3 2007 152.3 2006 164.5 • Country UK 28.57% France 19.10% Germany 12.59% Netherlands 10.83% Spain 6.45% • European PE Dry Powder (Euro/B) – European Focused Fundraising 7/31/14 225 58.4 2013 190 88.8 2012 175 73.8 • Key Buyout Stats – 7/31/14 PPX 9X Eq% 35% FDX 5X Source: S&P Capital IQ Amsterdam Institute of Finance October, 2014

  7. Euro Market • European LL Volume: Highest Level Post Crisis June/July YTD Volume €59.5B up 19% same period 2013/LY Includes M&A and PE • Leverage Up: 5X+ • Return of Cov-lite: Reduced Terms • 2L Increasing • CLO: Returning – 6 Mo 16 v 20 for YE13 Costs dropped from E+200 2013 to E+100 1H14 • MEZ N/A: 2L Wipeout • HYB (7/31/14): €61.3B v €47.2B LY Amsterdam Institute of Finance October, 2014

  8. Value Creating Transactions: Questions & Framework Amsterdam Institute of Finance October, 2014

  9. M&A Danger Signs • CEO only believer: headstrong; magazine cover effect • Only revenue synergies with no investment plan • Prefunctory Due Diligence • Reservation price changes during bidding • Must close deal • Failure to identify why buyer is best owner • Emphasis on time, effort, cost and reputation sunk into deal Amsterdam Institute of Finance October, 2014

  10. Private Equity Evolution Stone Age Bronze Age Silver Age Golden Age Back-to-the-Future Maturity (1974-84)(1985-90)(1990-2000)(2002-07)(2008-2012)(2013 - ?) Cottage Industry KKR Fund proliferation Goes global Shakeout/consolidation Exits Bootstrap deals High Yield Represents 40% higher equity levels Fund Raising of M&A smaller deals Dry Powder Mega Funds Operating improvements Diversification focus. Increase in PIPE and minority interests? Amsterdam Institute of Finance October, 2014

  11. PE Sector • PE Fund Performance Persistence – declining due to competition Access Networks Signaling • Crowded (> 5,000) 2,200 funds seeking funds as of July, 2014 Raise $750B Dry Powder • LP Selection Issues Strategy Returns Team Terms Relationship Amsterdam Institute of Finance October, 2014

  12. Private Equity Value Chain(From Financial Engineering to Value Creation) Tax – Legal – Accounting Knowledge Network Management Industry Expertise Corporate Finance Delivery VALUE Managing/ Monitoring Fund Raising Exit Investing Amsterdam Institute of Finance October, 2014

  13. Private Equity Value Added • Buy Right: PPX • Financial Engineering: FDX • Operating Improvements: (pf) EBITDA • Multiple Expansion: Exit X Amsterdam Institute of Finance October, 2014

  14. Corporate v PE Acquirers Amsterdam Institute of Finance October, 2014

  15. Most Active Sponsors - LTM SponsorShare CVC 10.13% Carlyle Group 5.06% Astorg Partners 5.06% Permira 5.06% Clayton, Dubilier & Rice 3.80% Goldman Sachs 3.80% Montagu Private Equity 3.80% Advent International 2.53% Bain Capital 2.53% Koch Industries 2.53% Cinven Ltd 2.53% Apollo Management 2.53% Bridgepoint Capital 2.53% Teachers’ Private Capital 2.53% Investcorp 2.53% Triton Managers 2.53% Ardian 2.53% Electra Partners 2.53% ATP Private Equity Partners 1.27% 3i pic 1.27% Source: S&P Capital IQ Amsterdam Institute of Finance October, 2014

  16. Credit Cycle Impact on PE Investments and Performance • Up Cycle Spreads Narrow Multiples Increase Leverage Increases Exits Accelerate Fundraising Dry Powder • Characteristics Government Bond Rates High Yield Spreads Amsterdam Institute of Finance October, 2014

  17. Wheel of (Mis)fortune Superior returns Attracts capital Deals chase money Macro Financial Markets Deal market Disappoint returns Impacts fundraising Capital chasings deals Amsterdam Institute of Finance October, 2014

  18. A Typical Private Equity Structure Diagram US Investors Fund manager US Exempt Investors General Partner Carried interest partner LP A LP B LP C Non-US Investors FUND Nominee Investment Investment Investment Investment CLO Hedge funds High Yield Investors Leverage finance syndicate participants Hold Co. Bank Hold Co. Mezzanine Investors FLL Bridge finance Syndicate participants Operating Entity SLL Amsterdam Institute of Finance October, 2014

  19. Private Equity LBO Transaction Economics - $ millions - NowIn 5 yrs EBITDA of Acquired Firm 125 188 (c) Sale value @ 8 x EBITDA 1,000 1,500 Financing Plan: Equity @ .20 200 Debt @ .80 800 Total Capital Raised 1,000 Fees 30 50 Net Sale Proceeds on Exit 1,450 Original Debt 800 Less: Debt pay down over 5 years 260 Debt at end of 5 years -540 540 Return of Original Equity -200 Net gain to be allocated 710 10% to mgmt options 71(a) 20% to general partner 142 70% to limited partners 497 (b) Total 710 • Share to CEO 2% points or $14.2 x 1 = $14.2 • Share to next 4 senior officers 1% points or $ 7.1 x 4 = $28.4 • Share to next 8 key players 1/2% points or $ 3.6 x 8 = $28.4 • Total Management share $71.0 (b) Equals a 28.4% compound annual rate of return on investment. (c) Assumes $12 taken out of cost structure immediately and 6.5% growth/year in EBITDA thereafter. Source: Casewriter – The Role of Private Equity Firms in Mergers & Acquisitions Transaction Harvard Business School case 9-206-1 Rev 10/16/06 Amsterdam Institute of Finance October, 2014

  20. Pricing v Valuation Price ≠ Value eventually converge, but… using price to justify M&A – increases overpaying Most valuations are really disguised Pricings Academic Surveys – DCF Reality – Name Only TV in DCF >60% Value TV calculated using market multiple Venture Capital Valuation Football Field: Flaw of Averages V x x x Average Fit Line x x Asset DCF Comp Comp Other Value Trade Trans (ROV?) Goose that Lays the Golden Egg Story: Price v Value Amsterdam Institute of Finance October, 2014

  21. Anatomy of a Premium Stupidity & Bias Fantasy Competitive Necessity Outlook/Information Advantage Synergies Lower Buyer WACC Undervaluation ROT: Greater than 40% premium over pre-bid market price is difficult to justify for any sizeable acquisition. Amsterdam Institute of Finance October, 2014

  22. LBO Analysis Focus on return: what is the maximum price I can pay based on given set of projections and earn X% return not risk adjusted? Tradition Valuation = Projected cash flows Discounted rate Terminal value LBO Perspective = IRR (Equity discount rate) Projected cash flows Purchase Price Sale Price (Terminal Value) Debt Policy Ratings/Corp Value Transfer from LP’s Amsterdam Institute of Finance October, 2014

  23. LBO Valuation(Pricing/Affordability) How much can I borrow (XEBITDA) Usually 4 - 6X depending on market Equity Percentage Required (% of PP) Usually 30% - 45% dependent on market Compare Market PPX IRR Adjustments FD Exit Multiple Equity PP EBITDA adjustment (pro forma EBITDA) Example – assume €100 EBITDA FDX – 5X Equity % - 35% Affordable bid 7500 or 7.5x EBITDA Amsterdam Institute of Finance October, 2014

  24. Cash Flow Available for Debt Service (CFADS) DCF Net Income + Dep/Amt +/_ Change in deferred taxes +/- Other noncash items +/- Change in working capital Cash flow from operations +After tax interest (hypo Ƭ) • CAPEX • Unleveraged FCF CFADS Net Income Dep/Amt Change in deferred taxes Other non cash changes Change in working capital Cash flow from operations Non interest expense adjustment Capex CFADS Amsterdam Institute of Finance October, 2014

  25. Converting IRR into Equivalent Multiple of Capital (MOIC) IRR Equivalent MOIC Over 6 Years 10% 1.8X 20% 3.0X 30% 4.8X 40% 7.5X 50% 11.4X Amsterdam Institute of Finance October, 2014

  26. Venture Capital • Future Value Market Size (Year 6) 1,000 Market Share 10% Revenue 100 Revenue Multiple 5 Value 500 • Ownership Need Investment (today) 10 Required Return (40%) 7.5X Expected Exit Value 75 • Today’s Ownership Requirement Expected Exit Value 75 Projected Value 500 % Ownership 15% Amsterdam Institute of Finance October, 2014

  27. Fixing the Broken Deal – Price and Structural Flex Increase spread Recycled Original issue discount Eliminate PIK Reduce debt Add a subordinate tranche More equity Add covenants Reduce Price Seller Paper Amsterdam Institute of Finance October, 2014

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