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Capital Markets The Construction Industry Ed Klinger, BMO Capital Markets Rick Kress, The PrivateBank Tim Hall, Cap

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Capital Markets The Construction Industry Ed Klinger, BMO Capital Markets Rick Kress, The PrivateBank Tim Hall, Cap

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    1. Capital Markets & The Construction Industry Ed Klinger, BMO Capital Markets Rick Kress, The PrivateBank Tim Hall, CapitalSource October 2008

    2. 2 The “Orderly Markets”…..

    3. 3 Future?

    4. 4 Instead, Let’s Shake the Magic 8 Ball

    5. 5 Sticking To What We Do Know

    6. 6

    7. 7 What Exactly Caused This?

    8. 8 This is Cyclical

    9. 9 Current State of the Bank Markets Dramatic slowdown since third quarter 2007 Nonetheless, 2007 was a record year with $1.7 trillion of syndicated loan volume However, 1Q - 3Q 2008 volume is down by over 50% from 1Q - 3Q 2007 1Q - 3Q 2007 volume was $1.3 trillion vs $0.6 trillion in 1Q - 3Q 2008 Investors remain cautious Cost of funding for most banks has increased dramatically Nearly all regional banks have tightened their lending standards Significant capital constraints Poor economic outlook impacting lender behavior and liquidity in the bank market Result is upward pressure on pricing and fees, tighter loan structures, and downward pressure on hold levels

    10. 10 Current State of the Bank Markets Relationships continue to drive the bank loan market Unfunded credit facilities exert significant pressure on banks overall relationship returns Banks have demonstrated a willingness to commit to credits with returns below their internal hurdle rates, only if the prospects for retaining and/or gaining ancillary business are clearly visible Returns on new deals are being weighted against buying discounted loan paper in the secondary markets Not withstanding the above, middle market (EBITDA < $50 million), non-levered (Total Debt/EBITDA < 3.0x) transactions continue to get done, though much slower Well structured, well priced transactions Solid Borrower track record Sensible use of funds Support from relationship lenders

    11. 11 Middle Market Syndicated Loan Volume

    12. 12 Middle Market Loan Pricing

    13. 13 Middle Market Leverage

    14. 14 But What About the Construction Industry… Typically not as levered as other industries due to bonding and cyclicality Banks still the largest source of acquisition debt for this industry Constraints on acquisition leverage in 2006 / 2007 have kept balance sheets relatively sane Strategics are more averse of leverage than PE Groups Leverage only retreated about 0.75x to 2.5x – 3.0x compared to a 1.5x retreat for the overall market (2007 vs. 3Q 2008) Banks and sureties continue to look at different financial metrics which can make loan structuring difficult Sureties – not as worried about collateral, want Tangible Net Worth Banks – show me cash flow! Tangible Net Worth is just a number

    15. 15 Equity Contribution Average equity contribution to LBO’s now averaging 44% (vs. 33% in 2007)

    16. 16 How Banks Structure A Loan When participating in a loan, banks now, more so than before, consider the “all-in-return” (what ancillary business can I cultivate from the company)

    17. 17 “Sample” of Key Terms

    18. 18

    19. 19 What is Mezzanine Debt? Subordinated debt or preferred equity Ranks behind senior bank debt but above equity Higher cost than senior bank debt Structure Cash interest PIK interest Ownership via warrants Primarily used in leverage buyouts

    20. 20 Benefits of a Mezzanine Financing Deep and aggressive market No amortization, bullet maturity Structured as senior subordinated notes or preferred stock Less restrictive covenants Priced well below private equity returns Equity co-invest or warrants might be required “Buy and hold” mentality; “total return” approach

    21. 21 Mezzanine Market Update Continued expansion of mezzanine providers New entrants (Carlyle, BlackRock Kelso) Numerous hedge fund entrants Follow-on funds (Blackstone-II, Hancock-III, Audax-III) While low to mid-teens all-in coupon structures were the norm 12 months ago, mid-to-high teens returns are standard today with the potential need for an equity co-invest or warrants Transaction size normally ranges from $15 million to $200 million

    22. 22 What Mezzanine Investors Generally Look For History of profitable operations and margins that meet or exceed industry averages Solid revenue growth and diversified cash flows Proven and experienced management teams that are financially motivated through equity ownership Leading and defensible market positions Ability to support a current pay coupon and pro forma debt levels

    23. 23 Summary of Key Terms

    24. 24 Summary of Key Terms

    25. 25

    26. 26 Public Comparable Stock Performance

    27. 27 Publicly Traded Valuations

    28. 28 Public vs Private Valuations Public valuations tend to be higher than private M&A transaction multiples due to: Short-term outlook of Wall Street vs longer-term cyclical outlook of acquirers Size discrepancy & breadth of service capabilities Multiple end markets and geographic focus tend to smooth results Access to multiple sources of capital provides investors with comfort Valuations across sub-sectors limited by: Bonding requirements & sureties focus on tangible net worth Cyclicality of industry & sustainability of earnings Vulnerability of problem jobs

    29. 29 What Drives Value? Companies with lower project risk & higher recurring service revenue Design & Engineering firms vs. Contractors Maintenance vs. New Construction “Hot” end markets including: Industrial maintenance and turnaround Environmental Energy/Power Infrastructure Healthcare Education

    30. 30 Why the Interest? Buyers have access to capital Geographic expansion Shortage of skilled labor Diversification of services Diversification of end markets

    31. 31 U.S M&A Activity – Down nearly 43% in 2008

    32. 32 E&C M&A Activity E&C M&A Activity Overview Robust volume dominated by large number of small deals ~ 30% of E&C deals have a disclosed value Over 60% of 2007 deals with disclosed values were under $25 million with a median deal size of $17.3 million 1H 2008 M&A activity on track with 2007; total transaction values lower due to lack of large deals Activity driven by: Solid fundamentals Availability of private equity capital needing to be deployed at reasonable multiples Strategics flush with cash

    33. 33 Strategic buyer interest will be driven by one or more of the following factors: Expertise and capabilities Service offerings Geographic coverage Customer relationships Ability to recognize and pay for potential synergies Current strong public market valuations may provide public acquirers with a valuable currency and create a strong “ability to pay” E&C Buyers Overview

    34. 34 Private Equity Ownership

    35. 35 Equity Contribution Average equity contribution to LBO’s now averaging 44% (vs. 33% in 2007)

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