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Imperial Air Group February 28, 2002

Imperial Air Group February 28, 2002. Frank Burke Jared Lawrence Gurkan Salk David Watson Travis Young. Agenda. Case Introduction Recommendation Valuation Options Conclusion – Case Update. Case Synopsis. Lufthansa is considering an investment in Chinese airline. Learning Objectives.

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Imperial Air Group February 28, 2002

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  1. Imperial Air GroupFebruary 28, 2002 Frank Burke Jared Lawrence Gurkan Salk David Watson Travis Young

  2. Agenda • Case Introduction • Recommendation • Valuation • Options • Conclusion – Case Update

  3. Case Synopsis • Lufthansa is considering an investment in Chinese airline

  4. Learning Objectives • Cost of capital considerations • Comprehensive DCF Modeling (debt restructuring, optional cash flows) • Strategic Bidding • Identification of Option Value

  5. Why the deal is happening • China Aviation Industry Consolidation • CAAC effort to revitalize industry • WTO Acceptance • Will boost Chinese aviation market • Need to be more cost effective • Increased competition

  6. Imperial Air Group • Flagship Chinese international carrier • Industry consolidation expands domestic presence • Strategic partner would increase operational efficiencies

  7. Lufthansa AG • German national carrier • Europe’s most profitable airline in 2000 • History of investing in China • Existing relationship with Imperial Air • Looking to diversify international revenues – 63% in Europe

  8. The Deal • 20% stake in Imperial Air • Debt restructuring • IPO in 2 years • Conditional on performance targets • Additional equity offering of 15% • Multiple strategic bidders

  9. Bid Recommendation • Bid $483 million • Competitive bid, w/ NPV = $73MM • Lufthansa is best strategic fit • Comps analysis not meaningful

  10. DCF Model • Comprehensive 10 year projections • Main Issues • Revenue Projections • Alliance/Consolidation Benefits • Fuel Costs • Debt Paydown • IPO

  11. DCF Model Projecting Airline Revenues • Passenger Revenue = RPM * Yield • RPM highly correlated with GDP growth • Yield subject to typical competitive forces (supply & demand, price wars, business cycles)

  12. Risk Assessment

  13. Cost of Capital • Assumptions: • Risk free rate: 5.5% • Market risk premium: 4% • ICCRC Cost of Capital ICCRC Rate 17.8% Currency Risk (1.3%) Adjusted CoC 16.5%

  14. DCF NPV Results E[NPV] = 607.5MM Rmb, S.D. = 997MM, P[NPV>0] = 72%

  15. Multiples Analysis • Acquisition Multiples • Not meaningful, due to regional and other differences • Trading Multiples • P/E: Regional differences, Imperial negative earnings • EBITDAR: Best multiple for industry, but also problematic due to high leverage

  16. Option Value to Lufthansa • Financial • Anti-Dilution option to purchase additional shares at 25% discount in the event that Imperial Air Group conducts an IPO • Value = $6.2 million • Real • Option to invite Imperial Air Group into the Star Alliance • Expansion of cargo service in China

  17. Conclusion – Case Update • WTO agreements did not liberalize Chinese air markets • CAAC has opposed debt-to-equity conversions • Some consolidations are in jeopardy • “Imperial Air” (larger) and CNAC (financially stronger) are in dispute over who should lead the consolidated “Imperial Air Group” • Smaller independent airlines have formed an alliance to compete with the majors

  18. Learning Objectives • Cost of capital considerations • Comprehensive DCF Modeling (debt restructuring, optional cash flows) • Strategic Bidding • Identification of Option Value

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