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Stub Equity

Stub Equity. Rights issues: Between a stub and a bad place March 2009. www.csquest.com. Quest™ helpdesk +44 (0)20 7523 8493 questclients@collinsstewart.com. All Large Cap Investment Research is independent and powered by Quest™. Sub Equity Screen: Introduction.

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Stub Equity

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  1. Stub Equity Rights issues: Between a stub and a bad placeMarch 2009 www.csquest.com Quest™ helpdesk +44 (0)20 7523 8493 questclients@collinsstewart.com All Large Cap Investment Research is independent and powered by Quest™ 1

  2. Sub Equity Screen: Introduction • Identify rights issue candidates • Stress test financial impact • Assess risk factors • Consider long-run valuation on mean reversion 2

  3. Stub Equity’ometer: Overview Section 1 The rights issue Section 2 Mean reversion and valuation Sec. 3 Otherrisks 3

  4. Section 1: The Rights Issue candidates Users’ assumptions for debt reduction target and EBITDAR stress test Net debt/EBITDA (FY1) Default filter of >2x, can be changed Net debt/EBITDA, compared with company’s 7-year average 4

  5. Section 1: The Rights Issue candidates Cash needed: Amount required to reduce net debt to target (default 2x, can be changed) Key metrics: P/Es, fixed charge cover and interest cover pre/ post-Rights Issue(adjusts for TERP, SII and interest charge) 5

  6. Section 1: The Rights Issue candidates Red flags: The risky situations 1/ Cash required high relative to market cap Red flags: The risky situations2/ P/E high post rights 3/ Solvency ratios still weak 6

  7. Section 2: Mean reversion and valuation EBITDAR margins: Stress-test for EBITDAR reduction and compare to long-run averages EVL/sales: Theoretical ratio if margins revert to long-run average EVL/sales: Compare ratios across sectors as leased assets are included EVL = EV + capitalised operating leases EDITDAR = EBITDA + rental expense 7

  8. Section 2: Mean reversion and valuation Theoretical upside in EVL if margins revert to long-run average Theoretical upside in market cap if margins revert to long-run average (spreadsheet ranked on this column) 8

  9. Section 3: Other financial risk indicators Pension liabilities Debt: Who has refinancing to negotiate Red flags: The risky situations 4/ Vulnerable to pension change 9

  10. Individual company models: Inputs Input EBITDA and … … debt assumptions Target net debt/EBITDA, or … … cash raised and price of rights issue 10

  11. Individual company models: Outputs Key metrics post rights issue — P/Es, fixed charge cover and interest cover Cash needed for optimal net debt/EBITDA Post rights net debt/EBITDA Theoretical EV and market cap upside in mean reversion 11

  12. EV/sales and margin charts 12

  13. Example 1: Construction stocks A rights issue may not be an option/ enough for allSo far… Saint Gobain, Lafarge and CRHRed flags suggested difficulty for Wolseley 13

  14. Red flags: Examples 14

  15. The next candidates Stocks where debt/EBITDA moves >2.5x if EBITDAR falls 20% 15

  16. Appendix: Stub Equity’ometer methodology Definitions EBITDAR = EBITDA + rental expense. Profit margin measure useful for comparison of companies that may rely heavily on leased assets. EVL = EV plus capitalised operating leases divided by sales. A variation on the more traditional EV/Sales ratio, to provide better comparisons in sectors where there is heavy dependence on leased assets. FCC = Fixed charge cover: Operating cash flow before net interest and tax cash payments and operating lease payments divided by all fixed charges - interest, preference dividends and operating lease payments. A value of 999.9 shows that net interest income exceeds other payments. 16

  17. Appendix: Stub Equity’ometer methodology Calculation for new P/E post-dilution EPS = ((Forecast EBITDA + Rental Expenditure (i.e. EBITDAR)) - Depreciation, Rent (i.e. EBTI) - Interest (ie PBT) - Tax )/ shares on issue New SII = (cash to be raised / (share price * 0.75)) + existing SII New EPS = ((PBT + (Interest saved @ 5.5%)) – Tax )/ New SII New P/E = TERP/ New EPS 17

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