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Dealmaking in Today’s Turbulent Markets: Where Do We Go? Presented by: Jack Helms Chairman Lazard Middle Market 612.339.0500 Kansas.

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Presentation on theme: "Dealmaking in Today’s Turbulent Markets: Where Do We Go? Presented by: Jack Helms Chairman Lazard Middle Market 612.339.0500 Kansas."— Presentation transcript:

1 Dealmaking in Today’s Turbulent Markets: Where Do We Go? Presented by: Jack Helms Chairman Lazard Middle Market Kansas City ® KC Private Equity Forum: Survival, Success & Succession

2 Kansas City ® JUNE 2009 STATE OF THE M&A MARKET

3 Kansas City ® 2 I.STATE OF THE ECONOMY II.CREDIT MARKET III.PRIVATE EQUITY IV.KANSAS AND MISSOURI ACTIVITY V.M&A MARKET Table of Contents

4 I.STATE OF THE ECONOMY

5 Kansas City ® 4 Cyclicality in the M&A Market Source: Mergerstat and S&P LTM EPS # of Deals Index S&P 500 IndexS&P 500 LTM EPS (Proxy for U.S. Economy) Deal Volume M&A volume is clearly linked to the state of the economy and is highly correlated with equity market performance. 0 2,000 4,000 6,000 8,000 10,000 12,000 14, $0 $10 $20 $30 $40 $50 $60 $70 $80 $90 $0 $200 $400 $600 $800 $1,000 $1,200 $1,400 $1,600

6 Kansas City ® 5 Public Market Indexes Over Time From peak to trough the DJIA, S&P and NASDAQ were down 53.8%, 56.9% and 54.8%, respectively. % of Index (56.8%) (55.6%) (53.8%) Dow Jones Industrial AverageS&P 500 IndexNASDAQ Composite Index Source: CapitalIQ, updated through 6/2/09 Note: Indexed off of September 1989

7 Kansas City ® 6 Public Market Indexes Over Time % of Index Source: CapitalIQ, updated through 6/2/09 Note: Indexed off of September 1989 Dow Jones Industrial AverageS&P 500 IndexNASDAQ Composite Index A long term view of public equity market valuations reflect: (i) the bizarre behavior of the NASDAQ in 1999 (tech bubble) and (ii) the recent loss of 13 years of value appreciation. $100 invested equally in 3 indexes on 9/1/89 $100 $200 $400 $200 $430 $190 ~7 yrs $255

8 Kansas City ® 7 Comparison to 1929 Stock Market Crash Source: Capital IQ updated through 6/2/09 Is the bear dead, or is this just a “bull-bounce” in a continuing bear?

9 Kansas City ® 8 Bull or Bear?

10 Kansas City ® 9 Bear Case

11 Kansas City ® 10 Debt Outstanding by Sector Over the Past 15 Years Source: Federal Reserve, Department of Commerce Note: $’s in trillions *2009 is Lazard estimate for illustrative purposes There has been a dramatic increase in leverage since the Depression years. $16 $26 $51 $60 $150mm $65 Great Depression E* 0.0x 0.5x 1.0x 1.5x 2.0x 2.5x 3.0x 3.5x 4.0x 4.5x HouseholdsBusinessState & Local Gov'tFederal Gov'tDebt/GDPGDP Debt/GDP $6.7 $9.8 $ x 2.4x 3.6x 2.7x 4.2x

12 Kansas City ® 11 Federal Government Deficit Analysis Source: Congressional Budget Office data and estimates as of 5/6/09;

13 Kansas City ® 12 Treasure Quarterly Net Marketable Borrowing Net marketable borrowing through the second quarter of FY 2009 has eclipsed total FY 2008 net marketable borrowing. “Net Cash” Fiscal Quarter BorrowingsBorrowings PaydownPaydown

14 Kansas City ® 13 Non-Investment Grade Debt Maturities Over the Next 5 Years Source: Bloomberg and S&P as of 3/31/2009 Note: $’s in billions $2,977 $3,594 $459 $1,017 $1,695 $2,364 Over $1.5 trillion in non-investment grade debt is coming due over the next 5 years.

15 Kansas City ® 14 Credit Providers Traditional banking lacks the capacity to service current debt levels. Equalization and government intervention will be the primary solutions. Source: “Downunder Daily”. Morgan Stanley Research. 1/28/09. Asset Backed Alert. Traditional Banking Shadow Banking System Others GSE and ABS Funds Insurance $ in tn

16 Kansas City ® 15 Death of the Securitization Market Source: “Downunder Daily”. Morgan Stanley Research. 1/28/09. Asset Backed Alert. US SECURITIZATION ISSUANCE

17 Kansas City ® 16 Percent of Leveraged Loans in Payment Default or Bankruptcy Source: Standard and Poor’s LCD and S&P/LSTA Leveraged Loan Index Note: Comprises all loans, including those not tracked in the LSTA/LPC mark-to-market service Note: Vast majority are institutional tranches Note: 2009 Projection from Edward Altman, Stern School of Business, NYU 2009 default rate expected to end higher than Current shadow default rate is 11.3%.

18 Kansas City ® 17 U.S. Housing Still A Problem Source: CB Richard Ellis (historical), National Association of Realtors (projections) Note: Retail vacancy data only available back to Source: U.S. Census Bureau Note: Sales price include the land Source: U.S. Census Bureau Housing InventoryMonthly Housing Starts Average Sales Price of New HomesCommercial Real Estate Vacancies

19 Kansas City ® 18 Bull Case SHORT TRADERS

20 Kansas City ® 19 Source: Yahoo Finance as of 6/9/09 Dow Jones Industrials Performance Post Bottom (3/9/2009) +38% +34% +46%

21 Kansas City ® 20 Equity Mutual Fund Inflow vs. DJIA Source: TrimTabs Investment Research Note: $’s in millions -$50,000 -$40,000 -$30,000 -$20,000 -$10,000 $0 $10,000 $20,000 Jul-08 Aug-08Sep-08Oct-08Nov-08Dec-08Jan-09Feb-09Mar-09Apr-09 (20%) (15%) (10%) (5%) 0% 5% 10% (25%) Equity Mutual Funds Inflows (mm)DJIA Δ in DJIA

22 Kansas City ® 21 Cash Held on the “Sidelines” Currently at Historical Highs Source: Bloomberg and Factset Cash “on the sideline” is at an all-time high compared to the value of equity markets. When will “in-flow” to equity funds begin?

23 Kansas City ® 22 U.S. Manufacturing and Services Source: Institute for Supply Management Inventory lags new orders and is shrinking. New orders are rising, causing an increase in new production due to low inventory. Possible increased demand for labor? As of 5/09. Blue-shaded areas indicate periods of recession. See last slide for definition of recession. Source: Bureau of Economic Analysis, FactSet, Institute of Supply Management (ISM), National Bureau of Economic Analysis (NBER). ISM Services Index Inventories and Orders ISM Services Index has turned. Services drives economy much more than manufacturing.

24 Kansas City ® 23 Housing Inventories Moving Down As of 4/09. Blue-shaded areas indicate periods of recession. See last slide for definition of recession. Source: Department of Commerce, FactSet, National Association of Realtors, National Bureau of Economic Research (NBER). Existing New New home inventories fully reversed bubble Foreclosures still feeding into existing home inventories

25 Kansas City ® 24 Home Prices Appear to be Stabilizing Note: As of 3/09. Based on S&P/Case-Shiller composite 20 Home Price Index. Source: FactSet, Standard & Poor’s.

26 Kansas City ® 25 Consumer Confidence – Jobless Claims Source: Bloomberg and Factset Have the bad things stabilized, and is confidence returning? Or, are they just taking a rest before continuing?

27 Kansas City ® 26 Layoff Announcements Down Noticeably Layoff announcements as of 5/09. Unemployment claims as of 5/29/09. Blue-shaded areas indicate periods of recession. See last slide for definition of recession. Source: Challenger Gray & Christmas Inc., Department of Labor, FactSet, National Bureau of Economic Research (NBER). Layoffs Layoff announcements are a true forward indicator.

28 Kansas City ® 27 No Signs of Inflation Traditional definition of Inflation Too many dollars chasing too few goods

29 Kansas City ® 28 Money Supply and Velocity Fed flooding system: could reach $3.5T by year-end But “velocity” of money remains depressed (money not getting into economy) As of 6/09. Source: FactSet, Federal Reserve.

30 Kansas City ® 29 Note: Dotted lines denote GS forecasts. Source: Department of Commerce, CBO & Goldman Sachs Estimates (4/09) Too Few Goods? The Output Gap Drives Inflation  The chart to the left from Goldman Sachs studies the Output Gap since 1960 as a measure of how the actual GDP can rise above or below its potential long-term average and its relationship with inflation.  Some economists believe that deflation is a near-term threat due to the recent shock to the global financial system.

31 Kansas City ® 30 Consumer Debt and Personal Savings Consumer net increase in liabilities as of 4Q08. Personal savings rate as of 4/09. Source: Bureau of Economic Analysis, FactSet, Federal Reserve. Consumer debt is contracting massively Source: Department of Commerce Americans are saving more of their paychecks than at any time since February Could prolong the recession, but will strengthen the financial health of U.S. households and overall economy for the long term. 5.7% Personal Savings as a Percentage of After-Tax Income Change in Liabilities

32 Kansas City ® 31 Bull or Bear?

33 Kansas City ® 32 Anemic Bull Headwinds for the Emerging Bull  Rising Energy Costs  Rising Interest Rates  Continued Consumer Delevering  Increasing Taxes  Increase in top rate, cap gains rate, dividend rate  Offshore income  Healthcare plans  Social Security  National Health  Radical Increases in Regulation

34 II.CREDIT MARKET

35 Kansas City ® 34 Leveraged Loan Volume Trends 34 U.S. Dollar Denominated New-Issue Leveraged Loan Volume Source: Standard & Poor’s, LCD Leveraged Lending Review 1Q09 Note: Excludes existing tranches of add-ons and amendments and restatements with no new money Leveraged loan volume was down 75% year-over-year, but up 30% compared to 4Q’08. (71%) (76%) $11 $46 $153 $535 $480 $295 $265 $166 $139 $185 $243 $256 $0.0 $100.0 $200.0 $300.0 $400.0 $500.0 $ Q081Q09 In Billions

36 Kansas City ® 35 Middle Market Loan Volume Trends – Pro Rata and Institutional Middle Market Volume By Year Institutional investors have all but left the middle market. Source: Standard & Poor’s, LCD Leveraged Lending Review 1Q09 Note: Middle Market defined up to $50 million of EBITDA Note: $’s in billions

37 Kansas City ® 36 Credit Providers Traditional banking lacks the capacity to service current debt levels. Equalization and government intervention will be the primary solutions. Source: “Downunder Daily”. Morgan Stanley Research. 1/28/09. Asset Backed Alert. Traditional Banking Shadow Banking System Others GSE and ABS Funds Insurance $ in tn

38 Kansas City ® 37 Fund Managers That Issued Arbitrage CLOs by Year Source: Standard & Poor’s LCD, Leveraged Lending Review 4Q CLO volume down 85% volume: $87 billion – 2008 volume: $13 billion – 2009 YTD volume: $300 million.

39 Kansas City ® 38 U.S. Bond Markets Source: Advantage Data and Bloomberg as of 06/10/09 The high yield markets show signs of spring and recovery. The market for investment grade issues appears to have reestablished itself. 24-Month U.S. High-Yield Issuance 24-Month U.S. Investment Grade Issuance

40 Kansas City ® 39 Credit Crisis Resulting in Unprecedented Price Declines 39 Average Discounted Spread of Leveraged Loans Average Bid of Leveraged Loans (% of Par) Last Date: 5/1/09 Ending Value: L+1479 Last Date: 5/1/09 Ending Value: 75.1% Source: Standard & Poor’s, LCD LoanStats Weekly as of 5/7/09 Note: Assumes discount from par is amortized evenly over a three-year life Primary and secondary trading levels depressed by a liquidity vacuum. Cause: CLO liquidations, portfolio fire-sales, record hedge/mutual fund redemptions. Result: Limited number of active buyers reaping the benefit of forced-selling by many sellers.

41 Kansas City ® 40 Average Debt Multiples of Highly Leveraged Loans Source: Standard & Poor’s LCD, Leveraged Lending Review 4Q Transaction leverage is at a 22-year low. (36%)

42 Kansas City ® 41 Middle Market Total Leverage Multiples Source: Standard & Poor’s, LCD Middle Market Lending Review 1Q09 Note: Defined as issuers with EBITDA of $50 million or less Note: For Q1’09, average leverage level is the Firm’s internal estimate Starting and ending attachment points for mezzanine debt continue to decline, reducing risk for lenders. Middle Market leverage was lower than overall market (see previous slide) prior to 2000, higher from 2001 through 2008, and is now lower.

43 Kansas City ® 42 Average Cash Flow Multiples of Highly Leveraged Loans (Cash Flow Coverage) Source: Standard & Poor’s LCD, Leveraged Lending Review 4Q08 Cash flow coverage of new issue loans strongest in 22 years. +55%

44 Kansas City ® 43 Capital Structures are More Conservative Source: Standard & Poor’s, LCD Leveraged Buyout Review 1Q09 Note: Defined as issuers with EBITDA of $50 million or less E Rollover EquityEquitySubSenior AVERAGE SOURCES OF PROCEEDS FOR MIDDLE MARKET LBO LOANS Capital structures continue their trend toward more equity.

45 Kansas City ® 44 SENIOR DEBT (B Rated Credit) Pre-LehmanPost-Lehman SUB DEBT 15-18% 10-12% plus 3-5% No warrants 18-20% 12% plus 6-8% and/or Warrants Rate Cash Pay PIK Warrants 7-9% No Libor floor L % 10-12% Libor floor of 3-4% plus L % Rate Libor Floor Spread Fees 5% No Libor floor 1% 5-8% W/& w/o Libor floors 1% Rate Libor Floor Fees Cash Flow ABL Pricing of Credit Source: Lazard Middle Market Credit Overview and Standard & Poor’s, LCD ABL Lending Review Q109 Note: ABL includes DIP financing

46 Kansas City ® 45 Pricing of Risk Source: LehmanLive Spreads over 5-year U.S. Treasuries jump substantially more for BB+ and below rated bonds when compared to AAA/AA-rated bonds. Yields on 5-year U.S. Treasuries drop while yields on AAA/AA-rated bonds and BB+ and below rated bonds jump dramatically.

47 III.PRIVATE EQUITY

48 Kansas City ® : M&A Market BILL THOMAS

49 Kansas City ® : M&A Market ANALYSTS’ RESEARCH LAB

50 Kansas City ® : M&A Market PAT HEALY (C3 CAPITAL)

51 Kansas City ® 50 Halloween 2008 “WHICH IS MORE SCARY?”

52 Kansas City ® 51 Lender Relationships

53 Kansas City ® 52 Portfolio Companies

54 Kansas City ® 53 Secretary Geithner

55 Kansas City ® 54 MBA Graduates

56 Kansas City ® 55 Private Equity Total Deal Flow

57 Kansas City ® 56 Private Equity Total Deal Flow

58 Kansas City ® 57 Private Equity Total Deal Flow $- $20 $40 $60 $80 $100 $120 $140 $160 $180 $200 Q1 '04Q2 '04Q3 '04Q4 '04Q1 '05Q2 '05Q3 '05Q4 '05Q1 '06Q2 '06Q3 '06Q4 ' 06Q1 '07Q2 '07Q3 '07Q4 '07Q1 '08Q2 '08Q3 '08Q4 '08Q1 ' Number of Deals

59 Kansas City ® 58 Private Equity Total Deal Flow $- $20 $40 $60 $80 $100 $120 $140 $160 $180 $200 Q1 '04Q2 '04Q3 '04Q4 '04Q1 '05Q2 '05Q3 '05Q4 '05Q1 '06Q2 '06Q3 '06Q4 ' 06Q1 '07Q2 '07Q3 '07Q4 '07Q1 '08Q2 '08Q3 '08Q4 '08Q1 ' Number of Deals

60 Kansas City ® 59 Private Equity Total Deal Flow Source: PitchBook Capital invested by PEGs has fallen dramatically, indicating substantial equity capacity Capital Invested ($B)Number of Deals

61 Kansas City ® 60 M&A Deals – Strategic vs. Financial Source: CapitalIQ In number of deals, PEG’s market share stays consistently small. In value of deals, PEGs win large deals when credit markets reach their most aggressive level. PEG $ $32 $69 $139 $133 $141 $305 $46 $38 $15 $36 $19 $7 $4 PEG # Strategic $ $331 $329 $212 $326 $308 $388 $240 $211 $135 $265 $308 $92 $253 Strategic # 2,406 2,708 2,612 2,561 2,825 2,898 2,618 2,631 2,436 2,449 2,481 1,954 1,517 $- $50 $100 $150 $200 $250 $300 $350 $400 $ ,000 1,500 2,000 2,500 3,000 3,500 Q1 ' 06Q2 '06Q3 '06Q4 '06Q1 '07Q2 '07Q3 '07Q4 ' 07Q1 '08Q2 '08Q3 '08Q4 '08Q1 '09 $ in billionsDeal Volume

62 Kansas City ® 61 Percent of Private Equity Transactions by Deal Size Source: Pitchbook The percentage of capital invested in larger deals expanded rapidly from 2002 to 2007, and then declined since 2007 as investors have recently focused their resources on smaller, more accessible deals.

63 Kansas City ® 62 Deal Structure – Average Equity Contributions to LBOs Source: Standard & Poor’s LCD, Leveraged Lending Review 4Q08 YTD 2009 deals involve more than 50% equity.

64 Kansas City ® 63 Private Equity Divestitures Divestitures in the up-cycle (’04 through ’07) increased to record levels, driving distributions, feeding new fund raises. As no surprise, divestitures now are limited to distressed or very special situations. Source: Pitchbook

65 Kansas City ® 64 Private Equity Fund Raising Funds bellow $1 billion accounted for the majority of funds, but larger middle market funds ($500 million to $1 billion) are proliferating since Source: Pitchbook Capital Raised by Fund SizeFund Count by Fund Size Large funds continue to raise a disproportionately large portion of capital and in Q1 2009, funds between $500 million and $1 billion received a slightly larger than normal percentage of funds raised.

66 Kansas City ® 65 -$100 $0 $100 $200 $300 $400 $500 Capital Overhang Source: Pitchbook $43 $77 $150 $198 $230$222 $232 $263 $292 $237 $378 $ Equity InvestedCapital Raised by FundsOverhang (By Year)Overhang (Cumulative Total) -$100 $0 $100 $200 $300 $400 $500 $43 $77 $150 $198 $230$222 $232 $263 $292 $237 $378 $

67 IV.KANSAS AND MISSOURI ACTIVITY

68 Kansas City ® 67 Private Equity and Mezzanine Investors Universe Source: Capital IQ 18N/A 5$300 and above 3$100-$300 5$100 and under Fund Size (mm) 4Food and Agriculture 11Media and Communications 13Business Services 15Healthcare 26 68Consumer 92Industrial Products and Manufacturing Portfolio Company Industry 26Missouri 5Kansas Office Location 18N/A 5$300 and above 3$100-$300 5$100 and under Fund Size (mm) 11 15Healthcare Technology 68Consumer Portfolio Company Industry 26Missouri 5Kansas Office Location 3N/A 2$300 and above 1$100-$300 1$100 and under Fund Size (mm) 2Food and Agriculture 4Media and Communications 5Business Services 4Healthcare 6Technology 23Consumer 33Industrial Products and Manufacturing Portfolio Company Industry 5Missouri 2Kansas Office Location 3N/A 2$300 and above 1$100-$300 1$100 and under Fund Size (mm) Portfolio Company Industry 5Missouri 2Kansas Office Location

69 Kansas City ® 68 Kansas and Missouri Headquartered Sponsor-Backed Companies Source: Capital IQ Portco Office Location Kansas158 Missouri266 Industry Industrial Products and Manufacturing 131 Consumer88 Technology67 Healthcare41 Business Services56 Media and Communications22 Food and Agriculture19 Revenues (mm) $50 and under109 $50 - $50055 $500 and above25 N/A235

70 V.M&A MARKET

71 Kansas City ® 70 (34%) M&A Activity – Volume by Year Recession 0 1,500 3,000 4,500 6,000 7,500 9,000 10,500 12,000 13,500 15, Deal Volume: – 34% decrease; – 34% decrease; 1Q08-1Q09 – 37% decrease Deal Value: – 68% decrease; – 42% decrease Source: Mergerstat (68%) $0 $150 $300 $450 $600 $750 $900 $1,050 $1,200 $1,350 $1,500 (34%) 1Q081Q09 (37% ) (42%) (68%)

72 Kansas City ® 71 The Lower and Middle Market Thesis Middle Market vs. Large Cap Market  Higher deal volume  Less cyclical  Less competitive and less efficient market  More value-add opportunities with less mature companies  Higher equity returns

73 Kansas City ® 72 M&A Activity – Volume by Deal Size # of Deals Deal volume in the “lower middle market” has declined steadily since Source: Mergerstat (70%) (73%) (86%)

74 Kansas City ® 73 Number of Deals by Industry Source: Factset Mergerstat Only 3 of 49 industries have seen an increase in deal volume activity since Q

75 Kansas City ® 74 Top 20 Transactions Announced or Closed Since September 2008 Three industries account for 82% of all deal value since September 2008 Source: Capital IQ

76 Kansas City ® 75 Source: PitchBook Business Products & Services (B2B)Consumer Products & Services (B2B)Financial Services Capital Invested ($B)Number of Deals EnergyHealthcareInformation Technology Deals by Industry

77 Kansas City ® 76 Deals Getting Done High-Performance Companies Distressed Companies DEALS ON EITHER END OF THE SPECTRUM

78 Kansas City ® 77 Deals Getting Done High Performance Companies  Midwest software business serving insurance brokerage  $30 million revenue, $8 million EBITDA (21% CAGR)  Management remaining, reinvesting  Significant new products in pipeline  Exclusive Private Equity marketing process  SELLER ROAD SHOW  Valuation: $125 million  Funding  $25 million senior debt  $80 million new equity  $20 million management rolled equity

79 Kansas City ® 78 Deals Getting Done High Performance Companies  Midwest test & measurement business  $50 million revenue, $15 million EBITDA (12% CAGR)  Management remaining, reinvesting  Strong quality of earnings, solid growth prospects  Marketed to Strategics and Private Equity (targeted)  Non-competitive strategics: $110 million in cash (7.3x)  Dilutive math in year 1  Highly accretive in year 2  Accretive on historic valuation  PEG won deal at $100 million  Cash reduced to $85 million  Replaced with: – $10 million Seller Note (10% PIK) – Warrants with “kick” at 2.0x and 2.5x return to buyer, $15 million valuation  Funding = 40% senior debt; 60% equity

80 Kansas City ® 79 Source: Thomson Financial Number of Bankruptcy Related M&A Transactions vs. U.S. GDP The number of bankruptcy transactions is surprisingly low when viewed in the context of the economic cycle. The lack of DIP and takeout financing is acting as a dam, with fast-rising water levels.

81 Kansas City ® 80 Correlation Between Default and Bankruptcy sales Source: Capital IQ In 2002, bankruptcy sales expanded dramatically, following increases in default rates and bankruptcies. Currently, bankruptcy sales could “explode” in volume when financing becomes available. Assets in BankruptcyBankruptcy SalesDefault Rate

82 Kansas City ® 81 Distressed M&A Observations  Distressed M&A, both in-court and out of court, is just now beginning to increase for several reasons  Relatively early in the cycle  As to 363 sales, lack of DIP financing has been a deterrent to filing under Chapter 11  First-lien creditors impaired in this cycle  therefore, can credit bid  Lack of take-out financing, whether in-court or out-of-court  Incumbent lenders often rolling-over/restructuring debt, hoping to maximize outcome when company performance and the markets improve

83 Kansas City ® 82 Deals Getting Done High-Performance Companies Distressed Companies DEALS ON EITHER END OF THE SPECTRUM SOME DEALS IN THE MIDDLE  Private (Non-PEG)  Facilitate management or family succession  Sell before capital gain rate increases  PEG  Replace tired capital; focus resources ($ and time)  Meet shareholder liquidity needs  Strategics  Merger of equals  Meet shareholder liquidity needs  Delever Through Sale of Non-Control Equity Position  Filing the GAP  PIPEs and RDs form public companies

84 Kansas City ® 83 Deals Getting Done Merger of Equals  Two national commodity chemical manufactures  Subsidiary of European conglomerate  Subsidiary of PEG-held portfolio company  Each with $300 million in Revenue and $5 million in EBITDA  Highly cyclical end markets, overcapacity  Both are sellers, but not for less than cost (book) of $100 million +/-  Merger integration allows closing 3 of 7 plants; purchasing, R&D, and G&A savings  EBITDA: = = 55  Asset based lending allows for $80 million in new funding  Neither would allow other to have control  New PEG invests with management to own 15%

85 Kansas City ® 84 Capital Gap Source: Factset and Bloomberg

86 Kansas City ® x 5.0x 6.0x 7.0x 8.0x 9.0x 10.0x YTD $0 $10 $20 $30 $40 $50 $60 $70 $80 $90 $100 Purchase Price Multiples Decrease Source: Mergerstat Note: Deal Size $10 million to $500 million, excluding negative and multiples over 25 Reported EBITDA multiples are down from record levels. Why do multiples peak in higher earnings years and fall in lower earnings years? 7.9x 8.8x 8.2x 7.8x 7.1x 6.9x 6.8x 7.5x 8.9x 8.7x 8.8x 6.3x 8.4x 9.4x EBITDA Multiple

87 Kansas City ® 86 Lower Valuations  Reduced Expectations  Increased discount rates against future cash flows  “Time value costs” very low now, will increase  Price of risk – very high  Increased cost of capital – Less leverage – More expensive leverage – More equity

88 Kansas City ® 87 Time and Performance Performance Time

89 Kansas City ® 88 S&P EPS vs. Median Purchase Price as Multiple of EBITDA Source: Mergerstat Note: Deal Size $10 million to $500 million, excluding negative and multiples over 25 Reported EBITDA multiples are down from record levels. Why do multiples peak in higher earnings years and fall in lower earnings years? EBITDA MultipleS&P 500 LTM EPS

90 Kansas City ® 89 Value of a Business Through Economic Cycles

91 Kansas City ® 90 Recession Investing Makes Great Vintages Source: Preqin; the Economist Intelligence Unit. Note: IRR = internal rate of return 1 Buyout funds with a focus on the U.S. market.

92 Kansas City ® 91 Structuring Deals in the New World  Senior debt:  Funding at closing = 2.0x  Availability = 2.5x  Mezzanine:  Funding and closing = 1.0x  Emphasis on PIK and warrant coverage  50% equity  Seller financing (PIK, subordinated, senior-like-pricing)  Earnouts

93 Kansas City ® 92 Earnouts  Performance Based Payouts  Revenues – Favored by Sellers (simplicity, control) – Buyers concerned with conflicts (margin dilution, pipe stuffing, etc.)  Operating Profit – Favored by Buyers – Resistance from Sellers (accounting issues, investment spending, control, allocations)  Gross Margin – Reasonable compromise – Issues include COGS allocations, CAPEX implications, variable costs arguments, etc.)  New Rules (FASB 141(R) and 160) – Fair value inclusion for Buyers – Counter intuitive result for Buyers – New cottage industry for “fair value” – Significant complexity for strategic buyers in calculating IRR’s and accretion/dilution models for preparing bids and negotiating/structuring deals

94 Kansas City ® 93 Earnouts  Performance Based Payouts (cont.)  Disconnect in Risk/Reward Equation Illustration: – Solution: Performance-Based Earnout  Theoretical structure (Seller’s view) – Issue $14.0 million note at close, due in 16 months – Principal adjusted pro rata based on achieving $2.0 million in earnings growth  Practical Issue – Strategic buyer can (but doesn’t like to) fund, with stock and/or cash – Private Equity rarely is able to structure second stage funding from lenders, and rarely consents to equity funding for earnout  Conventional Solution – Note is paid over time, or – Buyer pays seller X% of (revenues, gross profit, or EBITDA) in excess of ($12.0 million for Y years)

95 Kansas City ® 94 Earnouts  Performance Based Payouts (cont.)  Valuation Disconnect – For Seller to receive $14.0 million, the company will need to grow substantially beyond the original payout target (loss of residual value)  Funding Issues Remain – For Buyers, paying the earnout may create cash flow bind when company performance is strong – Often, buyers also face unexpected covenant barriers to payment

96 Kansas City ® 95 Earnouts  Retained Equity/Warrants  Win/Win Solutions Illustration:  Solution: – Cash price at closing of $70.0 million (assume $35.0 million in debt and $35.0 million in equity) – Capitalize company with $35.0 million preferred stock, with PIK dividend, convertible into common at deal valuation – Issue 29% of common (full conversion of preferred as of closing) to sellers 14 / (35+14) = 29% – PIK on preferred is negotiated and set so that seller’s percentage of common stock is diluted as company performance falls below hurdles, and visa versa for greater performance

97 Kansas City ® 96 Earnouts  Benefits  No accounting issues  Complete alignment on all strategy matters (investment spending, CAPEX, pricing, hiring, compensation, etc.)  No funding issues  Seller receives full residual value  Drawbacks  Seller is not in control  Seller’s timing is deferred  Buyer pays more (for performing companies)  Buyer has a partner, with full transparency

98 Kansas City ® 97 Structuring Convertible Preferred  Heighted arm wrestling over use of traditional convertible preferred vs. non-convertible preferred with detached common Illustration:  Situation: – Portco is acquired for $100.0 million – $50.0 million debt, $50.0 million equity – Gap between bid and ask is approximately $12.5 million – Portco’s EBITDA grows from $15.0 million to $25.0 million in 4 years, and is sold – If conventional earnout was used, with Seller getting 50% of EBITDA in excess of $15.0 million for 4 years, Seller would receive approximately $11.0 million over 4 years which is likely to be taxed as ordinary income – Instead Seller receives “20% retained interest”  Convertible Structure: – Sale at $175.0 million after year 4 – After debt proceeds of $125.0 million – If preferred had no PIK, and conversion was straight up:  Buyer – 80% – $100.0 million  Seller – 20% – $25.0 million – If preferred has 10%  Buyer – 85% – $106.0 million  Seller – 15% – $19.0 million

99 Kansas City ® 98  Detached Common – Preferred paid as if debt – If no PIK, proceeds to common are reduced from $125.0 million to $75.0 million  Buyer – 80% – $60.0 million (plus $50.0 million)  Seller – 20% – $15.0 million Structuring Convertible Preferred

100 Kansas City ® 99 PEG Strategy for Tomorrow  Many firms are out of the new platform market  Difficult portco performance  Diminishing and critical investor base  Estimates range from 20% to 50% of current firms will disappear  Economic Headwinds Create Change  Dynamic markets and industries  Increasing premium on efficiency  Increasing need to “catch a wave”; a few examples: – New healthcare paradigm – Emerging technologies – Exploit regulated markets – Be right on timing in energy related/influenced businesses – Select infrastructure opportunities (those that generate (not require) government funding)  Rewards for strategy/more than structure

101 Kansas City ® 100 Don’t Miss The Big Picture School for Private Equity

102 Dealmaking in Today’s Turbulent Markets: Where Do We Go? Presented by: Jack Helms Chairman Lazard Middle Market Kansas City ® KC Private Equity Forum: Survival, Success & Succession


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