April 2, 2003 Leveraged Buyouts
Building Shareholder Value
Through Capital Structure
Scot Sedlacek
INFORMATION TECHNOLOGY COMMUNICATIONS MEDIA
Pptname 2 01/07/98
Agenda
Market Environment for LBOs
LBO Fundamentals
Venture Investing vs. LBOs
Market Environment
for LBOs
Pptname 4 01/07/98
Nearly Three Years From The Peak, The Private
Equity Markets Remain In Transition
Technology recession
Over funding in numerous segments
Low appetite exists for innovative markets
Valuation collapse
IPO market disappearance
Corporate M&A retrenchment
The Current Business Cycle Has Radically Changed
The Landscape For Private Equity Firms
Pptname 5 01/07/98
The Current Business Cycle Has Driven Private
Equity Returns To All-Time Lows
Cumulative Weighted Average IRRs
61.5
Buyouts
Venture Capital
23.6 23.2
21.4 20.6
16.3 15.9
15.2 14.6
11.8 12.1 12.2
7.8
6.8
5.5 4.8
3.6
0.3
1993 1994 1995 1996 1997 1998 1999 2000 -1.9 2001 2002
-3.5
Pptname 6 01/07/98
The Current Market Environment Favors
Buyouts And Late Stage Investing
Rationalization of the Public Markets
Surge in micro caps
Regulatory Issues (e.g. Sarbanes-Oxley)
Massive Corporate Restructuring
Increase in divestitures/asset sales
Availability of seasoned executive management
High Availability of Capital
Inflow of equity capital into buyout funds
Improvement of the debt markets
Limited Shareholder Liquidity Options
IPO market closed
Precipitous decline of strategic M&A
LBO Interest Remains Strong Given The
Current Transaction Profile
Financial Buyouts
1,681 $230 8.4
7.9
1,438
1,319
6.1
$130
$65
2000 2001 2002 2000 2001 2002 2000 2001 2002
Number of Transactions Average Deal Size ($MM) Median EBITDA Multiple
LBO Fundamentals
Pptname 9 01/07/98
Characteristics Of LBO Candidates
Financial Characteristics Operating Characteristics
History of demonstrated Strong management team willing to
profitability and ability to maintain take the personal risks associated with
above average profit margins (e.g. an LBO
strong EBITDA)
Mature business with strong brand and
Repeatable and predictable cash market position (e.g. competitive
flows to service debt insulation)
Low current debt; leverageable Products are typically not subject to
asset base rapid technological obsolescence
Excess cash or marketable Diversified customers base that
securities generate recurring revenue through
long-term contracts/maintenance
Company is perceived to be a low-cost
producer with modern capital
equipment
Turnarounds and “messy” situations
will rely more heavily on asset-based
lending and equity financing
Pptname 10 01/07/98
Typical LBO Structure
Representative Representative
Capital Structure Equity Ownership
Typical 100% 100% Typical
Range: Range:
“Sweat Equity”
Common Equity 8 - 15%
Options
Equity Preferred Stock 0 - 5%
20 - 50%
Equity Former Owner 5 - 30%
Junior Subordinated Provided
debt with repayment in by
8-12 years Management
Senior Subordinated
debt with repayment in Equity
8-12 years
Debt Provided by
Financial 50 - 85%
50 - 80%
Investors
Bank debt with
repayment over 5-8
years
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Capital Structure Plays A Critical Role In LBO
Acquisition Pricing
Expected Growth On average, senior lenders (e.g. banks and
Rate, Operating institutions) will lend 2.0-2.5x trailing twelve
Margin and months EBITDA at 4-5% spread over LIBOR
Capital Investment
Requirements are Subordinated debt providers will lend an
Important Pricing additional 1.0-1.5x trailing twelve months
Variables EBITDA at 12-13% coupon with equity
kickers that provide 17-20% total return
Management typically receives 8%-15% in
“sweat equity” in options with 4-5 year
vesting
Given a 30-35% IRR target on equity
investment over 5 years, acquisition pricing
will typically range between 5x-6x trailing
twelve months EBITDA
Pptname 12 01/07/98
LBO Value Creation Can Be Derived From
Several Sources
Operating Improvement
Accelerated revenue growth
Enhanced cost efficiencies
Primary
Financial Leverage
Debt reduction through operating cash flow
Tax deductions on interest payments
Multiple Expansion
Buying at the bottom of a value cycle
Accelerated earnings growth
Secondary
Multiple Arbitrage
Monetizing undervalued assets
Below market acquisitions
“Critical Mass” premium (e.g. rollups/acquisitions)
Pptname 13 01/07/98
Case Study: Recapitalization For An
Eventual IPO
Situation Analysis
E-TEK was a private company based in San Jose, California where principals
owned 100% of the equity
E-TEK developed passive components used in fiber-optic networks to route and
guide light
TTM revenues of approximately $72 million with EBITDA margin of nearly 40%
Summit invested $120 million in E-TEK in July 1997 for 60% of the equity pre-
option dilution; approximately 7.5x TTM EBITDA
has completed a
recapitalization with Strategic Rationale
Founders wanted partial liquidity for themselves, upside of equity ownership for
their employees and assistance in scaling the business
Summit rebuilt the management team, drove significant operational/reporting
July 1997 improvements, provided acquisition assistance, recruited an outside board and
led the IPO process
Deal Parameters
E-TEK went public in December 1998 at a valuation of $1.5 billion1
E-TEK was eventually acquired in January 2000 by JDS Uniphase for $15.0
billion in a stock merger – 63x price/revenue multiple
Venture Investing vs. LBOs
Pptname 15 01/07/98
Venture Investors And Buyout Funds Typically
Target Different Points In The Market Lifecycle
Leaders Begin to Emerge
Market Validated With As
Least One or Two IPOs
Market
Heavy Capital
Lifecycles Play
Market Penetration
Requirements Entrenched Market
A Critical Role In Product Diversification Leaders
Determining The to Leverage Channel Distribution/
Appropriate Investment Customer Retention
Investing Disruptive Key Differentiators
Strategy Technology Market Share
Private Company Expansion Drives
Startups Scale Economies
Pre-Infrastructure
Build Out
Emerging Stage High-Growth Stage Mature Stage
Market/Business Risk High Low
Seed Investment, Going Private,
Private Equity
Transactions Technology Spinouts, Divestitures, PIPEs,
Growth Capital Recaps, Rollups
Pptname 16 01/07/98
The Typical Company Profile Reflects Major
Differences In The Risk/Reward Equation
Characteristics Early Stage Buyouts
Market Nascent Niche
Technology Disruptive Mature
Customer Early Adopter Follower
Management Visionary Seasoned
Revenue Model Unproven Recurring
Capital Consumption High Low
Competitive Advantage R&D; Manufacturing Distribution; Scale
Comparison Of Investment Characteristics
Characteristics Early Stage Buyouts
Target IRR 50% Plus 25% to 35%
Shareholder Position Minority Control
Management Control Personal Influence Capital Structure
Valuation Method Comparables Cash Flow
Value Creation Innovation Arbitrage
Time to Liquidity 3 - 5 Years 4 – 7 Years
Primary Exit Options IPO, Acquisition IPO, Acquisition, Recap
Pptname 18 01/07/98
Comparison Of Value Add Requirements
Based On Investment Lifecycle
Low High
Skill Set Venture Buyouts
Technology
Business
Development
Strategy
Organizational
Development
Sales & Marketing
Operations
Finance
Pptname 19 01/07/98
Buyout Funds Will Need To Design Their
Strategies To Meet The Challenge Of An
Increasingly Competitive Market
Provide greater value add
Fund
Characteristics — Strategic advice/market intelligence
That Will Drive
Superior — Operational skills to complement finance
Returns
— Business development assistance
— Exit assistance
Increase scale of sourcing, qualification and
execution processes
— Global awareness and reach
— Deeper industry and market knowledge
— Increased responsiveness under shorter
evaluation timeframes
Willingness to embrace a higher level of risk
INFORMATION TECHNOLOGY COMMUNICATIONS MEDIA