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Confidential Confidential
Buy/Sell/Hold: Evaluating Strategic Alternatives
Mark Padjen Director Financial Advisory Services
Confidential
Potential Shareholder Value Drivers
Capabilities Required to Succeed
Benefits
Ideal Market Characteristics
Organic Growth Acquisitions Monetization Financial
Engineering
Relies on core competencies
Low risk strategy
Strategically aligned
Enhanced growth
Diversification of revenue / earnings
Synergy potential
Enhanced shareholder returns
Lower cost of capital
Provides liquidity while maintaining control
Immediate realization of cash
Diversification of wealth
Potential to retain upside through partial rollover
Growing end markets
High barriers to entry
Enhanced value proposition
Availability / actionability of targets
Debt availability
Reasonable valuation multiples
Active debt / equity markets
“Cheap” money
Stable end markets
Active M&A market
Attractive end markets
High valuation multiples
Capital to invest
Financial flexibility
Defendable market position
M&A execution capabilities
Ability to integrate
Debt firepower
History / ability operating with leverage
Stable cash flows
Selling shareholder engagement
Good margins / returns inherent in business
Strong growth prospects
Adequate cash flow to support leverage
Delivering value to shareholders can be achieved through multiple strategies
1
Confidential
Formation of the Decision Making Process
General market outlook (economic and capital markets)
Industry outlook and growth potential
Debt / risk appetite and availability
Market Conditions
M&A Opportunities
Availability of acquisition targets
Expertise in acquiring and integrating businesses
Industry consolidation trends / acquisition activity / competitive dynamics
Business Performance
Trajectory and sustainability of top-line growth, margins and cash flow
Debt capacity and M&A firepower
Market position relative to peers
Owner Priorities
Active vs passive involvement in the business
Retirement objectives and timing
Near-term liquidity needs
Family legacy and ongoing family involvement
The decision making process is typically informed by owner priorities, business performance and general market conditions
2
Confidential
Understanding the Value of Your Business and Returns
Returns
Evaluate historical and projected returns in the business
Compare returns vs. peers
Understand the Company’s weighted average cost of capital (“WACC”)
Ensure capital being deployed in assets / projects that exceed Company’s WACC
Ensure equity returns commensurate with owning smaller, illiquid, private company
Private equity investors demand high teens or better, why shouldn’t you?
Valuation
Determine the fair market value of a business utilizing various valuation techniques
Leveraged Buyout Analysis
Comparable Acquisitions
Comparable Trading Analysis
Discounted Cash Flows
Before evaluating the alternatives, you must first be grounded in the value of your business and the returns it is generating
Self reflection of historical / projected returns will help serve as a basis to compare alternatives
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Confidential
Manufacturing company with strong reputation in highly fragmented market
Revenue growth forecasted at 2.5% annually
EBITDA margins increase 10 bps per annum
Cash builds with cash flow as debt is paid down – net cash position by 2019E
Cash tax rate of 40.0%
Capex equal to 3.0% of sales
Illustrative Scenario
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Forecast
Assumptions
Observations Historical equity growth of 7.3% is lower than forecasted growth of 8.9%
Forecasted equity growth of 8.9% falls short of Company’s cost of equity at 14.7%
Equity accretion to shareholders in the status quo scenario is suboptimal
Financial
Forecast
Note: Observations based on EBITDA valuation multiple of 8.0x
($ in 000's)
Historical Forecast '16 - '21FYE 12/31 2014A 2015A 2016A 2017E 2018E 2019E 2020E 2021E CAGR
Net Revenue $56,556 $58,252 $60,000 $61,500 $63,038 $64,613 $66,229 $67,884 2.5%% Growth n/a 3.0% 3.0% 2.5% 2.5% 2.5% 2.5% 2.5%
Adjusted EBITDA $9,501 $9,845 $10,200 $10,517 $10,842 $11,178 $11,524 $11,880 3.1%% Margin 16.8% 16.9% 17.0% 17.1% 17.2% 17.3% 17.4% 17.5%
Cash 0 0 0 3,568 7,297 11,202 15,299 19,600
Debt (14,000) (13,000) (10,200) (9,180) (8,160) (7,140) (6,120) (5,100)
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Stand Alone Value Creation
5
Enterprise Value Equity Value
$62 $71
$95
$14 $10
$76 $82
$95
2014A 2016A 2021EEquity Net Debt
3.6% IRR
3.1% IRR
$62 $71
$95
$14
$62 $71
$110
2014A 2016A 2021EEquity Net Cash
7.3% IRR
8.9% IRR
Leverage enhances return profile to shareholders
($ in millions)
2016A $10.2MM EBITDA
8.0x Multiple
2021E $11.9MM EBITDA
8.0x Multiple
2014A $9.5MM EBITDA 8.0x Multiple
Confidential
Weighted Average Cost of Capital (“WACC”) Analysis
6
WACC
Pro Forma Cost of Debt Cost of Equity (CAPM)
WACC analysis is highly dependent upon capital structure assumptions and size of company
WeightedAverage
Weighted Avg. Cost of Debt 4.0%
Tax Rate 40.0%
Weighted Avg. after tax Cost of Debt 2.4%
Weighted Cost % of Cap Average
Debt 2.4% 12.5% 0.3%
Equity 14.7% 87.5% 12.9%
Totals 100.0%
WACC 13.2%
Based on Duff & Phelps 2016 Valuation Handbook – CRSP
Deciles Size Premium
Source: Risk Free Rate based on current synthetic 20-year treasury yield; Market Risk Premium per Damodaran’s Implied ERP based on Average Cash Flow yield last 10 years; Size Premium per Duff & Phelps 2016 Valuation Handbook based on CRSP Deciles Size Premium
Metric
Risk Free Rate (Rf) 2.7%
Company Beta (Rb) 0.80
Market Risk Premium (MRP) 5.8%
Size Premium (SP) 7.3%
Cost of Equity (Rf+(Rb*MRP)+SP) 14.7%
Confidential
Assumptions
Sources & Uses and
Capitalization
Pro Forma
Financial
Forecast
Incorporating M&A Into the Mix
7
Assumes purchase of $4 million EBITDA target at 8.0x multiple
Consolidated leverage of 3.0x
Financed entirely with senior term debt
Target financial forecast aligns with Acquirer (similar margins and growth profile)
Assumes synergies valued at 5.0% of Target’s COGS
($ in 000's)
Sources % of Cap2016A EBITDA
Multiple UsesSenior Revolver -$ 0.0% 0.0x Purchase Target Company 32,000$ Senior Term Loan 42,700 48.7% 3.0x Refinance Existing Senior Debt 10,200
Total Senior (and Total) Debt 42,700$ 48.7% 3.0x Rollover Equity 45,000Book Value of Equity 45,000 51.3% Fees & Expenses 500 Total Sources (Capitalization) 87,700$ 100.0% Total Uses 87,700$
($ in 000's)
Forecast '16 - '21FYE 12/31 2016A 2017E 2018E 2019E 2020E 2021E CAGR
Net Revenue $83,529 $85,618 $87,758 $89,952 $92,201 $94,506 2.5%% Growth n/a 2.5% 2.5% 2.5% 2.5% 2.5%
Adjusted EBITDA $14,200 $15,520 $15,994 $16,483 $16,986 $17,504 4.3%% Margin 17.0% 18.1% 18.2% 18.3% 18.4% 18.5%
Cash 0 911 2,014 3,281 4,740 8,113
Debt (42,700) (37,519) (32,146) (26,609) (20,880) (16,610)
Confidential
$71
$132 $10
$8
$82
$140
2016A 2021EEquity Net Debt
11.4% IRR
$71
$132
$71
$132
2016A 2021E
13.0% IRR
Value Creation with M&A
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Enterprise Value Equity Value
Debt financed M&A drives an elevated return profile
($ in millions)
2016A $10.2MM EBITDA
8.0x Multiple
2021E $17.5MM EBITDA
8.0x Multiple
Confidential
Organic vs M&A Growth Summary
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Organic Growth
M&A Growth
Familiarity / expertise, ease of sticking to knitting
Premium placed on strong organic growth in valuation context
No transactional risk to implement
× Highly dependent on underlying growth of market
× Longer lead time to make fundamental shifts in the business
× Unlikely “game changing” strategy / outcome
Ability to transform / diversify business rather quickly
Opportunity to achieve revenue / operational synergies
May significantly enhance equity upside
× Transaction / integration risks
× Significant management time and effort
× Highly dependent on market, valuation and actionable targets
$71
$110 $132
2016AStandalone
2021EStandalone
2021EWith M&A
8.9% IRR
13.0% IRR
Equity Value ($ in millions)
Confidential
Monetizing the Business – Market Considerations
10
Global M&A Deal Volume 2008 - 2016 (US$ BN)(1)
U.S. M&A Transactions Multiples – EV/EBITDA(2)
M&A market remains at elevated levels and valuations are at record highs
$1,783$1,296
$1,760$2,021 $1,868 $1,884
$2,992
$3,655
$2,959 $2,546
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Num
ber o
f Dea
ls
North American Acquirers Europe Acquirers RoW Acquirers Number of Deals
8.4x
9.7x11.5x
9.7x11.0x
9.4x9.9x
10.9x
13.7x
2009 2010 2011 2012 2013 2014 2015 2016 2017YTD
Source: FactSet Note: 2017 is based on a run-rate basis, annualized from YTD activity as of June 30, 2017. 1. Includes all announced transactions 2. Includes all completed transactions with a U.S. acquirer and target disclosed values between US$200MM - US$5,000MM.
Confidential
$71 $68 $65 $62 $59 $55
$10 $21 $32 $43 $54 $71 $79 $86 $93 $101 $110
2016A 2017E 2018E 2019E 2020E 2021E
$71 $79 $86 $93 $101 $110
2016A 2017E 2018E 2019E 2020E 2021E
Sell Today vs Status Quo
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Future Equity Value
Present Value of Future Equity Value @ 14.7% Cost of Equity
In a low / no growth scenario, the greatest value might be achieved by selling the Company today
($ in millions)
($ in millions)
While Equity Value grows from
$71 million to $110 million...
…Present Value decreases from $71 million to
$55 million
Confidential
Potential Monetization Alternatives
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Sale to Third-Party Dividend Recap
Full valuation for selling shareholders
100% liquidity for shareholders at close
Strategic buyers may pay up for synergies
Maximize value through price discovery process
Pros
× Multiples may not meet expectations
× Execution risk
× Process creates significant management distraction
× Shareholders cede upside
Cons
Full ESOP
Maintain full ownership
Easy to execute
Provides partial return of capital to shareholders
× Provides only partial shareholder liquidity
× Significantly lower free cash flow than partial ESOP
× Lower leverage likely available vs. Full ESOP
Full valuation for selling shareholders
Significant liquidity event for shareholders
Highly tax efficient (Sub S Corp ESOP)
Optimal employee benefit / upside / potential for retention
× Multiple “steps” needed to achieve full liquidity
× Leveraged balance sheet × Trustee must agree to
valuation × Future repurchase obligations × Highly regulated structure
A monetization alternative can be structured to meet owners’ objectives
ESOP Basics
What is an ESOP?
Retirement plan for employees
Stock based compensation plan
It’s the law – governed by the Employee Retirement Income Security Act of 1974 (ERISA)
Provides tax benefits to encourage individual retirement savings
Virtual “stock market” for existing shareholders to sell shares
Highly customized structure (i.e., partial or full ESOP possible)
Similar to a leveraged share repurchase
Why Choose an ESOP?
Recruit and retain talent
Motivate employees with supplemental compensation
Monetize wealth for selling shareholders
Diversify holdings
Ability to maintain control of the business
Create tax shield for the Company
Create flexibility for shareholders to sell shares over time
Defer capital gains taxes indefinitely (30% Minimum ESOP & C-Corp required)
Preserve legacy
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Company Benefits Employee Benefits
Corporate tax shield created by ESOP contributions
Employee recruiting & engagement tool
Succession framework
Reduced uncertainty of potential M&A sale
Mitigation of estate tax exposure
Established fair market value for shareholder redemptions
Retirement savings vehicle
Ownership in company - wealth building opportunity
No cash out-of-pocket
Tax deferred savings
Potential for accelerated returns from equity growth + debt pay-down
Potential supplemental dividends
Confidential
ESOP Basics (Continued)
14
Comments
Management Retains Control
Trustee represents employee equity interests (NOT on Board of Directors) and votes unallocated employee shares, generally holding voting control until full exit is achieved (depending on structure of inside loan)
BOD constituted by existing shareholders, ratified by Trustee based on BOD recommendations Day-to-Day management remains in place Trustee oversees valuation/repurchase exercise and negotiates on behalf of employees Employees have no say in day-to-day operations
Employee Benefit
Governed by Employee Retirement Income Security Act of 1974 (ERISA), Department of Labor (DOL), & Internal Revenue Service (IRS) Encourages retirement savings Tax benefits borne out of retirement savings trade off Fundamentally similar to a stock bonus plan
Leveraged Share Repurchase
ESOP transaction is a leveraged share repurchase with significant tax benefits o 1042 Rollover election allows for no capital gains tax on sale proceeds o No corporate income tax under the 100% S-corp ESOP structure
ESOP buys shares from selling shareholders with leverage; then repurchases from employees later (typically T + 7 years or more) o Day 1 – employees own 0 shares (allocated, then vested, then repurchased at retirement / death / disability / termination)
Money flow: Bank Company ESOP Cash to selling shareholders
Highly Customized
Human Capital Considerations
Partial / full ESOP options Benefit levels determined by management Allocation of shares to employees / vesting rules / cash repurchases
Good retention strategy No cash contributions from employees, ESOP is funded with debt Enhanced compensation for employees when ESOP is used in conjunction with existing plans Wealth building opportunity for management and employees
7 yr loan 20+ yr loan Repurchase Shares
An ESOP is a well established, highly customized corporate finance tool
Confidential
ESOP: Steps to Formation
15
Preliminary Valuation
Preliminary Structure
Debt Capacity
Select ESOP advisory firm
Preliminary Independent Appraisal
Feasibility Study (“Decision Package”)
Plan Design + Benefit Level
Procure Debt Financing
Employee Communication
Transaction Valuation + Binding Bid
Close ESOP Transaction
Administration
Annual Valuation
Repurchase Liability Planning/Funding
Phase I Preliminary Analysis Phase II Phase III
Forming an ESOP takes time and it pays to be thoughtful
Today ~30 days ~60 days Ongoing
BMO has unique capabilities to help
with ESOP formation and ongoing ESOP
needs
Confidential
ESOP Execution: Roles & Responsibilities
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Board of Directors BMO Harris Bank
Trustee
•Serves as fiduciary on behalf of employees
•Buyer of shares in ESOP transaction
•Hires valuation firm and reviews work product
•Negotiates purchase price on behalf of employees
•Ratifies candidates nominated to Board of Directors
•Does NOT serve on Board of Directors
•Considers M&A transactions
•Votes unallocated shares in all important corporate matters
•Hires attorney to represent employees
•Fiduciary duty to select, monitor or remove ESOP Trustee and the ESOP Administrator
•Existing fiduciary responsibility to shareholders unchanged
•Engage ESOP advisory firm
•Determine appropriate capital structure
•Mandate financing sources
•Hire Record Keeper for the Plan
•Develop executive compensation program
•Develop communications team & strategy
•Educate management on ESOP structure and benefits to constituents
•Educate company on ESOP structure
•Provide capital structure alternatives
•Advise on market terms for various financial instruments – Senior Debt – Mezzanine Debt – Seller Note – Equipment
Financing •Perform financial modeling of alternative scenarios
•Provide preliminary view on valuation and structure
•Structure transaction •Negotiate with ESOP Trustee on key terms – Valuation – Seller note terms – Warrant value &
structure •Assist company with developing plan details & documents
•Provide Trustees to BOD for consideration
•Execute transaction / close deal
•Advises company on all ESOP related issues
– Employee rights
– Transaction structure
– Allocation limits
– Tax issues
– Fiduciary responsibilities
•Drafts plan documents
•Draft employee communications
ESOP Counsel BMO Harris Bank ESOP Advisory Firm
Multiple parties work together for seamless execution
Confidential
Illustrative Transaction Diagram: Leveraged ESOP
17
Sellers
ESOP TRUST*
(Employee Benefit Plan)
Cash
Debt (Outside Loan)
Promissory Note
(Inside Loan)
1
3
* Note: The ESOP Trustee is represented by independent legal and financial advisors
1. Company borrows money from BMO Harris – the “outside loan”
2. Company buys shares from selling shareholders, then sells to ESOP Trust
3. Company sells shares to ESOP in exchange for a note – the “inside loan”
Stock (or Cash)
2
Company
Confidential
$117 $88
$78 $59
100%ESOP
Sale of Company
$71 $47
$24
100%ESOP
Sale of Company
Illustrative Monetization Alternatives
After-Tax Cash Proceeds After-Tax Estate Value in 20 Years
(1) Assumes 8.0x multiple and does not account for control discount; (2) 33.7% Minnesota capital gains tax assumed; (3) Reinvestment yield of 5.8% (compounding 20 years on cash proceeds) based on Market Risk Premium. Assumes 3.0x EBITDA paid in cash at close ($30.6 million) with the remaining $40.8 million being paid out evenly over 8 years
($ in millions) ($ in millions)
18
100% ESOP Delivers +$29
million
($ in millions) 100% ESOP Sale of Company
Gross Proceeds (1) $71 $71
Less: Capital Gains Tax @ 33.7% (2) $0 ($24)
Net Proceeds $71 $47
Plus: Gains on Reinvestment @ 5.8% (3) $123 $100
Total Cash Delivered to Estate $194 $147
Less: Estate Taxes @ 40% ($78) ($59)
Net Proceeds to Heirs $117 $88
Confidential
Illustrative 30% Leveraged Share Repurchase
A leveraged share repurchase could drive a higher future share price for active shareholders
19
Note: Assumes minority interest is bought out at a 25% discount to 8.0x Fair Market Value due to lack of control; Transaction 100% senior debt financed
($ in millions)Today Standalone
2021ELSR
2021E
EBITDA $10.2 $11.9 $11.9
Enterprise Value Multiple 8.0x 8.0x 8.0x
Enterprise Value $81.6 $95.0 $95.0
+/- Net (Debt) / Cash (10.2) 14.5 (3.7)
Equity Value $71.4 $109.5 $91.3
"Active" Ownership Stake 70% 70% 100%
"Active" Shareholders' Value $50.0 $76.7 $91.3
"Active" Shareholders' Value Accretion 53.4% 82.7%
"Active" Shareholders' IRR 8.9% 12.8%
Confidential
In Summary
20
Make the decision that is right for you!
Understanding the intentions of key owners / decision makers is critical
Appreciate “what you have” before deciding “what you want”
Vet all possible alternatives and weigh their pros and cons
Multiple alternatives exist to generate and extract value from a business
Confidential Confidential
Q and A
Confidential
Mark Padjen
22
Mark Padjen currently serves as a Director in Commercial Middle Market Financial Advisory Services for BMO Harris Bank. Mark specializes in providing corporate finance advisory services on topics such as mergers & acquisitions, acquisition financing, recapitalizations, ESOPs, ownership transitions, shareholder monetization, valuation, pension risk transfer and tax mitigation. Over his 14 year finance career, Mark has a wealth of experience working with management teams, boards of directors, family owned businesses and financial sponsors to execute strategic and capital structure alternatives. Prior to joining BMO in 2016, Mark enjoyed a successful 12 year career in investment banking, most recently as a Director at Credit Suisse. While at Credit Suisse, Mark led and executed 60+ bookrun or lead advisory transactions across the diversified industrial, transportation, aerospace and business services sectors. Mark subsequently spent time in an interim CFO capacity and advisor to private, family owned businesses. Mark holds a BS in Finance with High Distinction from the University of Illinois at Urbana-Champaign. Mark lives with his wife and two children in Munster, Indiana.
Mark Padjen Director, Financial Advisory Services BMO Harris Bank Commercial Banking [email protected] 312-765-1040
Confidential
Disclaimer
These materials are confidential and proprietary to, and may not be reproduced, disseminated or referred to, in whole or in part without the prior consent of BMO Harris Bank (“BMO”). These materials have been prepared exclusively for the BMO client or potential client to which such materials are delivered and may not be used for any purpose other than as authorized in writing by BMO. BMO assumes no responsibility for verification of the information in these materials, and no representation or warranty is made as to the accuracy or completeness of such information. BMO assumes no obligation to correct or update these materials. These materials do not contain all information that may be required to evaluate, and do not constitute a recommendation with respect to, any transaction or matter. Any recipient of these materials should conduct its own independent analysis of the matters referred to herein.
BMO does not provide tax or legal advice. Any discussion of tax matters in these materials (i) is not intended to be used, and cannot be used or relied upon, for the purposes of avoiding any tax penalties and (ii) may have been written in connection with the “promotion or marketing” of the transaction or matter described herein. Accordingly, the recipient should seek advice based on its particular circumstances from an independent tax advisor.
Banking products and services are subject to bank and credit approval. BMO Harris Bank N.A. Member FDIC
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