Brevini Power Transmission

Silvia BaioccoAndrea Granelli

Alessandro GrassanoGian Marco Lago

Giulio Laudani

Bailout Consulting

1. Analysis of the company:I. Group of referenceII. HistoryIII. Strategic Business Units

2. Analysis of the industry:I. Porter’s five forces modelII. SWOT analysis

3. ROIC expectations:I. AssumptionsII. Results

Introduction and overview

Group of Reference

HistoryBrothers Renato, Luciano, and Corrado Brevini establish FRATELLI BREVINI in Reggio Emilia.

Brevini France,Brevini USA Brevini in Germany

Brevini China, Korea, South-east Asia (Singapore), Brevini Australia, and New Zealand. Brevini Latino Americana in Brazil.

Brevini India and Brevini Finland

Acquisition of the German company “P.I.V. Antrieb Werner Reimers”

Brevini South Africa

New production plant in China

Brevini UK, Brevini Svenska, Brevini Espana, and Brevini Canada

1960 1970 1980 1990 2000 2009 Our goal is to

get bigger

Type Approval Certificate

Brevini Power Transmission division

Strategic Business UnitsSBU MAIN CUSTOMER

TYPEDISTRIBUTION

CHANNELGEOGRAPHIC

AREASPRODUCT LINES/ SERVICES

Brevini Riduttori Energy Direct-distribution WorldwidePlanetary gear units for

industrial applications and mobile machines

PIV Drives Material Handling Transport Direct-distribution Worldwide

Parallel and right-angle shaft gear units and speed

variators

Brevini Winches Construction Direct-distribution Worldwide Hoisting and recovery systems

Piv Posiplan Waste Water / Recycling Direct-distribution Worldwide

New compact gear units for shaft-mounted

industrial applications

5%

19%

15%

14%12%

11%

9%

8%7%

Revenue by family in 2009

Agricolture

Industrial Equipment

Material Transport

Construction

Marine/Port Infrastruture

Mining

Energy

Plastic/rubber

Recycling

Brevini Power Transmission operates in the Industrial Machinery sector (NACE 2811)

Which product do we sell?

Sourced by Brevini Power Transmission website

23%

47%

18%

12%

Geographic distribution in 2009

ItaliaUE (ex-Italy)Asia-PacificoAmerica

Where do we sell?

Sourced by Brevini Power Transmission website

Buyer Power: Moderate•Brand reputation is of negligible value in this market•Buyer power is weakened by the substantial number of buyers in this market, but a big part of the revenues comes from a small number of big commissions

•There is the possibility to easily switch due to the high goods standardization, except for the engine sub-sector

Supplier Power: Moderate•Suppliers operate in the Commodity sector, so they have very low power due to low differentiation of products

•Raw materials purchasing carries prices volatility and exchange rate risk

•In the last 20 years there has been an increasing level of prices due to the continuous global economic growth, sustained by high demand from China and other emerging economies

Threat of new entry: Low•High level of fixed costs and capital investment•Economies of scale•Government regulations and high level of intellectual property

•Recent poor growth in the market

Threats of substitution: Moderate•Substitutes as such do not exist but used-products sold privately may be considered as an alternative. This would be cheaper than buying brand new products; however, the machinery is unlikely to be under any kind of warranty if sold privately which may pose a high risk to buyers as the machines are expected to work in difficult heavy-duty environments

Competitive aggressiveness:

Competitive aggressiveness: Moderate•The market is mature and it shows a global slow growth rate (1,6%), but there are differences between the different geographic area and sub-sector.•The concentration in the market is low, the top 5 player account for the 12% of the overall market•There is an high cost to convert the production, this increase the competitors attitude to stay in the market as long as possible

Porter: What is the market like?

38%

32%

28%

2%

Revenue by geographic area

Americas Asia-Pacific EuropeRest of the world

36%

25%23%

16%

Market segmen-tation

Engine, Turbine and RelatedWood and Plastic ProcessMetalworkingOther Purpose

Data: What is the market like?

Sourced by DataMonitor

Strengths:•Capability to exploit economies of scale•A flexible structure•The main good is highly appreciated by the market because of lower prices with respect to traditional technologies possibility of configuration according to the costumer’s needs and high versatility

• Innovating technologies and strong investment in R&S

Weaknesses:•The firm is auto-financing,: exploiting its operating cash flows

• It is a family-owned business are they good manger on the long run?

Opportunities:•The recent investment in USA and China could allow the company to capture the higher expected growth of those markets

•The EU environmentally friendly legislation can boost Brevini’s growth

Threats:•The recent crisis could lead to a new phase of aggregation between companies

SWOT : Competitive advantage

After analysing the market and our company, we identified 4 competitors which operate in the same market and whose businesses are tightly connected to Brevini’s

Using the historical data available for our competitors, we built a statistical periodic fit with the least squares method and, hence, we were able to determine the future ROICs for those companies

Assumptions for our ROIC expectations

Financial data (billions €)

 

BREVINI POWER TRANSMISSION MAN SE OKUMA MITSUBISHI KAWASAKI

2008 2009 2008 2009 2008 2009 2008 2009 2008 2009

Net Sales 0.359 0.224 14.945 12.026 1.354 1.272 28.096 29.610 13.167 11.741

EBITA 0.037 0.012 1.643 0.613 0.189 0.091 1.180 0.917 0.671 0.246

NOPLAT 0.026 0.008 1.150 0.429 0.132 0.064 0.826 0.642 0.470 0.172

ROIC 20.43% 6.83% 9.41% (8.92%) 21.86% 8.29% 12.43% 12.05% 8.77% 2.77%

ROE 20.16% 6.93% 23.03% (5.35%) 16.39% 3.80% 4.30% 1.95% 11.22% 4.04%

ROA 12.46% 4.51% 9.00% (1.35%) 14.31% 6.15% 2.31% 1.68% 5.03% 1.12%

ROIC expectations on the main player for the next 5 years

Kawasaki MAN SE

Okuma Mitsubishi

◦ We applied the ROIC trend deduced from our competitors to Brevini, keeping in mind that:• We have expected a constant growth rate for the IC, which is

explained by Brevini’s will to bust its production and geographical expansion

The parameters of this function respond to the qualitative sentiments that have been presented in our SWOT analysis

We have assumed an higher “pro-cyclical” movement than most of the other competitors and a more flexible capital structure, which has allowed Brevini to reduce the negative effect of the revenue contraction this has lead to an upward asymmetrical behavior

Brevini’s ROIC

Expectations on Brevini Power Transmission for the next 5 years

1. Enterprise DCFI) WACC estimate

a) Capital structure : target structure, D (book value), E (iteration method)

b) Ke Capital Asset Pricing Modelc) Kd Spread approach

II) Free Cash Flow estimatea) Time frames : scenariosb) Main assumptions

III) ResultsIV) Sensitivity analyses

2. Economic profit

DCF valuation

◦ The key element of DCF and how we have estimated them: Ke: we have used a Market model, based on the

CAPM Kd: we have used the Debt ratio to find the

appropriate rating and the cost of debt. We have analyzed the historical path of the main

financial items to find out the relationship between them and any existing trend.

We have estimated the revenues growth rate through a three period model that describes our qualitative judgment on the company.

Enterprise DCF(I)

WACC

FCF

Enterprise DCF(II) Capital structure :

◦ Our target has been the characteristic median Debt-to-Equity ratio in the industrial machinery market, which is about 14% (source: McKinsey)

◦ This goal is too far from the present structure, so we have developed a correction in the DCF model, to better fit our hypothesis with those of the model

◦ The company is not financially distressed, therefore the book value of the net debt can be a good proxy of its market value

◦ The market equity value has been calculated through an iteration◦ Our solution has been to develop a changing structure from 2010 to 2014, which has lead to a variable WACC, due to changes in Ke, Kd and weights

o Ke has been calculated using the formula:

o The risk free chosen is an equally weighted blend between the most recent German and Italian 10y zero coupon bonds rate, because the company is mainly exposed in those two countries

o The market risk premium has been taken from the paper by Fernandez. It is an average between the German and Italian ones for the same reason as before

o The marginal tax rate chosen is 30%

WACC Estimate: Ke (I)

Risk free + Beta*Mkt premium

We have chosen our comparables◦ The criteria used have been: similar Business

and Geographic Area We have built a table to find out the sector

unlevered beta (Hamada formula)◦ The weights used have been (tot.Mkt cap/Mkti)

and then normalized. These weights allow us to give more importance to the smallest companies in our portfolio

◦ The Betas for the comparables have been calculated using the 2004-2009 interval, monthly frequency, and the MSCI World Index

WACC Estimate : Ke (II)

Man se Kawasaki Okuma Mitsubishi MRO LN

COMPARABLES BETA LEVERED NET DEBT EQUITY (MKT CAP) BETA UNLEVERED WEIGTH WEIGHT NORMAL

Man SE 1,557 € 2.634,00 € 5.538,87 1,17 322% 4,01%

Okuma 1,434 - € 32,17 € 617,95 1,49 2889% 35,98%

Mitsubishi 0,958 € 9.657,82 € 8.302,72 0,53 215% 2,68%

Kawasaki 0,729 € 3.117,09 € 2.949,44 0,42 605% 7,54%

MRO LN 1,598 € 362,49 € 446,49 1,02 3999% 49,79%

Weighted Average 1,14 8031% 100,00%

WACC Estimate: Ke (III)

We have re-levered the beta of the sector:

◦ We have estimated a debt/equity structure trend converging to a target structure in 2025

◦ The target structure has been decided using the average of the steadiest comparables

◦ Assuming a slow approach to the target value, we have developed a variation to the DCF model. Mainly, we re-levered the beta using different target D/E between 2010 and 2014

2009 2010 (E) 2011 (E) 2012 (E) 2013 (E) 2014 (E)

Brevini Beta 1,86 1,53 1,52 1,44 1,49 1,43

Net Debt 48,0% 33,2% 33,1% 28,3% 31,2% 27%

Equity 52,0% 66,8% 66,9% 71,7% 68,8% 73%

WACC Estimate: Ke (IV)

Market premium

5,85%

Risk free 4,06%

2009 2010 (E) 2011 (E) 2012 (E) 2013 (E) 2014 (E)

Ke 15% 13,02% 13% 12,54% 12,81% 12,42%

Risk free + Beta*Mkt premium

Kd: we have estimated a change in the rating of our company, following our expectations:

◦ We have assumed a variable interest expense linked to the German and Italian 5y bonds + the premium corresponding to its rating (Spread Approach, though Interest Coverage Ratio calculation)

◦ We have taken into account the possible future monetary policy, which is going to cause the increase of the risk free rate, but at the same time our rating will improve and, so, the spread reduce. In conclusion, we hypnotised a stable level of Kd of 5.5%, considering the result of the two opposite effects

WACC Estimate: Kd

WACC Estimate: Results2010(E) 2011 (E) 2012 (E) 2013 (E) 2014 (E) 2015(E)

10,58% 10,58% 10,60% 10,59% 10,61% 10,50%

Betas

1,15 1,35 1,55Mkt p.

5,25% 9,12% 9,12% 9,95%5,85% 9,67% 9,67% 10,58%6,45% 10,21% 10,21% 11,22%

The chart above is a sensitivity analysis on the WACC. The row represents a standard deviation range from the beta value used, the column is a range of possible market premiums.

1. We have divided our model into three time periods:◦ 2010-2014 We have built an IS & BS by estimating each item◦ 2015-2024 By estimating Key drivers ◦ 2025-infinity We have computed a terminal steady growth rate using

macroeconomical inputs2. We have chosen different tools to implement our

proxies for each period, the ratio for each of them is:◦ In the first period, we have less uncertainty, so we have felt

confident enough to develop three scenarios with a considerably low standard deviation

◦ In the second period, due to higher uncertainty, we have developed three scenarios with a higher volatility

◦ In the last period, we have relied on the general accepted belief that the firm will reach a certain stability and will follow the global growth rate

Time frames: Scenarios

We have set up three different scenarios:◦ The Normal case will assume that the firm will follow its forecast

growth path, which has been estimated through a periodic function based on historical data

◦ The Best scenario is going to assume that the firm’s revenues will have the same growth rate as the market when the economy faces a downturn, while it will keep its forecast growth in positive economic conditions.

◦ The Worst scenario will assume that the firm will keep behaving as forecast in negative conditions and will not be able to outperform the market growth in positive circumstances and, therefore, as a proxy, we have chosen the market growth rate itself as the path that it will follow.

2010-2014 Scenario (I)

2010-2014 Scenario (II) The Revenue has been forecast by means of a statistical periodic

fit: we have found the periodic function that approximates the data we had with the least squares method

The properties of the function we obtained confirmed the qualitative analysis of the revenue’s growth:

◦ The minimum of the function is in 2011, it grows to reach the pre crisis level until 2013 and it reaches the maximum in 2014

2010 (E) 2011(E) 2012 (E) 2013 (E) 2014 (E)Revenue 202.280 185.532 239.336 315.325 361.362

% (t+1-t)/t -8,19% -8,28% 29% 31,75% 14,6%

2010-2014 Scenario (III)

The expected CAGR of the three scenarios is 0,042% with a variance of 20%

CAGR

Probabilities

Best case 6% 2/7Worst case -11% 1/7Normal case 1% 4/7

2008 2009 2010 2011 2012 2013 20140

100000200000300000400000500000

NormalWorstBest

During this period, Brevini will experience a “transition” phase which will lead to a steady growth level

We have set up three different scenarios:◦ The Best scenario is going to assume an higher growth rate in comparison

to the market the company will be able to increase both its production and geographical coverage

◦ The Normal case will assume a continuous growth path at a rate lower than previously, but still higher than the market average

◦ The Worst one will assume the failure of the company to achieve a satisfying competitive advantage it will reach a steady state level at the beginning of the period

Our work has been lead both by qualitative and quantitative analysis:

◦ The qualitative argument is based on the capability to retain extra-earning thanks to competitive advantage

◦ The quantitative analysis is based on the shift of the geographical exposure and global growth expectation

2015-2025 Scenario (I)

2015-2025 Scenario (II)

We have taken the expected value of the compound annual growth rate of our three scenariosAbout 7,7% with a variance of 80,91%It means that the company will double its size in 10 years

CAGR

Probabilities

Scenario 1 (best) 15% 14%Scenario 2 (normal) 7% 57%

Scenario 3 (worst) 4,5% 29%

Free Cash Flow : Assumptions

“Brevini Group’s industrial plans include substantial investments [...] because our growth depends on our presence around the globe […]. We are looking beyond the crisis and focusing on the recovery that will arrive,” said Renato Brevini, President of Brevini Power Transmission

From this we have deduced that the company will increase its production and its investments starting from 2012

FCF: Assumptions (I) We have assumed an “exotic” function for the COGS, whose parameters

have been set to capture a loss of efficiency due to a revenue contraction in 2010-11 (less scale efficiency) and then a normalization in the remaining years

We have linked SGA growth to the COGS for 2/3 and to an intrinsic growth for 1/3, following the expected business plan

“Other Revenues” is composed of two parts: one correlated to sales for 2/3 and the other independent and pretty steady through time

FCF: Assumptions (II) Operating cash represents the minimum amount of cash necessary for daily

business it has been assumed as a fixed percentage of revenues

Inventories are defined as a percentage of revenues We have assumed a reduction in production and a disbanding of its inventories for 2010-11, on the other hand in 2012 there will be an increase to anticipate the higher revenue-growth expectation

A positive net change has been estimated for Receivables and Payables. We have also considered a renewed investment in WC to mach the increase in revenue in 2012-2014.

FCF: Assumptions (III) Net PPE is defined as a % of revenue, our estimate consistently matches our

hypothesis on the Invested capital trend

Our estimate on the Debt repayment converges to the target value, as forecast through our assumptions on the Debt ratio

We have chosen to have a positive trend in PPE, independently from the revenue growth, due to our strong confidence on the IC hypothesis.

To define the Debt position we have also tried to:◦ Bound the excess cash into a coherent interval◦ Ensure enough liquidity availability to sustain the CAPEX and new building

expense 2010 (E) 2011(E) 2012 (E) 2013 (E) 2014 (E)%PPE 26% 28% 32% 30% 32%

Debt Rep. (5.000) (4.000) (6.000) 17.000 (6.000)

FCF: Assumptions (IV)

12% 1

8%

47%

23%

Present geographical distribution

America Asia-Pacific

UE ex Italy

Italy

20%

12%

38%

30%

Target geographical distribution

AmericaItalyUE ex ItalyAsia-Pacific

We forecast Brevini’s revenue growth also considering the kind of geographical expansion that we expect the company to follow and, therefore, making a weighted average of the GDP of each area.

FCF: Terminal value estimate

We have assumed a unique case, in which the company reaches a steady growth of 3%, following the global economy

Our estimate has an upper limit to ensure a terminal ROIC of about 15%, which is in line with the sector average

The implicit multiple of the terminal value is 7,9

60 % of our Enterprise value depends on the terminal value

There isn’t any Non-operating asset in our valuation, besides excess cash

Enterprise DCF: Results

PV FCF

2010 -14 € 22.717,14

2015-25 €127.587,03

Terminal value €229.766,28

EV €380.070,46

Debt value € 87.771

Equity value € 292.299,46

Enterprise DCF: Sensitivity analysis (I) The WACC range comes from the sensitivity

analysis made previously The column variable represents the terminal

growth rate

Wacc 9,58% 10,08% 10,58% 11,08% 11,58%

g2,5% € 457.074,59 € 412.787,30 € 374.685,31 € 341.644,77 €312.792,54

3,0% € 466.979,37

€420.091,34 €380.070,46 € 345.600,54 €315.675,45

3,5% €478.532,87 € 428.518,41 €386.224,91 € 350.084,01 €318.919,07

Enterprise DCF: Sensitivity analysis (II) The WACC range comes from the sensitivity

analysis made previously The column lines represent the revenue

CAGR of the 2015-24 estimate

Wacc

9,58% 10,08% 10,58% 11,08% 11,58%CAGR

1,6% €356.297,02 €326.333,93 €300.016,00 €277.739,73 €257.788,76

7,67% €466.979,37 €420.091,34 €380.070,46 €345.600,54 €315.675,45

13,72% €641.169,10 €567.096,85 €504.528,45 €451.211,38 €405.427,37

PV of EP € 99.453 PV of

Continuing value

€104.908

Invested capital at start

of forecast € 175.709

Enterprise value € 380.070

Equity value € 292.299

The relationship between ROIC and WACC has been negative only for the first 3 years of our valuation model

The IC contribution has been constantly increasing in value

Economic Profit

A brief comparison: Source of value of the Economic profit is mainly the Initial IC,

while the terminal value accounts for 27,37%. Our assumptions on the IC are consistent with our qualitative belief of an increase over time even in the deepening of the crisis the growth rate in the IC is higher than the revenue’s

The chart below shows that the economic profit model is less dependent on the terminal value hypothesis than the enterprise DCF one

Economic profit Enterprise DCFTerminal Value 27,37% 60%

PV 26,05% 40%IC0 46,05% -

Economic profit

Enterprise DCF

0%20%40%60%80%

100%

IC0PVTerminal value

Numerical ROIC prediction

Our ROIC expectations trend calculated through the period function approximation has been confirmed by the results obtained through the enterprise DCF method.

I. Identification of the right comparables

II. Identification of the value drivers

III. Time framework

IV. Results

Multiples approach

WARNING: finding companies which have the same mix of businesses, products and size and at the same time are listed, is almost impossible. Therefore the companies which have been picked are those which belong to a very similar market –indicated by the NACE classification-. Moreover, they either operate in the same geographical areas or have a similar size.

Multiples approach (I): Identification of the right comparables

Brevini belongs to the classification NACE 2811, i.e. Manufacture of engines and turbines, except aircraft, vehicle and cycle engines. NACE 28 indicates manufacturers of machinery and equipment.

the company has been chosen as its products are complementary to those of Brevini: i.e. they tend to be used together as a unique component

the company has been kept in consideration since the beginning of the work as their businesses are tightly correlated

Direct multiple: EV/EBITDA

Less easily influenced by different accounting and fiscal

policies and, hence, more difficult to manipulate or

cause misleading judgement

Multiples approach (II): Identification of the value drivers

Indirect multiple: EV/Sales

More commonly used in times when the company is not

achieving very positive margins or is facing a turnaround moment

Source: Valuation Guide by Borsa Italiana (2004)

When discussing about the time frame to consider, we had to keep in mind that 2008 and 2009 were years afflicted by the financial crisis.

1. We started with the classical approach, which is using the last available year, i.e. 2009. The values we obtained where excessively low. This can be explained by the fact that this year has been considerably affected by the financial crisis and the situation presented by most of the companies worldwide, and in particular companies belonging to the industrial machinery sector, does not do any justice to their real value.

2. We then tried to capture the value of the company by using forecast data, which we found available only up to 2012. Unfortunately, the economy is excessively negatively biased during this period, as we do not expect any recovery before 2011, therefore the values we obtain are again not doing any justice to the real value of the company.

3. It would have been more appropriate to use data from 2007, when the company was able to show all its potential and external causes where not affecting its activity, but unfortunately Brevini data were not available.

4. The ultimate chance we were left with was to consider data from 2008. 2008 financials are available, not too badly influenced by the financial crisis and therefore sufficiently reliable.

Multiples approach (III): Time framework

Multiples approach (IV): ResultsHamworthy Spirax-Sarco Okuma CVTech Comparables' average

EV / EBITDA 08 7,26 8,41 5,02 4,79 6,37EV / SALES 08 0,63 1,78 0,83 0,60 0,96

Comparables' averageEV / EBITDA 08 6,37EV / SALES 08 0,96

Brevini48.152 EBITDA

356.054 SalesX=

BreviniEV1 306.732

EV2 341.693Mean 324.212

Are these results consistent with the previous ones?

YES

You have to take into account that the value we calculated is slightly lower than the one we get

through the discounted cash flow model and close to the value we obtain in our worst case

scenario because the unfortunate circumstances which hit the economy cannot be completely

avoided.

Orbis and Amadeus Balance sheet information DataStream Risk free Central bank of key country and IMF Growth

expectation on GDP Bloomberg Betas, Mkt cap and Enterprise value Capital iQ information about competitors Data Monitor Information about the overall

market “Market Risk Premium used in 2010 by Analysts

and Companies: a survey with 2.400 answers”, P. Fernandez and J. del Campo

Sources

After a careful analysis, we have come to the conclusion that Brevini is a company that operates in a highly competitive business which requires a great amount of fixed investments. On the other hand, it has high growth potential, as it is planning to expand geographically. Moreover, its products are very versatile and, hence, can serve different purposes. It also presents a high efficiency of production, which might come even handier whether new plants were to be opened by developing economies of scale . The financial crisis has had a very negative impact on the company, but we expect a prompt recovery. We have used different approaches to measure the value and each time we created a set of assumptions that were both realistic and thought through. We even tried to adapt such methods to every specific circumstance. The results we obtained were consistent and sound; therefore we are confident enough that the value we got is pretty fair.

Conclusions