Case Study: Brazos Partners’ Leveraged Buyout of CoMarkMelissa Fregosi

Taylor Miller

Thunderbird School of Global Management

Professor Mark Simonson

GF5999, Mergers & Acquisitions

June 22, 2009

Given its financial statements, without a Cash Sweep, Brazos’ equity providers would achieve a 27.86% IRR. The IRR to all capital providers in this case falls to 20.85%:

Pro Forma Income Statement ($ millions) 2002 2003 2004 2005 2006

Net Sales 50.5 56.0 60.9 64.8 69.1COGS 31.6 35.0 38.1 40.7 43.4Gross Margin 18.9 21.0 22.8 24.1 25.7SG&A 4.2 4.7 5.1 5.3 5.8Adjusted EBITDA 14.7 16.3 17.7 18.8 19.9Depreciation 0.3 0.3 0.3 0.3 0.3Amortization of Transaction Costs 0.4 0.4 0.4 0.4 0.4EBIT 14.0 15.6 17.0 18.1 19.2Interest Expense

Senior Debt @ 6.25% 1.0 0.9 0.9 0.8 0.8Junior Debt @ 8% 0.7 0.7 0.6 0.6 0.5

Total Interest Expense 1.7 1.6 1.5 1.4 1.3EBT 12.3 14.0 15.5 16.7 17.9Income Taxes 4.9 5.6 6.2 6.7 7.2Net Income 7.4 8.4 9.3 10.0 10.7

FREE CASH FLOW TO EQUITY (FCFE)EBIT 14.0 15.6 16.9 17.9 19.0 Less: Interest (1.7) (1.6) (1.5) (1.4) (1.3)EBT 12.3 14.0 15.4 16.5 17.7 Less: Taxes 4.9 5.6 6.2 6.6 7.1Net Income 7.4 8.4 9.2 9.9 10.6 Add: Depreciation 0.3 0.3 0.3 0.3 0.3 Less: Increase (Decrease) in Capex (0.5) (0.5) (0.5) (0.5) (0.5) Less: Increase (Decrease) in NWC (2.4) (0.5) (0.5) (0.5) (0.3) Add: New Debt 0.0 0.0 0.0 0.0 0.0 Less: Debt Repayment (1.7) (1.6) (1.5) (1.4) (1.3)FCFE 3.1 6.1 7.0 7.8 8.8

IRRYear 0 Year 1 Year 2 Year 3 Year 4 Year 5

27.86% (15.0) 3.1 6.1 7.0 7.8 8.8

FREE CASH FLOW TO ALL CAPITAL EBIT 14.0 15.6 16.9 17.9 19.0 Less: Taxes (5.6) (6.2) (6.8) (7.2) (7.6) After Tax Operating Cash Flow 8.4 9.4 10.1 10.7 11.4 Add: Depreciation 0.3 0.3 0.3 0.3 0.3 Less: Increase (Decrease) in Capex (0.5) (0.5) (0.5) (0.5) (0.5) Less: Increase (Decrease) in NWC (2.4) (0.5) (0.5) (0.5) (0.3)FCFF 5.8 8.7 9.4 10.0 10.9

IRRYear 0 Year 1 Year 2 Year 3 Year 4 Year 5

20.85% (25.0) 5.8 8.7 9.4 10.0 10.9

Even with a Cash Sweep, Brazos’ equity providers will have a cash flow available to them in years 4 and 5 of the project:

Cash Flow Forecast 2002 2003 2004 2005 2006Net Income 7.4 8.5 9.6 10.6 11.4+ Depreciation 0.3 0.3 0.4 0.5 0.5+ Amortization of Transaction Costs 0.4 0.4 0.4 0.4 0.4- Net Capital Expenditures 0.5 0.5 0.5 0.5 0.5- Increase (Decrease) in NWC 2.4 0.5 0.5 0.5 0.3Cash Flow Available for Debt Repayment 5.2 8.2 9.4 10.5 11.5Cash Flow Available to Equity 0.0 0.0 0.0 8.3 11.5

Capitalization Year 0 Year 1 Year 2 Year 3 Year 4 Year 5Senior Debt 16.0 10.8 2.6 0.0 0.0 0.0Sellers Note 9.0 9.0 9.0 2.2 0.0 0.0Total Equity 15.0 22.4 30.9 40.5 51.1 62.5 Total Capitalization 40 42.2 42.5 42.7 51.1 62.5

Senior bank debt 40.0% 25.7% 6.1% 0.0% 0.0% 0.0%Seller's note 22.5% 21.3% 21.2% 5.2% 0.0% 0.0%Ow ner's equity 10.1% 14.3% 19.6% 25.6% 27.0% 27.0%Brazos LBO equity 27.4% 38.7% 53.1% 69.2% 73.0% 73.0% Total capitalization 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

With a Cash Sweep, IRR rises significantly based on 4 different exit scenarios. In the model, looking at a Year 5 exit, IRR’s could range from 44 to 71%. However, when early exits are taken into consideration, IRR’s could range from 50 to 454%.

Cash Flows to Common Equity Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

EBITDA 14.7 16.3 17.7 18.8 19.9Total Debt 25.0 19.8 11.6 2.2 0.0 0.0Add: Cash Flow in Excess of Cash Sweep 0.0 0.0 0.0 8.3 11.5

PV of growing perpetuity IRR (15.0) 0.0 0.0 0.0 27.1 269.584.36%

Exit Multiple Outflow Inflows3 x (15.0) 24.3 37.3 50.9 81.3 94.25 x (15.0) 53.7 69.9 86.3 135.5 157.07 x (15.0) 83.1 102.5 121.7 189.7 219.8

Exit in: IRR

Year 1 3 x 62.00% (15.0) 24.35 x 258.00% (15.0) 53.77 x 454.00% (15.0) 83.1

Year 2 3 x 57.69% (15.0) 0.0 37.35 x 115.87% (15.0) 0.0 69.97 x 161.41% (15.0) 0.0 102.5

Year 3 3 x 50.27% (15.0) 0.0 0.0 50.95 x 79.19% (15.0) 0.0 0.0 86.37 x 100.94% (15.0) 0.0 0.0 121.7

Year 4 3 x 52.58% (15.0) 0.0 0.0 0.0 81.35 x 73.37% (15.0) 0.0 0.0 0.0 135.57 x 88.58% (15.0) 0.0 0.0 0.0 189.7

Year 5 3 x 44.41% (15.0) 0.0 0.0 0.0 0.0 94.25 x 59.94% (15.0) 0.0 0.0 0.0 0.0 157.07 x 71.08% (15.0) 0.0 0.0 0.0 0.0 219.8

Conclusion (1/2)

• In the IRR analysis, the LBO is a good idea. With the cash sweep schedule, all IRR’s in the model were found to be above a presumed target IRR of 30%.

• The pro forma income statements for CoMark seem slightly conservative, forecasting an 8% growth rate when CoMark’s recent growth rate has been in excess of 30%.

Conclusion (2/2)• From a Valuation standpoint, calculating the present value of the LBO Fund’s

equity investment using a Target IRR of 30% as the cost of capital, we find under 3, 5, and 7 x EBIT Multiples, PV’s of 16, 27, and 38 million, respectively. This would indicate that a price of 40 million is in the area of what Brazos should pay, depending on the type of premium it expects to pay to capture synergies:

.

Valuation Initial ConservativeMost LikelyAggressive

Operating Income Year 5 19.9 19.9 19.9EBIT Multiple 3 5 7Proceeds to Seller 40 59.7 99.5 139.3Add Trans Cost 2Less Debt 25 0 0 0Initial Cost of Acquisition 17 59.7 99.5 139.3

OwnershipLBO Fund 73% 43.581 72.635 101.689Management 27% 16.119 26.865 37.611

PV of Investment 16.07895 26.79824 37.51754