Capital Markets Overview

1
Capital Markets Overview

• June 20, 2001

2
Table of Contents

• Overview of Howard Frazier Barker Elliott, Inc.
• Capital Markets Overview
• Recent HFBE Transactions

3
I. Overview of Howard Frazier Barker Elliott,
Inc.

• Valuation and financial advisory firm
• Established in September 1991
• Broker/dealer established September 1999
• All principals have backgrounds with regional
  investment banking firms in Houston and national
  valuation firms
• Rotan Mosle
• Underwood Neuhaus
• Lovett Mitchell Webb Garrison, Inc.
• Each principal has at least twenty-five years of
  experience
• Chartered Financial Analysts and Senior Members
  of the American Society of Appraisers

4
I. Overview of Howard Frazier Barker Elliott,
Inc.

• One of the largest independent financial
  valuation and advisory firms in the Southwest
• Six managing directors, three vice presidents,
  nine associates and analysts and four support
  staff
• Based in Houston, HFBE has a national clientele
  base
• Valued securities of hundreds of companies in a
  broad spectrum of industries

5
I. Overview of Howard Frazier Barker Elliott,
Inc.

• Valuation Services
• Specialize in valuing various kinds of financial
  securities such as common stock and preferred
  stock, general and limited partnership interests,
  notes, and derivative securities of private
  closely held companies
• Provide a variety of valuation opinions,
  including

Fairness opinions Sales representations Tax
and estate planning Incentive stock options
plans Employee stock ownership plans
Mergers and acquisitions values and exchange
ratios Company reorganizations and
restructuring Bankruptcy advisory services
6
I. Overview of Howard Frazier Barker Elliott,
Inc.

• Corporate Finance and Advisory Services
• Strategic acquisitions and mergers
• Management and leveraged buyouts
• Acquisition searches
• Private placements of debt and equity
• Senior debt financing
• Financial restructuring and recapitalization

7
II. Capital Markets Overview Current Conditions

• Slowing economy
• Longer than expected recovery time
• Uncertain future economic conditions
• Volatile public equity markets
• Initial public offerings almost non-existent
• Selective private capital sources
• Many funds focused on existing portfolio
  companies
• Weak public markets beginning to affect ability
  to raise private capital
• Private equity general partners will be focused
  on delivering realized gains/liquidity on
  existing funds, prior to raising new funds
• Tight credit markets
• Especially affecting smaller businesses (less
  than 25 million in revenues)
• Shift from cash flow to asset-based loans
• Disappearance of smaller (1-5 million)
  subordinated debt funds

8
II. Capital Markets Overview Nature of Merger
and Acquisition Market

• Companies are building critical mass/economies of
  scale in selected fragmented industries
• Shift from technology to old economy businesses
• Public offering poof deals replaced by private
  equity financing
• Increasing difficulty and costs to obtain
  financing
• Significant amount of dry powder at private
  equity funds
• Overall MA market is still active however,
  primarily larger transactions

9
II. Capital Markets Overview Consolidations

• Consolidations still a popular strategy
• Must make business sense economies of scale no
  longer sufficient as sole purpose
• Funds providing a significantly greater
  percentage of equity - much less reliance on
  senior debt financing
• Slower growth implies longer holding period
• IPO time frame may be as long as seven years

10
II. Capital Markets Overview Slowdown in
Lending

• Consolidation of banks fewer lending sources
• Greater scrutiny of bank loan portfolios by
  Office of Comptroller of the Currency
• Banks attempting to sell or move questionable
  and/or higher risk loans (typically smaller
  loans). Several loan portfolios recently for
  sale (ex Bank of America, FINOVA, Transamerica)
• Shift from cash flow oriented loans to asset
  based loans (ABL)
• Historically high purchase multiples resulting in
  excessive leverage
• Recent economic slowdown
• Increased uncertainty about economic future
• Increased regulatory pressures
• Banks holding smaller positions (from 20-30
  million to 10-20 million)

11
II. Capital Markets Overview Shift from Cash
Flow to Asset-Based LoansWhat Does This Mean for
Borrowers?

• No more air balls
• Asset-based loans (ABL) favorable for volatile
  cash flow, lower margin and asset intensive
  businesses
• Debt service coverage requirements more relaxed
• Term debt is generally a maximum of 50 of total
  senior debt borrowings (vs. revolving line of
  credit)
• Real estate financing is very limited and
  typically requires a separate lender such as an
  SBA lender
• Higher borrowing costs
• ABLs typically require more administrative work,
  reporting requirements and financial controls
• Service and other businesses with low fixed asset
  base will have difficulty securing senior bank
  debt

12
II. Capital Markets Overview Significant
Effect on Merger and Acquisition Market

• Banks have decreased the multiple of senior debt
  and total debt to cash flow they are willing to
  lend
• Recent historical multiples of 4-5x currently at
  2.0-3.5x
• Senior lenders now funding less than 50 of
  purchase price was recently greater than 50
• Equity percentage of transaction size increased
  to 30-50 was 20-30
• Seller financing and/or earnouts are necessary to
  complete most transactions, especially service
  and low fixed asset base businesses
• Higher borrowing rates
• Pricing increase of ½ - 1 ½ compared to year ago
  levels (somewhat offset by rate cuts)
• Up front fees and servicing fees have also
  increased

13
II. Capital Markets Overview Typical Deal
Structure
12-24 Months Ago
Current
50-60 20-25 20-35 100
Senior debt Subordinated debt Seller
Financing Equity Total
30-40 10-20 10-25 30-50 100
14
II. Capital Markets Overview Significant
Effect on Merger and Acquisition Market

• Disappearance of small and mid-market
  subordinated debt players
• E.g., Sirrom, FINOVA
• Very difficult to raise subordinated debt less
  than 5-10 million
• Typical target rate of return for a 5 million
  subordinated debt financing is 25 12-14 coupon
  plus warrants more common to have another fund
  as co-investor to reduce risk level
• Lack of private equity for smaller deals
• Increasing size of funds has resulted in an
  increased minimum deal size, e.g., from 3-5
  million to 10 million minimum
• Equity funds on sidelines unless price decreases
  and/or owner agrees to greater percentage of
  purchase price in seller notes
• High net worth individuals have curtailed private
  equity investing due to the significant drop in
  the stock market

15
II. Capital Markets Overview Venture Capital
Financing

• Venture capital funds bracing for worst year in
  three decades
• Many portfolio companies cannot go public and/or
  raise new private capital
• Public market valuations lower than last private
  equity round
• Balance of power has shifted from company to
  investor
• Focus on structuring investments to minimize
  future problems
• Down rounds from prior investment funding
• More onerous terms
• Ratchets, repricings and liquidation preferences
• Later stage funds tie current valuation to future
  IPO valuation
• E.g., in the event of liquidation, investor(s) in
  current round may require full repayment (and
  possibly a minimum rate of return) before any
  other earlier investor(s) receive any proceeds

16
II. Capital Markets Overview Future of Private
Equity

• Private equity statistics
• 165 billion in private equity raised in 2000 vs.
  12 billion in 1990
• 620 private equity funds in 1999 vs. 387 in 1989
  and 95 in 1980
• Average size of funds 217 million in 1989 vs.
  86 million in 1989
• Average returns of 60 during 1998 2000
• Collapse not limited to Internet related
  businesses or small dollar investments
• Regal Cinemas (KKR, Hicks Muse)
• Winstar, Teligent (Telecom)
• Many funds not expected to survive

17
II. Capital Markets Overview Future of Private
Equity

• Difficulty raising new funds
• Stock market decline
• Lower realized returns
• Uncertain future economic environment
• Pension funds (primary supplier of private
  equity) have reached allocation limits
• Result
• Lower target amounts (e.g., KKR)
• Cancelled funds (e.g., Crosspoint - 1 billion)
• Equity returns over the next several years will
  be much lower and holding periods will be longer

18
II. Capital Markets Overview Conclusion

• Increased amount of equity required to complete
  transactions
• Higher weighted average cost of capital
• Must decrease purchase multiples for deals to
  make economic sense
• Potential sellers do not want to accept lower
  purchase multiples
• Recent decline in cash flow multiples from 5-7x
  to 3-5x(less impact on larger companies)
• Low asset base businesses will be at lower end of
  range
• Larger industry buyers may still pay premium for
  acquisitions that promise significant synergies
• MA market is still alive however, significant
  decrease in MA activity for small and mid-market
  companies
• Difficult and complex market conditions require
  guidance of experienced financial advisor to
  complete transactions

19
III. Recent HFBE Transactions Corporate
Finance Transactions

• Andress Walsh
• Niche equipment rental business
• Targeted single buyer
• Negotiated earnout bonus
• Working capital adjustment
• Increased buyers original offer by approximately
  1 million
• Dunn Equipment
• Heavy crane rental business
• Asset vs. stock purchase issues
• Tax solution

20
III. Recent HFBE Transactions Corporate
Finance Transactions

• Wacom Products
• Radio communication products
• Sale during regulatory changes
• Numerous strategic alternatives
• Geographic location issues
• OMS Partners
• Consolidation of 24 oral surgery practices
• Financial advisor set valuation and exchange
  ratios

21
III. Recent HFBE Transactions Corporate
Finance Transactions

• HFBE was retained to assist in restructuring
  certain convertible notes and refinance the long
  term debt of a fiberglass products manufacturer
• Mediated negotiations between the company and the
  investors in the convertible notes
• Prepared a financing memorandum, contacted
  various debt financing sources, negotiated the
  terms of the financing and assisted management
  with closing (pending expected closing June 30)
• Difficult financing given the relatively smaller
  transaction size, large real estate component and
  high leverage
• Leveraged acquisition of a fiberglass products
  manufacturer
• Assisted buyer with structure, negotiations with
  seller and financing
• Completed private equity placement
• Arranged senior debt financing
• Represented investor group on Board of Directors

22
III. Recent HFBE Transactions Fairness and
Advisory Opinions to ESOP Trustees

• Watson
• Food distribution
• Sale of company
• Retained after deal negotiated
• Forced renegotiation
• PM Holdings Corporation (Purina Mills)
• Animal nutrition products
• Over 1 billion in revenues
• Sterling Group LBO
• Sale of company

23
III. Recent HFBE Transactions Fairness and
Advisory Opinions to Other Fiduciaries

• Texas Olefins
• Petrochemicals and additives
• Over 500 million in revenues
• Represented trust for minority shareholders
• Hired outside consultants for industrry analysis
• HOPCO
• EP business
• Financial advisory to trust (majority owner)
• Evaluate business and recommend strategic
  alternatives

24
III. Recent HFBE Transactions Fairness and
Advisory Opinions to Other Fiduciaries

• Trustees of a large family trust
• Contemplated private equity investment by the
  trust in a privately held consumer products
  company
• Certain beneficiaries of the trust had requested
  the trust carve out a small percentage of its
  assets for alternative investments
• Trustees were concerned about the structure and
  risk level of the investment
• HFBE assisted in due diligence, valuation of the
  business and structure of the investment

25
III. Recent HFBE Transactions Fairness and
Advisory Opinions to Board of Directors of
Publicly-Traded Company

• Synagro
• Waste and residuals management
• 250 million equity commitment
• Formula based valuation
• Full draw of capital results in change of control
• Pinnacle Global Group
• Financial services holding company
• Merger of investment banking subsidiary
• Issued new shares representing 50 ownership in
  combined company

26
III. Recent HFBE Transactions Fairness and
Advisory Opinions to Boards of Directors

• 100 million revenue oil service client
• 30 million equity funding commitment toward
  future acquisitions
• Complex transaction involving a one year
  commitment, variable amount of warrants, fixed
  purchase price and pre-emptive rights for
  existing shareholders
• Opinion requested since the company had several
  existing institutional investors, the commitment
  was from a new investment fund, and management
  was seeking a third party opinion on the
  transaction
• 20 million market cap publicly traded medical
  services business
• Transaction involved a controlling equity
  investment and additional future funding by a
  large (200 million value) privately held
  technology based holding company
• Acquiror held various ownership interests in 20
  different technology and medical related
  businesses
• In rendering our opinion, we valued each of the
  investments of the holding company as well as the
  publicly traded business

27
III. Recent HFBE Transactions Financial
Advisory / Strategic Alternatives

• Midas Rex
• Manufacturer of surgical instruments
• Company owned by two families
• Represented one family in sale of company
• After receiving offers, right of first refusal
  exercised by other family
• Timber Tech Texas
• Truss manufacturer
• Three non-active investors owned 50 of business
• Evaluated business and negotiated sale of
  interest to the company

28
III. Recent HFBE Transactions Current Projects

• Engineering and placement services business for
  the energy industry assisting in evaluating
  and financing an acquisition
• 20 million distributor of process control
  systems and automation products representing
  company in evaluating, negotiating, structuring
  and financing selected acquisition targets
• New private equity fund financial advisor and
  assisting in fundraising
• Landscape services business assisting with the
  recapitalization or sale of the company
• Advertising and public relations business owner
  succession alternatives possible sale to
  management