Capital Markets

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Capital Markets The Construction IndustryEd
Klinger, BMO Capital MarketsRick Kress, The
PrivateBankTim Hall, CapitalSource

• October 2008

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The Orderly Markets..
Are acting like Moe, Larry Curley!
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Future?
If We Knew the Future, We Wouldnt Be Bankers!
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Instead, Lets Shake the Magic 8 Ball
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Sticking To What We Do Know
CAPITAL SPECTRUM
Senior
Junior
Mezzanine
Equity
Senior Debt
Expensive
Cheaper
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Senior Bank MarketsRick Kress, The PrivateBank
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What Exactly Caused This?
Net Percentage of Banks Responding Tightening
Credit Standards
Factors Causing Unprecedented Tightening

• Writedowns and further exposure to
  mortgage-related securities / commercial real
  estate
• Writedowns and further exposure to leveraged
  loans
• Writedowns and further exposure to SIVs / auction
  rate securities
• Meltdowns in the commercial paper market
• Weak economic data and recession fears

Source The Federal Reserve Board
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This is Cyclical
Not the first time banks have tightened, wont be
the last
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Current State of the Bank Markets

• Dramatic slowdown since third quarter 2007
• Nonetheless, 2007 was a record year with 1.7
  trillion of syndicated loan volume
• However, 1Q - 3Q 2008 volume is down by over 50
  from 1Q - 3Q 2007
• 1Q - 3Q 2007 volume was 1.3 trillion vs 0.6
  trillion in 1Q - 3Q 2008
• Investors remain cautious
• Cost of funding for most banks has increased
  dramatically
• Nearly all regional banks have tightened their
  lending standards
• Significant capital constraints
• Poor economic outlook impacting lender behavior
  and liquidity in the bank market
• Result is upward pressure on pricing and fees,
  tighter loan structures, and downward pressure on
  hold levels

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Current State of the Bank Markets

• Relationships continue to drive the bank loan
  market
• Unfunded credit facilities exert significant
  pressure on banks overall relationship returns
• Banks have demonstrated a willingness to commit
  to credits with returns below their internal
  hurdle rates, only if the prospects for retaining
  and/or gaining ancillary business are clearly
  visible
• Returns on new deals are being weighted against
  buying discounted loan paper in the secondary
  markets
• Not withstanding the above, middle market (EBITDA
  lt 50 million), non-levered (Total
  Debt/EBITDA lt 3.0x) transactions continue to get
  done, though much slower
• Well structured, well priced transactions
• Solid Borrower track record
• Sensible use of funds
• Support from relationship lenders

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Middle Market Syndicated Loan Volume
Total Middle Market Volume by Year
in Billions
Defined as Issuers with EBITDA of 50 Million or
less Source Standard Poors Loan Commentary
Data
12
Middle Market Loan Pricing

• The second half of 2006 and the first part of
  2007 saw record low spreads for non-levered deals
• Then Libor 200 or less
• As the middle market feels the effects of the
  credit crunch, spreads on non-levered deals have
  increased
• Now Libor 300 or more
• While pricing is certainly higher for non-levered
  deals, levered deals are much higher
• Levered spreads L 450 or more
• Availability of credit for middle market issuers
  has not been as affected as those in the large
  corporate market as most deals are done on a
  club basis among relationship banks
• Even these club lenders are demanding higher
  spreads

Spreads are increasing
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Middle Market Leverage
Rolling Three-Month Total Debt/EBITDA and Senior
Debt/EBITDA Ratios
FOR ISSUERS WITH 50MM OR LESS IN EBITDA
Total Debt/EBITDA
Senior Debt/EBITDA
Excludes Media and Telecom Source Standard
Poors Loan Commentary Data
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But What About the Construction Industry

• Typically not as levered as other industries due
  to bonding and cyclicality
• Banks still the largest source of acquisition
  debt for this industry
• Constraints on acquisition leverage in 2006 /
  2007 have kept balance sheets relatively sane
• Strategics are more averse of leverage than PE
  Groups
• Leverage only retreated about 0.75x to 2.5x
  3.0x compared to a 1.5x retreat for the overall
  market (2007 vs. 3Q 2008)
• Banks and sureties continue to look at different
  financial metrics which can make loan structuring
  difficult
• Sureties not as worried about collateral, want
  Tangible Net Worth
• Banks show me cash flow! Tangible Net Worth is
  just a number

CE Balance Sheets remain relatively healthy
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Equity Contribution

• Average equity contribution to LBOs now
  averaging 44 (vs. 33 in 2007)

Average Equity Contribution for Leveraged Buyouts
44.0
41.9
40.6
40.0
39.5
37.8
35.7
35.1
33.6
32.9
32.1
31.7
30.0
26.2
25.2
23.7
22.9
Equity as a Percent of Total Sources
22.0
20.7
13.4
9.7
7.0
Source Standard Poors Loan Commentary Data
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How Banks Structure A Loan

• When participating in a loan, banks now, more so
  than before, consider the all-in-return (what
  ancillary business can I cultivate from the
  company)

Its a Balancing Act
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Sample of Key Terms
General Parameters
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Mezzanine MarketsTim Hall, CapitalSource
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What is Mezzanine Debt?

• Subordinated debt or preferred equity
• Ranks behind senior bank debt but above equity
• Higher cost than senior bank debt
• Structure
• Cash interest
• PIK interest
• Ownership via warrants
• Primarily used in leverage buyouts

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Benefits of a Mezzanine Financing

• Deep and aggressive market
• No amortization, bullet maturity
• Structured as senior subordinated notes or
  preferred stock
• Less restrictive covenants
• Priced well below private equity returns
• Equity co-invest or warrants might be required
• Buy and hold mentality total return approach

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Mezzanine Market Update

• Continued expansion of mezzanine providers
• New entrants (Carlyle, BlackRock Kelso)
• Numerous hedge fund entrants
• Follow-on funds (Blackstone-II, Hancock-III,
  Audax-III)
• While low to mid-teens all-in coupon structures
  were the norm 12 months ago, mid-to-high teens
  returns are standard today with the potential
  need for an equity co-invest or warrants
• Transaction size normally ranges from 15 million
  to 200 million

Recent upward pressure on returns, but not nearly
as affected as the rest of the credit markets
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What Mezzanine Investors Generally Look For

• History of profitable operations and margins that
  meet or exceed industry averages
• Solid revenue growth and diversified cash flows
• Proven and experienced management teams that are
  financially motivated through equity ownership
• Leading and defensible market positions
• Ability to support a current pay coupon and pro
  forma debt levels

Strong appetite for growing, profitable companies
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Summary of Key Terms
Mezzanine Debt
Unsecured subordinated obligation
Ranking
5 - 7 year bullet maturity
Maturity
None
Amortization
Similar to senior credit facility, but 10 - 15
less restrictive
Covenants
Typically NC2, 105 in year 3, declining annually
thereafter
Prepayment
15 - 19
Total Return

• 2.0 - 3.0 closing fee
• 10.0 - 12.0 cash coupon
• 3.0 - 7.0 PIK coupon and
• Equity co-invest or warrants, if
• necessary

Components of Total Return
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Summary of Key Terms
Mezzanine Debt
Senior Debt
Unsecured subordinated obligation
Senior Secured
Ranking
5 - 7 year bullet maturity
3 - 5 years
Maturity
None
None if Revolver Term Loan amortization depends
on use of Funds
Amortization
Similar to senior credit facility, but 10 - 15
less restrictive
Debt / EBITDA Fixed Charge Ratio Tangible Net
Worth
Covenants
Typically NC2, 105 in year 3, declining annually
thereafter
Allowed, with no penalties
Prepayment
15 - 19
Depends on each bank
Total Return

• L 300 450 bps (cash coupon) and
• 1.0 - 3.0 closing fee
• 3.0 LIBOR floor

• 2.0 - 3.0 closing fee
• 10.0 - 12.0 cash coupon
• 3.0 - 7.0 PIK coupon and
• Equity co-invest or warrants, if
• necessary

Components of Total Return
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Equity and MA MarketsEd Klinger, BMO Capital
Markets
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Public Comparable Stock Performance
3 Year Relative Price Performance
Index Members
CONSTRUCTION Granite Construction (GVA) Perini
Corp. (PCR) Sterling Construction (STRL) DESIGN
ENGINEERING Aecom Technology (ACM) Stantec
(TSXSTN) Tetra Tech (TTEK) INTEGRATED Chicago
Bridge (CBI) Foster Wheeler (FWLT) Fluor
(FLR) Jacobs Engineering (JEC) McDermott
(MDR) Shaw Group (SGR) URS Corp. (URS) SPECIALTY
INDUSTRIAL Comfort Systems (FIX) EMCOR Group
(EME) Dycom (DY) MasTec (MTZ) Matrix Service
(MTRX) Quanta Services (PWR)
Indexed Value
44.1
28.1
27.3
(15.9)
(17.3)
Source Factset Note Updated as of October 14,
2008
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Publicly Traded Valuations
EV / EBITDA
EV / EBITDA
Note See previous page for index members
3 Year Historical EV / EBITDA
Historical Averages
Construction 8.5x
EV / EBITDA
Design Engineering 12.3x
Integrated 13.8x
Specialty Industrial 11.8x
Note See previous page for index members
updated as of October 14, 2008
Valuations have declined with the rest of the
market
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Public vs Private Valuations

• Public valuations tend to be higher than private
  MA transaction multiples due to
• Short-term outlook of Wall Street vs longer-term
  cyclical outlook of acquirers
• Size discrepancy breadth of service
  capabilities
• Multiple end markets and geographic focus tend to
  smooth results
• Access to multiple sources of capital provides
  investors with comfort
• Valuations across sub-sectors limited by
• Bonding requirements sureties focus on tangible
  net worth
• Cyclicality of industry sustainability of
  earnings
• Vulnerability of problem jobs

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What Drives Value?

• Companies with lower project risk higher
  recurring service revenue
• Design Engineering firms vs. Contractors
• Maintenance vs. New Construction
• Hot end markets including
• Industrial maintenance and turnaround
• Environmental
• Energy/Power
• Infrastructure
• Healthcare
• Education

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Why the Interest?

• Buyers have access to capital
• Geographic expansion
• Shortage of skilled labor
• Diversification of services
• Diversification of end markets

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U.S MA Activity Down nearly 43 in 2008
U.S. MA Activity
Volume ( in billions)
Private Equity Activity
Source Thomson Reuters
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EC MA Activity

• EC MA Activity Overview
• Robust volume dominated by large number of small
  deals
• 30 of EC deals have a disclosed value
• Over 60 of 2007 deals with disclosed values were
  under 25 million with a median deal size of
  17.3 million
• 1H 2008 MA activity on track with 2007 total
  transaction values lower due to lack of large
  deals
• Activity driven by
• Solid fundamentals
• Availability of private equity capital needing to
  be deployed at reasonable multiples
• Strategics flush with cash

Total Number of EC Deals
Number of Deals
EC Deals with Disclosed Values
Value of Deals
Number of Deals
MA activity within the EC sector remains strong
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EC Buyers Overview
Strategic North American
Strategic International
Private Equity

• Strategic buyer interest will be driven by one or
  more of the following factors
• Expertise and capabilities
• Service offerings
• Geographic coverage
• Customer relationships
• Ability to recognize and pay for potential
  synergies
• Current strong public market valuations may
  provide public acquirers with a valuable currency
  and create a strong ability to pay

• International buyer interest will be driven by
  one or more of the following factors
• Grow existing operations in U.S.
• Entrance into the U.S.
• Customer relationships
• Expertise
• Weak US will help to attract foreign buyers
• Synergies may be limited unless buyer already has
  North American presence

• Financial buyer interest will be driven by one or
  more of the following factors
• Market leadership
• Strong management
• Growth opportunities
• Platform for acquisitions
• Investors value growth and cash flow generation
• Valuations limited by targeted returns and lack
  of synergies
• Leverage limited by bonding requirements and
  credit crunch

Focus on strategic fit and
geographic expansion
Focus on North American footprint
and access to customers
Focus on cashflow characteristics, platform and
quality asset
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Private Equity Ownership
Private Equity Ownership

• Access to growth capital
• Management usually continues to run the business
• Shareholder liquidity (cash offers)
• Potential synergies with any existing CE owned
  firms
• Significant amount of capital waiting to be
  deployed

Positives

• Few Private Equity firms truly understand the CE
  space
• May potentially lose equity upside
• Usually increases leverage sureties need to be
  comfortable
• Hold horizon may vary return driven

Issues / Concerns
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Equity Contribution

• Average equity contribution to LBOs now
  averaging 44 (vs. 33 in 2007)

Average Equity Contribution for Leveraged Buyouts
44.0
41.9
40.6
40.0
39.5
37.8
35.7
35.1
33.6
32.9
32.1
31.7
30.0
26.2
25.2
23.7
22.9
Equity as a Percent of Total Sources
22.0
20.7
13.4
9.7
7.0
Source Standard Poors Loan Commentary Data
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?? Questions ??