Valuing a Cross-Border LBO: Bidding on the Yell Group By Friday April 13, 2001, the team from Apax Partners and Hicks, Muse, had been working around the clock all week, They were preparing their investment pro- posal for the largest European leveraged buyout transaction ever executed by a finan- cial buyer: the acquisition of Yell Holdings from British Telecom (BT), Hicks Muse and Apas, tvo of the biggest names in the global private equity industry, had joined forces to acquire the directories business of BT, a business that owned and operated assets in both the United Kingdom and the United States. The team was under pressure to reach a final consensus on the valuation of Yell and how much to bid for it. The deal was cru cially important to both Apas aud Hicks Muse because of its high visibility—simnply by virtue of its size and complesity, it woul leave its mark on the: reputations of both pris vate equity firms, Pate & Furst The valuation of Yell was complicated by the cross-border nature of the deal, Yell consisted of two main assets: BT Yellow Pages, the market-leading classified directory business in the United Kingdom; and Yellow Book USA, the market-leading inde- pendent publisher of business directories in the United States. Not only were those businesses located in different markets, but they also were had by different growth rates and cash flow characteristics. Further complicating matters, each business unit faced an immediate uncertainty. The U.K.'s Office of Fair Trading (OFT) was reviewing BT Yellow Pages's leading position in the classified directories advertising services market. ‘The OFT was expected to recommend the imposition of a limit on the annual increase in rates for advertising, thereby affecting BT Yellow Pages’ valuation. It was critical to understand how much value was dependent on such regulatory imposition, At the same time, Yellow Book USA’s management was projecting continied rapid expansion into new markets, Their financial forecasts were based on sustained future growth and high EBITDA margins from the business. The Apax and Hicks Muse professionals noticed Professor Mihir A. Desai, Paolo Notarnicola (MBA ‘02), and Research Associate Mark F. Veblen prepared this ease. Certain details have been disguised. HBS eases ure developed solely as the basis for class discussion. Cases are not intended to serve as endors effective or ineffective management, ts, sources of primary data, oF illustrations of Copyright © 2003 President and Fellows of Harvard College, To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing. Boston, MA 02163, (oF go to http:/Awww bsp harvard.edu. No part ofthis publication say be reproduced, stored in a retricval sgstem, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical photocopying, recording, or otleriso—without the permission of Harvard Business School 203204 * Chapter 10; Valuing a Cross-Border LBO: Bidding on the Yell Group the as of significant investment to expand the business, and they wondered how sensitive the value of the combined entity was to these assumptions. Two investment banks, Merrill Lynch andl CIBC World Markets, had been chosen as partners for the deal. Provisionally, they would lead a syndicate contributing £1.45; billion of total debt to finance the acquisition. This borrowing would take the form of ££950 million in senior debt and £500 million in bridge loans to be repaid with the pro- ceeds of a future high-yield offering, BT would also contribute £100 million in the form of vendor loan notes. With the banks’ documentation and all business projections in front of them, the two private equity groups had to decide whether to proceed further with the deal and, if so, how to arrive at an appropriate hid, The clock was ticking, and the Apax/Hicks Muse team needed concrete answers. How much was Yell worth? How muck to bid? And, most importantly, was the Yell buyout a good deal for Apax Part- ners and Hicks Muse? THE SPONSORS Apax Partners and Hicks, Muse, Tate, & Furst were among the leading private eq groups in the world.! Apax Partners was formed in 1977 when MMG (founded in 1972) joined forces with U.S.-bused Alan Patricof Associates (forded in 1969). By 2001 Apax managed almost $12 billion on behalf of leading institutional investors around the world. The firm had 150 investment profedsionals operating in 10 countries across Europe, s+ racl, Japan, and the United States (through Patricof & Co. Ventures). Apax had a strong track record in the telecoms and media sector, with investments including Juertel, The Stationery Office. Future Publishing, anid Ginger Media Group. In 1999 Apax Funds acquited TDL Infomedia, Yells main competitor in the United King. ntly sold to SEAT Pagine Gialle in 2000 for a transaction vale ity dom, which it subsequ of 745 million « The Dalhas-hased Hicks, Muse, Tate & Furst raised its initial fund in 1989, Since its inception, Hicky Muse had invested approsimately $10 billion of equity capital in over 65 platform ined transuction values exceeding, $50 billion, After opening its Enropean office in London in 1998, the firm was looking to expand ils preseace on the continent, AL that time, Hicks Muse was the largest private equity media owner in the world, with more than $4 billion invested in media sector transactions. Among Hicks Muse's key: me dlia investments were Clear Channel Communications, LIN Television, Davivo. In- ternational, Mandeville Cable, International Outdoor Advertising, Marcus Cable, and Claxson Interactive Group. Hicks Muse had amade a number of acquisitions in En= rope including Media Capital, a Portuguese company with activities in television, r prtfolio investments and over 300 add-on acquisitions with com= wines. The firm had recently declared its return toa "back- to-hasies” strategy. which meant investing in media, branded consumer goods, and icturing. industries weed one of the kargest European private: equity fines, worth €44 bile 1 to help pay alio, nesespapers, and Apay mana lin, while Hicks Muse would use its $1.5 billion dedicated European for the: purchase, should the deal he close This setion is Based on the Offering Memorandhnn for the high-yield offering, “Yell Binance BY'.7 Ave st 2001, Mernll Lonel Intersational Sele Book-Runninue Manager) andl CHC World Markets (Joint eal Mansawer. 3: al the follwing press chppings: “Twn Inynnt firms vill aire Yell of Britain Ihe New York Times. May 2%. 2001, aud “Hicks. Apsy Take: Voll fon IES Brats, Jame 2087Yell Group Limited # 205 (HE EUROPEAN PRIVATE EQUITY MARKET Compared to the United States, the private equity market for karge transactions in Ee Pope was still at an early stage (see Exbibit | for a recent history of European L1BOs) Nevertheless, inereased attention from major players was bringing more competition into the market, Suecessfil European funds (e.g, BC Pattuers. CVG Capital, Sclioder Veutures) were augressively targeting yrowth and sestructuring opportunities mainly the United Kingdom, Prance, ane ¢ the same time, some af the most promt nent U.S. priv Hs moving into Kuvape. In particular, U.S. bat aund private equity investors were shifting portfolios toward Enrope hecause of a belief that Europe would in time mirror the size and depth of the U.S. buyout market Critical to the development of the European buyout market was the yaoswth of the Eu ropeun high-yield debt narket—the preferred instrument for financings these large lever aged acquisitions. Even though issimice was expected te incr two years, the Europe i: equity finds we we significantly in the nest high-yield market was still developing as an asset ches (see Eshibit 2). European high-yield inarkets did not offer cither the diversification (honds from telecoms, media, and cable companies made up almost 70% of the market value in 2000) or the depth (there wats little liquidity in the European secondary market) ofthe US, mare kets, This exposed investors to ar ly lowered pricing levels because small announts of selling pressure could lel to plummeting hond prices? ter risk (and therelore ger By the middle of 2001, the high-yield fines he ‘gin to experience net inflows, and fresh capital was being paced into: new issues, Goldman Sachs's high-vield indices showed that spreads on high-vield debt had bogsun to reverse their steady increase since Fobriary (see Exhibit 3). In partic spreads o CCC-ratedl paper were declining sharply. Some analysts interpr edd suck data as evidence of ineressing investor tisk ap- petite in the market? Indeed, « recon issue of almost $560 million was planted in Mas for Messer Grieshetin, the industria gases company in which Allianz Capital Partners nd Goldman Sachs had bought a two-thirds share at the beginning of 2001, A €220 tmiliion issue that your to finance the buyout of United Biscuits by Cinven, PAL Man- agement, and DB Capital had also heen very suecesstl ‘ELL GROUP LIMITED Yell Group Ltd, was the company to be created to act as a holding company’ for the Yellow Pages business in the United Kingdom and the Yellow Book business in the United States. British Telecom, under pressure to reduce its heavy debt load, had been wavering for months about the future of its two Yellow Pages divisions Investors in BT, one of the giants in the European telecommnnication industry, were concerned about BT's high leverage and the generally adverse conditions BT was fueing inthe tele- com market. Year-to-date its stock price had declined 15% compared with a 5% drop nthe FTSE 100 stock index. (See Exhibits 4 and 5 for a history of finanedal results and stock price performance for BT.) Shortly before Apax and Hicks Muse had initiated talks with BT executives about the future of Yell, the telecom giant had announced plans to raise £11 billion by selling See “Brightness fading fast” The Financial Times, November 1, 2000 available on li Iep//specials.& com, rn "Dresdner Kleinwort Wasserstein Research report, “Gre Wasserstein, pp. 67 (Check May 24, 2001, Dresdhier Kleinwort “Anjana Menon and Tom Bawden, “Hicks Muse, Apas eut offer for BT Yellow Pages: Yell unit forced to lowor ad rates," National Past, May 25, 2001; Charles Pretik, “BT looks ready to sell Yell lor GBP 2hn, The Financial Pines, May 25. 200190% EXHIBIT 1 EUROPEAN LEVERAGED BUYOUTS FOR A TRANSACTION VALUE OVER $1 BILLION, 1999-2001 Date ns2001 axovor oy 3500 oven oration 0222/0 x 205d 022000 Faithar Mosser Griesheinn Ganbl i I Mealtheare Group. Tomkins PLC North Bhine Westphalia United Biscuits Zewoea Specialties wWithaw Hill Sourve: Thomson Financial Securities Data Industrial gases Chemicals Hoypitals Food manufacturing Cable network Food! manalactarin Chemica Botting shops Atlan Capital. Goldman Sachs Kohlbong Kravis Roberts & Company BC Partners Dont Hanson & Conspany Callahan Associates Intersational PAL Management, Cinven, DK Capstal ven, Investeorp Cinvon, CVE Capital Partners 2,100 1,337 Value ‘Target Name Acquirors (S millions) __Debt Providers Paabs and bars Siongin Grenfell Private Equity 2.538) Lehman NA ‘Chase Manhattan, Merrill Lynch, Goldman Sachs Morgan Stanley JP Morgan Salomon Smith Barney Denische Bunk, DLJ European Private Equity Chase Manhattan, The Industrial Bank of Japan ‘The Industrial Bank of JapanYell Group Limited © 207 EXUUBIT 2 EUROPEAN AND U. TOP 10 UND! IGH-YIELD BONDS ISSUANC ERS IN 2000 illions) Share (%)* Credit sve First Boston 7 3.115 4.34 Merrill Lynch 6 Mut 12.6 GitigrompiSalomon Suith: Barney ‘ 07 100% JP Morgin 3 8 99% Goldinan Sachs A 7H S24 Lelia Brothers 3 269 30% Drescher Kleinwort Wasserstein 1 aL 26% ABN AMO. 1 198 22% CIBC World Markets 1 193, 21% Morgan Stanley 1 la 1.6% US Market ‘Credit Suisse First Boston 26 6913 20.3% Golda Sachs 2 15st 13.4% Morgans Staley 5 1492 2a CiigroupSalonon Sith Busey 16 4.366 Raw JP Morgan 5 s1% Deutsche Bank 13 73% Bane of Anerien Securities " at Mersll Lynch 9 5.2% Lelunan Brothers 6 49% UBS Warlnarg 4 22% “Basel on Share of totais in 2000 by all wudenesiers | Sources Thonn Financial Securities Data assets and shares as it tried to pay down some of its £28 billion of debt? In addition to an outright sale, BT had considered a demerger of the directories business or a partial stock market floatation, According to The Financial Times, the Apax/Hlicks Muse eonsor- tium was just one of at least three groups understood to have approached BT about Yell Another private equity consortium, inchiding Kohlberg Kravis Roberts and Texas Pacific Group, was aso interested, as was SEAT Pagine Gialle, the Italian Yelleny Pages business. The most serions competition for Apa/Hlicks Muse and the other groups promoting buyout came from the possibility of a demenger, which would result in a separation of the directories business (Yell) from BT followed by a distribution of 90% of the shares of the di rectories business to existing BT shareholders. In the demerger scenario, Yell would have cartied up to £1 billion of BT debt ¢ nce sheet. A floatation of up to 20% of the directories business would have raised up to £1 billion, but was no longer under con- sideration because ofthe recent deetine in stock prices. Investors, however, seemed to pre- {eran outright sale, welcoming the prospect of more than £2 billion of eash flowing into BT fo its own bal SBT reported £121 billion of tous and other borrowings embedded in net current assets ‘Apas and Hicks Muse head consortium to buy Yell” PrivateEguityOnline com, Apell 3, 2001, (ht// wom privateequitonline-conv); Clive Mathieson, “BT holds talks over Pounds 2Sbn trade sale of Yell” The Times (London), Apri 6, 2001208 + Chapter 10: Valuing a Cross-Border LBO: Bidding on the Yell Group EXHIBIT 3 SPREADS ON THE GOLDMAN SACHS EUROPEAN HIGH-YIELD INDICES (BASIS POINTS) 3,000 ----cCC. ——B 2,500 2,000 1,000 SS 500 0 +}, —_— Oct-00 Nov-00 Dec-00 Jan-01 Feb-01 Mar-01 Apr-01 Source: Bloomberg, BT Yellow Pages BT Yellow Pages was a series of annual, regional, chissified directories that listed the name, address, and telephone number of substantially all business telephone snbseriber in the United Kingdom. The listings were organized into over 2.500 available classifi cations; with more-thanr-one-classificatione patentially applicable terac business. Hav che 2000 fiscal year (ending on Mareh 31). BT Yellow Page ies contained $13,000 advertisements for approximately 390,000 advertisers. That represented nearly 85% 0 the U.K, classified dircetories advertising revenues 1s directYell Croup Limited + 209 EXHIBIT 4 1996-2000 (POUNDS IN MILLIONS, EXCEPT PE! ELECTED HI DRICAL FINANCIAL INFORMATION, SHARE DATA) Yeary Ended 31 March 1997 1998 199) 2000 2001 Income Statement Total turnover Total operating pr Profit on sale of Net interest payable Profit (loss) before taxation Profit (loss) after taxation Minority interests Profit (Loss) for th Basie earnings (loss) per share Gash Flow Statement Sash flow from op Dividends from associa 879 1AM 18,228 21,003 29.666 roti (loss) 3,461 3A74 3,198 (336) sed assets 63 1,107 126 oy (ay) (286) 1383) 3 3214 1.295 2.942 (L031) 17! 3,002 2.05 11,683) (25) ay 10 (137) 1 nancial year 1,703, 2,983 2,055 (nsi0) 26.6p. 416.3p 317p perating activities 6.185 6071 6.035 5.819 san! JVs 7 5 2 5 Investment Return & Finance Servicing (160 2h) (163) Favation paid (1045) 1SS6) (630) asi (66) -apital expenditure and investment (2.820) (3.108) 1 is Acquisitions and disposals (252) (1501) 1967) 137: Equity dividends pail ) 1186) 1.364 432 Management of liquid resources Go1) 2207 (ui) 1.236 450 em L794 458) 5.959 tus. ner. (deer. in eash for the year (90) ay o at 12s Deer. (iner.) in net debt for the year S19 (3.860) 3.146 (6.582) (18.942) Balance Sheet [ntangible fixed assets NA 18,380) Tangible fixed assets 16,802 Fixed asset investments 1273 1.832 5.204 Net current assets (liabilities) (495) (11,143) LT loans and other borrowings (3889) (3.386) as, Provisions for bailities & charges (139i) (1.426) (1.391) (1,056) (723) (208) 23) (216) (498) (499) Total equity shareholders’ funds 11,116 10,785 14,940 15,795 14,069 Total assets 25,062 23.285 27,962 37588 54,799 Source: British Tele Yellow pages advertising expenditures tended to be more stable than other forms of media advertising and did not fluctuate widely with economic cycles. They were con- sidered a “must buy” by many small and medium-sized businesses since the yellow pages were their principal means of reaching customers in the United Kingdom. The strength of the yellow pages as compared with other forms of advertising lay in its consumer reach, lasting presence, and cost-effectiveness. The following table illustrates the growth of the classified directories market in comparison to the overall advertising market in the United Kingdom.210 + Chapter 10: Valuing a Cross-Border LBO: Bidding on the Yell Group Taste A Growth in the Advertising Market, 1985-1999 Classified Directories Advertising Market Total Advertising Market 1955-1999__ 1985-1995 1996-1999 1085-1990 «1985-1905 1996-1 Nominal 4% «10% 66% 19% 79% 8.06 Real 6.1% 7.0% 38% 3.7% 3.1% 5.19 Source: Apax Partners, adspted by easewriter ‘The economics of the business were dependent on the number of advertiseme sold in a given year and the advertisements’ prices, Such prices varied according to ferent types and dimensions of advertisements, Premium options upgraded the appr nce of advertisements by adding bold fice or color type and graphics. For an additic charge, special placement in the directory—on the back cover, for instance—ec be purchased. Management forecasted the business performance in terms of num of advertisements to be sold each year and average price per advertisement ( Exhibit 6). Management also provided estimates of costs for discounts and promotic other direet costs, and overhead costs together with working capital and capital exp ditures requirements for this business Regulation? In 1995, the U.K. Office of Fair Trading, the goverment ageney responsible far forcing antitrust policy, undertook a review of the classified dirvetories industry di concerns regarding the market position of BT Yeliow Pages. The Monopolies and Mc ers Commission investigated the issue and concluded thai BT Yellow Pages lied at hopoly position in the ckwsified directories advertising services market and that pri were “higher than would he the case if competition were effective. The Commiss nual increase in rates for advertis in BY Yellow Pages. For a period of three years, BT Yellow Pages could inerease average price of its advertisements by the inflation rate (ay inclicated by the official U Retail Price Index) mi to March 2001 In April 2001, the Office of Fair Trading began investigating the issue agi Many sourees indicated that the government agency would recommend a permit rate of growth in prievs of inflation less an even larger adjustment. Although Y Ihanagement way not as pessimistic, Apay/Hicks Muse speculated that the Offies Pair recommended the imposition of a 18 2%. ‘This had happened each year for three years leading rading would cap the advertising price growth rates al 6% below the inflat rate. In other words, starting from year 2002. the average advertisement price expected to decline since projections for inflation were 2.4% in 2002, 2.34 in 20 and 2.0% thereafter. As a result. the management's top-line revenne projecti« wonld have to be revised. The Office af Fair Trading was expected to sumone new recommendation for the following years soon, so it was crucially important *Oflering Memorandum for the: highsield alfering. “Yell Finnie HAN Sugst 6. 2001, Merrill neh lemrationa Sele-onks anninge Managerramb 21H Wr Marorasjome Deal Managers: *Monopoks and Mergers Commission report ob classified aking senvevs, chapter 1 " Atte competition-comanission ney nkirep_pulyeporty/19%b 3S3lassfieeb dn).Yell Croup Limited + 201 EXHIBIT 5 DATA (PENCE/SHARE) OM’S SHARE PRIC 200 | Jan-99 Apr-99 Jul99 Oct-99 Jan-00 Apr00 JulL0O Oct-00 Jan-Ol Apr-Ol ote: The PTSE 100 Index is indexed to the BT stock price on Janay 1. 1998, ‘ouree: British Telecom the sponsors to understand how sensitive the Yell uation was to the p lated by re; lators, ‘ellow Book USA Yellow Book was the market-leading independent publisher of yellow pages directories in the United States. In 2001, Yellow Book published 270 directories with a combined circulation of over 26 million copies in 18 states east of the Mississippi River. It had ap- proximately $330 million in revenues and $42 million in EBITDA. (See Exhibit 7 forzz EXHIBIT 6 v BT YELLOW PAGES—HISTORICAL FINANCIAL INFORMATION AND MANAGEMENT PROJECTIONS FOR THE BUSINESS, 1999-2005 (POUNDS IN THOUSANDS) Actual Actual ~—-Projected Projected Projected Projected Projected Projected Year 31-Mar-00 31-Mar-01 31-Mar-02 31-Mar-03 31-Mar-04 31-Mar-05 31-Mar-06 31-Mar-07 A Wertivement Volume (0008) 813 ry 991 1,058 1.136 1,194 1254 Weighted Average Advertisement Price (£) 641 645 648 649 649 649 640 Disconnts ancl ree ads (£000s) 86,585 84.324 86615 85,366 86,049 Direct costs (C000) 187.595 201742 206,649 1,278—214,996 216,716 Overhe casts (£000) sss70 T7137 79,013 80,783 82,204 82/862 Change in WE (000s 2 6,000 8.497 6,300 4375 2.023 Capes £0008 9,730 9,230 8,380 8,000 8,000 Depreciation (C0008 8.850 8,400 7,630 8,000 8,000 Capital cash Hos ater tases (€000s) 14566) (14.488) (5.238) 1,362 1,956 10,000 20,000" "Does not include depeveiation, of millions of pounds, Management, however, found i difficult to evaluate the cash di grove drasnatieally into the te Fsstarting i 2008, cash flows from Other UK, Businesses shos js rncertainty sueronnding those Future projections stream post tes: figures have been digs Sourees Apas Partners: easewsiter estiEXHIBIT 7 YELLOW BOOK USA—HISTORICAL FINANCIAL INFORMATION AND MANAGEMENT PROJECTIONS FOR THE BUSINE! 1999-2005 (DOLLAR FIGURES IN THOUSANDS) Actual Actual Projected Projected Projected —Proj ected Projected Projected Year Si-Mar-00 31-Mar-01 31-Mar-02 31-Mar-03 31-Mar-04 31-Mar-05 31-Mar-06 New launches (number) wa wt . 5 0 0 Total Revenues (5000s) 217,500 330,000 421,600 453.200 oun 658.590 Capex ($0005) 7.000 10.600 s.1t0 sow $.000) S00 Depreciation 7,000 6.240 zo 7.430 ssto S000) sa) Source: Apax Partners; casewriter estioates, fig res have been disguised214 + Chapter 10: Valuing a Cross-Border LBO: Bidding on the Yell Group historical financial information and management's projections for the business.) Britis: Telecom had purchased Yellow Book USA in August 1999 for $665 million The US. yellow pages market was @ $13 billion industry that had been growing a steady 4%-5% per year. The yellow pages were an important source of new busine for small to medium-sized enterprises (SMEs) throughout the country. It was estimate that 80% of consumer purchases in the United States were made within 20 miles fro heme. Recognizing this tendency, 75% of SMEs advertised in the yellow pages, The industry had been historically dominated by the Regional Bell Operating Con panies (RBOCs). RBOCs had continued to rely upon their well-established brands ar had grown directory revenues primarily through rate increases. They had general treated the directory business as & “cash cow” and had offered the dire service rather than a main vehicle for growth, The industry dynamics had be changing over the previous decade us independent directory providers had em Independents experienced a growth rate of 19.8% in 2000 versus 4.3% for the RBC and the independents were projected to increase their market share fron 11% to 30° over the 2000-2005 period. For Yellow Book, this growth was to be fueled by expat sion efforts such as launching new directories into contiguous markets and lamebir wide area books into cities without an independent presence. y as an adde slow New Market Launches Hoping to capture nich of the predicted sn cet share gains, Yellow Book's growt phus were ambitions. Although the Apav Hicks Muse team was confident that som organic growth could be achieved in the nest few years, they thought that an aggre sive strategy of new product Jiamches would have to complement organic growth ino ions on the revenne side. Asa result, they built se der to achieve imamagement proje feral neae Tamehes each ves into ther forveasts (sew Eshibit 7) Management expected EBITDA margins to increase as the portfolio mat their experience very low margins were achieved in the first your of operations Tamnches, Margins could improve significantly and almost matcl margins on organ of operations. Accordingly, the sponsors thong)it it importa reventies from new kunch revenues and only apple an EBITD sales inthe second ye to segregate ong margin to organic sales while separately adding in the impact of new kumches in orde to roll the: twa very different types of markets together. The sponsins believed that 17% EBITDA margin on organic sales was a more realistic target for 2002, improvin at a 2% inerease per year as business went mp until the 25% target rate was hit in 200 suid maintained thereafter Since the risk of a cold kuch was perceived to be too high in a new market sive at strong, incumbent publisher or hick of Yellow Book brand awareness, snanagemer tral opted in the past to give away advertising for one year for free. ‘Phis approach in volved identifying the advertisers in the incumbents’ books and providing then with Similar advertisement at no cost in the first year. This required an investment in diroe sales costs (list-year disconnts, free copies, promations, nel costs of prototyping) + around $4 million in the first year of each launch, ‘Phis initial-year investment was pra Ficularly significant when compared with first-year average revenues of $8.1 million fi each hnnch, Moreover, there was significant uncertainty aronnd these reventies figure the sponsors believed they could range between $3. amillion ant SH millions. s nie revenmes fron the res Apa Hicks Mase felt it necessary ter segregate out the or canes associated with new lanches, all of which management had rolled syp into a sinDeal Structure and Financing © 215 gle top-line forecast. ‘This approach also aiforded an opportunity to aive a more so. phisticated treatment to operating incase froin new kaunches, which coukd nat be de- rived as reliable from applying EBITDA iargins to new humeh revenues as eould EBEPDA fronvonginie revenues Working Capital He weas the orn in the U.S. and the U.K, to take a very stall up-front deposit and to bill the customer monthly over the [2 months post publication, Asa rule of thinly it would take TSO days (on averay to receive pavaient from customers, (A $34 million increase in working capital in 2001 had boo aust anomaly: stemming from the early stage of the bnsiness.) On the contrary, payables gement’s view —an turned over in approsintately one month Other U, . Businesses tw adldition to its core directory business, BT Yellow Payes cwned and operated four relatively small divisions in which the company liad invested E14 snillion in 2001, Those: siniess mittket + Business Pages: six directory editions aimed at the business-to- + Talking Pages: a 24-hour, telephone-hased, operatorassisted directory service # Business Databases direct nesses in the United Kingdom, ctinyg sand database: development services to busi © Yell.com: an interactive. constimer-Lucing. edition of Yellow Pages’ UK. listing elute, searchable by business type. company’ anatne, «ad postoude While the sponsors recognized that suc businesses could represent seme poten tial good opportunities in the future, projections over the five prospective investnent indicated that those businesses were still in their carly stages. (Exhibit 6 details the expected cash flow after taxes from other U.K. businesses.) time horizon of the DEAL STRUCTURE AND FINANCIN Merrill Lynch and CIBC World Markets had agreed to raise £145 billion of debt through £950 million of syndicated senior term loans and £500 million through a bridge loan to be refinanced via a high-yield offering on the U.K. and U.S. markets The senior term loans and bridge loan would be drawn down in full at closing to fund the acquisition. Apay/Hlicky Muse believed that the subsequent high-yield bond is stance to pay off the bridge loan would require a yield of between 10% and 11.5% Moreover Apav/Hicks Muse had arranged for an additional vendor loan from British Telecom for £100 million (see Exhibit § for a summary of debt terms and conditions) and @ £100 million revolving credit facility to provide a enshion for working, capital swings Exhibit 9 illustrates the planned corporate structure (devised by accountants PwC and lawyers Weil, Gotshal & Manges) and the company’s ownership following the buy- out, The new parent company, Yell Group Limited, would establish a wholly owned subsidiary, Yell Finance B.V., to act as the issuer of the high-yield offering, and this216 + Chapter 10: Valuing a Cross-Border LBO: Bidding on the Yell Group EXHIBIT 8 DEBT PACKAGE OFFERED BY M1 RRILL LYNCH—CBIC WORLD MARKETS (POUNDS IN MILLIONS) Debt Amount Interest Type Senior Term Loan A 2600) Libor® + 2.5% ‘Teyear amortizing” — —<—— Senior Term Low B Libor + 2.75% 8-year bullet =~ Senior Term Loan © Libor + 3.0% 9-year bullet —_— High Yield boned £500 10.75% expected 10-year instrument Vendor Loan £100 Libor (rolled) 12-year bullet Revolving Credit Facility £100 Libor + 2.59% undrawn at closing. “10-year LIBOR is 5.454 at the time 50 elon de Tent amotnts antl anatarity 1 the seconde ar, E75 millon in the third yes £100 million in the fourth year, and equivae “nverest wats tay dectible and accrual a floating ate of sicimenth sterling LIBOR. Interest accrued an tolled emer.” hunwever. i was ot payable til eecemmption Ln that sense it resembled « paysinckinel (PIK) sceusity Source: Adapted from Offering Mi EXHIBIT 9 femorandum, “Yell Finance BLN.” August 6,204: easewriter estimates CORPORAT PRUCTURE AND OWNERSHIP Menagement | Somos ————— Yel Group Limited aren) fen | Yottinence By] ‘asco ————— Yellow Popes Limited ‘cvararar ———— Yet Hing 2d Security and uararees fom : Sotain nen on OX, emo, US ve eperaing Holding Gompny ne companies forthe ‘Swans bene sen ere facies ve rouny ‘Company Subsidiary US Operating — Company Subsidiany Somurves Adapted fron Offering Mesnorandny “Vell Fiuanens BL" Angst 6 2040, py 22BIDDI Bidding for Yell © 217 subsidiary would in turw awn all of Yellew Py cs Limited, the holding company that would guarantee all of the senior notes. Through various other subsidiaries, Yellow Pages: Limited would own all of the operations of the former BT Yellow Pages and of Yellow Book USA. YellowPages tates seta: sof the high-vield-offering would-be sabor- dinated to its guarantee of the senior creclit fwcilities. Apa and Ticks Muse finds (the sponsor fuuds) would contribute 46.3% of the eq- uity cach, while 7.3% of equity was reserved! for managenent participating in the buy out. BT's vendor loan would provide €100 million in additional capital, Funding pro- vided hy the sponsors and BT would flow first iuto Yell Group Limited, the parent company, and then from Yell Groap Limited dawn to the U.K. and U.S. operating com panies. Fees payable to bankers, accountants, kiwyers, and equity: providers were ex pected to account for no more than 5% of the transuetion value. FOR YELL ‘The Apavtlicks Muse team had the weekend to prepare an appropriate valuation for Yell. First they huel to build their own projections for the U.K. and U they had to figure out which assumptions were critical and how changes in those as- sumptions could affect their valuation results. Second, they hdl to decide which method to choose for valuing the two businesses. fn the contest of high leverage and a chang- businesses. and ing capital structure over the investment period, onc of the partners had suggested that the capital cash ow method might be preferred to the WACC oF APV techniques Third, they had to consider that the U.S-and U.K, businesses operated using different currencies. (Exhibit 10 provides further information ow the hetas and capital structures of comparable companies. Exhibit HE shows data on U.S. and U.K, interest, exchange and tay rates.) Finally, after vatuing Yell, they had to recommend to thei internal in- vestiient committees a exact bid value that would result in an attractive risk/reward proposition for doing the deal. After all, significant portion of the compensation Apa and Hicks Muse received fro 20% carried intorest i their respective limited partners came in the form of a » portfolio investiieIz EXHIBIT 10 DATA FOR COMPARABLE LISTED COMPANIES (FIVE-YEAR AVERAGE UNLESS OTHERWISE INDICATED) Beta vs. Beta vs. Beta vs. S&P 500 MSCI Company Main Business Activities Local Index Local Index __Index__World Index__Debt/EV SBC Communications Long distance service. local service, wireless, S&P 500 054 0.63 15.4% and directory publishing Verizon Long distance service. local service. wiseless, S&P 58K) 053 053 oe 22.6% and directory publishing BellSoyth Long distance service, loeal service, wireless, S&P 500 oat oat 042 175% and directory publishing Quest DSL services, broadband and wireless S&P 500 123 1.23 1.39 25.0% communications. directory publi Sprint Long distance service, local service S&P 500 066 0.56 068 16.4% distribution, and directory publishing MeLendUSa Internet access, system integration services S&P 500 175 NA 20.7% and yellow: pages publishing WorldPagest Independent directory publisher recently SP 500 0.89 0.89 1.08 24.4% dliversifying in Internet portal services SEAT Pagine Gialle White and yellow pages telephone directories. MIB 30 (Italy) 097 056 087 2.8% More recently Internet access services Wanadoo! Internet Service Provider, Also offers client CAC 40 (France) 146 119 147 11% portals, esmerchant services, andl directories Telefonica Publicidad! Directory publishing IBEX 35 (Spain) 233 113 1:90 19% formac Eniro! Catalog und telephone directory publishing OMX (Sweden) 043, 0.67 0.79 8.2% =Tee-year da SOne-veae dat Two-year data se Source: Bloonuberg InternationalBidding for Yell + 219 EXHIBIT 11 COUNTRY-SPECIFIC {INFORMATION ABOUT CURRENCY, AND TAXES REST RATES, On April 12, 2001 United States United Kingdom Yield on 5-year Til 177% 5.06% Yield on Weyear T-bill 5.17% 4.949% Yield ou 30-year T-bill 561% 4 S/£ spot rate 1.439 bid—L4 ask S/E Lever forward id rat $/E 2-veur forward anid rat SE B-yeur forwutd sid rate S/E 4-year loa! wil rate 9/6 5-year forward mid rate Tas rate 30% Suu: Adapted fron Blasber Internation: Ofering Memorandum, “Vell Finance BY’, August 6, 2001