Strategic Due Diligence Training

Contacts: Bill Halloran, Tom Holland

August 2003
This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent.
Background – Use of this presentation

 This training module is intended to be used in

buyout fund analyst training programs to provide
an overview on strategic due diligence
 The framework which is used in this module
parallels a Bain Stanford GSB teaching note
 The example analytic slides shown in this training
session are disguised work from prior client
assignments
 When using this training module, client-specific
slides from prior Bain case work should be used
to illustrate key points
GXC

 These materials can be covered in 2 hours

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This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent.
Objectives

 Share Bain perspective on strategic due diligence

-Objectives
-Process

 Introduce core analytic tools

 Provide case examples

 Identify patterns of success and failure

GXC

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This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent.
Agenda

• Bain private equity background

• Due diligence overview

• Tools and examples

• Success and failure patterns

• Recap

• Appendix: Checklists and sources

GXC

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This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent.
Bain private equity group

 Over two decades’ experience working with private equity

clients
-Dedicated capacity in all major geographies
-Significant % of Bain’s business
-Global Bain network of 2,500 professionals in 28 offices

 Relationships with 50+ leading funds in the U.S., Europe and

Asia
-300+ transaction assignments per year

 Have invested significant personal Bain Partner capital in funds

and transactions
-Co-investments have achieved top quartile private equity return
GXC

 Integral part of Bain’s business

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Potential Bain roles: LBO

Portfolio
Due diligence/ Strategic full
Deal generation Company
deal completion potential
improvement

Objective: •Right investment •Better deal •Blueprint to •Increased portfolio

focus decisions realize value company value
- Validate thesis - Right pricing improvement
- Identify targets - Avoid Dogs post-close

Typical •1-4 months •4-6 weeks •1-3 months •3-12+ months

duration:

Bain •Industry profile •Business/strategic •Develop strategic •Broad company

activities: review roadmap improvement
•Target
screening - Market trends - Key strategic efforts
- Customers and milestones - Growth strategies
•Target approach suppliers - Quick hit - Add on acquisitions
- Competitors operational plan - Cost and asset
GXC
- Costs - Prioritize business reduction
- Technology development - Customer retention
opportunities
- Management/ - Organizational
organization development

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This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent.
Agenda

• Bain private equity background

• Due diligence overview

• Tools and examples

• Success and failure patterns

• Recap

• Appendix: Checklists and sources

GXC

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This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent.
 The deal professional sits at the center of a
complex transaction process
Managing due diligence Other deal responsibilities

• Industry attractiveness Buyout fund • Selling the deal

• Competitive situation Business
partners/
• Target strength and stability (commercial)
investment
• Exit paths diligence
committee
• Business plan

• Pending litigation diligence • Auction/transaction

- Legal landmines Selling process
Legal
agent/bank • Data requests/data rooms

• Audit • Negotiation, transaction

Buyout fund
- Accounting landmines Accounting Legal counsel contracts
associate/
diligence (own, seller’s)
VP

• Environmental liability • Building relationships

Environmental Target’s • Data requests/interviews
diligence management

• Value of assets • Securing financing

FundingGXC
- Real estate Asset - Selling the deal
sources/
- PP&E appraisal
lenders

Focus of today’s discussion

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Confluence of factors conspiring to pressure
deal returns
80%

65%
60 Multiple
Expansion
(7x - 10x)

-17%
Buy 10%
Cheaper
40 -7% 34%
Leverage
Leverage 60%
Double
90% Debt Earnings

20
Growth
(7.5%

-22% - 15%)

Base Base
0
1980's No Unable Lower Future
Deal multiple to buy Leverage Deals
expansion cheaper GXC

Adding value to acquired companies

now critical
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The buyout market has become quite
crowded …

Number of U.S. PE Funds ≥ $500M

400+
400

300

200

~125
100
~40
~10
0 GXC
1970s 1980s 1995 2002

Source: Internal Bain data, As of December 2002

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… and a large pool of of un-invested capital
has accumulated
Uninvested capital

$125B

100

75

50

25

0
79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98
GXC
99 00 01 02

Source: “Private Equity Overview and Update 2002” Thomson Venture Economics
2002 number from Buyouts
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Deals are getting done, but returns for the
industry are declining …
IRR by vintage year
North America

20% 19% 19% 19%

15% 15%
15 14% 13% 13%

10 9%

5
1%
0
Median
-1%
IRR
-5
Pooled
IRR
-10 GXC

90 91 92 93 94 95 96 97 98 99 00

Fund vintage year

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This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent.
… and outcomes vary significantly fund by
fund
Top 20 funds - CalPERS book value
Cumulative return (ranked by % returns)

40%
31%

24%

20 16%

4%
0%
-0
-8% -9%
-12%

-20 -16% -16%

-20%
-25%
-28%
-32%
-32%
-40 -39%
-44%

-51%
-52%
-60 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
-57%
20

GXC

Top 20 CalPERS funds have a cumulative negative

return of 18%, and have destroyed over $0.5B in
value over the period of investment
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Questions answered through business
diligence drive investment decisions

More industry-focused
Industry attractiveness

Competitive position

Strength & Stability  Primary focus of

diligence effort will vary
Business plan &
deal by deal
P&L forecast
Exit
paths

More target-specific
GXC

Investment
decision
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Questions answered through business
diligence drive investment decisions
• What is the underlying market growth?
• Do participants earn attractive returns?
• What key trends will shape the market going
Industry attractiveness forward?

• What is the target’s performance relative to the

Competitive position industry?
- Growth/share gain
- Economic return
Strength & Stability
• How healthy are current customer relationships
Business plan & and base?
• What are the true drivers of profit performance?
P&L forecast - Product and customer level
Exit • How strong is the existing management team
and organization?
paths
• What is the likely P&L?
• Is there a realistic plan in place to realize
forecast financial results?
- Base case, downside, upside
GXC

• What are the probabilities and values of various

Investment exit pathways?
decision - Strategic or financial buyers
- IPO
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A range of factors conspire to complicate
diligence, and cloud investor judgment
Managing complexity Drinking the management “Kool-Aid”

 Predicting 5-year financial  Management motivated to

outcomes inherently put the best “spin” on
complex information
- Avoid “boiling the ocean” - Resist temptation to
“default” to the
management plan

Information imbalance Bias toward “putting money to work”

 P.E. investors can learn  Culture and incentives of

only so much about an funds bias investment
industry/target in the professionals to make not
limited time available avoid investments
- Invest heavily in focused - Foster a “truth seeking”
independent analysis culture with a rigorous
deal review process
GXC

Focus is critical given the limited timeframes

frequently associated with diligence efforts
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Five diligence imperatives

Reality check

Find the
hidden gold

Think the
unthinkable
Talk, talk,  Ensure that
talk to new actions/
customers  Few great strategies
deals are required to
Drive work from own,
independent thesis  Visualize the characterized reach targets
are realistic
true downside by “more of
case the same”
 No single
element of
 Thesis-driven business
work-planning diligence is GXC
focuses more
diligence important
efforts
immensely
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Investment thesis: A foundation for
diligence
Business Diligence

Highlights critical
Unbiased framework Focuses team effort
value drivers
Limits influence of seller/ Sets up the deal model All activities drive to
management forecasts proving/disproving the thesis

Developed
‘80/20’ Structured Specific
early
… but frequently Answers critical Few, logical … enough to allow
revisited deal questions categories it to be disproved
without descending •Focus on the right
into a morass of deal sub-questions GXC
•MECE – mutually
detail
exclusive, collectively
exhaustive

Investment thesis
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Talk to customers: No substitute for
first- hand perspective
 Primary research invaluable for informing all aspects of business
diligence
- Industry attractiveness
- Competitive position
- Target strength and stability
- Business plan & P&L forecast
- Exit paths
 Interviews with target customers, competitors, consumers, industry
experts, analysts, management team, and others provide insight
into:
- Industry dynamics and trends
- Health of target with key customers and/or consumer segments
- Validity of key components of the deal thesis
-…

GXC

Primary research is a critical component of

any business diligence

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Think the unthinkable: Downside case
is not just the base case –5%
Chemical Co

Base Case Downside Case Sustained Downside

Volume • X units in Q4 • X units (for 5 quarters) • X units (for 3+ years)

“Setpoint:” • X + Y units in 2002

Actions: • X FTE reductions • Reduced shift schedules • Mothball equipment

• 300mm COGS • Y additional FTE reductions • Z additional FTE reductions
improvement • Pay cuts
• Reduced IP expenses
One-Time • Severance • Severance • Severance
Costs: • Shutdown & restart
COGS • $68M (relative to 2Q 01) • $20M relative to base case • $12M in 2002
Savings: • $35M net over 3 years
MAT • $17M (18% FTES, 24% of • $11M relative to base • $0M
Savings: cash costs) case(19% of FTEs, 40% of
cash costs)
GXC

The downside case can turn out to be

the base case
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Find the hidden gold: Multiple
expansion driven by…
Technology Co(s)

Commentary
EV/EBITDA
5/00  Company split into
40 EV/EBITDA=30.43 2 post-acquisition
to unleash value
- Tele-
30 communications
manufacturing
Target 141% - Fabless
20 6/96 increase semiconductors
EV/EBITDA = 12.62

10

GXC
0
May-95

Sep-95

May-96

Sep-96

May-97

Sep-97

May-98

Sep-98

May-99

Sep-99

May-00
Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Note: All indexes are aggregated by Standard & Poor’s

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Reality check: Few buyouts hit “base
case” targets

(Better) 35%
 Company A
 Company B
25%
10%  Company N
LTM Performance vs. Model

 Company C
 Company C  Company G
5% 
 Company L
Company D  Company B
 Company E  Company A
 Company F
0%  Company G


Company
Company
O
D
 Company I
 Company F
-5%  Company M
 Company J
 Company K
-10%  Company H
 Company H
 Company I
-15%
 Company J
20%  Company K
 Company L
 Company M
-30%
 Company N
 Company O
(Worse) -40%
LTM Revenue EBITDA %

GXC

Upside and downside cases just as

frequent as base case

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Agenda

• Bain private equity background

• Due diligence overview

• Tools and examples

• Success and failure patterns

• Recap

• Appendix: Checklists and sources

GXC

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This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent.
Agenda: Tools and examples

1
Industry attractiveness

Competitive position

Strength & Stability

Business plan &

P&L forecast
Exit
paths

GXC

Investment
decision
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 1

Industry attractiveness: Key questions

How large are the
What is the appropriate
available revenue and What is the market’s
business/industry
profit pools and how competitive structure?
definition?
are they evolving?
 What are the  How large is the  How concentrated or
relevant customer, market (revenue, fragmented is the
channel, and product profit)? market?
boundaries?  How fast is it  Are there significant
 Are these boundaries growing, and in barriers to entry?
shifting? If so, what which segments?  Do buyers or
are the implications  What are the drivers suppliers have
for industry
of revenue growth? significant industry
attractiveness?
 What are the drivers power?
 What drives returns?
of profitability?  How does this market
- Local, regional, structure impact
national,
participants’
GXC
returns?
international scale?
- Innovations cycles?
- Customer loyalty?
- Other factors? StrategicDueDilige
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Industry attractiveness: Tools and
1

analytics
I. Business definition II. Revenue & Profit pools analysis
Industry revenues
Business definition matrix 100%

80
High
One business
60

Separate businesses with 40 Industry profits

potential for cost leadership
$60B
Cost 20
Sharing
Separate businesses Separate One business
businesses with potential 0
with for 40
potential for substitution
bundling

Low 20
Low Customer Sharing High

III. Market driver analysis IV. Industry life-cycle analysis

GDP/pop. growth S-curves: Penetration

100%

80

60
YoY customer growth 40 S-curves: Substitution
20
100%
0 GXC
80

60

40

20

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Business definition: Critical to identify
1

the correct battlefield

High One business with potential One business
for differentiation or niche (WIFI chips and
position (Prescription & generic microprocessors; OS and
drugs; private label & brand-name browsers; Cable TV triple
goods) play)

Separate businesses with

potential for cost leadership
(Oil and refinery by-products)
Cost
Sharing
Separate businesses Separate One business
(Beer and distilled spirits) businesses with potential
with for
potential for substitution
bundling (Pay phones & cell
(Fixed line & phones; VAN and
cell phones) Internet EDI)

Low
Low Customer Sharing High
GXC

The business definition matrix delineates economic

boundaries; it is primarily determined by the degree of
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Business definition: Leaders enjoy higher
1

profits in accurately-defined businesses

ROA-Cost of  True leaders in properly defined businesses
Capital (%)
realize benefits
- Leverage scale in purchasing and overhead to be
20% low cost
>3 RMS - Technical know-how to make things
better/cheaper
- Ability to leverage low cost position and existing
15 2-3 RMS
customer relationships to grow
- High margins lead to ability to out-invest
competition
10 1-2 RMS - Management focus not distraction
 Followers often experience challenges
- Higher costs
5 - Leader takes down pricing
- Players under 1/3 the leader’s size rarely earn cost
of capital

0
 Business definition shifts over time, blindsiding
1 2 4 incumbents
GXC

Relative Market Share

Getting the business definition right
is a prerequisite for accurate
industry diligence
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Revenue and profit pools: Assess the
1

potential of target-addressable segments

Industry revenue pools Industry profit pools
(US telco revenue) (US telco EBITDA)

2002E US Market Total =

$4B
$3B
$4B
$72B $1B $55B $84B $15B $25B $45B $38B $12B ~$360B 2002E market EBITDA
100% Other Other Sprint Total =

Pega-
Other Other

sus
AT&T

Bell South
Other
Sprint Qwest Bell South ~$108B

Other
Insight Comm
SBC
T-Mobile/DT Cablevision 50.0%
Qwest Verizon

Charter
Other

80 Qwest
Nextel Adelphia $31B
Qwest

EchoStar
Sprint WorldCom
Bell South SBC Cox
Cox 40.0 $14B
Sprint
Bell South

60 SBC Charter $15B

WorldCom Verizon
$24B
AOL/Time Warner
Outsourcing

Cingular 30.0
Verizon AOL/Time
Verizon

$14B
WorldCom

Warner
Verizon

40 WorldCom
AT&T Wireless 20.0
$2B
Direct TV

AT&T >10% CAGR $3B

20 $1B
Comcast

Comcast <10% CAGR 10.0

SBC
SBC
SBC

Verizon
AT&T AT&T
<0% CAGR
0 0.0
Local Long Wireless Mgd Business Cable Local Long Wireless Mgd
Data Cable DBS
DSL
ISDN

DBS/

ISDN
DSL
Out-
Cable

Satellite
Out-

sourcing

Cbl Mdm
Cable Mod

Svcs

Cable Tel
Data TV Video
sourcing

Svcs
Telephony

(Access/Toll) Distance (Access/Toll) Distance (>DSL)

2002 revenue

Proj 02-06E Growth -2% 39% -7% 11% 3% 6% 10% GXC

-10%

20% 10%
33%
35%

Voice Services Data Video

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Growth drivers: Underlying macro factors
1

important in assessing market growth

QSR Co

Context:  Target is a specialty • Macro analysis example: analyze

retailer trends in specialty retailer per capita
to support market growth forecasting
U.S. population per unit
CAGR CAGR
(90-95) (95-00)

11,000

Question:  What is the potential of 10,000

the U.S. market for
continued specialty 9,000

retailer growth? 8,000 Cat 1 -2.9% -1.4%

Approach:  Analyze company, 2,000

industry, and macro and 1,000

Cat 2 -1.1% -0.5%

macro data to develop Retail -0.4% -0.6%

perspective on segment 0
90 91 92 93 94 95 96 97 98 99 00 01E 02F 03F

outlook GXC

Macro analysis provided explanation of industry

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Growth drivers: Understanding target
1

linkages to macro cycles is critical

Fitness Co
Total US Health Club Members Annual Membership Fees

40M $1,000

Context:  Target is a U.S. operator of Fees

800

health clubs 30
Members

600

20

400

Question:  What are the primary 10

200

drivers of health club fees 0 0

and membership? 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01

Change in employment rate

1.0%
0.8% 0.8%

Approach:  Search for correlations of

0.7%
0.6%
0.5% 0.5%
0.5 0.4%

fee and membership figures

0.3%
0.2% 0.2% 0.2%

0.0

with key industry and

macro-economic variables
-0.5 -0.4%

-0.6%

-0.8%
-1.0

-1.2%

-1.5
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01
GXC

Health club membership growth and fees found

to be very sensitive to macro-economic cycles
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S-curves: Industry lifecycle can also
1

impact growth rates

 Cumulative sales of consumer durable products follow an S-shaped curve
 Many models have been developed to represent and forecast the shape of this
curve
- Bain relies on a Product life-cycle (PLC) model, which is based on 4 product phases (early
adoption, mass adoption, saturation/substitution, decline)
 In practice, this s-curve can follow a log or a sine curve
- The Bain s-curve template uses a natural log function to generate the s-shape
- The curve may be mathematically derived by other models; e.g. Bass model
 This s-curve has shown to be predictive across a number of industries, market
sizes and end users
- It does work as a predictive tool so long as the forces acting on the curve are understood
 To use the s-curve, then, it is critically important to understand the forces that
can affect its shape, which are:
- Market definition
- Substitution
- Product or process innovations
GXC
- Exogenous shocks
- Projection timeframe

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S-curves: New units sales trajectory is
1

essential in understanding lifecycle

Personal Watercraft Co
Kawasaki introduces
stand-up Jet Ski
(1970)
Safety, emissions, noise,
Popularity of sit-down
and water access issues
300K Yamaha enters multi-passenger models
caused rapid decrease in
PWC market drives sales increase
sales
Personal watercraft unit sales

with sit-down
model (1986)
250
Since 1998, PWCs
have been cleaner
Rest and quieter
Bombardier
200 introduces of world
Sea-Doo
(1988)

Honda enters
150 Polaris enters
PWC market
(2002)
PWC market
(1992)
*
100 US

50
Arctic Cat Arctic Cat
enters PWC exits PWC
market market
0 (1992) (1999)

9 70 9 87 988 989 990 991 992 993 994 995 996 997 998 999 GXC
0 00 001 002
1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2

Personal watercraft sales peaked in the mid-90’s

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S-curves: New unit sales drop sharply
1

as an industry matures
Personal Watercraft Co
Personal watercraft units (US)

1,500K
Installed Base
7%
Relatively new Introduction of
product causes multi-passenger
sales and models cause
installed base to sales and 10%
1,000 grow with a installed base to
very young fleet surge
Slide in sales
slows down but
Safety and still very little
regulatory issues retirement of old
cause sales to PWCs. Fleet is
drop, but little
500 26% retirement in
getting older
relatively young
fleet
35%
31% -15%
24% -9%
New Sales
0
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02
19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20
New sales
as a %
of base 31% 38% 36% 30% 22% 21% 24% 24% 26% 21% 18% 12% 10% 7% 6% 6%
GXC

Personal watercraft industry beginning to

shift from mass adoption to mature
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S-curves: Insights into industry lifecycle can
1

inform successful investment decisions

Example 1 :
Asphalt tar company
2 Investment  Low historical growth
immediately
before growth  Bain uncovered regulatory- driven
deceleration: Product penetration
increase in road spending in key
Potential
disaster
local markets
 Led to unexpected period of
differential growth for the company
1 Investment
immediately
before growth
Example 2 :
acceleration: Electronic parking meter company
Likely
success  Strong historical growth
New product  Management forecasting continued
sales
high growth
 Bain identified substitution
GXC
had
already passed point of inflection
 Investment avoided - sales
subsequently dropped precipitously
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Agenda: Tools and examples

Industry attractiveness

2
Competitive position

Strength & Stability

Business plan &

P&L forecast
Exit
paths

GXC

Investment
decision
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 2

Competitive position: Key questions

What does the

How does target What are the drivers of
competitive landscape
performance compare differential
look like, and how is it
with competitors? performance?
changing over time?

 How does market  What is the target’s  What are the target’s
share break down by growth trajectory strengths &
competitor? relative to peers? weaknesses relative
 Who is gaining/losing  How does profitability to peers?
share? compare with peers?  What opportunities
 What are the drivers  What is the target’s and threats exist in
this competitive
of share/gain loss? relative cost position?
environment?

GXC

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 2

Competitive position: Tools and analytics

I. Market share trends II. Relative performance: Profitability

Share shifts ROS/RMS

30%
22%
20

10 Gaining share

-0

-10
Losing share
-20
-22%
-30

II. Relative performance: Cost position III. Drivers of variability

Relative cost position

GXC

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ROS/RMS: Market share drives 2

profitability; Mercedes is underperforming

Chemical Co
ROS: Operating
Context:  Target is a chemical Margin (2000)
20%
manufacturer

Target w/
Savings
Question:  How much profit 15
E
improvement potential
exists given target’s D
industry position? 10 C

B
Approach:  Use ROS/RMS tool to
calculate “expected 5
A
profitability” based on Target (2000)
share position, and
compare current target 0
performance 0.1 0.2 0.5 1 2

Relative Market Share

GXC

Target underperforming given share; significant

profit upside opportunity available

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ROS/RMS and business definition: 2

Explaining performance variations

Grocery Stores

Nationally Defined Regionally Defined

% Return on Sales (1995)
% Return on Sales (1995)

7 7

6 Hannafords 6 Pathmark
Path- Kroger
mark Albertsons American
Harris Teeter Harris Teeter
Giant Safeway Giant
Food Safeway Ingles Food
Ingles Food
4
4 Lion Lion Vons Publix
Smart n Final Vons
Publix Kroger Winn-
Shaws Winn- Dixie
Dominicks Brunos Dixie Shaws American
2 Stater Bros 2 Dominicks Stores
A&P Brunos
Foodarama A&P Foodarama Stater $10B
Super $10B Bros
Sales Supervalu Delchamps Sales
valu (1995) (1995)
Delchamps
0 0
0.01 0.02 0.05 0.1 0.2 0.5 1 2 0.1 0.2 0.5 1 2

Relative Market Share (1995) Weighted Average Local Relative Market Share (1995)

GXC

Regional scale is a key driver of grocery chain

profitability
*Statistical market areas (I.e. the larger US cities including dependent suburbs) StrategicDueDilige
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Regional share: Accurately assessing share 2

position may require detailed regional view

Retail Co

Context:  Target is a specialty

retailer

Target Share Rank

Question:  Does #2 national (by units in state)

position overstate
#1
competitive strength?
#2
- i.e., could target be
#2 nationally but still #3
be sub-scale in each
#4
region?
#5
Approach:  Calculate market
share by state
GXC

#2 national position translates to #2 position in

most regional areas

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Share of wallet: Share by account can 2

be a key performance driver

Active Wear Co
Av. account
 Target is a U.S. Share of Distributor Sales
Context: penetration
manufacturer of active 100%
Other 26%
wear
C 13%
80
Question:  How well is the target Target 13%
represented across
distributors, relative to its 60
competition?

40 B 25%

Approach:  Interview distributors to

estimate share of
20
distributor wallet held by
market participants A 23%
0
1 2 3 4 5 6 7 8 9 101112
GXC

Target reasonably well-penetrated across

distributors

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RCP: In commodity businesses, ensuring 2

low cost position is critical

Active Wear Co

Cost per unit

Context:  Target is a U.S.
$20.00 Shirts
manufacturer of active
Competitor A advantage 5%
wear
G&A Allocation Potential Reasons
$14.90
15.00 $14.17  Both companies similar
Question:  How does the target’s modular production and
Sewing
cost position compare Sewing locations

with other players in the Cutting

 Target cutting
10.00
market? Cutting Dye advantage vs.
Company C
Dye  Competitor A stream-
Knitting
lined SKU’s/ knitting
Approach:  Segment total costs into Knitting process
5.00
largest components;  Competitor A has better
yarn purchasing on open
calculate units costs and Yarn
Yarn
market for cotton
compare across like-for-
like products 0.00
Competitor A Target Adjusted
Adjusted for 2001 Yarn
for G&A GXC

The target currently has higher unit costs than

Competitor A, with room to improve in Yarn & Knitting

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 Experience curves: Target manufacturing 2

experience provides insight into cost position

Manufacturer of plastic packaging
Estimated extrusion Cost per 1000 units
cost breakdown (%) (Extruded excluding cap)
100%
100% National$200
packagin
SG&A g scale
effects Regional National Global
players players players
80 Plant
Overhead 150

Packaging
60 Cost Plant-
level tube
scale
Printing effects
100

40 Depreciation

Labor 50
20 Global Player A
Raw plastics B
scale C D
Material effects
E F
0 0
Extrusion cost 20 50 100 200 500 1,000 2,000 3,000M
Millions of Units
Produced (Log Scale)
GXC

Global players can develop significant cost

advantage in plastic packaging manufacture
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Agenda: Tools and examples

Industry attractiveness

Competitive position

3 Strength & Stability

Business plan &

P&L forecast
Exit
paths

GXC

Investment
decision
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Strength and stability: Key questions
3

How strong is the How does profitability

How well is the target
target’s customer vary across the target’s
executing?
franchise? operations?

 What dimensions of  How does profitability differ  Is the business plan aligned
product and service are by customer or distribution with key industry trends?
most important to channel?  What is the potential for
customers?  How does profitability differ revenue uplift?
 How does the target by product? - What investment is required
perform on these  How does profitability differ
to achieve forecasts?
dimensions by production facility or  Has target been keeping
- Relative to importance to costs in line with industry
site?
customers?
trends?
- Relative to competitors?
- What is the potential for
 How strong is the target’s further cost reduction?
relationship with its  How strong is the
customers? management team?
 How healthy are key  If the target is part of a
customers? larger
GXC entity, how ready is

it to operate on its own?

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Strength and stability: Tools and analytics
3

II. Profitability by
I. Customer franchise III. Execution
segment
Customer satisfaction Customer profitability Price/cost curves

100%
$60B 100% 100%
80
80 80
60 40
60 60
40
40 40
20
20
20 20
0
0 0 0

Customer concentration Product line profitability

Best demonstrated practice

100%
$60B

80
40
60

40 20
20

0
0
GXC

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Customer satisfaction: Well-designed 3

surveys can identify potential issues

Active Wear Co
Distributor rating
(importance & performance)
Context:  Target is a U.S. 5.0
manufacturer of active 5
4.7
wear 4.4

Question:  How well does the target 4

3.7
perform on key
3.4
customer needs?
3.0
3
Approach:  Interview customers to 2.6
determine what is most
important to them, and
2 Target perform.
how well the target is
Competitor A
performing, compared perform.
with other players Importance
1

Co y
rs

n
Se ce

Q e

Ra e
no g e
GXC
lit

yl

tio
ic

lo
i

n
Pr

rv

St
ua

va
In
The target performs well on most
dimensions, but needs to lift service
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Customer profitability: Customer-level 3

analysis can identify drivers of performance

Consumer packaged goods
Return on Capital Employed Total =
19% $117.4M
20%

-0
-5%

-20

-40

-47%

-60
Top tier Middle tier Remainder
Total private
of acounts label
FY 02 EBITDA $9.9 $0.4 -$12.2 -$1.9M
PP&E $15.4 $16.8 $11.9 $44.1M
GXC
Inventory $13.8 $20.1 $16.9 $50.8M

Less than 20% of accounts are profitable

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Customer concentration: Limited major 3

customers presents risks and opportunities

Consumer packaged goods
Percentage of Percentage of
total retail sales total retail sales
$0.7B $4.1B $0.4B $9.8B
Others 100%
Others
80 Next 10 80
Next 10
Safeway
Eckerd Eckerd
60
Albertsons 60 Sam's Club
Costco

Costco
40 40
Sam's
Club WalMart
20 20
WalMart
0 0
Target Industry total Target Industry total
Product A Product A Product B Product B
Percnet of GXC

sales in Big 3 51% 43% 65% 30%

Target’s customer concentration is significantly higher

than the market in Product 2, which may pose a risk
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PLP: Food Co’s non-branded businesses 3

do not cover cost of capital

Food producer

Return on Capital Employed

Total =
~$500M
100%
84%

50
29%
24%
15%
5% ~9%
0 WACC
-7% -11%
RegionalBrand -21%
-37%
-50

NewBrand2
FreshBrand
NewBrand OldBrand Private Food

Other
Industrial
label service
(retail)

GXC

Foodco’s non-branded businesses do not cover the cost of

capital
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Price curves: Most tech products follow a 3

predictable cost reduction path

Electronics Co

Disk Drives DRAM

$10,000 $100
Slope = 55% Slope = 57%
$5,000 $50
R² = 1.00 R² = 0.94
$2,000 $20 1988
1993 1989
$1,000 $10
1994
$500 $5 1991 1993 1994
Price/GB

Price/Mbit
1995 1990
$200
1996 $2 1995
1992
$100 $1 1996
$50
1997
1998 $0.5
$20 1999 1997 2000
2000 $0.2
$10 1998
2001 $0.1
$5 1999
2002 $0.05
$2 2003
$0.02
$1
10 20 50 100200 500 1K 2K 5K 10K 20K 50K 100K $0.01
1 2 5 10 20 50 100200 500 1,000
Cumulative Petabytes Cumulative
GXC Mbits (Billions)

As the experience curve drives prices down, costs must be

managed aggressively to ensure profitability is maintained

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Price/cost curves: Target must manage 3

costs in line with pricing trends

Electronics Co

Context: • Target is an electronics $10

Industry
manufacturer CAGR=-11%
1994
1993
5 1995

Real Price (Industry) or

1996

Cost (Target) per Unit

Question: • How well has the 1997
target managed costs, Target
’95-’97
given industry pricing 1998
CAGR~-2% 2000
trends? 2
1997 1999
1995 1998
1999
1996
Approach: • Use price/cost curve to 2000

compare industry unit 1

price reductions with Target
’97-’00
target unit cost
reductions CAGR=-13%
0.5
20 50 100 200 500 1,000 2,000 5,000 10,000

Accumulated
GXC
Volume - Units

The target has eroded profitability by failing to

reduce costs in line with industry price reductions

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 BDP: Benchmarks clarify extent of under- 3

performance, and margin for improvement

Electronics Co
Process A Process B Process C
80% 100% 100%
74%
98% 97%
65% 97%
60%
60 56% 95 94% 95
92%

40 90 90

20 85 85

0 80 80
Plant A B C D Plant E C B D Plant F A G B D C

EBIT ~$18M ~$2M ~$8M

improvement GXC

(annualized)

Improving yields to internal best-in-class

improves EBIT by ~$28M
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Agenda: Tools and examples

Industry attractiveness

Competitive position

Strength & Stability

4 Business plan &

P&L forecast
Exit
paths

GXC

Investment
decision
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Business plan and P&L forecast: Key 4

questions
What is the target’s near-to-
How strong is the target’s business
medium term revenue and profit
plan?
growth potential?

• What is the specific business plan? • What are the target’s main
- Does it allow for capital revenue and profit drivers?
preservation? - Volume, price, cost drivers
- How well does it align with industry • What is the outlook for these
trends? drivers, given market conditions,
• To the extent that there is a competitive position, and target’s
change in trajectory planned - strength?
- What is the likelihood that the plan • What are the key risks to revenue
can achieve that change?
and profit outlook?
- What is the timing involved?
- How strongly might they impact
- What contingencies are included? outcomes?
- What is the likelihood
GXC of them
occurring?
• What is the downside case?

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Business plan and P&L forecast: Tools and 4

analytics
I. Target growth drivers II. Growth cascade

Driver tree Sources of growth

Revenue

Volume Price

% of market
Market volume
volume

III. Sensitivity analysis IV. Variable autocorrelation

IRR table Driver interdependencies

5 Year Comps CAGR (FY02 - FY07)

6.5x
-2.0%
-20%
-1.0%
-3%
0.0%
7%
1.0%
13%
2.0%
18%
2.4%
19%
3.0%
22%
4.0%
26% •
---
---
7.0x -13% 1% 10% 16% 21% 22% 25% 29%
Trailing
EBITDA
exit
7.5x
8.0x
-8%
-4%
5%
8%
13%
16%
18%
21%
23%
25%
24%
27%
27%
30%
31%
33% •
8.5x -1% 10% 18% 23% 28% 29% 32% 35%
multiple
9.0x
9.5x
3%
5%
13%
15%
20%
22%
25%
27%
30%
31%
31%
33%
34%
36%
37%
39% •
GXC
Unit openings (FY02 - FY07) - % of TPG base case (@ 2.0% comp CAGR)
20% 40% 60% 80% 100% 120% 140% 160%
6.5x 11% 13% 15% 16% 18% 19% 21% 22%
7.0x 14% 16% 17% 19% 21% 22% 23% 25%
Trailing
EBITDA
exit
7.5x
8.0x
17%
19%
18%
21%
20%
22%
22%
24%
23%
25%
24%
27%
26%
28%
27%
29% ---
8.5x 21% 23% 25% 26% 28% 29% 30% 32%
multiple
9.0x 24% 25% 27% 28% 30% 31% 32% 33%
9.5x 26% 27% 29% 30% 31% 33% 34% 35%

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Forecasting: Various methodologies 4

available for building target growth forecasts

Software Co

Product A spend

X
Product A volume Price

X
EDI Volume % of EDI on Product A

Description: • Continued strong EDI • … but Product A dropping • Continued price pressure
volume growth expected by as a percentage of EDI for likely
customers … some customers

Drivers: • New partners • Cost savings • IT budget pressure

• Increasing volumes with • Viable non- Product A options • Competitive alternatives
existing partners • Trading partner pressure • Viable non- Product A
• New transaction sets • Customer migration plans and options
timing

Inputs: • EDI growth expectations • Current Product A share of • Multiple cases

(primary) EDI (primary) - Software Co has
• For base case, assume • Steady state Product A experienced declines
growth reduced by 50% share of EDI (primary) YoY
each year • Timing (2 years assumed)
GXC

Clarity on key revenue drivers & how they can be

measured is a crucial component of forecasting
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Sources of value creation: Focus 4

diligence on most important vectors

Retail Co
Total Enterpise Value
Context: • Target is a retailer

Question: • What is target’s full

potential enterprise
value in 2007?
WW
Int'l
Approach: • Add individual sources U.S.
of growth to current- FY02 Comps New Closed G&A Other Multiple FY07
year estimates to TEV stores stores EBITDA expansion TEV
reach 2007 full
potential % of
total 61% 63% -18%-26% 1% 19%

GXC

Growth in comps, new store openings, and

multiple expansion can off-set negative
factors, allowing significant growth to 2007
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Variable autocorrelation: Failure in one 4

growth driver can impact all others

Retailer

• For the target’s franchised

retail stores, failure in any link
of the growth driver cycle can
Store Increased mean failure in the others
up- sales - Decreased sales leads to limited
grades cashflow, resulting in reduced
investment in store upgrades,
resulting in further sales decline
• Effect can extend outside
immediate cycle
- Reduced comp sales in turn
Cash flow negatively impacts the likelihood
available for of new stores opening
investment
GXC

Modeling the downside requires a

detailed understanding driver
interdependencies StrategicDueDilige
60
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Agenda: Tools and examples

Industry attractiveness

Competitive position

Strength & Stability

Business plan &

P&L forecast
5 Exit
paths

GXC

Investment
decision
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Exit paths: Key questions 5

What is the most attractive

What exit options exist?
option likely to be?

• Which exit options exist • What are the current trends in

currently in the market? IPOs, strategic acquisitions,
- How is this likely to change? other financial deals?
- How is this likely to change?
• If a buyer will exist in the
future, why are they not • Which kind of buyer will find
interested now? the target most attractive?
• What multiples are being paid?

GXC

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Exit paths: Tools and analytics 5

I. Industry consolidation II. IPO cycles & outcomes

Share of industry sales Funds raised by year

100% 30

80

20
60

40
10
20

0
0

III. Deal multiples

EBITDA multiples
10.0x

8.0

6.0

4.0 GXC

2.0

0.0

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Industry consolidation: Strategic exits 5

more likely in consolidating markets

Retailers
CAGR CAGR
Percentage of US retail sales (FDMC) (95-02) (02-07F)
$553B $674B $885B $992B $1,370B 6% 7%
100%

80
Other 3% 5%

60

Next 7
40 retailers 9% 7%
Sams
8% 9%
20 Costco 10% 9%
Wal-Mart 11% 10%
0
1990 1995 2000 2002 2007
Percentage of
top 10 20% 36% 45% 47% 51%
GXC

Type of consolidation (organic, acquisition) drives

possible exit options

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IPO cycle: IPO activity varies 5

significantly over time

Funds raised Funds raised by
all US IPOs ($B) VC-backed IPOs in US ($B)
30 28
80
25
66 65
60
20
47
40 15
40 37 38
31
26 10 10

20 18 5 6 5
4
3

0 0
94 95 96 97 98 99 00 01 02 94 95 96 97 98 99 00 01 02
Number
of IPO 430 484 717 511 332 479 354 86 73 171 209 281GXC
140 79 273 262 41 24

Recent IPO activity has been

the lowest since the mid 70’s
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Agenda

• Bain private equity background

• Due diligence overview

• Tools and examples

• Success and failure patterns

• Recap

• Appendix: Checklists and sources

GXC

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Success patterns

Growth Exits to Corporate spin-

Successful Well-timed
companies that strategic outs (sellers in
turnarounds need)
cycle plays
keep growing buyers

Rationale: •Growth can hide •Distressed •Strategic buyers •Under- •Over the last 20
other flaws situations offer can afford performing, years,
•Growth provides motivated higher multiples non-core approximately
flexibility sellers, limit the than financial businesses of 2/3rds of all
- Cash flow number of buyers conglomerates private equity
- Debt reduction competing - Strategics will are often under- returns have
- Expansion pay for
investors managed and come from
- Exit prospective
- Can lead to flourish under multiple
attractive deal synergies
new, focused expansion
terms
management
Key •What is the •Is the company •If strategic exit •Is the business •Where is the
questions: likely future failing for is likely in the fundamentally industry, target
growth rate? controllable future, why is sound but positioned in
(e.g. manage- the future buyer under- relevant cycles
ment) or not interested managed, over- (equity, macro,
structural today? burdened? industry
reasons? GXC lifecycle, etc.)?
•How much time
will be required?

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Investing watchouts
“OK”
Roll-up “Gold rush” Snowball Market Hockey stick
manage-
theses markets effects disruptions forecasts
ment
• Need a • Avoid • Consider • Model the • Take a hard • Pressure test
compelling “irrational “auto- extremes of look at management
rationale, exuberance” correlation” “exogenous” management and base
detailed around new of industry market • “OK” or case
plans, technologies, success disruptions “acceptable” forecasts
seasoned regulatory variables in downside management extensively
management changes, cases rarely is
• Single • Few
and patience etc. - Regulatory/
variable • More than companies
for roll-ups legislative
• Changes can sensitivities changes, 40% of achieve the
• Execution/ create extra- can often bailouts, senior P&L
integration ordinary over-/under- etc executives forecasts laid
extremely wealth but estimate are replaced out in a
challenging often creates true impact over time private
more losers on valuation following a equity deal
than winners (e.g. private model,
insurance equity especially in
companies) change in the early
GXC
ownership years

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Agenda

• Bain private equity background

• Due diligence overview

• Tools and examples

• Success and failure patterns

• Recap

• Appendix: Checklists and sources

GXC

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Recap
- Key role in complex deal process
Diligence is increasingly
- Increasingly difficult and competitive environment
important - Adding value is critical to deal success
Diligence questions lead - Industry attractiveness
to investment decisions - Competitive position
- Target strength & stability
- Business plan & P&L forecast
- Exit options

5 diligence imperatives - Use an independent thesis

- Talk to customers
- Think the unthinkable
- Find the gold
- Reality check

4 diligence watch-outs - Managing complexity

- Drinking the management ‘Kool-Aid’
- Information imbalance
- Bias toward ‘putting the moneyGXCto work’

- Limited number applicable on any given deal

Wide range of analytic
- A well-articulated thesis and focused effort are
tools available essential
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This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent.
Agenda

• Bain private equity background

• Due diligence overview

• Tools and examples

• Success and failure patterns

• Recap

• Appendix: Checklists and sources

GXC

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Industry review checklist

Risks to assess Illustrative activities

Declining or limited growth Isolate sources of company

Distressed/negatively-trending growth
industry profitability (e.g. Gather appropriate industry
commoditization, maturing, analyst reports, interview
globalization, delayering) analysts, adjust as necessary
Intensely competitive market Interview target management
Low barriers to entry Interview target sales staff
Strong/difficult to manage Interview industry experts,
cyclicality experience managers to isolate
Poor or declining regulatory key trends
relations Build target mix-adjusted
Product substitution industry growth and profitability
forecast

GXC

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Competitive position review checklist

Risks to assess Illustrative activities

Insufficient/declining advantage Identify key competitors and

of products and services (e.g. attack paths – evaluate with
maturing, underinvested) customers, sales staff, industry
Insufficient sustainability of experts, etc.
advantage (absence of self-re- Identify sources of advantage of
enforcing scale, intellectual target’s products – evaluate
property) importance and performance
Declining market share with customers, sales staff, etc.
Interview industry analysts –
evaluate points of agreement
and controversy
Compare target performance
with key competitors
GXC

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Company review checklist

Risks to assess Illustrative activities

Excessive profit dependence of Isolate sources of profit – test

few products, regions, etc. sustainability of advantage
Volatility of profitability – e.g. Evaluate historical profit and
cyclicality, blockbuster product loss stability – isolate drivers
dependence, etc. Evaluate acquisition integration
Poorly integrated acquisitions with senior and mid-level
Inability to accommodate management
growth – space, controls, Inquire about and evaluate
systems, access to labor pool, investments required to support
etc. management plans
Workforce inadequacy - poor Compare financial/operational
training, high attrition rate, metrics to key competitors for
poor trade relations, etc. comparable lines of business
Lacking discipline – overstaffed,
overcompensated, etc.
Approaching minimum efficient GXC
scale

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Customer review checklist

Risks to assess Illustrative activities

Excessive customer concentration Isolate customer concentration

Low customer loyalty – risk of and profitability
defection Interview purchase decision
Low customer lock-in/switching makers at key customers
costs Interview all significant recent
Deteriorating stability of customer defectors – compare
customers rationale with that offered by
Impact of transaction on management
retention – particularly if LOB Evaluate impact of transaction on
overlap with competitor customer retention – incentives,
lock-in

GXC

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Management/seller dynamics checklist

Risks to assess Illustrative activities

Management or seller motivation Systematically evaluate key

to conceal Target threats/ elements of management or
weaknesses seller thesis with customers, staff,
Ineffective management, industry experts, etc.
appropriateness for post- Interview key managers –
acquisition plan evaluate in context of post-
Consequences of change of acquisition requirements
ownership – continuity of Evaluate M&A history of industry
contracts, key employee Evaluate potential for strategic
retention, etc.q Inadequate buyers
succession planning
Difficult exit path

GXC

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