Private Alternatives to the Public Markets How to Survive and Grow in a Capital Constrained Environm

1
Private Alternatives to the Public Markets How
to Survive and Grow in a Capital Constrained
Environment

• A Private Conference on
• May 16, 2001
• Sponsored by
• Windsor Group Investment Banking
• Deloitte Touche
• Holland Knight LLP
• Holland Knight Consulting

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Agenda

• Introduction to SKM (A Brief SKM Commercial)
• State of the Capital Markets (Ugly)
• Private Equity as an Alternative Source of
  Capital (A Viable Option)
• Overview of Saunders Karp Megrue (A Longer SKM
  Commercial)

3
SKM Overview

• Founded in 1989
• Market Leader in Private Company
  Recapitalizations and Growth Company Buyouts
• Selectively Pursue Buy--Build Strategies
• Over 1.7 Billion of Equity Capital Raised
• Fund I 300 Million
• Fund II 516 Million
• Fund III 943 Million
• 2 Distinct Investment Teams Focused on the Entire
  Middle Market
• Successfully Executed over 50 Investments in Last
  Seven Years
• High Quality Group of Limited Partners
• Rely, to a Lesser Extent, on the Public Capital
  Markets

4

• State of Capital Markets

5
Current market conditions have made accessing the
capital markets more difficult

• Factors effecting how you grow your company,
  capital formation, capital investment and MA
  activity are all struggling
• Economy
• Public equity market
• High yield market
• Senior bank market
• Need to pursue non-traditional sources to access
  growth / liquidity capital

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• Economy

7
Turbulence in the Stock Market is the Result of
Changes in the Macroeconomic Climate

• Industrial production fell in April for the
  seventh consecutive month, the longest stretch
  since 1982
• Economy lost more jobs in April than at any time
  in the last decade, leading to highest
  unemployment levels in two-and-a-half years
• Persistent erosion in current and expected
  profitability across all sectors
• Retail sales reports showed a drop in sales at
  U.S. retailers during March
• Consumer confidence, as measured by Consumer
  Sentiment Index, has dropped 19 since November
  2000
• Lay-offs impacted 545,000 employees during the
  first 3 months of 2001 at over 4,500 companies

8

• Public Equity Markets

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After a Sustained Period of Growth, Major Stock
Market Indices Have Fallen from Peak Valuations
Over the Past Year
10
The Equity Capital Markets Continue to Suffer a
Hangover From the Slump in Technology Stocks and
a Slowing Economy
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- 12
- 41
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As Performance of Stock Market Indices Remain
Flat, Access to the the IPO Markets Has Been
Curtailed
LTM IPO Underwriting
12
The Slowdown in the IPO Market Has
Disproportionately Impacted the Ability of
Smaller Deals to Come to Market
IPO Volume
2000
2001
13
Change in capital allocation model to large
companies has left majority of small cap stocks
orphaned in the public markets

• Mutual funds focus on liquidity and efficient
  capital deployment renders small and mid-cap
  stocks unattractive
• Lack of institutional interest exacerbated by
  small floats and lack of research coverage
• Narrow market interest has left many profitable
  and solidly growing companies without access to
  capital
• Valuations do not reflect healthy operating track
  records
• In many cases, small and mid-cap companies behave
  like private companies with the burdens of being
  public

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• High Yield Markets

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High Yield Capital Market Conditions are also
Challenging, as Highlighted by Accelerating
Default Rates and Lower Volumes
Moodys Trailing-12-Months Default Rate
Annual High Yield New Issue Volume
Millions of Dollars (( of Issues)
As of February 2001.
As of May 2001.

• Default rates are trending up towards levels of
  early 1990s
• Trends are projected to continue as fallout from
  aggressive telecom lending continues to shake out
  (Winstar, ICG)

• High yield issuance has significantly decreased
  after the LTCM and Russian debt crises in late
  1998

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While the Fed has Aggressively Slashed Interest
Rates in 2001, Spreads for Non-Investment Grade
Issuers Remain High
Absolute Yields
Spreads
1/1/99 10.50
1/1/99 585
1/1/99 8.04
1/1/99 339
1/1/99 4.65
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High Yield Issuance Has Accelerated Recently As a
Result of Interest Rate Cuts but the Market for
First Time Issuers Remains Soft
Proceeds Raised in Billions of Dollars( of
Transactions)
Year EndedMonthly Avg
Latest 12 Months
First Time Issues
38.5
25.0
27.2
27.8
45.5
38.5
5.9
57.1
42.9
33.3
9.4
15.4
37.5
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Investors Have a Strong Bias in Favor of Repeat
Issuers and Highly Liquid, Large Bond Issues

• Aftermarket liquidity concerns continue to be a
  major theme in the market
• Consequently, the size of the average completed
  transaction spiked dramatically in 1999 and into
  2000
• Transactions of 1.0 Billion or greater have
  become increasingly common in the market and
  continue to attract a disproportionate amount of
  investor interest
• While deals of less than 100 million can be
  completed, investors are increasingly demanding
  pricing concessions

Average Transaction Size (1993-2001)
Millions of Dollars( of Transactions)
Issues of 100 million or Less
As a of All High Yield New Issuance
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• Senior Bank Markets

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Mirroring the High Yield Market, the Leveraged
Loan Market Has Also Tightened

• A significant contraction in leveraged lending
  began in 2000 and continues into 2001
• Significant consolidation in bank market yields
  fewer players
• Non-performing assets at large domestic financial
  institutions soared
• Economic concerns and weaknesses within certain
  industry sectors are adversely impacting credit
  outlook
• Banks have responded to the wave of covenant
  defaults with calls for new equity to both cure
  default and adjust leverage to current conditions
• While the market has recently shown heightened
  activity from cross-over credits
  (fallen-angels) and add-on financings from
  seasoned issuers, the overall financing outlook
  for middle market issuers remains difficult

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Since early 2000, Commercial Lenders Have Been
Tightening Underwriting Standards for Commercial
Loans

• Change in standards is attributed to
• Renewed sensitivity to credit risk among lenders
  following credit market turbulence
• Continued high delinquency and increase in
  non-performing assets
• Efforts of OCC (Office of the Comptroller of the
  Currency) to make underwriting practices more
  rigorous

Source Federal Reserve Board survey of senior
loan officers. Tightening reflects increasing
premiums borrowers have to pay on loans, as well
as toughening covenants and upping collateral
requirements.
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Decreased Leverage Ratios Reflect Banks Aversion
to Risk Stemming from Higher Default Rates

• Deteriorating fundamentals and the inability to
  service debt requirements have produced a credit
  crunch. Leverage ratios declined through 2000 to
  slightly less than 3.0x senior and 4.0x total
  debt.

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Leverage Multiples, Across all Loan Sizes,
Continue to Come Under Pressure
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Lenders Continue to Require Larger Equity
Contributions From Sponsors
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• Private Equity

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The Turmoil in the Capital Markets Has
Disproportionately Impacted Small and Mid-Cap
Companies

• Equity and debt markets have become increasingly
  more difficult to access
• As a result, increasing numbers of small and
  mid-cap companies in need of capital are
  considering private equity
• As an alternate pool of capital, private equity
  is less dependent on the public capital markets

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Private Equity is Defined as an Equity Investment
in any Commercial Enterprise that is not
Registered for Public Sale

• Types of P.E. Investing
• Venture Capital Eearly stage or start-up
  investment. Highest risk profile, VC investments
  are relatively small compared to other P.E.
  classes.
• LBO Substantial ownership / control interest in
  an established company, funded by a mix of
  sponsor equity and borrowings.
• Mezzanine Intermediate debt capital between
  equity and senior debt. Debt holder
  participates in equity appreciation through
  conversion features such as warrants or options. 

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The Process for Making Private Equity Investments
is Similar Across all Asset Classes

• Fund Mechanics
• P.E. investment is generally through unquoted
  funds, which are structured as limited
  partnerships that have a fixed life of ten to
  twelve years
• Limited Partners investors no direct
  investment decision-making
• General Partners private equity managers
  select, monitor and arrange exit strategies for
  the investments
• During the initial funding period, the limited
  partners will make funds available for
  investment. The GP will draw down these
  resources as opportunities arise.
• The proceeds of any sales or other disposals of
  the investments are distributed when they occur
  rather than at the end of the term of the
  partnership
• The Investment Process

Due Dilligence
Investment Decision
Documentation and Closing
Monitoring
Exit
Origination
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The Majority of Investments in Private Equity
Funds are By Large Pension Funds and Corporations
30
LBO Funds Represent a Large Pool of Un-Deployed
Private Equity Capital
Buyouts Funds Raised (In Billions),1992-2000
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Private Equity IRRs Have Outperformed Public
Equity Benchmarks, Driving Increased Commitments
to the Asset Class
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The Tide of the Private Equity Market is Changing

• Prior to March 2000, traditional buyout firms had
  difficulty attracting interest in their
  strategies as VCs posted returns far exceeding
  the 30 targeted by buyout shops
• As NASDAQ multiples contract and small and
  microcap firms exhibit recession level
  valuations, interest in buyouts has rebounded
• Having said that, given the contraction in the
  public equity markets, allocations to the
  entire private equity asset class are down

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LBO Deal Volume Has Contracted As a Result of
Volatile Financing Markets
Actual Buyout Deal Volume (In Billions),
1988-2000
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Multiples for US LBOs Have Contracted While
Strategic Buyer Multiples Remain Constant

• Throughout most of the 1990s , the average
  multiple of EBITDA increased year after year, but
  then leveled off in February 1999 and has
  contracted since
• Restricted access to debt markets in 2000 has
  contributed to this contraction
• Multiples paid depend significantly on growth of
  business, capital requirements and leverage
  available

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Partnering with a Private Equity Investor

• Huge pool of un-deployed capital
• Many private equity investors favor small-cap
  companies
• Private equity sponsors can be valuable partners
• Expert in accessing capital
• Strategic / growth decisions
• MA activity
• Attracting management talent
• Optimizing exit scenarios

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• Saunders Karp Megrue

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Overview of Saunders Karp Megrue

• A private leveraged buyout fund focused on the
  middle market
• Over 1.7 Billion of Equity Capital Raised
• Fund I 300 Million
• Fund II 516 Million
• Fund III 943 Million
• 25 experienced investment professionals
• High quality group of Limited Partners
• Two investment efforts
• Saunders Karp Megure
• SKM Growth Investors

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Manufacturing
Business Services
12
Restaurant
7
Industry Experience
Telecom
10
Financial Services
20
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Specialty Retail
Consumer Products
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Investment Parameters

• General
• Invest Exclusively in Established (Non-Venture)
  Middle Market Companies
• Transaction Types
• Private Company Recapitalizations
• Growth Buyouts and Investments
• Buy--Build Strategies
• Going Private Transactions
• Private Investments into Public Entities
• Size and Structure
• 5-200 Million of Equity Capital Per Investment
• Flexible, Creative Structures(Common, Preferred,
  Convertibles, Sub. Debt)
• Flexible as to Use of Proceeds

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SKM Has an Active Investment History
Characterized by Flexible Structures and a
Variety of Securities
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Platform Company Investments
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Add-on acquisitions to the platform companies
57
Executed transactions since 1993
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SKM aligns itself with superior management teams
who continue to hold significant equity stakes in
the business post-transaction

• Commonality of economic interests bolster
  productive working relationship
• Partnership approach encourages open and
  cooperative long-term relationships
• Emphasis on growth rather than financial
  engineering provides support that allows
  management to execute a growth plan
• Long-term perspective to allow management to
  fulfill its strategic plan
• Flexible exit expectations in cooperation with
  management

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Growth-Oriented Acquisitions/Other
75
Private Company Recaps
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Benefits of a Private Company Recapitalization
OWNER
SKM

• Provide Personal Liquidityor Buyout Retiring
  Partner
• Finance Future Growth or Acquisition
• Retain Significant Ownership (15-30)
• Second Bite at the Apple
• Remain as CEO/Visionary

• Qualitative Factors Crucialto Entrepreneur
  Decision Process
• Entrepreneur RemainsActive in Management anda
  Significant Shareholder
• Help Build Infrastructureand Accelerate Growth
• Favorable Accounting Treatment

ESTABLISH WINNING PARTNERSHIP
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Buy and Build Case Study - Applied Technology
Partners
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Buy and Build Case Study - Applied Technology
Partners
Sales
250
204.9
200
146.0
150
(US mm)
100
58.1
50
10.3
0
1997
1998
1999
2000
45
Recapitalization Case Study Dollar Tree Stores,
Inc.
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Recapitalization Case Study Dollar Tree Stores,
Inc. 1
Sales
1,688
1,600
1,352
1,074
1,200
847
666
(US mm)
800
439
232
400
168
0
93²
94²
95
96
97
98
99
00
Notes 1 Fiscal years ended December 31 2 Do not
reflect pooling-of-interests acquisition of
Dollar Express in May 2000