Proposed Leveraged Buyout of MedSource Technologies

1
Proposed Leveraged Buyout of MedSource
Technologies
May 16, 2003

• Jon Fellows
• Mike Holland
• Malik Shakur

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Agenda

• Description of MedSource
• Valuation
• Current
• Current with Improvements
• LBO Analysis
• Characteristics
• Valuation
• Recommendation

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What is MedSource?

• Began as a component manufacturer in 1998 built
  on acquisitions
• Current product segments include
• Surgical Instrumentation
• Electro medical Implants
• Interventional Medicine
• Orthopedics
• Expanding to design and assembly to improve scale
  and profitability

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Where is MedSource? Operational Comparisons
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Where is MedSource?Financial Comparisons
Source MSN Money Central
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What is MedSource worth?

• Current Situation without LBO
• No improvements
• Improvements without LBO
• Include improvements
• Improvements with LBO
• Include improvements
• Take on debt through LBO

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Current Situation Without LBO
Operating Cash Flow Assumptions
Includes a NOL carryforward of 42 million
Source UBS analyst reports common size
statements
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Current Situation Without LBO
Financial Assumptions
Cost of Equity 15.72
WACC 10.58
Source UBS analyst reports common size
statements
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Current Situation Implied Valuation

• Enterprise Value - 122 million
• Debt - 42 million
• Equity Value - 80 million
• Price per share - 2.88

Implications

• The market is not recognizing managements
  ability to improve companystock is fairly valued
  under these assumptions

• Without improvements, an LBO would be impossible

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Value Creating Opportunities

• Operational Improvements
• Increase Gross Margins
• Evolve business towards higher margin design
  areas
• Relocate production from lower to higher margin
  locations
• Improve Operating Leverage
• Utilize excess capacity by increasing unit volume
• Rationalize other capacity
• Improve Working Capital Management
• Extend payables to suppliers
• Improve receivables collections
• Reduce inventory
• Goal Move closer to more efficient of Medical
  Device Industry or Contract Manufacturing
  Industry

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Implied Valuation With Improvements
Assumption Improve COGS, SGA, and NWC by 1
each
Operating Cash Flow Assumptions
Includes a NOL carryforward of 42 million
Source UBS analyst reports common size
statements
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Implied Valuation with Improvements

• Enterprise Value - 178 million
• Debt - 42 million
• Equity Value - 136 million
• Price per share - 4.89

Implications

• There is significant value to be gained from
  marginal improvements

• Value-added is approximately 69 from 1
  improvements in
• COGS, SGA, and NWC

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Attribution Analysis Wheres the Value?
The 55.9 million incremental value is primarily
attributed to cost of goods sold and SGA

• COGS 25.9 Million
• SGA 25.9 Million
• WC 4.1 Million

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What Makes for a Good LBO Candidate?

• Limited Vulnerability to Predatory Pricing
• MEDT is already market leader
• Diffuse Industry
• 4,000 players in medical outsourcing industry
• Areas for Improvement (Operating and/or
  Financial)
• COGS, SGA, NWCefficiency improvements
• Unutilized Debt Capacity
• Acquisition strategy leads to uncertainty

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What Makes for a Good LBO Candidate?
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• High, Stable Cash Flows
• Optimistic for the future, but unproven past
• Low Business Risk (Low Asset Beta)
• Asset beta 1.34
• Low Reinvestment Requirements
• Potentially very high for acquisition strategy
• Mature Industry
• Components side maturing, but design and
  manufacturing business in its infancy

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LBO Acquisition Cost Assumptions

• Current Value
• Market Cap 80.6 million
• Debt Level 41.9 million
• Enterprise Value 122.5 million
• Stock Premium Offered (30)
• Acquisition Cost 146.7

Equity Value as of 5/9/03
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LBO Deal Structure Assumptions
Acquisition Cost 146.7 million
Equity Capital 36.7 million (25)
Debt Capital 110.0 million (75)

• Represents anticipated maximum leverage available
  in HLT
• Lower equity capital provides greater upside

Source High yield desk of major investment bank
our assumptions
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LBO Debt Characteristics

• Senior Debt 38.8 million
• Assets for Collateral
• Accounts Receivable at 75 of value
• Inventory at 50 of value
• Property, Plant, Equipment at 25 of value
• Total 38.8 million
• Repayment Schedule
• Principal payments equally over five years
  beginning in year two
• Interest rate (5.28)
• LIBOR plus 400 bps

Source High yield desk of major investment bank
our assumptions
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LBO Debt Characteristics

• Mezzanine Debt 71.2 million
• Repayment Schedule
• Principal payments equally for five years
  beginning in year three
• Interest rate (12)
• 52-week average of Merrill Lynch High Yield Index

Source High yield desk of major investment bank
our assumptions
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LBO Valuation with Improvements
Adjusted Present Value Framework

• Enterprise Value - 176 million
• All equity firm value 161 Million (excludes
  NOLs)
• Interest tax shields value 15 Million
• Unlevered Cost of Equity 12.26
• Debt - 42 million
• Equity Value - 134 million
• Price per share - 4.82

Implications

• From a valuation standpoint, LBO is attractive

• 28 return potential over and above 30
  acquisition premium

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LBO Debt Payment Capabilities
Cash Deficits

• Free cash flow from operations is insufficient to
  support debt load from LBO

Cash deficits continue until 2012
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Simulation Analysis

• Simulation assumptions
• NWC, SGA, COGS
• Normal distributions
• 10 standard deviations
• Simulation Results
• 3 chance for meeting interest and principal
  payments

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Simulation Results
Based on assumptions, there is only 3 chance of
success
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Risks MedSource

• Concentrated Customer Base
• Few (4) customers account for 52 of revenue
• Susceptible to Outsourcing Trends
• Is trend toward outsourcing sustainable?
• Length of Customer Contracts
• Short project by project few long-term
  contracts
• Reduce volume
• Cancellation can occur anytime

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Risks MedSource

• Inability to Transfer Increased Costs
• No pricing power over customers
• Price volatility of raw materials
• Evolving Business Strategy
• See Revco LBO failure
• Acquisition Strategy
• Problems with integration
• Diversion of management resources

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Possible Alternatives to LBO

• Roll-up Strategy
• Consolidate industry via acquisitions, primarily
  using equity
• Due to depressed stock price, roll-up strategy
  would be too dilutive
• Most effective when stock price is fairly valued
• Leveraged Build-up
• Consolidate industry via acquisitions, primarily
  using debt
• Similar difficulties as LBO, but with added
  acquisition vs. debt payment conflict
• Requires efficient integration of acquired
  companies

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Recommendation

• Do not undertake an LBO
• Improve operational efficiencies to align with
  respective industry benchmarks
• COGS, SGA, NWC
• Successfully integrate past acquisitions
• Assuming stock price appreciates, begin roll-up
  strategy using a fairly-valued equity currency