Investment Banking University of Colorado Rob Kaufman November 3, 2004

Investment Banking University of Colorado Rob Kaufman November 3, 2004

Investment Banking Agenda • Overview of IB industry • Perspectives on market risk • Valuation perspective • Case study: .com valuation • Case study: Sell-side M&A • Q&A

RWK Bio • Rob Kaufman • BA in Economics, Yale University (1981-85) • International Capital Markets, Goldman Sachs (85-89) • MBA in finance, Harvard Business School (1989-91) • Partner, Sierra International Partners (1991-1995) • Partner, The Wallach Company (1995-1999) • CFO and CEO, netLibrary, Inc. (1999-2002) • Partner, Q Advisors LLC (2002-present)

Overview of the I-Banking Industry • Investment Banking • Private placements • Mergers and acquisitions • LBOs, MBOs • Sales/Trading • Public company research • Stock brokers • Retail/institutional sales coverage • Corp. Finance • Corporate and municipal issuance of equity/debt • Capital markets Hybrid Securities

Perspectives on market risk An attempt to define the expected return which corresponds to investments at various levels of risk.

Risk/Reward Relationship • The Risk/Reward Frontier • Required Rates of Return • Developing an appropriate discount rate for an investment decision

Risk/Reward Frontier An attempt to define the expected return which to corresponds investments at various levels of risk U.S. T-Bills Low RISK

Risk/Reward Frontier An attempt to define the expected return which to corresponds investments at various levels of risk U.S. T-Bills Seed-Stage VC Low RISK High

Risk/Reward Frontier Seed Stage Venture Capital Start-up Venture Capital Early Stage Venture Capital Private Equity Mezzanine Debt “Junk” Bonds Senior Debt Small Capitalization Equities Large Capitalization Equities U.S. T-Bills High RISK Low

Expected Annual Returns Seed Stage Venture Capital Start-up Venture Capital Early Stage Venture Capital Private Equity Mezzanine Debt “Junk” Bonds Senior Debt Small Capitalization Equities Large Capitalization Equities U.S. T-Bills 50%+ 40-50% 35-45% 25-35% 18-25% 14-20% 8-12% 14-18% 10-14% 4-5 % High RISK Low

Required Rates of Return • Venture Capital • Private Equity • Mezzanine Debt • Senior Debt Risk • Small Cap Equities • Large Cap Equities • U.S. T-Bills Return

Valuation perspective • Why is valuation important? • Fundamental to all boutique investment banking work • Private placements require premoney valuation • M&A work requires relative value of acquirer/acquiree • Financing of transactions requires fundamental understanding of value

Valuation perspective • Methodologies • Public Comparable Analysis • Control Transactions • Discounted Cash Flow Analysis

Public Comparable Analysis • Select publicly-traded comparable companies • Analyze financial and operating performance • Derive valuation multiples for minority positionbased on performance of comparables • Adjust for size/liquidity discount and control premium

Control Transactions • Collect historical transactions in SIC Codes • Compute financial performance of targets • Derive valuation multiples from disclosed information (multiple of sales, EBIT, EBITDA, NI) • Adjust for size discount • Apply multiples to target

Discounted Cash Flow Analysis • Develop financial model with aid of management • Projected after-tax, free cash flows, discounted to present • Terminal value calculated as a multiple of final year Operating Profit, discounted to present • Appropriate discount rates applied to cash flows and terminal values • Appropriate terminal value multiples applied to final year profit

Case study: .com valuation Valuations gone haywire: 1998-2000 Case Study: netLibrary, Inc.

Case study: netLibrary, Inc. • The netLibrary Story • Founded 1998, three founders • Raised $120+ million • Grew to 520+ employees in March 2000

Case study: netLibrary, Inc. • The netLibrary Story • Founded 1998, three founders • Raised $120+ million • Grew to 520+ employees in March 2000 • Reduced headcount to 122 in September 2001 • Sold in Chapter 11 for $10 million • Zero capital returned to investors, shareholders

Case study: netLibrary, Inc. • Founding • Founded 1998, three founders • Create an ASP model for reference content • Compete in $5+ billion market for published content from leading publishers into institutional libraries in academic, public and corporate libraries • Early support from University of Colorado libraries and University Press • Raised $5 million 8/98 Anschutz and Sequel

Case study: netLibrary, Inc. • Growth • Bring on CFO in February 1999 • Raising venture funds • Requirements: • Executive Summary • PowerPoint • Challenges • Too many interested parties • Valuation ramping too high/too quickly

Case study: netLibrary, Inc. • Funding • Venture funding • Series A, $5 million at $5 million premoney • Series B, $25 million at $40 million premoney • Series C, $72 million at $225 million premoney • Series D, $15 million at $450 million premoney • Public offering • CSFB/Merrill Lynch/JP Morgan • Timing  April 2000

Case study: netLibrary, Inc. • Restructuring • Headcount reduction • Focus on customers/publishers and not investors • Aggressive move toward EBITDA positive • Move toward sale of Company as endgame, not IPO or organic growth

Case study: netLibrary, Inc. • Lessons Learned • Running the business • Meet customer needs, not investor/buyer needs (“Built to Flip”) • “Traditional” business requirements apply • Financial • Cost of capital  higher valuation needs to be earned • Beware competing stage investors

Case study: netLibrary, Inc. • netLibrary Epilogue • Investor conflict • Series A/B aligned against Series C/D • Buyers identified (three @ $40-50 million) • Conflict over the “cram down” • Sale in Chapter 11 bankruptcy despite cash in bank • Currently 60+ employees, $20+ million revenue and still EBITDA positive

Case study: Sell-side M&A Sale/Merger Characteristics • Must possess strategic/financial value to buyer • Established product/service and installed customer base • Management team optional • Proprietary process or technology preferred • Opportunity for moderate growth or enhanced market share • Sufficient company size

Advantages Value could be the highest of alternatives Greatest liquidity of Alternatives Possibly tax-deferred exchange No Publicity if private transaction Complete exit from business Moderately expensive transaction costs Case study: Sell-side M&A Disadvantages • Loss of Control • Management could be dramatically affected • No “upside” for future performance for 100% sale • You could be unemployed • Your company could lose its identity

Case study: Gates Rubber Company • Facts • World’s leading manufacturer of rubber hoses and belts with revenues of over $1.5 billion • Family owned business • Desire for a tax deferred transaction • IBer had completed seven other assignments for Gates

Case study: Gates Rubber Company • Facts • World’s leading manufacturer of rubber hoses and belts with revenues of over $1.5 billion • Family owned business • Desire for a tax deferred transaction • IBer had completed seven other assignments for Gates • Assignment • Conduct a worldwide sale process to a limited number of strategic buyers

Case study: Gates Rubber Company • Facts • World’s leading manufacturer of rubber hoses and belts with revenues of over $1.5 billion • Family owned business • Desire for a tax deferred transaction • IBer had completed seven other assignments for Gates • Assignment • Conduct a worldwide sale process to a limited number of strategic buyers • Result • Nine entities approached; three final offers • Sold to Tomkins PLC for a package of securities valued at $1.2 billion

Investment Banking University of Colorado Rob Kaufman November 3, 2004

Investment Banking University of Colorado Rob Kaufman November 3, 2004