Presenter: Ishar Sawhney © Leverage Academy 2009. All rights reserved. 0 CLO & Distressed Investment Professional – Marathon Asset Management Prior Experiences

Presenter: Ishar Sawhney

© Leverage Academy 2009. All rights reserved.1

CLO & Distressed Investment Professional – Marathon Asset ManagementPrior Experiences include:•Founder – LeverageAcademy.com•Founder – MarketRealist.com•SPP Hambro Mezzanine Fund – Mezzanine Investing•Brookside Private Equity – PE & Mezzanine•Moelis – Investment Banking/Restructuring•Bank of America Merrill Lynch – Leveraged Finance•GE Capital – Structured Products•HedgEye – Healthcare Equity Research•KLD Research – Asset Allocation Analyst•Batterymarch Quant Fund – Risk•Legg Mason – Risk & Infrastructure•Citigroup – Infrastructure•ZepInvest.com – Business Development

Ethics – The Most Important Slide


This is not just about the dangers of insider trading….but

…understanding that…

1.We are managing the tuition and benefits to future Boston University Students.

2.Our performance will determine how the business school is perceived.

3.We have a fiduciary duty to maximize return and minimize losses.

4.The difference between sustainable and repeatable returns vs. short-term gains and speculation.

Balance Sheet

o Separated into three main categories: Assets, Liabilities and Equity

Assets = Liabilities + Equity

oAssets – What you have

oLiabilities – What you owe

oEquity – What you own

oEach line item of the Balance Sheet is organized by liquidity and shows “at one point in time” picture

Assets: Main Line Items

o Separated into Current Assets & Long-Term Assets

Current assets are resources that will be turned into cash within a year

Main Current Asset Items: •Cash & Cash Equivalents•Receivables •Inventories•Deferred Income/Prepaid Expenses

Liabilities: Main Line Items

o Separated into Current & Long-Term Liabilities

Current liabilities are items that must be paid off within one year

Main Current Liabilities: •Accounts Payable•Current Portion of Long-Term Debt•Notes Payable

Total Equity: Main Line Items

o Separated into Shareholders’ Equity & Noncontrolling Interest

Main Shareholders’ Equity Items: •Common Stock•Additional Paid-In Capital•Retained Earnings

Income Statement

o Flows in a organized order Revenue Cost of Goods Sold Net Income Earnings per Share

Shows a company’s performance over time, generally one quarter or one fiscal year

Statement of Cash Flows

Cash Flow Statement: Operations

Cash Flow Statement: Investing

Cash Flow Statement: Financing

oTracks the cash position resulting from operations involving external financing such as loans, dividends, equity issuances and debt issuances

oExamples of Cash Flow from Financing Line Items:Issuance of StockΔ in Notes PayableRepurchase of Treasury Stock


Where to find 10-K’s, 10-Q’s and other filings

Company Webpage Third-Party Websites SEC.gov / Edgar Online

Accessed with investor relations

• Easy path

• Will find other resources:

• Earnings calls

• Analyst presentations

• Important announcements

Accessed under their filings “tab”

• Easy Access

• These resources will often provide additional information

• Bloomberg

• Morning Star

• Yahoo! Finance

http://www.sec.gov/edgar/searchedgar/companysearch.html

• Very straightforward

• May need additional information

• Can find public debt of private co’s.

• Can search by SIC, State, Country


SEC Filings, Option #1: Company Webpage

1 2

1. Locate the company webpage

2. Find the investor relations “tab”



3

• Company Overview

• Current Stock Information

• Quarterly Earnings Material

• SEC Filings

• Corporate Governance

• Upcoming Events

• Email Alerts

• FAQs

• Nuance Investor Contacts

Always be on the lookout for other important

information:

•“Notice of Ability to Convert 2.75%...”

•“Discussion of Non-GAAP Financial…”

3. Identify SEC Filings Section



4

4. Locate 10-K’s & 10-Q’s


SEC Filings, Option #2: Third-Party Website

1

1. Search for a company using the website



22. Identify “SEC Filings” or “Filings” Section



3 3. Locate 10-K’s & 10-Q’s


SEC Filings, Option #3: SEC.gov

1. Go to http://www.sec.gov/edgar/searchedgar/companysearch.html

1



2. Enter company name or ticker

OR Narrow a search by country and SIC code (to find potential comps)

2



3

3. Locate 10-K’s & 10-Q’s

Extra: How to find the SIC, NAICS, ISIC code?


1. Use Morningstar.com

2. Search for your company

3. Go to “Company Profile” under “Quote”

4. Scroll down…

How to Organize and Store your 10-K, 10-Q


Use a convention that is useful for you:

Use Dropbox (to share, and save space on yourpersonal computer).

Usually in order of importance•TICKER (NUAN) – might be superfluous•YEAR – Very important •Filing type •Month & Day (if necessary)

Analyzing the 10-K: Business Description


• Includes:

• Overview – general description of the business

• Segment Operations – description of each business segment

• Research & Development (R&D)

• International Operations

• Competition

• Employees

• Company Information

Analyzing the 10-K: Business Description, Overview


• Includes:

• General business description

• Discussion of distribution channels and revenue generation

• Breakdown of revenue by segments

• Useful for comparing between competitors to see if they are in the same business or if they define themselves in a similar fashion

Analyzing the 10-K: Business Description, Segment Operations


• Includes:

• General segment description

• Discussion of distribution channels and revenue generation

• Sometimes breakdown of revenue by products or customers

• Historical trend of revenue, clients, or product mix

• Sometimes includes customer list, supplier list

• Companies that have the same or similar suppliers or customers can be comparable businesses

• Important for understanding revenue generation and supply chain

Analyzing the 10-K: Business Description, Research & Development (R&D)


• Includes:

• General description of research

• Discussion of recent R&D expenses

• Number of patents / touting intellectual property

• Sometimes discussion of scientists or research facilities

Analyzing the 10-K: Business Description, International Operations


• Includes:

• General description international exposure

• Revenue breakdown by geography

• Historical trend of geographic breakdown

Analyzing the 10-K: Business Description, Competition


• Includes:

• General discussion of markets that they compete in

• Listing competitors (possibly comparable companies)

• Explanation of competitive advantage (sometimes)

Analyzing the 10-K: Business Description, Employees


• Includes:

• General discussion of employees

• Listing number of employees and segmented by division, function, or location

• Discussion of unions, pensions or bargaining agreements

Analyzing the 10-K: Business Description, Employees


• Includes:

• Information regarding the companies incorporation, ticket symbol, any possible name changes, etc.

• Information about the company website and SEC filings

Analyzing the 10-K: Risk Factors


• Includes:

• Overview – general description of risk factors

• Risk Factors Related to our Business

• RFR to our Intellectual Property & Technology

• RFR to our Corporate Structure

• RFR to our Organization

• RFR to our Common Stock


Analyzing the 10-K: Risk Factors, Overview

• Includes:

• Statement of downside risk for investors

• Common across companies


Analyzing the 10-K: Risk Factors, Related to our Business

• Includes:

• Operating results fluctuation

• Industry Specific Regulation risk

• Dilution of earnings to existing shareholders

• Acquisition synergy risk

• FOREX Risk

• Bankruptcy/Debt related risk

• Industry cyclical, seasonal and overall risk

• Economic, Political, Legal, Social and International risk


Analyzing the 10-K: Risk Factors, Related to our Intellectual Property & Technology

• Includes:

• Litigation Risk

• Copyright, trademark, brand infringement

• Problems with Software implementation and bugs


Analyzing the 10-K: Risk Factors, Related to Corporate Structure, Organization and Common Stock

• Includes:

• Single Investor / Entity Controlling risk

• Liquidity risk in common stock

• Compliance with corporate governance and disclosure regulation

• Anti-takeover provisions

• New common stock offerings

• Common across companies

Analyzing the 10-K: Management’s Discussion & Analysis (MD&A)


• Includes:

• Forward looking statements clause

• Overview of performance (historical)

• Overview of strategy (forward looking)

• Key metrics

• Results of operations & annual comparison

• Costs and expenses & annual comparison

• Discussion of Acquisitions & annual comparison

• Segment Analysis & annual comparison

• Liquidity & Capital Resources & annual comparison

• Credit facilities & debt

• Off-balance sheet arrangements

• Contingent liabilities

• Financial Instruments & pension plans

Analyzing the 10-K: MD&A, Overview


• Includes:

• Includes additional detail from business description

• Offers management commentary as to how or why things occurred

• Very important for understanding the business

• May provide year end assumptions, and will help you forecast

Analyzing the 10-K: MD&A, Strategy


• Includes:

• Insight into potential acquisition targets

• Changes in product mix

• Changes in technological focus

• Changes in segment prioritization

• Very important for understanding the business

• May provide year end assumptions, and will help you forecast

Analyzing the 10-K: MD&A, Key Metrics


• Includes:

• Metrics from the financial statements (boiler plate)

• Non-GAAP metrics (may be useful for understanding management’s focus)

• Non-financial metrics: industry growth, market penetration, values of contracts, etc.

• Important financial / operational / accounting ratios

Analyzing the 10-K: MD&A, Results of Operations


• Includes:

• Revenue generation and expense allocation by division, segment, function or geography

• Breakdown of purchase price allocation for significant mergers

• Compares most recent fiscal year to year prior

• Cites explanation for changes in specific metrics

• i.e. prices went up 5%, volume was down 3%, netting in a sales increase

Analyzing the 10-K: MD&A, Segment Analysis


• Includes:

• Extensive description of each segment, and partial P&L for each segment

• Relevant when there is a change of reported operating segments

Analyzing the 10-K: MD&A, Segment Analysis


• Includes:

• Extensive description of each segment, and partial P&L for each segment

• Relevant when there is a change of reported operating segments

Analyzing the 10-K: MD&A, Liquidity & Capital Resources


• Includes:

• Amount of debt raised, type of debt, when it was raised, how much it costs, and why it was raised

• Comparison with fiscal year prior,

• Credit facilities & debt elaborates on reasoning for debt

• Will help predict how the company will respond to a near-term maturity of debt

• Breakdown of off-balance sheet arrangements, and payment due for contractual obligations

• Contingent liabilities – debt incurred if XYZ occurs

• Financial instruments shows what the company is hedged against

Debt Maturity

Key Points•Can the company pay maturing debt?•What is the interest rate charged on those debt

– Used for discounted cash flow valuation

Capital Structure and Seniority

1.Senior

2.Senior subordinated

3.Mezzanine

•Revolving credit •Libor•Credit ratings: S&P and Moody’s•Secured and unsecured (collateralized or not)

– Non-recourse– Limited-recourse– Full-recourse

Notes on Debt

Maturing Debt Schedule

Leases & Effect on the Financial Statements

Operating Lease•Balance sheet: off-balance sheet item

– Debit: NA– Credit: NA

•Income statement: lease reported as rental expense on the financial statement– Debit: rental expense– Credit: cash

Capital Lease•Balance sheet: leases are capitalized as asset

– Debit: fixed asset account– Credit: capital lease liability

•Income statement: the asset will be depreciated over the term of use– Debit: capital lease liability, interest expense and depreciation expense– Credit: cash and accumulated depreciation

Operating & Capital Leases

Companies have strong incentives to record as operating lease. •Operating leases are an off-balance sheet item•Capital Leases increases liabilities and assets

– Negative effects on certain leverage (e.g. debt to equity) and return (e.g. return on assets) ratios

Capital lease if any of the following is met:

1. If lease life exceeds 75% of life of the asset

2.If there is a transfer of ownership to the lessee at the end of the lease term

3.If there is an option to purchase the asset at a “bargain price” at the end of the lease

4.If the present value of the lease payments, discounted at an appropriate discount rate, exceeds 90% of the fair market value of the asset

Adjustments•Discount future operating lease obligations back to the present using appropriate discount rate•Approximate discount rate: using the firm’s current pre-tax cost of debt as the discount rate (perhaps even higher) — best: marginal cost of debt

Pensions

Defined Contribution Plan •Contribution (input) is defined •Retirement withdraw (output) based on investment performance •Accounting

– Will not remain on the balance sheet – Debit: Pension expense– Credit: Cash or pension liability

Defined Benefit Plan •Contribution (input) may vary based on investment return•Benefits (output) defined based on formula

– Factors include salary history and duration of employment

•Accounting– Projected benefit obligation (liability)– Planned asset (asset) – Company only shows the net difference on financial statement

• If planned asset > projected benefit obligation, then the company records net asset • If planned asset < projected benefit obligation, then the company records net liability

Pensions

Simplified Comparable Company Analysis


Evaluates value using common sized metrics and ratios of companies of similar size in the same industry.

Focuses on creating a benchmark for the industry which the company will be valued on.

Find the right competitors is important. It can be done in several ways, and there is no correct answer to who their competitors are.

On the right Sal’s Pizza is used the industry.

Sal’s Pizza Co.Valued at $100,000

2010 EBITDA: $50,0002010 Earnings: $10,000

Enterprise Value / Sales (EV/EBITDA) = 2x

EV/ Net Income = 10x

University Grill, Inc.2011 EBITDA: $40,0002011 Earnings: $7,000

Using the established ratios or multiples…

Implied Valuation: 2x EBITDA = $80,000Implied Valuation: 10x Net Income =

$70,000

How to identify competitors


Standard Industrial Classification Third-party Website

http://www.sec.gov/edgar/searchedgar/

companysearch.html

• Will find other resources on competitors

• 10-Q’s, 10-K’s

• Used by the SEC

Accessed under their Competitor tab

• Sectors are different from SIC

• Gives a financial snapshot of competitors

• Yahoo Finance is one example

Investext

Accessed in the Pardee library

• Gives you access to analyst reports

• Will give you the competitors that the

Street uses

DisclaimerEven though these methods provides you with companies that are in the same industry they are not always direct competitors. Other factors to take into consideration is revenue generation, size, geographic location etc.

Competitors, Option #1: Standard Industrial Classification


1. Look up your company on Edgar



2. Find the Standard Industrial Classification (SIC) and go back to the previous page



3. Look up the SIC code, and see the results



4. Find competitors

Competitors, Option #2: Third-Party Websites


1. Look up the company on site



2. Identify the Competitors tab



3. Look for competitors

Competitors, Option #3: Investext


1. Look up your company on Investext



2. Choose research from the menu



3. Choose the report you want and click view



4. Select all to retrieve the entire report. Then click view



5. Use the competitor from the report as a reference.

Sample Industry Comparable – Healthcare


Forward PE to PE


The Price to Earnings ratio (Share price/Earnings per share) is one of the most used comparable. It shows you how many dollars people are willing to pay for $1 of earnings.

One issue with PE is that it is calculated using historical earnings. Using historical earnings does not display the growth of the company.

This can corrected by using the Forward PE multiple. It uses the estimated 1-year EPS instead of historical earnings. (Share price/1-year forward EPS).

Now we have a measure of how much people are willing to pay for $1 of future earnings.

PE varies from industry to industry, so finding the right competitors is important.

Look at difference in Forward PE and PE

Trailing twelve months (ttm)


Trailing twelve months is the company’s performance over the twelve months before their last filing.

Ttm is calculated to show a more recent picture of the financials of the company. Since the quarterly reports does not include, the full year so it might be skewed because of seasonality or events.

This is not done for the balance sheet, since the balance sheet only reflects one point in time.

You calculate ttm by adding their performance in their latest quarter, you add their last full year performance and then subtract out last years corresponding quarter.

Ttm calculation

Most Recent Quarter(s) + Most Recent Year – Last years Corresponding Quarter(s)

IncomeTtm 4 + 10 - 1 = 13

How to calculate ttmQ1 2012

$4 $102011 Q1 2011

$1

Documents

Presenter: Ishar Sawhney © Leverage Academy 2009. All rights reserved. 0 CLO & Distressed Investment Professional – Marathon Asset Management Prior Experiences