Asset Management: Buyout Firm Derek Priest … · Asset Management: Buyout Firm Derek Priest ......

5/2/2007

Blackstone Group (BX) Analyst: Derek Priest of 13

BX: A Breakthrough in Private Equity Evolution Asset Management: Buyout Firm

Derek Priest Ticker: BX Recommendation: Buy Price: N/A Price Target: N/A Valuation Target: Value/NOPLAT = 27.7 Value/Invested Capital = 9.1 Highlights

• Investment in Steve Schwarzman: Steve Schwarzman, CEO of Blackstone Group, is a renowned investor. An investment in Blackstone is, as much as anything, an investment in Schwarzman’s abilities and consistent positive track record.

• Strong Expected Growth: Blackstone is expected to grow revenues and profits at a vigorous rate over the next few years. Reasons supporting the high growth forecast include a steady stream of income from sources other than pure private equity, and an ever-growing portfolio of acquisitions.

• Portfolio Diversification: Private equity in its purest form is risky. To hedge the inherent risk in the business, Blackstone invests in other asset classes to create a steady stream of income, which makes earnings less volatile. A less volatile business results in a lower beta, which means Blackstone is a good source of positive alpha without significantly increasing the volatility of a portfolio of equity securities.

• Large Market Value Added: Blackstone’s internal analysts (as reported by the Wall Street Journal “Valuing Blackstone Group 3/24/2007) estimate Blackstone has created $40 billion in market value added, a number confirmed from my own DCF model (see spreadsheet addendum to this report). The large MVA comes from strong, sustained ROIC and a low WACC. My forecasts show that if the company decides to pay dividends, as appears to be the trend from other PE firms going public, MVA could rise even higher.

• Reasonable Valuation: Blackstone's valuation ratios (such as Value to NOPLAT and Value to Invested Capital) compare favorably to those of American Capital Strategies and MCG Capital.

Investment Summary The BUY recommendation is derived from the discounted cash flow model used to value the company, which has been modified in order to take into account the unique variables of management, income, and acquisitions. Because Blackstone is not currently a publicly traded company, I cannot currently value it using the traditional valuation ratios such as Price/Sales or Price/Earnings. I instead use a market value added approach and multiples

Blackstone Group

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of value/NOPLAT and value/invested capital. Value/NOPLAT indicates how much the market value each dollar of NOPLAT the firm produces. It is a close equivalent for Price/Earnings for a firm without any public shares. A key assumption in my projections is BX's growth: I forecasted a 5-year growth rate of 20%, tapering from 18% to 11% in years 6-10, and a long-term horizon-value growth rate of 7%. Other assumptions include return on invested capital of 25%, tapering to 20% over 10 years, and a weighted average cost of capital of 9.81%. These assumptions suggest a Value/NOPLAT of 27.7. When compared with American Capital Strategies (Value/NOPLAT of 32) and MCG Capital (Value/NOPLAT of 29.08), two private equity firms which have gone public, Blackstone shows no sign of being overvalued relative to the industry.

A key component of the growth forecasts, and thus all other projects, derives from Steve Schwarzman’s talents as an investor. I forecast revenue growth slowing in 2007 and declining further over time, but I am projecting a more positive trajectory for Blackstone compared to the entire private equity space. Access to capital and the best deals will be a critical intangible for the increasingly-crowed private equity space, and the Steve Schwarzman "brand" is likely to provide Blackstone with key advantages here.

The ability to leverage these intangibles for continued growth is critical to Blackstone's prospects as an investment. Blackstone continues to attract some of the best deals on the Street, thus the positive long-term outlook for growth. With several acquisitions last year and five so far this year, Blackstone has the potential to continue generating strong profit growth.

Another contributor to my valuation forecast is the diversity of Blackstone’s business. By running several distinct asset management divisions, Blackstone should be better positioned for a possible downturn in private equity compared to most firms.

BX's large market value added is a key element in my Buy recommendation. The current market value added is about $40 billion. If MVA continues to grow, the company's stock price should rise. In addition, after investigating other recent private equity firms that have gone public, it appears some have started paying out a 7% dividend yield. With the large amounts of cash generated by Blackstone, it is not out of the question they will immediately begin paying out similar dividends. This would be particularly beneficial, as the Student Investment Fund will enjoy the same tax-free status as the Washburn Endowment Association (being a non-profit organization).

There are, of course, always potential negatives that could negatively impact BX:

1. The loss of Steve Schwarzman. 2. A larger than anticipated drop off in the private equity sector. 3. Blackstone missing out on key acquisitions throughout the year. 4. Because I am valuing an IPO, I do not have all the financial data necessary for a

typical valuation. These are the main negatives that can be foreseen at this time. However, it is imperative to remain vigilant for other potential hazards that may be difficult to anticipate at the time of the IPO.

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Bear Case: The bear case presented by analysts against the Blackstone IPO is not without reason. Bear analysts first of all argue about the value of Blackstone being too high. Blackstone's MVA of $40 billion was built on strong growth, which must continue for its stock to outperform post-IPO. Another concern is how long Steve Schwarzman will remain with the firm. Analysts have voiced concerns that one of the reasons for Schwarzman taking the company public is he wants to ensure the company will live on after he retires, and that he would only go public if he was planning retirement in the foreseeable future. Yet another potential theory is Blackstone is going public because it is attempting to "cash out" before a slowdown in the private equity sector. The decision to go public may be a signal that private equity has peaked, and the only direction to go from here is down. An Investment in Steve Schwarzman Steve Schwarzman is one of the most experienced private equity mergers and acquisitions players of our time. Steve Schwarzman’s experience dates back to 1977, when he worked for Lehman Brothers in the mergers and acquisitions division (until 1984). Schwarzman was the chair for Lehman Brother’s mergers and acquisitions from 1983 to 1984. Afterwards, he and another partner started Blackstone, where he was designated as the CEO and has held the position ever since. It can be argued Steve Schwarzman is one of the main reasons for Blackstone’s early success. He is actively involved in the management of all aspects of the business, and the company has demonstrated sustained superior performance. As mentioned earlier, an investment in Blackstone is really an investment in the abilities of Steve Schwarzman and all of the excellent talent he has recruited. The firm's large MVA attests to the talent Blackstone has attracted. Some of the bear analysts argue Blackstone went public in order to keep going when Steve Schwarzman retired, and that he could retire very soon. Such an event is possible. However, a public offering also means Blackstone is now capable of offering stock option-based incentive compensation to its employees. These options could have two potential benefits. First, they may help keep Schwarzman around longer. But in the event he does retire, a good incentive plan can help recruit top managers to replace him and to continue guiding the company down the same path. Another positive is private equity tends to be a long-term investment business. When a buyout firm such as Blackstone acquires a company to keep in its portfolio, it has the flexibility to hold the company in its portfolio as long as necessary to build the maximum value for Blackstone. This means when Steve Schwarzman retires, strategies-in-place will continue to develop for years down the road. It is most probable that Schwarzman took Blackstone public with full awareness of the reputation he has built. It isn’t uncommon for CEOs of successful private companies to go public for reasons of prestige. As will be discussed in greater detail below, Blackstone doesn’t necessarily need the amount of cash it hopes to raise from its IPO.

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Sources of Growth Assets Under Management: Since 1995, assets under management (AUM) have increased steadily from $3.1 billion to a current level of $78.7 billion (from the IPO filing on 03.22.07). Blackstone's growth in AUM has averaged 34% a year, considerable even for the best private equity firms. In particular, growth has jumped dramatically since 2001, when Blackstone’s AUM was $14.1 billion. Compared with today's level of $78.7 billion, that is a lot of growth in a relatively short period of time, averaging 39.5% per year in 6 years. Growth of assets under management is critical — this is how a business such as Blackstone derives all of its profits. Without asset growth, the value of a private equity firm would stagnate, and eventually decline. BX's closest competitor, Kohlberg Kravis Roberts & Company, has $75 billion in AUM. However, KKR has been in business since the mid-70s. Though it has AUM comparable to Blackstone, Blackstone has outpaced its rival in growth of these assets.

AUM Breakdown %

31.10 , 40%

17.70 , 23%

17.10 , 22%

6.90 , 9%

1.50 , 2%

1.30 , 2%

1.90 , 2%

1234567

Amounts in Billions

Corporate Private Equity

Real Estate Opportunity

Funds of Hedge Funds

Mezzanine Funds

Distressed Securities Hedge

Equity Hedge

Closed-End Mutual Fund

Blackstone’s assets under management can be broken down into three basic categories. The first and most important is Corporate Private Equity. These assets are the core of Blackstone’s business in that they represent Blackstone’s original business; the acquisition of firms in order to invest in them and eventually resell them on public markets. Of Blackstone’s assets under management, corporate private equity makes up $31.1 billion, or 39.5%. This is the largest single chunk of the assets controlled by

AUM IRR Corporate Private Equity 22.8%Real Estate Opportunity 29.2%Funds of Hedge Funds 11.9%Mezzanine Funds 9.3% Distressed Securities Hedge 7.9% Equity Hedge 8.9% The India Fund 43.9%The Asia Tigers Fund 42.5%

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Blackstone. Currently, these assets have an average annual IRR after fees of 22.8% since 1987. The second piece of Blackstone’s assets under management is Real Estate Opportunity Funds. These assets make up the smallest part of assets under management at $17.7 billion, or 22.49% of the total portfolio. However, this class of assets has an average annual IRR of 29.2% after fees, generating the highest percentage returns in the portfolio. The third class is more of a group of Alternative Assets. These assets include managing funds of hedge funds which consist of $17.1 billion in assets with an annual IRR of 11.9%, mezzanine funds which consist of $1.5 billion in assets with an IRR of 9.3%, adistressed securities hedge which consists of $6.9 billion in assets and has an IRR of 7.9%, an equity hedge fund which consists of $1.3 billion in assets and 8.9% IRR, and a closed-end mutual fund which consists of $1.9 billion in assets. The closed-end fund is actually made up of two funds, The India Fund with an IRR of 43.9%, and The Asia Tigers Fund with an IRR of 42.5%. The equity hedge fund and closed-end mutual fund have only been in operation for a few months, so the IRRs of these funds are volatile and most likely not representative of future performance.

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1 Blackstone S-1 Prospectus

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Revenues: Revenues come from several main sources. The first source is the annual fee charged for managing assets. This is the most stable source of income for Blackstone. These fees are typically 1.5% of assets under management — the more assets under management, the higher the income from managing assets. This is one reason why Blackstone is taking on assets at such an aggressive rate; if the revenues from the sale of firms in its portfolio declines, it still has a reserve source of revenue. It is the most stable of all of Blackstone’s revenue sources. For 2006, these revenues totaled $1.2 billion, and netted $600 million after taxes and expenses. This is a sizable portion of the total $2.3 billion earned by the firm in 2006. The next income source comes from carried interest. Carried interest is a 20% charge on all income earned by companies held within Blackstone’s portfolio. When companies in Blackstone’s portfolio make strong profits, carried interest results in a majority of Blackstone’s income. However, a company must make at least 7% gross profit. If it does not achieve this goal, Blackstone does not charge carried interest. If the economy is not doing well and the companies in Blackstone’s portfolio under-perform, Blackstone loses out on a large share of profit. Carried interest consisted of the largest share of Blackstone’s profit, making up $1.5 billion in after tax income.

Blackstone Profit Sources

1.50 , 65%

0.60 , 26%

0.20 , 9%

123

Carried Interest

Other

Asset Management Fees

Amounts in Billions

However, the chance for another profitable year appears positive for 2007. Since its acquisition of Equity Office Properties in February, Blackstone has sold off $22 billion in EOP’s holdings. Since EOP would have profited from this sell off, Blackstone could very well profit in the form of carried interest. Balance Sheet/Cash Flow:

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Blackstone is a cash flow machine. It is capable of generating cash in the range of 85% of revenues, a number that has been trending upward. A large amount of cash allows Blackstone to make its acquisitions with as little debt as possible. It also generates substantial free cash flow, which makes the firm highly liquid. Current and quick ratios are estimated at 1.83 for 2007. Blackstone also has a high amount of long-term debt. However, this amount can be explained by the origin of the industry, which requires borrowing large amounts of money to purchase companies, turn them around, and then profit from the eventual sale of the company. Because all of these acquisitions require more cash than most firms can produce and comfortably hold, private equity firms employ significant leverage. Acquisitions: Currently, Blackstone is aggressively buying more businesses. This helps by boosting its assets under management. In turn, increasing assets under management can increase revenue, and also further diversifies the industries Blackstone has a control in, thus reducing the risk of experiencing a loss in profit. It has already acquired five companies this year, and at this rate will acquire to quite possibly sustain a strong profit in light of a potential economic downturn. Not only is making numerous acquisitions, it is doing more than its closest competitor, Kohlberg Kravis Roberts & Company. Last year, KKR made seven acquisitions all year. On the other hand, Blackstone made nine, and with five already in 2007, Blackstone may be on track to break double digits this year. Included is a timeline of Blackstone’s major activities since January 1st of 2006: 1/31/2006 Partners with Lion Capital to buy Cadbury Schweppes PLC’s drink

division.

2/22/2006 Buys MeriStar $940 million 3/7/2006 Buys CarrAmerica $5.6 billion 4/25/2006 Buys 4.5% of Deutshe Telekom AG from German government $3.3 billion 4/26/2006 Sells Kabel Baden-Wurttemberg GmbH to PE firm EAT Partners AB

of Sweden $1.6 billion

6/6/2006 Pairs with Brookfield Properties Corp. to buy Trizec $4.8 billion 7/1/2006 Pairs with Bain Capital to buy Michael Stores Inc $6 billion 7/1/2006 Affiliate buys Cendant Corp $4.3 billion 9/16/2006 Buys Freescale Semiconductor $17.6 billion 10/26/2006 Partners with PAI Partners to buy United Biscuits PLC $3 billion 1/26/2007 Acquires Cardinal Health $3.3 billion 2/8/2007 Blackstone Acquires Equity Office Properties $39 billion 2/12/2007 Blackstone Acquires Pinnacle Foods 3/6/2007 Acquires Tussauds Group $2 billion 3/16/2007 Blackstone Partner’s with GE for purchase of PHH $1.69 billion 3/23/2007 Blackstone files for IPO

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Higher Diversity Means Lower Risk Private equity is naturally a risky business. The main profits of a company in this industry come from a percentage charging fees on a percentage of profits made by the companies being held in a PE’s portfolio, and to a lesser extent, from the sale of the held companies themselves. If the companies held in a PE firm’s portfolio do not perform well, such under-performance can lead to poor earnings. To hedge against the risk of volatile profits, Blackstone diversified into other, more stable forms of asset management, such as hedge funds and mutual funds. Such diversity reduces Blackstone’s exposure to the potential losses from dealing in just one form of asset management. I used the beta of Apollo Investment Corporation, another recent private equity firm turned public, as a proxy because the beta of Blackstone has yet to be calculated. Apollo’s beta is 0.74, but it is possible Blackstone’s could be lower because it is a larger firm with a larger, more diversified portfolio. Valuation The valuation model used to estimate the buy recommendation for Blackstone comes from a discounted cash flow mode. The first ratio used is Value/NOPLAT (27.7), and the second is Value/Invested Capital (9.12). Value/NOPLAT (27.7): Since it is not possible to estimate a price/earnings ratio because Blackstone does not currently have publicly traded shares, it is necessary to use alternative methods to evaluate when to buy Blackstone shares. The first method is Value/NOPLAT. Value/NOPLAT uses a long term growth rate (7%), ROIC (31.6%), and WACC (9.81%) to determine how much the market values each dollar of NOPLAT. With these numbers, I came up with a Value/NOPLAT of 27.7. This says as long as The SIF purchases shares at or under a Value/NOPLAT of 27.7, it should be buying them at or under the market value. Compared with American Capital Strategies and MCG Capital, this ratio is about average. Value/Invested Capital (9.12): Another ratio used in place of price ratios is Value/Invested Capital. To measure Value/Invested Capital, I used long-term growth (7%), ROIC (31.6%), RONIC (40%), and WACC (9.81%) to come up with a Value/Invested Capital of 9.12. This says as long as the SIF purchases shares at or under a Value/Invested Capital of 9.12, it should be buying the share at or under market value. Business Description Blackstone Group operates primarily as a private-equity buyout firm, but is continuously expanding into other forms of asset management in order to stabilize revenue. Currently,

5/2/2007


Blackstone has over 40 companies in its portfolio. The company participates in managing mutual funds, hedge funds, real estate, and most of all, acquiring companies. The portfolio currently contains $78.7 billion in assets, a majority of those in its primary business of holding companies. Currently, Blackstone is ranked by Forbes magazine as the number one private equity firm in the United States. It maintains a competitive advantage through aggressive, large acquisitions. It achieves many of these acquisitions through the use of partnerships with other companies. These partnerships allow Blackstone to purchase a large portion of a target company while borrowing as little as necessary to achieve the acquisition. Blackstone’s greatest asset is its ever-growing pool of funds to use for investments. Some analysts predict it will soon be able to make acquisitions of companies over $50 billion. Such a large investment capability puts it in range of acquiring larger true asset management firms, such as Lehman Brothers. If Blackstone were to merge with a firm of this type, it could effectively become a true asset management firm, putting it in more direct competition with the likes of Goldman Sachs. Blackstone also has a few key weaknesses. A major one is its dependency on Steve Schwarzman. Blackstone heavily relies on his abilities and the general influence he has over the masses. If Schwarzman were to leave, it could have a negative impact on the company. Another weakness is despite Blackstone’s diversity strategy, it is still currently exposed to the potential downfalls of a weak economy. Blackstone has not had enough time to develop its diversification strategy to a point where it can generate significant income from alternative forms of asset management. If the economy drops, Blackstone could be affected. Recent Developments As of April 14th, Blackstone declared interest in purchasing Sallie Mae, along with several other companies and groups. The Sallie Mae acquisition is valued in the $10’s of billions, and could result a large increase to Blackstone’s portfolio. Industry Overview and Competitive Positioning Blackstone is in a very competitive market, with high barriers to entry, though for the most part it is not heavily regulated. Private Equity firms are constantly in fierce battle with one another and with other asset management firms for acquisitions. The one who gets the acquisition makes money, and those who fail to make the purchase receive nothing. As such, the competition is fierce and a company must maintain some sort of advantage in order to survive.

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One competitive advantage is to partner with others in order to make large acquisitions. It is better to buy a percentage of the company and take a reduced profit than to lose out on a purchase and all potential profits associated with the purchase. Another competitive advantage is to diversify a company’s portfolio. This allows a company to ride out the downturns better than “pure private equity firms.” Investment Risks Economic Decline: If the economy declines, investors become more cautious with their money and consumers tend to spend less. In these instances, it becomes more difficult for a private equity firm to sell off companies and to make profit from income from its held firms. If severe enough, it could have an impact on the growth of Blackstone. Difficulty Acquiring New Assets: If a private equity firm has difficulty acquiring new assets, it will experience similar problems to being in an economic decline. However, these problems will be more severe in that the firm is one of a few private equity firms falling behind. This situation would magnify its losses, as other companies would continue grow. Loss of a Key Employee: In the case of Blackstone, the loss of Steve Schwarzman could be a problem for the company. Not only would it be a loss of intellectual capital, investors could lose confidence in the firm, thus causing prices to drop. Volatile Financial Forecasts: Because Blackstone is issuing an IPO, it is only providing potential investors with 2-3 years of financial data. Two to threes years is not enough financial information to make an accurate forecast. Typically, the discounted cash flow model used should have five years to make an adequate forecast. As a result, it is a possibility the forecasts could be inaccurate, and the future financials may differ from what we forecasted.

Buy Recommendation:

Because I cannot formulate a market value per share or a price to earnings ratio, I must use different ratios to make a buy recommendation. According to my calculations the Student Investment Fund should buy shares of Blackstone if Value/NOPLAT<=27.7 and a Value/Invested Capital<=9.12. I have derived these values from a strong growth rate which slowly declines over time. This growth rate is fueled by the assumption Steve Schwarzman will stay as CEO and continue to lead the company in a positive direction, revenue growth from assets under management stays strong, and the company continues to acquire more assets under management.

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BLACKSTONE GROUP Combined Statements of Income (Dollars in Thousands)

Year Ended December 31,

2006

2005

2004

Revenues Fund Management Fees $ 852,283 $ 370,574 $ 390,645 Advisory Fees 256,914 120,137 108,356 Interest and Other 11,082 6,037 4,462 Total Revenues 1,120,279 496,748 503,463 Expenses Employee Compensation and Benefits 250,067 182,605 139,512 Interest 36,932 23,830 16,239 Occupancy and Related Charges 35,862 30,763 29,551 General, Administrative and Other 86,534 56,650 48,576 Fund Expenses 143,695 67,972 43,123 Total Expenses 553,090 361,820 277,001 Other Income

Net Gains from Investment Activities 7,587,296 5,142,530 6,214,519 Income Before Non-Controlling Interests in Income of Consolidated Entities and Income Taxes 8,154,485 5,277,458 6,440,981 Non-Controlling Interests in Income of Consolidated Entities

5,856,345

3,934,535

4,901,547

Income Before Taxes 2,298,140 1,342,923 1,539,434 Income Taxes

31,934

12,260

16,120

Net Income $ 2,266,206 $ 1,330,663 $ 1,523,314 2 Statements of Income from 2004-2006 per IPO prospectus

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BLACKSTONE GROUP

Combined Statements of Financial Condition

(Dollars in Thousands)

December 31,

2006

2005

Assets Cash and Cash Equivalents $ 129,443 $ 86,414Cash Held at Consolidated Entities 810,725 363,657Investments, at Fair Value 31,263,573 20,072,582Accounts Receivable 656,165 168,841Due from Brokers 398,196 —Investment Subscriptions Paid in Advance 280,917 214,437Due from Affiliates 257,225 159,889Other Assets 94,800 55,304 Total Assets $ 33,891,044 $ 21,121,124 Liabilities and Partners' Capital

Loans Payable $ 975,981 $ 837,627Amounts Due to Non-Controlling Interest Holders 647,418 1,043,914Securities Sold, Not Yet Purchased 422,788 —Due to Affiliates 103,428 42,122Accrued Compensation and Benefits 66,301 46,044Accounts Payable, Accrued Expenses and Other Liabilities

157,355 113,064

Total Liabilities 2,373,271 2,082,771 Commitments and Contingencies Non-Controlling Interests in Consolidated Entities

28,794,894

17,213,408

Partners' Capital

Partners' Capital 2,712,605 1,818,749 Accumulated Other Comprehensive Income 10,274 6,196 Total Partners' Capital 2,722,879 1,824,945 Total Liabilities and Partners' Capital $ 33,891,044 $ 21,121,124 3 Balance Sheets from 2005-2006 per IPO prospectus

Enter Firm Ticker BX

Enter first financial statement year in cell B6 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 Average ManualTotal revenue 0 0 503 497 1,120 Revenue Growth 0.0% 5034530.0% -1.3% 125.5% 62.1% 20% Cost of goods sold - - 140 183 250 COGS % of Sales 0.0% 0.0% 27.7% 36.8% 22.3% 28.3% 23.0%Gross profit 0 0 364 314 870 SG&A expense - - 49 57 87 SG&A % of Sales 0.0% 0.0% 9.6% 11.4% 7.7% 9.5% Research & Development - - - - - R&D % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Depreciation/Amortization - - - - - D&A % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Interest expense (income), operating - - 16 24 37 Inc. Exp. Oper. 0.0% 0.0% 3.2% 4.8% 3.3% 3.8% Non-recurring expenses - - - - - Exp. Non-rec 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other operating expense - - 73 99 180 Other exp. 0.0% 0.0% 14.4% 19.9% 16.0% 16.8%Operating Income 0 0 226 135 567 Interest income (expense), non-operating - - - - - Int. inc. non-oper. 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Gain (loss) on sale of assets - - - - - Gain (loss) asset sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other income, net - - 1,313 1,208 1,731 Other income, net 0.0% 0.0% 260.8% 243.2% 154.5% 219.5% 120.0%Income before tax 0 0 1,539 1,343 2,298 Income tax - - 16 12 32 Tax rate 0.0% 0.0% 1.0% 0.9% 1.4% 1.1%Income after tax 0 0 1,523 1,331 2,266 Minority interest - - - - - Minority interest 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Equity in affiliates - - - - - Equity in affiliates 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% U.S. GAAP adjustment - - - - - U.S. GAAP adjust. 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Net income before extraordinary items 0 0 1,523 1,331 2,266 Extraordinary items, total - - - - - Extrordinary items Too unpredictable to forecast, set to zero in the forecastsNet income 0 0 1,523 1,331 2,266 Total adjustments to net income - - - - - Adjustments to NI Too unpredictable to forecast, set to zero in the forecasts Basic weighted average shares 1 1 1 1 1 Share growth 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Basic EPS excluding extraordinary items 0.01 0.01 1,523.31 1,330.66 2,266.21 Basic EPS including extraordinary items 0.01 0.01 1,523.31 1,330.66 2,266.21 Diluted weighted average shares 1 1 1 1 1 Diluted share growth 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Diluted EPS excluding extraordinary items 0.01 0.01 1,523.31 1,330.66 2,266.21 Diluted EPS including extraordinary items 0.01 0.01 1,523.31 1,330.66 2,266.21 Dividends per share -- common stock - - - - - Gross dividends -- common stock - - - - - Dividend growth 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Retained earnings 0 0 1,523 1,331 2,266

values in millionsHistorical Income Statements Forecasting Percentages

Year-by-year revenue growth 18.00% 17.00% 15.00% 12.00% 11.00% 11.00%

year 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016Total revenue 1,344 1,613 1,936 2,323 2,741 3,207 3,688 4,131 4,585 5,090 Cost of goods sold 309 371 445 534 630 738 848 950 1,055 1,171 Gross profit 1,035 1,242 1,491 1,789 2,111 2,470 2,840 3,181 3,531 3,919 SG&A expense 127 153 183 220 260 304 349 391 434 482 Research & Development - - - - - - - - - - Depreciation/Amortization - - - - - - - - - - Interest expense (Income), operating 5 6 7 8 10 11 13 15 16 18 Non-recurring expenses - - - - - - - - - - Other operating expenses - - - - - - - - - - Operating Income 903 1,084 1,300 1,560 1,841 2,154 2,477 2,775 3,080 3,419 Interest income (expense), non-operating (265) - - - - - - - - - Gain (loss) on sale of assets - - - - - - - - - - Other income, net 1,242 1,491 1,789 2,146 2,533 2,963 3,408 3,817 4,237 4,703 Income before tax 1,880 2,574 3,089 3,707 4,374 5,118 5,885 6,592 7,317 8,121 Income tax 21 29 34 41 49 57 66 74 82 91 Income after tax 1,859 2,545 3,055 3,665 4,325 5,061 5,820 6,518 7,235 8,031 Minority interest - - - - - - - - - - Equity in affiliates - - - - - - - - - - U.S. GAAP adjustments - - - - - - - - - - Net income before extraordinary items 1,859 2,545 3,055 3,665 4,325 5,061 5,820 6,518 7,235 8,031 Extraodinary items, total 0 0 0 0 0 0 0 0 0 0Net income 1,859 2,545 3,055 3,665 4,325 5,061 5,820 6,518 7,235 8,031 Total adjustments to net income 0 0 0 0 0 0 0 0 0 0 Basic weighted average shares 1 1 1 1 1 1 1 1 1 1 Basic EPS excluding extraordinary items 1859.23 2545.45 3054.54 3665.44 4325.22 5060.51 5819.59 6517.94 7234.91 8030.75 Basic EPS including extraordinary items 1859.23 2545.45 3054.54 3665.44 4325.22 5060.51 5819.59 6517.94 7234.91 8030.75 Diluted weighted average shares 1 1 1 1 1 1 1 1 1 1 Diluted EPS exluding extraordinary items 1859.23 2545.45 3054.54 3665.44 4325.22 5060.51 5819.59 6517.94 7234.91 8030.75 Diluted EPS including extraordinary items 1859.23 2545.45 3054.54 3665.44 4325.22 5060.51 5819.59 6517.94 7234.91 8030.75 Dividends per share -- common stock 185.92 254.54 305.45 366.54 432.52 506.05 581.96 651.79 723.49 803.08 Gross dividends -- common stock 186 255 305 367 433 506 582 652 723 803 Retained earnings 1,673 2,291 2,749 3,299 3,893 4,554 5,238 5,866 6,511 7,228

Forecasted Income Statements -- 10 Years


year 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 Average ManualAssets

Cash & equivalents 450 940 Cash % of Sales 0.0% 0.0% 0.0% 90.6% 83.9% 87.3% Short term investments - - ST Invest. % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Receivables, total 169 1,335 Receivables % of Sales 0.0% 0.0% 0.0% 34.0% 119.2% 76.6% 150.00% Inventory, total - - Inventory % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Prepaid expenses - 281 Pre. Exp. % of Sales 0.0% 0.0% 0.0% 0.0% 25.1% 12.5% 25.10% Other current assets, total - - Other CA % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Total Current Assets - - - 619 2,556 Property, plant and equipment (net) - - Net PPE % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Goodwill - - Goodwill % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Intangibles - - Intangibles % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Long term investments 20,073 31,264 LT Invest. % of Sales 0.0% 0.0% 0.0% 4040.8% 2790.7% 3415.7% 2000.00% Notes receivable -- long term - - Notes Rec. % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other long term assets, total - - Other LT ass. % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other assets, total 55 95 Other assets % of Sales 0.0% 0.0% 0.0% 11.1% 8.5% 9.8%Total assets - - - 20,747 33,915

Liabilities and Shareholders' Equity Accounts payable 113 157 Acc. Payable % of Sales 0.0% 0.0% 0.0% 22.8% 14.0% 18.4% Payable/accrued - - Pay/accured % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Accrued expenses - - Acc. Exp. % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Notes payable/short term debt - - Notes payable % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Current portion of LT debt/Capital leases - - Curr. Debt % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other current liabilities 1,132 1,240 Other curr liab % Sales 0.0% 0.0% 0.0% 227.9% 110.7% 169.3% 80.00%Total Current Liabilities - - - 1,245 1,397 Long term debt, total 838 976 LT debt % of Sales 0.0% 0.0% 0.0% 168.6% 87.1% 127.9% Deferred income tax - - Def. inc. tax % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Minority interest - - Min. Int. % of Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Other liabilities, total 17,213 28,795 Other liab. % of Sales 0.0% 0.0% 0.0% 3465.2% 2570.3% 3017.8% 1500.00%Total Liabilities - - - 19,296 31,168 Preferred stock (redeemable) - - Equal to 2006 balance Preferred stock (unredeemable) - - Equal to 2006 balance Common stock - - Equal to 2006 balance Additional paid-in capital 1,819 2,713 Equal to 2006 balance Retained earnings (accumulated deficit) 6 10 Treasury stock -- common - - Equal to 2006 balance ESOP Debt Guarantee - - Equal to 2006 balance Other equity, total Equal to 2006 balanceTotal Shareholders' Equity - - - 1,825 2,723 Total Liabilities and Shareholders' Equity - - - 21,121 33,891 Diluted weighted average shares 1 1 1 1 1 Equal to 2006 balance Total preferred shares outstanding - - - - - Equal to 2006 balance

values in millionsHistorical Balance Sheets Forecasting Percentages

year 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016Assets

Cash & equivalents 1,173 2,200 2,400 2,900 5,800 7,200 11,000 13,500 17,000 17,000 Short term investments - - - - - - - - - - Receivables, total 1,553 1,863 2,236 2,683 3,166 3,704 4,260 4,771 5,296 5,878 Inventory, total - - - - - - - - - - Prepaid expenses - - - - - - - - - - Other current assets, total - - - - - - - - - - Total Current Assets 2,726 4,063 4,636 5,583 8,966 10,904 15,260 18,271 22,296 22,878 Property, plant and equipment (net) - - - - - - - - - - Goodwill - - - - - - - - - - Intangibles - - - - - - - - - - Long term investments 26,887 32,264 38,717 46,460 54,823 64,143 73,764 82,616 91,704 101,791 Notes receivable -- long term - - - - - - - - - - Other long term assets, total - - - - - - - - - - Other assets, total 132 158 190 228 269 314 361 405 449 499 Total assets 29,744 36,485 43,542 52,271 64,058 75,361 89,386 101,292 114,449 125,168

Liabilities and Shareholders' Equity Accounts payable 247 297 356 428 504 590 679 760 844 937 Payable/accrued - - - - - - - - - - Accrued expenses - - - - - - - - - - Notes payable/short term debt - - - - - - - - - - Current portion of LT debt/Capital leases - - - - - - - - - - Other current liabilities 1,075 1,291 1,549 1,858 2,193 2,566 2,951 3,305 3,668 4,072 Total Current Liabilities 1,323 1,587 1,905 2,286 2,697 3,156 3,629 4,065 4,512 5,008 Long term debt, total 3,760 3,913 3,064 2,305 3,515 2,816 3,913 2,879 2,262 2,262 Deferred income tax - - - - - - - - - - Minority interest - - - - - - - - - - Other liabilities, total 20,165 24,198 29,038 34,845 41,117 48,107 55,323 61,962 68,778 76,344 Total Liabilities 25,248 29,698 34,006 39,436 47,330 54,079 62,866 68,906 75,552 83,614 Preferred stock (redeemable) - - - - - - - - - - Preferred stock (unredeemable) - - - - - - - - - - Common stock 100 100 100 100 100 100 100 100 100 100 Additional paid-in capital 2,713 2,713 2,713 2,713 2,713 2,713 2,713 2,713 2,713 2,713 Retained earnings (accumulated deficit) 1,684 3,974 6,724 10,022 13,915 18,470 23,707 29,573 36,085 43,313 Treasury stock -- common - - - - - - - - - - ESOP Debt Guarantee - - - - - - - - - - Other equity, total - - - - - - - - - - Total Shareholders' Equity 4,496 6,787 9,536 12,835 16,728 21,282 26,520 32,386 38,897 46,125 Total Liabilities and Shareholders' Equity 29,744 36,485 43,542 52,271 64,058 75,361 89,386 101,292 114,449 129,739 Total common shares (diluted) 1 1 1 1 1 1 1 1 1 1 Total preferred shares outstanding - - - - - - - - - -

AFN (interactive with 3 items below) (0) - (0) - - - (0) (0) (0) (4,570) Adjustment to LT Debt (iterate or use Solver) 2784.16055 152.633957 -849.10978 -758.93174 1210.46373 -699.15552 1097.11166 -1034.1833 -617.27373 Issue Common Stock to Fund AFN Set Balance Sheet Cash Lower to Fund AFN 2,200 2,400 2,900 5,800 7,200 11,000 13,500 17,000 17,000

Forecasted Balance Sheets -- 10 Years


2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016Liquidity Current 0.00 0.00 0.00 0.50 1.83 2.06 2.56 2.43 2.44 3.32 3.46 4.20 4.49 4.94 4.57 Quick 0.00 0.00 0.00 0.50 1.83 2.06 2.56 2.43 2.44 3.32 3.46 4.20 4.49 4.94 4.57 Net Working Capital to Total Assets 0.00 0.00 0.00 -0.03 0.03 0.05 0.07 0.06 0.06 0.10 0.10 0.13 0.14 0.16 0.14Asset Management Days Sales Oustanding 0.00 0.00 0.00 124.06 435.05 421.58 421.58 421.58 421.58 421.58 421.58 421.58 421.58 421.58 421.58 Inventory Turnover 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Fixed Assets Turnover 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Total Assets Turnover 0.00 0.00 0.00 0.02 0.03 0.05 0.04 0.04 0.04 0.04 0.04 0.04 0.04 0.04 0.04Debt Management Long-Term Debt to Equity 0.0% 0.0% 0.0% 45.9% 35.8% 83.6% 57.7% 32.1% 18.0% 21.0% 13.2% 14.8% 8.9% 5.8% 4.9% Total Debt to Total Assets 0.0% 0.0% 0.0% 4.0% 2.9% 12.6% 10.7% 7.0% 4.4% 5.5% 3.7% 4.4% 2.8% 2.0% 1.8% Times Interest Earned N/A N/A N/A N/A N/A -3.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Profitability Gross Profit Margin 100.0% 100.0% 72.3% 63.2% 77.7% 77.0% 77.0% 77.0% 77.0% 77.0% 77.0% 77.0% 77.0% 77.0% 77.0% Operating Profit Margin 100.0% 100.0% 45.0% 27.2% 50.6% 67.2% 67.2% 67.2% 67.2% 67.2% 67.2% 67.2% 67.2% 67.2% 67.2% Net After-Tax Profit Margin 100.0% 100.0% 302.6% 267.9% 202.3% 138.3% 157.8% 157.8% 157.8% 157.8% 157.8% 157.8% 157.8% 157.8% 157.8% Total Assets Turnover 0.00 0.00 0.00 0.02 0.03 0.05 0.04 0.04 0.04 0.04 0.04 0.04 0.04 0.04 0.04 Return on Assets 0.0% 0.0% 0.0% 0.06 0.07 0.06 0.07 0.07 0.07 0.07 0.07 0.07 0.06 0.06 0.06 Equity Multiplier 1.00 1.00 1.00 1.04 1.03 1.02 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Return on Equity 0.0% 0.0% 0.0% 72.9% 83.2% 41.4% 37.5% 32.0% 28.6% 25.9% 23.8% 21.9% 20.1% 18.6% 17.4%

EPS (using diluted shares and excluding extraordinary items) 0.01 0.01 1523.31 1330.66 2266.21 1859.23 2545.45 3054.54 3665.44 4325.22 5060.51 5819.59 6517.94 7234.91 8030.75DPS (dividends per share) 0.00 0.00 0.00 0.00 0.00 185.92 254.54 305.45 366.54 432.52 506.05 581.96 651.79 723.49 803.08

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016NOPAT (net operating profit after tax) 0 0 224 134 559 893 1,071 1,286 1,543 1,821 2,130 2,450 2,744 3,045 3,381 ROIC (return on invested capital) 0.0% 0.0% 0.0% 26.4% 26.4% 36.0% 28.4% 30.0% 29.9% 21.5% 20.7% 16.8% 15.7% 14.2% 15.4%EVA (economic value added) 0 0 224 84 352 650 702 866 1037 991 1119 1020 1026 942 1229FCF (free cash flow) N/A 0 224 (372) (1,053) 533 (216) 773 667 (1,485) 278 (1,817) (186) (896) 2,891 Weighted Average Cost of Capital 9.81%Net Operating Working Capital (NOWC) - - - 506 2,118 2,478 3,766 4,280 5,156 8,462 10,314 14,581 17,511 21,452 21,942 Operating Long Term Assets - - - - - - - - - - - - - - - Total Operating Capital - - - 506 2,118 2,478 3,766 4,280 5,156 8,462 10,314 14,581 17,511 21,452 21,942

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016Long-term Horizon Value Growth Rate (user-supplied) 7.00%PV of Forecasted FCF $43,539.63 $47,276.74 $52,129.37 $56,468.89 $61,339.46 $68,840.00 $75,313.03 $84,515.95 $92,990.00 $103,004.72 $112,847.66Value of Non-Operating Assets 940$ 1,173$ 2,200$ 2,400$ 2,900$ 5,800$ 7,200$ 11,000$ 13,500$ 17,000$ 17,000$ Total Intrinsic Value of the Firm $44,479.80 $48,449.84 $54,329.37 $58,868.89 $64,239.46 $74,640.00 $82,513.03 $95,515.95 $106,490.00 $120,004.72 $129,847.66Intrinsic Market Value of the Equity $43,503.82 $44,689.70 $50,416.59 $55,805.22 $61,934.72 $71,124.80 $79,696.99 $91,602.79 $103,611.03 $117,743.02 $127,585.96Per Share Intrinsic Value of the Firm 43,503.82$ 44,689.70$ 50,416.59$ 55,805.22$ 61,934.72$ 71,124.80$ 79,696.99$ 91,602.79$ 103,611.03$ 117,743.02$ 127,585.96$ MVA (market valued added) $40,780.94 $40,193.51 $43,629.50 $46,269.05 $49,099.65 $54,397.03 $58,414.75 $65,082.92 $71,225.02 $78,845.59 $81,460.85

Item Value Percent Cost Weighted CostST Debt (from most recent balance sheet) 0 0.00% 7.00% 0.00%LT Debt (from most recent balance sheet) 975.981 4.65% 6.25% 0.29%MV Equity (look up mkt. cap of firm's stock and enter in cell B53) 20,000 95.35% 9.98% 9.52%Weighted Average Cost of Capital

9.81%

Risk Free Rate 4.80%Beta 0.74Market Risk Prem. 7.00%Cost of Equity 9.98%

values in millionsHistorical Ratios and Valuation Model

Valuation Metrics Trend Analysis (NOPAT, EVA, MVA, FCF and Capital in millions)

Valuation (in millions where appropriate) -- through year 2016

Forecasted Ratios and Valuation Model -- 10 Years

Forecasted Ratios and Valuation Model -- 10 Years

Weighted Average Cost of Capital Calculations

Capital Asset Pricing Model

Gross MarginFirm Ticker BX 2004

72.3%77.7%2006

Operating Margin SG&A/Revenue2004 2004

Pre-tax ROIC 62.6% 9.6%2004 70.0% 7.7%

61.5% 2006 2006ROIC 37.0%2004 2006 Depreciation/Revenue

60.9% 200436.5% 0.0%2006 Cash Tax Rate 0.0%

2004 20061.0%1.4% Average Capital Turns Op. Working Cap./Revenue2006 2005 2005

0.98 101.8%0.53 189.1%2006 2006

Fixed Assets/Revenue20050.0%0.0%2006

Historical ROIC and Drivers

Gross MarginFirm Ticker BX 2007

77.0%77.0%2016

Operating Margin SG&A/Revenue2007 2007

Pre-tax ROIC 67.5% 9.5%2007 67.5% 9.5%

36.6% 2016 2016ROIC 15.7%2007 2016 Depreciation/Revenue

36.2% 200715.4% 0.0%2016 Cash Tax Rate 0.0%

2007 20161.0%1.4% Average Capital Turns Op. Working Cap./Revenue2016 2007 2007

0.54 184.4%0.23 431.1%2016 2016

Fixed Assets/Revenue20070.0%0.0%2016

Forecasted ROIC and Drivers

Firm Ticker BX

Value Score RationaleNet Income 559.31 1 1 Point for Positive NIFree Cash Flow 352 1 1 Point for Positive FCFROA (% change NI/ % change TA) 0.07 0 1 Point if % increase in NI > % increase in TAEarnings Quality (EBIT/NI) 1.01 1 1 Point if EBIT > NITotal Assets to Total Liabilities 1.09 1 1 Point if % increase in TA > % increase in TLWorking Capital (Current Ratio) 1.83 1 1 Point if Current Ratio is at least as large as last year% Change Shares Outstanding (Diluted) NA NA 1 Point if total diluted shares increased by less than 2%Gross Margin 77.7% 1 1 Point if GM increased over last yearAsset Turnover (% Change Sales/ % Change assets) 0.03 0 1 Point if sales increased faster than total assetsTotal Liabilities to EBITDA 13.78 0 1 Point if ratio is less than 5.0Total Liabilities to Operating Cash Flow (EBIT) 13.78 0 1 Point if ratio is less than 4.0

Total Score (Possible 11) 6

Piotroski's Financial Fitness Evaluator

Asset Management: Buyout Firm Derek Priest … · Asset Management: Buyout Firm Derek Priest ......

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