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Private Equity 101Dan Cremonsdcremons@alpine-investors.comOctober 13, 2014Jeff Tottenjtotten@alpine-investors.com

Alpine InvestorsBackgroundAlpine Investors is a private equity firm focused on making investments inmiddle market privately held companies Core Values: Unwavering Character, Persistence, Continuous Improvement, Performance,Intellectual Honesty, and Balanced Lives Funds under Management: 900m of committed capital since inception (Fund V - 400m) Industries of Interest: i) Software, ii) Internet and iii) Business Services Target Deal Size: 5 – 15mm EBITDA Value-Added Investment Partner: We take an active role in our portfolio companies including:i) key hiring, ii) strategic planning, iii) add-ons (sourcing and transaction) and iv) other operationalprojects Long Term Orientation: We expect to grow businesses over a 5-10 year period Example Portfolio Companies:B2B Communication SoftwareALPINE INVESTORSBenefit Administration ProviderPhysician Practice ManagementOnline Continuing Education Provider

Goals of Tonight’s DiscussionGoals of tonight:1. Explain/simplify private equity investing2. Discuss the process by which new deals are evaluated3. Prep you for the Alpine PE Case Competition!ALPINE INVESTORS

Goals of Tonight’s DiscussionWhat we won’t cover tonight1. Financial modeling training2. Public equities3. Comparative Analysis of the Hoover Tower (285 ft) andCampanile Tower (307 ft)ALPINE INVESTORS

Rules of the Game1. Speak up if something doesn’t make sense2. Question / challenge / debate openly (although we’ll need to beconscious of time)ALPINE INVESTORS

Explain and SimplifyPrivate Equity Investing

What is a Leveraged Buyout?Antonio’s Leveraged BuyoutAntonio’s Nut HouseAntonio Antonio’s generates 1 million per year of profitand its owner is looking to sell the company for 5million Alpine Investors thinks that it can grow Antonio’sand decides to buy it using a combination of debtand equity Alpine arranges a 3 million loan from a bank andputs in 2 million of it’s own money to buyoutAntonio’s In exchange, Alpine receives 100% ownership ofAntonio’s and Bank of America receives a securedpromise from Antonio’s to pay its debt and interestALPINE INVESTORS 2m 3m100% ofAntonio’sStockPromissoryNote

What is a Leveraged Buyout?Impact of Leverage Deal Structure:Alpine Equity 2.0m 3.0m 4.0m 0.0mDebt 3.0m 3.0m 3.0m 3.0mEnterprise Value 5.0m 6.0m 7.0m 3.0m0%50%100%-100%Alpine Return* What is Alpine’s return if the next year, Alpine sells the company for 6.0m,20% higher than it’s entry price? (ignore interest/dividends) What is Alpine’s return if the next year, Alpine sells the company for 7.0m,40% higher than it’s entry price? (ignore interest/dividends) What is Alpine’s return if the next year, Alpine sells the company for 3.0m,40% lower than it’s entry price? (ignore interest/dividends)*Return ignores impact of interest or dividendsALPINE INVESTORS

The process by which new deals are evaluated

How Private Equity Deals HappenPrivate companydecides to sellCompany retainsinvestment bankerInvestment bankerprepares pitchbook and buyer listPitch-book (orCIM) distributed topotential buyersBid or pass?Deal championpresents tocommitteeManagement callPrivate equitygroup reviews CIMCompany selectsbidders for meetingsCompany selectsbest bidder forexclusivityDue DiligenceClose!ALPINE INVESTORS

How Private Equity Deals HappenPrivate companydecides to sellCompany retainsinvestment bankerInvestment bankerprepares pitchbook and buyer listPitch-book (orCIM) distributed topotential buyersMost Critical Phase of Deal Process: EvaluationBid or pass?Deal championpresents tocommitteeManagement callPrivate equitygroup reviews CIMCompany selectsbidders for meetingsCompany selectsbest bidder forexclusivityDue DiligenceClose!ALPINE INVESTORS

Deal Evaluation SimplifiedYour Job in Deal Evaluation:Become an expert at valuing the underlying assetUnderlying Value is a Function Of:MarketCompany andCompetitivePositionALPINE INVESTORSManagementValuationStructure

Deal Evaluation SimplifiedMarketCompany Tony Hsieh, Founder of Zappos, on Business Strategy:“Table selection is the most important decisionyou can make in poker and in business.Choose a table where you know you can win.”ALPINE INVESTORS

Deal Evaluation SimplifiedCompany , Growing Market although companiesin small growingmarkets are OK ifadvantages apply tobigger market.Large, Growing MarketWe seek to invest inlarge, growing marketswith enough headroomfor growthLarge, Contracting MarketContractingSmall, Contracting MarketValuationSmallALPINE INVESTORSLargeStructure

Deal Evaluation SimplifiedMarketCompany Growth and certainty over long-term determine success Market growth – ride a rising tide Big market – size of your canvas Look for endogenous factors (eg. execution), not exogenous (eg. commodity prices) Small business can be competitive and build barriers Can we reasonably know what industry will look like in 5 years?ALPINE INVESTORS

Deal Evaluation SimplifiedCompany uctureAntonio’s MarketCriteria? / - CommentaryMarket Growth?OStanford enrollment proxy for market growthBig Market?-Est. 125mm market (student pop x food/bevspend); very localized businessRisks Endogenous? No regulatory risk. Success within Antonio’scontrol; HOWEVER, low barriers to entryCan small biz compete? Restaurant / bar market fragmentedALPINE INVESTORS

Deal Evaluation SimplifiedMarketCompany What is different or unique today?Why is this sustainable?Why will Company ABC win over long-term?ALPINE INVESTORS

Deal Evaluation SimplifiedMarketCompany Buffet says look foremost for durable competitive advantage:"The key to investing is not assessing how much an industry is going to affect society, or how much it willgrow, but rather determining the competitive advantage of any given company and, above all, thedurability of that advantage. The products or services that have wide, sustainable moats around themare the ones that deliver rewards to investors." Warren Buffett, Fortune Magazine, 1999http://www.youtube.com/watch?v OnI64XuR4uIALPINE INVESTORS

Deal Evaluation SimplifiedMarketCompany Sources of Competitive Advantage:vs. Switching costs (brand, hassle, technology) Local economies of scalevs.vs. Supply barriers (access to key resources, vendor exclusivity) Cost or Process (management, efficiency, culture)ALPINE INVESTORSvs.

Deal Evaluation SimplifiedMarketCompany andCompetitivePositionManagementValuationThat all sounds great but how do I assess acompany’s competitive position?SWOT AnalysisALPINE INVESTORSStructure

Deal Evaluation SimplifiedMarketCompany That all sounds great but how do I assess acompany’s competitive position?Look at the Company’s Data!!!REVENUEPRICINGCOSTS / MARGINSIf revenue is growing,why?How is pricingtrending?How are gross marginstrending?Why are customerschoosing them?Is company able tocommand more or lessfor products?How do gross marginscompare to comps?ALPINE INVESTORS

Deal Evaluation SimplifiedCompany uctureAntonio’s Competitive PositionCriteria? / - CommentarySwitching Costs? Brand loyalty; benefit from network effectsLocal Economies of Scale?-Single store; no real scale todaySupply Barriers?-Access to all the same product as other barsCost or Process? Cost advantage in rent controlALPINE INVESTORS

Deal Evaluation SimplifiedMarketCompany Q: The single most highly correlated factor withinvestment success for Alpine?A: Quality of the CEO.Steve Schwarzman & David Bonderman (Blackstone):“After exhaustively studying our databases of dozens of deals across twenty years, we concluded that the keys tosuccess in private equity are:1) Buying RightALPINE INVESTORS2) Having an ‘A”Team3) Selling Right

Deal Evaluation SimplifiedMarketCompany andCompetitivePositionManagementValuationAn A Management Team is Key Track record of success – have they done what you’re asking them to do? Alignment of incentives – make money together Surround themselves with smart people – hire people better than themselves Passion for their business – you can “feel it” although keep it tempered.ALPINE INVESTORSStructure

Deal Evaluation SimplifiedMarketCompany andCompetitivePositionALPINE INVESTORSManagementValuationStructure

Deal Evaluation SimplifiedMarketCompany andCompetitivePositionManagementValuationReturn model must meet 3 criteria: Low chance of principal loss (solvable via valuation and structure) 3x return on capital in base case (70% probability; conservative assumptions) 5x in reasonably attainable caseALPINE INVESTORSStructure

Deal Evaluation SimplifiedMarketCompany How do we determine valuation we’re willing to pay?TickerApollo Group Inc.Career Education Corp.Corinthian Colleges Inc.DeVry, Inc.ITT CorporationSmartPros Ltd.Strayer Education Inc.Universal Technical Institute, Inc.Capella Education Co.SmartPros Ltd.Intuit Inc.LivePerson Inc.K12, NALPINE INVESTORSMarket ApproachTEV/LTM EV/LTM EV/NTM 35.682.8423.550.666.910.666.91Step #1 – Understandwhere the market is pricingsimilar dealsPUBLIC COMPSPRIVATE COMPSBANKER GUIDANCE

Deal Evaluation SimplifiedCompany uctureHow do we determine valuation we’re willing to Earnings before 183,2022,00013,8322,4812,00015,651TaxesNet 09,390Cash Flow to Debt7,4008,3059,27110,29911,390Debt Schedule 9013,33500000RevenueOperating 000Common Equity DistributionsExit Enterprise ValueMinus: DebtPlus: CashEquity ValueInvestor Cash E INVESTORS104,83121%3.0xCAGR10%6.1%Step #2 – Based onconservative company growthassumptions and yourestimate of valuation that willwin, can we hit requiredreturns of:3X RETURN ON CAPITAL

Deal Evaluation SimplifiedMarketCompany Balance benefit of leverage with ability for company to invest Remember equity vs. debt? Don’t handcuff company with debt – manage business for growth, not repayment ofdebt Minimize risk of principal loss through preferenceALPINE INVESTORS

Deal Evaluation SimplifiedMarketCompany These things feed your model:How to generate returns in private equity:Paying down leverageMultiple growthEarnings growthPaying down debt increases valueof equity – remember theAntonio’s example?All else constant, selling a businessat a higher multiple than youbought it for increases equity valueBusinesses are valued based onearnings potential (eg. multiplemethod)ALPINE INVESTORS

Deal Evaluation SimplifiedPaying down leverageMultiple growthEarnings growthPaying down debt increases valueof equity – remember theAntonio’s example?All else constant, selling a businessat a higher multiple than youbought it for increases equity valueBusinesses are valued based onearnings potential (eg. multiplemethod)Exit Scenario #1:Exit Scenario #2:AtNo growth, payNo growth,Exit Scenario #3:Earnings growthPurchasedown debtmultiple growthmultiple growthEarnings1,000,000Multiple5.0xEnterprise ValueLess: DebtPlus: CashEquity ValueReturn on capitalALPINE INVESTORS 5,000,000Exit in Year5 underthesescenarios 3,000,000 0 2,000,000 1,000,0001,000,0001,500,0005.0x7.0x7.0x 5,000,000 7,000,000 10,500,000 0 0 0 1,000,000 1,000,000 1,500,000 6,000,000 8,000,000 12,000,0003.0x4.0x6.0x

How Private Equity Deals HappenPrivate companydecides to sellCompany retainsinvestment bankerInvestment bankerprepares pitchbook and buyer listPitch-book (orCIM) distributed topotential buyersCase Competition!Bid or pass?Deal championpresents tocommitteeManagement callPrivate equitygroup reviews CIMCompany selectsbidders for meetingsCompany selectsbest bidder forexclusivityDue DiligenceClose!ALPINE INVESTORS