125333-spring 2013

Bridging the GAAP to Tax n 23

U.S. Bank National Association v. Verizon Communications, Inc.: The Importance of Reconciling Valuation Conclusions n 49

Oil and Gas Minerals: How They and Their Holding Entities Are Valued n 66

Should the Pattern Be the Brand?: A Potential Revenue-Generating Bonanza n 97

Reasonable Certainty Remains Uncertain n 102

journal

S P R I n G 2 0 1 3

M&A Market Update: Weve Jumped Off the Cliff Who Packed the Parachute? n 4

journal 4 M&A Market Update:

Weve Jumped Off the Cliff Who Packed the Parachute?

Gian G. Ricco

9 Plastics Industry Snapshot Michael D. Benson and

David M. Evatz

16 Hospital/Healthcare Valuation and ASC 958-805: Not-For-Profit Mergers and Acquisitions

John W. VanSanten and Jason J. Krentler

21 Guest Article: Vesting of Founders Stock

Jeff M. Mattson Freeborn & Peters LLP

23 Bridging the GAAP to Tax Marc C. Asbra

28 Dealing with Commodity Price Fluctuations

Vincent J. Pappalardo and Christopher A. Merley

32 Two is Better Than One: Even a Simplified Analysis of Ordinary in the Industry is Better Than None at All

Neil Steinkamp and Alexandra C. Pierce

34 Defer or Eliminate Capital Gains Taxes by Selling Your Company to an ESOP

Mark R. Fournier

38 Guest Article: Uncovering Hidden Value in Family Businesses

Norbert E. Schwarz The Family Business Consulting Group, Inc.

41 The Orchard Enterprises, Inc.: The Delaware Court Analyzes Valuation and Whether or Not Only a Bum Would Utilize the BUM

Jeffrey M. Risius and Jesse A. Ultz

45 Valuing Forbearance in Fraudulent Transfer Actions

James H. Millar WilmerHale, and Neil Steinkamp

49 U.S. Bank National Association v. Verizon Communications, Inc.: The Importance of Reconciling Valuation Conclusions

Brian A. Hock

53 Appraisal Issues Surrounding the Leveraged Reverse Freeze: Consult with an Appraiser in the Early Stages of Planning

Alex W. Howard and Bradley A. Gates

CO

nT

En

TS

2013

journal journal4

2353

49

41

34

58 The Valuation of Oil and Gas Properties: Are They Really Worth 3x Cash Flow?

Alan B. Harp, Jr.

62 Guest Article: Wandry v. Commissioner: The Secret Sauce Estate Planners Have Been Waiting For?

Tiffany B. Carmona Bessemer Trust, and Tye J. Klooster Katten Muchin Rosenman LLP

66 Oil and Gas Minerals: How They and Their Holding Entities Are Valued

Alan B. Harp, Jr.

71 E-Discovery Cost-Shifting Phillip M. Shane

Miller, Canfield, Paddock and Stone, PLC, and Denise B. Bach

76 Managing Risk Associated with Occupational Fraud

Michael N. Kahaian, Jason T. Wright, and Raymond A. Roth, III

81 Using the Monte Carlo Method to Value Early Stage, Technology-Based Intellectual Property Assets Bruce W. Burton, Scott Weingust and Jake M. Powers

87 Interview with Former Chief Judge David Folsom of the U.S. District Court for the Eastern District of Texas

John R. Bone and David A. Haas

93 Decisions from the District Courts

Erich W. Kirr and Matthew Paye

97 Guest Article: Should the Pattern Be the Brand?: A Potential Revenue-Generating Bonanza

Marc A. Lieberstein and Kristin G. Garris Kilpatrick Townsend & Stockton LLP

102 Reasonable Certainty Remains Uncertain

Neil Steinkamp, and Regina Alter Butzel Long

108 In Case You Were Wondering Double Dipping Revisited

Mary V. Ade

112 Its All Relative: A Fresh Look at Value in Divorce Cases

Benjamin I.S. Bershad and Jason E. Bodmer

117 The Taxing Side of Divorce: Individual Income Tax Returns as Discovery Tools

Justin L. Cherfoli and Mary V. Ade

71

62journaljournaljournaljournal

We welcome any comments, suggestions, or questions. Please refer to the end of each article for the individual author contact information. The SRR Journal is also available online at www.SRR.com.

The SRR Journal is intended for general information purposes only and is not intended to provide, and should not be used in lieu of, financial, accounting, legal or other professional advice. The publisher assumes no liability for readers use of the information herein and readers are encouraged to seek professional assistance with regard to specific matters. All opinions expressed in these articles are those of the authors and do not necessarily reflect the views of Stout Risius Ross, Inc. or Stout Risius Ross Advisors, LLC.

2013 Stout Risius Ross, Inc. This work may not be copied, distributed, displayed, or used to make derivative works without attribution to Stout Risius Ross (SRR).

SRR is a trade name for Stout Risius Ross, Inc. and Stout Risius Ross Advisors, LLC, a FInRA registered broker-dealer and SIPC member firm.

102

11297

journal

M&A Market Update: Weve Jumped Off the Cliff Who Packed the Parachute?Gian G. Ricco [email protected]

2013 4

Overview n n n

As predicted in our last update, the anticipated rise in capital

gains taxes drove significant capital gains activity among private

companies with the fourth quarter of 2012 particularly robust.

We are now over three years into a strong, bullish cycle fueled

by pent-up demand for deals, accommodative senior lenders,

and a rebound in earnings levels. Given recent history and

the current economic climate, our outlook for 2013 remains

cautious, but favorable:

n Taxes: The rise in the maximum tax rate on capital gains pulled forward a portion of deals that otherwise would have fallen into the 2013 tax year. Exactly how many deals were accelerated cannot be known, but suffice it to say that transaction activity in the first quarter of 2013 has ground to a proverbial halt. The second half of this year should bring a return to normalcy.

n Accommodative credit markets: We see no reason to believe that senior credit markets, which by some measures are fully back to 2007 levels, will significantly tighten any time soon though some signs of a slight pullback are beginning to appear according to sources within the lending community.

n Private equity: A collective $450 billion of dry powder, combined with 6,500 (and growing) domestic sponsor-backed companies under private equity ownership, means that professional investors will continue to remain quite active and relevant.

n Macroeconomic environment: At the time of this writing, Congress has yet to approve a plan to resolve the sequester, which would add up to $85 billion in budget cuts. These cuts, which would be extremely damaging and severe, would affect a wide range of domestic programs including education, public safety, law enforcement, scientific and medical research, and national defense. Furthermore, these cuts would result in the loss of thousands of jobs and would certainly not help the softness in the economy as exhibited in the lackluster GDP growth seen in the fourth quarter of 2012.

For the remainder of this year, the motivation for private business

owners to sell their businesses will not be to avoid taxes,

but rather to exit in the face of uncertainty over the long-term

economic picture and the perceived risk of the United States

falling into a prolonged period of economic stagnation similar to

that experienced by Japan between 1992 and 2010.

20135

M&A Market Activity n n n

Improved availability of capital, better

and sustained company performance,

and narrower valuation gaps have driven

increased U.S. M&A transaction activity

since 2010. Activity in 2012 experienced

gains both in number of deals completed

and in aggregate value, with total number

of deals up 3.0% and total deal value

up 8.9% year-over-year. Of course, the

number of transactions are not spread

evenly throughout the year, as the fourth

quarter has historically always shown

a disproportionately larger number of

transactions relative to the first three

quarters of the year (due, no doubt, to

the calendar year-based bonus cutoffs

for investment bankers!). In spite of this,

the fourth quarter was still remarkably

robust, with more transactions completed

in October through December than any

other quarter in recent memory. The

realization that the Democratic party was

going to retain control over much of the

federal government, and raise taxes as

promised, provided strong impetus to

accelerate the harvesting of capital gains

in the 2012 tax year.

U.S. Gross Domestic Product, often

viewed as a proxy for the overall health

of the economy, has recovered from

the contraction experienced during the

recession in the late 2008 and early

2009 timeframe. Although few economists

are predicting another recession in

the near future, neither are forecasters

predicting rampant growth, with GDP

growth (which was unexpectedly

soft in the fourth quarter) projected to

hover around 3% through much of the

remaining decade.

Consumer confidence is generally

improving as the unemployment

situation improves (though the long-term

impact of the apparent structural

unemployment created by the recession

remains to be seen). It should not be

terribly surprising that people feel better

about spending money when that

money will be replaced via a paycheck

vs. unemployment benefits.

Annu

aliz

ed R

eal G

DP G

row

thVo

lum

e (in

thou

sand

s)

2.3

2.8 2.93.0

2.22.5

2.7 2.6

2.0 2.12.4

3.0 3.1 3.23.2

4.0

3.53.7 3.7

4.1

3.6 3.8 3.7

4.4

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

$500

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2007 2008 2009 2010 2011 2012

Volume Value

Total U.S. M&A Deal Volume and Value by Quarter

Valu

e ($

billi

ons)

Source: S&P Capital IQ

Historical Projected

-9.0%

-7.0%

-5.0%

-3.0%

-1.0%

1.0%

3.0%

5.0%

7.0%

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4 P P P

2004 2005 2006 2007 2008 2009 2010 2011 2012 13 14 15

Change in U.S. Gross Domestic Product

U.S. Bureau of Economic Analysis

50

60

70

80

90

100

110

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

Unemployment

Consumer Confidence

Unemployment and Consumer Confidence

Source: U.S. Bureau of Economic Analysis, University of Michigan Consumer Confidence Report

Unem

ploy

men

t Rat

eAn

nual

ized

Rea

l GDP

Gro

wth

Volu

me

(in th

ousa

nds)

Cons

umer

Con

fiden

ce

2013 6

As mentioned in previous articles, data on lower middle market

transactions is notoriously difficult to come by, but year-over-year

comparisons appear to suggest that smaller deals falling within

the lower middle market (in this context defined as transactions

less than $250 million in total value) demonstrated strength

relative to their larger counterparts. The notable exception to this

was the activity for the very largest deals ($1 billion+) with these

transactions showing double-digit increases in both number and

total value in 2012 versus 2011. As has always been the case,

these smaller transactions dominate total deal flow, accounting

for nearly 98% of total M&A activity over the past 12 months.

Which sectors were hot in 2012? Perhaps somewhat

surprisingly, Financial Services remains the single most active

sector as measured by number of deals, presumably driven by the

continued regulatory pressures and capital threshold requirements

placed upon depository institutions and the resulting need for

further consolidation. However, companies operating within

both consumer-related fields and general manufacturing (as

represented by Industrial & Basic Materials below) also continue to

exhibit strong interest among both strategic and financial buyers.

The continued resurgence in deal volume from the depth of the

recession was facilitated in large part by the renewed relevance

of the strategic buyer. For much of 2005 through 2007, many

strategic buyers found themselves scratching their heads over

the valuations paid by private equity groups for transactions,

valuations achieved purely as the result of financial engineering

(read: leverage) available and not due to potential synergies

available as part of a deal. The chart on the next page shows the

increase, by sector, in total number of deals completed in 2012

vs. 2009, and how many of those deals were financial buyers vs.

strategic buyers. As can be seen, with the exception of Financial

Services, which experienced a relatively equal mix of interest, the

overall return of deal activity can be attributed in large part to the

return of strategic acquirers.

The stimulus for strategic-led deals is

a combination of lower organic growth

prospects absent acquisitions,

more reasonable valuations,

aforementioned accommodative

senior debt markets, and a record $2

trillion in cash and other liquid assets

held by nonfinancial companies,

which as a percentage of total

assets represents a nearly 10-year-

high water mark (though it should

be noted that a portion of this cash

is overseas with structural barriers

against tax-advantaged repatriation).

These large cash holdings are likely

a result of continued skittishness

Recent U.S. M&A Activity by Deal Size

Number of Deals Agg. Value ($ billions)

12 Months Ended % 12 Months Ended %

Deal Size 12/31/11 12/31/12 Change 12/31/11 12/31/12 Change

$ 1 Billion + 132 155 17.4% $487.3 $591.8 21.4%

$500M to $999.9M 161 139 (13.7%) 109.4 96.8 (11.5%)

$250M to $499.9M 280 247 (11.8%) 96.9 84.6 (12.8%)

$100M to $249.9M 510 497 (2.5%) 80.0 77.1 (3.6%)

$50M to $99.9M 585 607 3.8% 42.0 42.6 1.6%

$25M to $49.9M 835 867 3.8% 29.3 30.8 5.4%

$10M to $24.9M 1,199 1,188 (0.9%) 19.6 19.1 (2.3%)

Under $10M 2,600 2,534 (2.5%) 8.8 8.5 (3.0%)

Value not Disclosed 8,011 8,506 6.2% n/A n/A N/A

Total 14,313 14,740 3.0% $873.2 $951.3 8.9%

2,490

577

4,221

1,122

2,502

1,794

237

Consumer

Energy

Financials

Healthcare

Industrials & Basic Materials

Information Technology

Telecom & Utilities

Full Year 2012 U.S. M&A Volume by Sector



20137

borne of the panic that unfolded during the Great Recession,

when capital was a scarce commodity at any cost and lender

covenants were under attack from every direction. The post-

traumatic stress disorder that is driving firms to hoard cash is also

evident in the continued deleveraging of firms balance sheets,

as debt as percentage of total assets remains at one of its lowest

points in the past decade.

Private equity remains a potent force in deal flow, and will

continue to be so for at least the next few years. Favorable credit

markets and an estimated $450 billion capital overhang ($100

billion of which is nearing the end of its investment horizon), will

continue to provide impetus for investors to remain competitive in

transactions. Furthermore, it should be kept in mind that the capital

overhang actually translates into $1 trillion or more in purchasing

power, given leverage available in todays marketplace.

One interesting trend seen within private equity

in 2012 was the volume of exit activity, which

increased for the third consecutive year in both

volume and capital exited. In spite of this volume, the

inventory of domestic sponsor-backed companies

has continued to grow and now sits at more than

6,500; holding periods have crept up as well, as the

median holding time for a portfolio company has

crept above five years for the first time in history.

Another fundamental change in private equity

investing has been the prominence of secondary

buyouts, not only as an exit strategy but also as a

deal-sourcing opportunity. According to PitchBook,

in 2012 for the first time ever sponsors exited more

companies via secondary buyouts than corporate

acquisitions. Furthermore, 17% of transactions

executed in 2012 were one sponsor selling to

another, also a record.

Deal-making declined throughout the year before

the much-predicted December buying spree ensued

ahead of impending tax rate hikes. In fact, deal-

making jumped 79% from november to December

and quarterly deal-making accelerated for the first

time in a year during the fourth quarter despite

november being the slowest month for deal-making

in all of 2012. Investors were particularly keen to

complete large deals with the threat of increased

taxes, as there were 19 transactions of $1 billion

or more in the final quarter of the year. These large

deals helped push the total capital invested in the

last quarter of the year to $102 billion, the second

highest quarterly total in the last four years.

The first quarter of the year has traditionally seen a

slowdown in deal-making, and that slowdown may

be even more pronounced in 2013 as the robust deal activity in

fourth quarter was undoubtedly the result of investors pushing

to execute deals that would have closed in early 2013 under a

normal deal timeline. However, the growing inventory of sponsor-

backed companies and building dry powder reserves will force

investors to sell, if not in the near term then certainly by the end

of this decade.

Private equity investors continued to focus their attention on the

middle market in 2012, as the $25 million to $100 million size

bracket emerged as the sweet spot for sponsor investing. These

deals escalated from 24% of deal flow in 2011 to 29% in 2012,

as the slightly larger $100 million to $500 million size bucket fell

from 28% to 24% during the same period. Transactions less

than $500 million increased their proportion of total private equity

capital invested to 49%, the second highest total since 2005. Deal

flow for transactions of $1 billion or more remained consistent

136 21

1,059

79 143 28 7

42495

1,187

171431

292 11 -

500

1,000

1,500

2,000

2,500

Consumer Energy Financials Healthcare Industrials &Basic

Materials

InformationTechnology

Telecom &Utilities

Sponsor Backed Strategic

Comparison of U.S. M&A Volume by Sector, 2009 vs. 2012

Deal

Vol

ume

15.0%

18.0%

21.0%

24.0%

27.0%

30.0%

33.0%

36.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

Cash as a % of Total Assets for Non-Financial Companies in the S&P 500

Debt as a % of Total Assets for Non-Financial Companies in the S&P 500

Cash Holdings and Debt as a Percent of Total Assets for the Largest Nonfinancial U.S. Publicly Traded Companies

Cash

as

% o

f Tot

al A

sset

s

Debt

as

% o

f Tot

al A

sset

s



2013 8

with 2011, due primarily to the volume of deals that closed at

the end of the year. Private equity firms completed 19 deals of

$1 billion or more in the fourth quarter more than the rest of

the year combined and the highest quarterly total since the heady

investing witnessed in 2007.

As can be seen below, prices paid by private equity investors, as

measured by mutiples of EBITDA, contracted slightly in spite of

ready access to debt financing. While the exact reasons for this

contraction are not clear, it could be the result of uncertainty

over the near term economic outlook (i.e., 5 year horizon or

less) resulting in highly disciplined investment stances. The

contraction could also be a recognition of the fact that a greater

percentage of exits to another sponsor decreases the likelihood of

capturing synergistic-value in a sale to a strategic buyer. All things

equal, lower exit price assumptions drive down exit multiple

assumptions in leveraged buyout excel

models. These lower exit prices assumptions

reduce equity return calculations, resulting in

reduced entry prices that a financial investor

would be willing to pay in order to hold

equity returns (typically, 20-30% annually,

compounded) constant.

As mentioned, one of the interesting

dynamics seen in 2012 was the large number

of sponsor-to-sponsor transactions. There

were a record-breaking 275 secondary

buyouts in 2012, and it was the first year

that secondary buyouts exceeded corporate

acquisitions as an exit strategy. Amazingly,

just three years ago secondary buyouts

represented only one quarter (25%) of exits;

they now account for nearly half (47%).

Beyond the next 24-36 months, leveraged

buyout activity in the lower middle market

will be fueled by the additional private

equity capital raised by lower middle

market-focused funds in 2012, which

represented nearly half of the total private

equity fundraising completed over the

course of the year.

Conclusions and Outlook for 2013 and Beyond n n n

In summary, the conclusion we can draw

for the current market is that, despite

the pull forward of deals from 2013

into the 2012 calendar year due to tax

law changes, and the uncertain federal

government budgetary situation, our

view on the near-term outlook for M&A activity remains cautiously

optimistic. Furthermore, we believe that we should continue to

operate within a relatively normalized M&A environment for the

foreseeable future.

Gian G. Ricco is a Vice President in the Investment Banking Group

at Stout Risius Ross (SRR). In that capacity, he focuses on merger

and acquisition advisory, institutional private placements of debt

and equity, and strategic consulting. Mr. Ricco can be reached at

+1.312.752.3359 or [email protected].

This article is intended for general information purposes only and is not intended to provide, and should not be used in lieu of, professional advice. The publisher assumes no liability for readers use of the information herein and readers are encouraged to seek professional assistance with regard to specific matters. Any conclusions or opinions are based on the individual facts and circumstances of a particular matter and therefore may not apply in other matters. All opinions expressed in these articles are those of the authors and do not necessarily reflect the views of Stout Risius Ross, Inc. or Stout Risius Ross Advisors, LLC.

4.7 5.35.8

4.5 4.9 4.2 4.7 4.1 4.1

2.4

3.23.2

4.03.8

3.53.3

4.13.2

7.1

8.59.0

8.5 8.7

7.78.0 8.1

7.3

0x

1x

2x

3x

4x

5x

6x

7x

8x

9x

10x

2004 2005 2006 2007 2008 2009 2010 2011 2012

Debt / EBITDA Equity / EBITDA Valuation / EBITDA

Buyout Purchase Price Multiples

Source: PitchBook

0

50

100

150

200

250

300

350

20122011201020092008200720062005

Corporate Acquisition IPO Secondary Buyout

Comparison of Method of Exit for Private Equity Investors, 2005 through 2012

Source: PitchBook

Michael D. Benson [email protected] M. Evatz [email protected]

9 2013

Plastics Industry Snapshot

There are a number of positive factors and industry dynamics

that could result in continued strong plastics M&A activity

during 2013. Plastics industry valuation multiples continue to

be heavily impacted by end market served, although there are

a number of other drivers, including company size, profitability/

margins, customer concentration, resin pass-through ability,

book of business/future prospects, proprietary products

or processes, and overall amount of value-added content

and niche market leadership.

Plastics Industry Highlights n n n

n Plastics M&A volume increased approximately 26% in 2012 led by plastic packaging and industrial plastics transactions, which increased 47% and 30%, respectively.

n M&A activity within the plastics industry outperformed the overall M&A market, which was down slightly during 2012 as the election, uncertain year-end tax changes, and other geopolitical events had an effect on the market

n Industrial plastics continues to represent the largest number of transactions with 57% of the volume followed by plastic packaging at 28% and automotive plastics and medical plastics at 8% and 7%, respectively.

n The plastics industry has benefited from a number of factors, including high demand and a flight to quality for less volatile plastic packaging and medical plastics companies, while more cyclical end markets such as automotive and heavy truck have been seen as attractive given the current upswing in their respective cycles

102013

n There are a number of positive factors and industry dynamics that could result in continued strong plastics M&A activity during 2013.

n Significant amount of capital available for both small and large transactions, including senior debt, mezzanine debt, and equity

n An estimated $425 billion private equity capital overhang ($100 billion of which is nearing the end of its investment horizon) and large cash stockpiles for strategic buyers

n Continued pent-up demand for high quality acquisition targets and a general imbalance in transaction volume (i.e., more buyers than sellers)

n Plastics industry valuation multiples continue to be heavily impacted by end market served, although there are a number of other drivers, including company size, profitability/margins, customer concentration, resin pass-through ability, book of business/future prospects, proprietary products or processes, and overall amount of value-added content and niche market leadership.

Enterprise Value / EBITDA

Source: Capital IQ and public filings.

Medical Plastics Plastic Packaging Industrial Plastics Automotive Plastics

2012 M&A Volume by Process

57%

28%

8%

7%

Industrial Plastics

Plastic Packaging

Automotive Plastics

Medical Plastics

35%

28%

14%

7%

5%

3%

3% 2%2%

1%

Injection Molding

Extrusion

Resin/Compounding

Thermoforming

Machinery

Blow Molding

Tool & Die

Prototyping

Rotational Molding

Distribution

59%

25%

16%

54%

30%

16%

0%

10%

20%

30%

40%

50%

60%

70%

Strategic Financial Hybrid Private Corporate Private Equity

epyT relleSepyT reyuB


57%

28%

8%

7%

Industrial Plastics

Plastic Packaging

Automotive Plastics

Medical Plastics

35%

28%

14%

7%

5%

3%

3% 2%2%

1%

Injection Molding

Extrusion

Resin/Compounding

Thermoforming

Machinery

Blow Molding

Tool & Die

Prototyping

Rotational Molding

Distribution

59%

25%

16%

54%

30%

16%

0%

10%

20%

30%

40%

50%

60%

70%




57%

28%

8%

7%

Industrial Plastics

Plastic Packaging

Automotive Plastics

Medical Plastics

35%

28%

14%

7%

5%

3%

3% 2%2%

1%

Injection Molding

Extrusion

Resin/Compounding

Thermoforming

Machinery

Blow Molding

Tool & Die

Prototyping

Rotational Molding

Distribution

59%

25%

16%

54%

30%

16%

0%

10%

20%

30%

40%

50%

60%

70%




2012 M&A Volume by End Market

2012 M&A Volume by Buyer/Seller Type

10.4x

8.9x 9.8x

9.2x 8.4x

9.4x

7.5x

6.5x

7.5x 8.3x

7.5x 8.0x

7.2x

4.6x

6.2x 6.9x

4.8x

6.9x

3.9x

2.8x

4.7x 4.6x 3.7x

4.8x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

12/07 12/08 12/09 12/10 12/11 12/12 12/07 12/08 12/09 12/10 12/11 12/12 12/07 12/08 12/09 12/10 12/11 12/12 12/07 12/08 12/09 12/10 12/11 12/12

11 2013

Plastics Industry M&A Activity n n nEnd Market Trends

n Plastic packaging transaction volume increased 47% during 2012 and the sector continues to generate some of the largest deal values in the industry with a strong mix of both strategic and private equity buyers.

n Medical plastics transaction volume decreased 7% during 2012, although the sector has generated some of the highest valuations in the industry as strategic buyers have driven most of the activity.

n Industrial plastics transaction volume increased 30% during 2012 and generated a majority of the plastics M&A activity, from both strategic and financial buyers, as the sector continues to be highly diverse and fragmented.

n Automotive plastics transaction volume decreased 11% during 2012, although there has been renewed interest given the industry recovery and current point in the automotive volume cycle; there has been a higher percentage of corporate carveouts relative to other sectors as suppliers focus on core competencies.

Trends by Process

n In 2012, injection molding and extrusion represented more than half of all plastics transaction volume, followed by resin/compounding and thermoforming; while not a significant amount of volume, M&A activity also occurred in areas such as machinery, blow molding, tool & die, prototyping, rotational molding, and distribution.

n M&A volume for nearly all processes grew in 2012, with particularly strong growth in machinery, extrusion, prototyping, and thermoforming.

n The majority of injection molding activity occurred in industrial plastics, followed by automotive plastics and plastic packaging.

n Extrusion and thermoforming were essentially a mix of industrial plastics and plastic packaging transactions, while blow molding was primarily related to plastic packaging.

n There was a consistent mix of buyer and seller type across the various plastic processes, although strategic buyers were relatively more active in resin/compounding, machinery, and tool & die.

Buyer/Seller Trends

n Both strategic and financial buyers have been active in plastics transactions, including financial-backed hybrids, which have made a number of add-on acquisitions.

n While private sellers represented more than half of plastics M&A volume during 2012, the number of transactions sold by private equity firms increased 65% largely due to increased valuation multiples and portfolio companies that have reached the end of their investment horizon.

n While strategic buyers represent the majority of plastics transaction volume, financial buyer transactions increased 52% during 2012 largely due to favorable credit markets and an abundance of equity capital in the marketplace.

n Strategic buyers represented the largest share of transactions sold by private or corporate sellers, while financial buyers acquired a majority of transactions sold by private equity firms

26%30%

47%

-11% -7%

-20%

-10%

0%

10%

20%

30%

40%

50%

TotalPlastics

Industrial Plastics

Plastic Pacakging

Automotive Plastics

MedicalPlastics

58%

42%33%

26% 23% 22% 19%

0% 0% -33%

-50%

-25%

0%

25%

50%

75%

100%

Mac

hine

ry

Ext

rusi

on

Pro

toty

pin

g

Ther

mof

orm

ing

Res

in/C

omp

ound

ing

Tool

& D

ie

Inje

ctio

n M

old

ing

Blo

w M

old

ing

Rot

atio

nal M

old

ing

Dis

trib

utio

n

52%

21%

11%

65%

27%

9%

0%

10%

20%

30%

40%

50%

60%

70%

Financial Strategic Hybrid Private Equity Private CorporateepyT relleSepyT reyuB

2012 vs. 2011 Growth by End Market

26%30%

47%

-11% -7%

-20%

-10%

0%

10%

20%

30%

40%

50%

TotalPlastics

Industrial Plastics

Plastic Pacakging

Automotive Plastics

MedicalPlastics

58%

42%33%

26% 23% 22% 19%

0% 0% -33%

-50%

-25%

0%

25%

50%

75%

100%

Mac

hine

ry

Ext

rusi

on

Pro

toty

pin

g

Ther

mof

orm

ing

Res

in/C

omp

ound

ing

Tool

& D

ie

Inje

ctio

n M

old

ing

Blo

w M

old

ing

Rot

atio

nal M

old

ing

Dis

trib

utio

n

52%

21%

11%

65%

27%

9%

0%

10%

20%

30%

40%

50%

60%

70%


2012 vs. 2011 Growth by Process26%30%

47%

-11% -7%

-20%

-10%

0%

10%

20%

30%

40%

50%

TotalPlastics

Industrial Plastics

Plastic Pacakging

Automotive Plastics

MedicalPlastics

58%

42%33%

26% 23% 22% 19%

0% 0% -33%

-50%

-25%

0%

25%

50%

75%

100%

Mac

hine

ry

Ext

rusi

on

Pro

toty

pin

g

Ther

mof

orm

ing

Res

in/C

omp

ound

ing

Tool

& D

ie

Inje

ctio

n M

old

ing

Blo

w M

old

ing

Rot

atio

nal M

old

ing

Dis

trib

utio

n

52%

21%

11%

65%

27%

9%

0%

10%

20%

30%

40%

50%

60%

70%


2012 vs. 2011 Growth by Buyer/Seller Type

122013

Macroeconomic Indicators n n nn Gross domestic product has recovered with positive growth

achieved over the past 13 quarters, and is expected to continue over the next several years.

n The Institute for Supply Management Purchasing Managers Index (PMI), an indicator of the economic health of the manufacturing sector, has expanded in 38 out of the last 42 months.

n Consumer confidence has gradually improved since 2009, while the unemployment situation has experienced a similar trend.

n Both housing starts and existing home sales have experienced recent gains after several years of flat to declining performance, which should have a positive impact on the overall economy as well as plastics companies tied to the industry.

n Interest rates are expected to remain at historically low levels for the next several years and inflation has maintained a relatively consistent level between 1% and 4% since the downturn.

-9.0%

-7.0%

-5.0%

-3.0%

-1.0%

1.0%

3.0%

5.0%

7.0%

Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3 P P P P P P2004 2005 2006 2007 2008 2009 2010 2011 2012 12 13 14 15 16 17

Historical Projected

GDP Growth

Source: Bureau of Economic Analysis

Annu

aliz

ed R

eal G

DP G

row

th

30.0

35.0

40.0

45.0

50.0

55.0

60.0

65.0

Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12

Purchasing Managers Index

Source: Institute for Supply Management

>50

= E

xpan

sion

>50

= C

ontr

actio

n

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%


Federal Funds Target Rate

Federal Funds Rate

Source: Federal Reserve

Fede

ral F

unds

Tar

get R

ate

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12

Inflation Rate

Inflation

Source: Inflationdata.com

Infla

tion

Rate

50

60

70

80

90

100

110

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%


Unemployment

Consumer Confidence

Unemployment & Consumer Confidence

Source: U.S. Bureau of Labor Statistics, University of Michigan Consumer Confidence ReportUn

empl

oym

ent R

ate

Cons

umer

Con

fiden

ce

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

0

500

1,000

1,500

2,000

2,500

Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12

Housing Starts

Existing Home Sales

Housing Statistics

Source: Bloomberg

Hous

ing

Star

ts (t

hous

ands

)

Exis

ting

Hom

e Sa

les

(thou

sand

s)

13 2013

note: EV = Enterprise value equals market value plus total straight and convertible debt, preferred stock and minority interest, less cash and investments in unconsolidated subsidiaries.Source: Capital IQ and public filings.

selpitluM noitaulaVsnigraM MTLsa ecirPrep ecirPShare at % of 52wk Enterprise Gross EV / LTM EV / LTM Price/LTM Debt/

($ millions, except share data) 12/31/2012 High Value Margin EBITDA Revenue EBITDA EPS EBITDA

Medical Plastics1 ATRION Corp. $196.00 74.8% $356.0 48.3% 35.7% 3.07x 8.6x 16.5x 0.0x2 ICU Medical, Inc. 60.93 96.2 684.4 48.5 23.5 2.20 9.4 18.9 0.03 Medical Action Industries Inc. 2.69 42.3 116.7 14.7 3.2 0.26 8.1 NM 5.14 Merit Medical Systems, Inc. 13.90 90.4 644.8 46.8 15.2 1.68 11.1 24.7 1.15 West Pharmaceutical Services, Inc. 54.75 97.7 2,104.5 30.3 17.3 1.70 9.8 24.5 1.9

Group Mean 80.3 781.3 37.7 19.0 1.78 9.4 21.1 1.6

Plastic Packaging6 AEP Industries Inc. $59.23 90.0% $533.3 15.1% 6.6% 0.48x 7.2x 12.2x 2.8x7 Amcor Limited 8.38 98.5 13,809.4 16.9 10.6 1.11 10.5 24.4 3.08 AptarGroup, Inc. 47.72 86.0 3,393.7 31.9 17.6 1.47 8.4 19.7 1.09 Ball Corporation 44.75 98.4 10,209.4 17.6 13.2 1.18 8.9 17.0 2.9

10 Bemis Company, Inc. 33.46 98.6 4,833.8 18.0 11.9 0.93 7.8 22.5 2.411 Berry Plastics Group, Inc. 16.08 96.6 6,199.5 18.0 14.9 1.30 8.7 NM 6.312 RPC Group plc 6.45 88.3 1,368.4 17.1 12.8 0.80 6.2 20.3 1.513 Sealed Air Corporation 17.51 81.4 7,803.0 33.4 12.3 1.01 8.2 NM 5.214 Sonoco Products Co. 29.73 85.4 4,044.5 17.4 12.2 0.85 7.0 16.7 2.115 Winpak Ltd. 14.80 88.7 857.4 29.0 19.0 1.28 6.7 14.0 0.0

Group Mean 91.2 5,305.2 21.4 13.1 1.04 8.0 18.3 2.7

Industrial Plastics16 A. Schulman, Inc. $28.94 99.8% $939.8 13.2% 6.0% 0.45x 7.5x 16.8x 1.7x17 Core Molding Technologies Inc. 6.62 65.9 59.3 16.1 10.7 0.35 3.3 5.6 0.618 Myers Industries Inc. 15.15 84.3 601.6 27.5 10.6 0.78 7.4 18.7 1.219 Nolato AB 12.06 96.3 299.7 14.1 10.4 0.55 5.2 11.9 0.020 PolyOne Corporation 20.42 97.2 2,277.8 18.4 6.1 0.77 12.6 23.0 3.921 Spartech Corp. 9.07 98.6 413.2 9.7 4.9 0.36 7.4 NM 2.422 UFP Technologies, Inc. 17.92 89.8 95.3 29.0 15.1 0.74 4.9 11.8 0.3

Group Mean 90.3 669.5 18.3 9.1 0.57 6.9 14.6 1.4

Automotive Plastics23 Compagnie Plastic Omnium SA $30.04 98.2% $2,224.7 14.0% 9.1% 0.38x 4.2x 7.6x 1.9x24 Delphi Automotive PLC 38.25 99.9 13,066.4 17.4 14.0 0.83 5.9 10.1 1.025 Faurecia S.A. 15.45 51.3 3,790.6 8.5 5.4 0.18 3.3 4.7 2.626 Lear Corp. 46.84 97.1 4,030.1 8.4 6.5 0.28 4.3 9.4 0.727 Magna International, Inc. 49.84 99.6 10,596.5 12.3 7.7 0.35 4.6 8.4 0.228 Visteon Corp. 53.82 94.4 3,227.8 8.1 6.7 0.44 6.6 NM 1.2

Group Mean 90.1 6,156.0 11.4 8.2 0.41 4.8 8.0 1.3

Public Company Analysis: Select Operating And Market Performance Parameters

Plastic Resin Pricing and Stock Price Performance Last Three Years

Source: Plastics news Source: S&P Capital IQ

Rela

tive

Pric

e Pe

rfor

man

ce

0%

20%

40%

60%

80%

HDPE PVC PP ABS Nylon

-20%

0%

20%

40%

60%

80%

100%

Industrial Packaging Auto S&P 500 Index (^SPX) Medical Plastics

142013

Select TransactionsAnn. Date Target (Ownership) Acquirer (Ownership) 1 Dec-12 C. Brewer Co. Balda AG (XTRA:BAD) 2 Dec-12 Twin Bay Medical, Inc. Saint-Gobain Performance Plastics (Compagnie de Saint-Gobain) 3 Nov-12 Thomas Medical Products, Inc. Merit Medical Systems, Inc. (NasdaqGS:MMSI) (Vital Signs, Inc.) 4 Nov-12 Sage Products, Inc. Madison Dearborn Partners, LLC 5 Oct-12 MedVenture Technology Corp. Helix Medical, LLC (Freudenberg Group) (Ampersand Capital) 6 Oct-12 Affinity Medical Technologies, LLC Molex Incorporated (NasdaqGS:MOLX) 7 Oct-12 Vortex Medical, Inc. AngioDynamics Inc. (NasdaqGS:ANGO) 8 Oct-12 Coeur, Inc. (The Riverside Company) Illinois Tool Works Inc. (NYSE:ITW) 9 Aug-12 Cambus Medical Ltd Helix Medical, LLC (Freudenberg Group) 10 Jul-12 US Endoscopy, Inc. Steris Corp. (NYSE:STE) 11 Jul-12 Safety Syringes, Inc. Becton, Dickinson and Company (NYSE:BDX) 12 Jun-12 NP Medical Inc., Filter Product GVS S.p.A. Business (Nypro Inc.) 13 Apr-12 Oliver Products Company Berwind Corporation (Mason Wells) 14 Apr-12 Austar Pharma Renolit AG (JM Gesellschaft) (medical films division) 15 Apr-12 United Plastics Group, Inc. MedPlast Inc. (Baird Capital Partners) (Aurora Capital Group)

Ann. Date Target (Ownership) Acquirer (Ownership) 1 Dec-12 Charter Films, Inc. NEX Performance Films, Inc. (Mason Wells) 2 Nov-12 Stull Technologies, Inc. Mold-Rite Plastics, LLC (Irving Place Capital) 3 Nov-12 Hilex Poly Company, LLC Wind Point Partners (TPG Growth) 4 Oct-12 United States Container Corp. Berlin Packaging, LLC (Investcorp) 5 Oct-12 Scandia Plastics, Inc. Graham Partners 6 Oct-12 WNA, Inc. (Seven Mile, Norwest) Olympus Partners 7 Oct-12 BWAY Company, Inc. Platinum Equity, LLC (Madison Dearborn Partners, LLC) 8 Jul-12 HCP Holdings Inc. TPG Capital, L.P. 9 Jul-12 Rexam PLC Silgan Holdings Inc. (NasdaqGS:SLGN) (Thermoformed Food Business) 10 Jun-12 Klckner Pentaplast GmbH Strategic Value Partners, LLC & Co. KG (Blackstone Group) 11 May-12 Consolidated Container Bain Capital Company LLC (Vestar Capital) 12 Apr-12 Jet Plastica Industries, Inc. D&W Fine Pack, LLC (Mid Oaks) (MCG Capital Corporation) 13 Mar-12 The Interflex Group, Inc. Nicolet Capital Partners, LLC (Red Diamond Capital) 14 Mar-12 Solo Cup Co. (Vestar Capital) Dart Container Corporation 15 Jan-12 Polytop Corp. MeadWestvaco Corp. (NYSE:MWV)

Ann. Date Target (Ownership) Acquirer (Ownership) 1 Dec-12 Tenere, Inc. (Stonehenge Partners) The Watermill Group 2 Oct-12 Spartech Corp. (NYSE:SEH) PolyOne Corporation (NYSE:POL) 3 Sep-12 KraussMaffei Technologies GmbH Onex Corporation (TSX:OCX) (Madison Capital) 4 Sep-12 Quadion Corporation Norwest Equity Partners 5 Aug-12 TimberTech Limited AZEK Building Products, Inc. (CPG International) (Crane Building Products) 6 Jul-12 Quality Synthetic Rubber, Inc. Lexington Precision Corp. (Industrial Growth Partners) (Blue Point Capital Partners) 7 Jul-12 Synventive Molding Solutions, Inc. Barnes Group Inc. (NYSE:B) (Littlejohn & Co.) 8 Jun-12 Pexco LLC (Saw Mill Capital LLC) Odyssey Investment Partners, LLC 9 Jun-12 Tank Intermediate Holding Corp. Leonard Green & Partners, L.P. (Olympus Partners) 10 Jun-12 Xaloy Superior Holdings, Inc. Nordson Corporation (NasdaqGS:NDSN) (Industrial Growth Partners) 11 Apr-12 Plasticolors, Inc. Arsenal Capital Partners, Inc. 12 Apr-12 PolyPipe, Inc. (Halifax Capital Partners) Dura-Line Corporation (CHS Capital Partners) 13 Mar-12 Milacron, LLC (Avenue Capital Group) CCMP Capital Advisors 14 Mar-12 Drilltec, Inc. (Hancock Park) Lubar & Co. 15 Mar-12 Citadel Plastics Holdings Inc. Huntsman Gay Global Capital (Wind Point Partners)

Ann. Date Target (Ownership) Acquirer (Ownership) 1 Nov-12 D.A. Inc. Corvac Composites, LLC (Humphrey Enterprises, LLC) (Kojima Press Industry Co., Ltd.) 2 Oct-12 ACH, LLC (climate control business) Valeo SA (ENXTPA:FR) 3 Sep-12 Century Plastics, Inc. Autometal S.A. (BOVESPA:AUTM3) 4 Sep-12 Nyloncraft, Inc. (Hammond, Dickten Masch Plastics, LLC (Patmian LLC) Kennedy, Whitney & Company, Inc.) 5 Aug-12 Parker Hannifin Corporation ContiTech AG (air conditioning business) 6 Jul-12 Pyongsan FT Corp. (Pyongsan Corp.) Stant Corporation (H.I.G. Capital) 7 Jul-12 Poschmann Gmbh & Co Kg Nief Plastic Groupe (Sintex France SAS) 8 Jun-12 Ground Effects Ltd. LINE-X (Graham Partners) 9 Jun-12 Edwin Deutgen LPL Technologies Holding GmbH (Amphenol Corporation) Kunststofftechnik GmbH 10 May-12 ACH, LLC (lighting business) Flex-N-Gate Corp. 11 May-12 ACH, LLC Faurecia S.A. (ENXTPA:EO) (interior components business) 12 Mar-12 Visteon Corp. Varroc Engineering (automotive lighting business) 13 Jan-12 A.P. Plasman Corporation Insight Equity & Invotronics, Inc. 14 Dec-11 Injectech Industries Inc. Engineered Plastic Components 15 Dec-11 Toledo Molding & Die, Inc. Industrial Opportunity Partners

Trends by Plastics SectorMedical Plastics

n Strategic buyers were most active in medical plastics during 2012 representing approximately 74% of transaction volume, with the majority of transactions involving injection molding and extrusion companies.

n Transaction multiples for medical plastics companies continue to be some of the highest in the plastics industry as the relatively few transactions in the marketplace are in high demand.

n Medical plastic processors tend to be exclusively focused on the sector as indicated by the number of corporate divestitures involving non-medical operations, which have increased.

n Investment in state-of-the-art facilities with clean room and other capabilities are required to be a major supplier in the sector.

Plastic Packaging

n Plastic packaging continues to generate some of the largest M&A transactions in the industry with both strategic and financial buyers active in the sector.

n Many plastic packaging companies have decided to supplement organic growth with acquisitions.

n The number of plastic packaging deals involving extrusion, thermoforming, injection molding, and blow molding increased and financial buyers acquiring new plastic packaging platform companies more than doubled.

n Margins for plastic packaging companies tend to be higher as resin pass-through ability and other successful resin cost strategies are more prevalent.

Industrial Plastics

n Industrial plastics continues to represent the largest number of plastics transactions, which is highly diverse and fragmented.

n Injection molding, resin/compounding, extrusion, tool & die, and machinery saw significant increases in M&A volume during 2012.

n Strategic buyers and private sellers represent the majority of industrial plastics transactions, although growth has occurred for all buyer and seller types.

n Building products and other markets tied to housing are showing signs of recovery as the sales of existing homes and new housing starts begin to improve.

n Heavy truck and other cyclical end markets have grown over the past two years and are positioned for additional growth.

Automotive Plastics

n In 2012, the majority of automotive plastics transactions involved strategic buyers acquiring injection molding companies.

n While strategic buyers have historically been most active in the sector, private equity has renewed, although selective, interest given the current point in the automotive cycle, which has experienced more than two years of growth since the trough.

n Corporate sellers represented the largest number of automotive transactions in 2012, followed by private sellers and private equity.

n north American automotive production totaled 15.4 million units in 2012, up from 13.1 million units in 2011, and is expected to increase further to approximately 15.9 million units in 2013.

2013 7 2013

Michael D. Benson is a Managing Director in the Investment

Banking Group at Stout Risius Ross (SRR). He is responsible for

the execution of investment banking transactions, which include

mergers, acquisitions, divestitures, and the private placement of

senior debt, subordinated debt, and equity securities. Mr. Benson

can be reached at +1.248.432.1229 or [email protected].

David M. Evatz is a Director in the Investment Banking Group

at Stout Risius Ross (SRR). He has extensive mergers and

acquisitions experience having participated in a wide variety of

transactions involving both public and private companies. He has

executed numerous M&A transactions, including buy and sell side

assignments, leveraged buyouts, joint ventures, restructurings,

shareholder rights plans, and fairness opinions. Mr. Evatz can be

reached at +1.312.752.3328 or [email protected].


Are you maximizing the value of your business?

Gregory P. [email protected]+1.310.775.2510

Our services for Middle Market Companies include:

n Sale advisory and succession planningn Capital raises for acquisitions, recapitalizations, and restructurings

(senior debt, subordinated debt, equity)n Employee stock ownership plan (ESOP) planning,

formation, compliance, and exitn Buy-sell agreement consultingn Litigation advisory related to shareholder or

commercial disputesn Valuations for financial and tax reporting purposes

Hospital/Healthcare Valuation and ASC 958-805: Not-For-Profit Mergers and AcquisitionsJohn W. VanSanten, MAI, MRICS [email protected] J. Krentler, MAI, MRICS [email protected]

2013 16

Approximately 58%1 of hospitals and health systems in the

United States operate as not-for-profits, whereby all revenues

are utilized in pursuing the organizations objectives as opposed

to owner distribution. As the volume of consolidations within

the industry continues to accelerate, a thorough understanding

of Financial Accounting Standards Board (FASB) Accounting

Standards Codification (ASC) 958 and valuation issues unique

to healthcare are critical. Since tangible assets (in particular the

real estate) often make up the bulk of the assets for not-for-profit

health systems, this article will primarily focus on valuation issues

specific to hospital real estate though intangibles and equipment

will also be touched upon.

There are several important factors that should be considered

when it comes to healthcare valuation. This is largely due to

the ever-changing regulatory environment, advancements in

healthcare technologies and procedures, changing market

demands, and political influence. In recent years, several

changes have occurred that significantly affect the way hospitals

and other healthcare facilities should be valued. Some of these

changes include the following.

n The implementation of ASC 958-805: Not-for-Profit Mergers and Acquisitions (previously codified as FASB 164)

n Changing market demands and the creation of new building standards and codes by the Joint Commission on Accreditation of Healthcare Organizations (JCAHO) and the American Institute of Architects (AIA)

n The passage of The Patient Protection and Affordable Care Act and the potential impact that this and other current political issues, such as the federal budget crisis, will have on the performance of the healthcare industry

Each of these areas will be discussed in more detail on the

following pages.

FASB ASC 958-805 n n n

In January of 2010, FASB issued Accounting Standards Update

no. 2010-07, which recodified FASB Statement 164 to ASC

958-805. According to FASB the purpose of this statement

is to: Improve the relevance, representational faithfulness,

and comparability of the information that a not-for-profit entity

provides in its financial reports about a combination with one or

more other not-for-profit activities.

1 According to AHA Hospital Statistics, 2013 Edition.

201317

The main provisions of this standard are that it:

1I Determines whether a combination is a merger or an acquisition

2I Applies the carryover method in accounting for a merger3I Applies the acquisition method in accounting for an

acquisition, including determining which of the combining entities is the acquirer

4I Amends ASC 350 (formerly FASB 142): Goodwill and Other Intangible Assets to make it fully applicable to not-for-profit entities

ASC 958-805 essentially makes the financial reporting

requirements for for-profit mergers and acquisitions (via ASC

805: Business Combinations) applicable to those of not-for-profit

entities. Prior to this statement, the financial reporting requirements

for combinations of not-for-profits was much less stringent and

complex. Both ASC 805 (formerly FASB 141r) and ASC 958-

805 are based on the premise of Fair Value accounting, which is

considered to be more detailed, current, and comprehensive than

cost-based accounting. Further, Fair Value accounting is reflective

of a market value (exit price) and takes into consideration the

highest and best use of an asset. This move toward Fair Value

accounting has increased the need for qualified and experienced

valuation professionals in the financial reporting arena.

According to ASC 958-805, the accounting requirements differ

depending on whether a combination of a not-for-profit entity is

a merger or an acquisition. As previously mentioned, in the case

of a merger, the carryover method is used; and in the case of an

acquisition, the acquisition method is used. Each method is briefly

discussed in the following paragraphs.

A merger occurs when the governing bodies of the combining

entities cede control and, in turn, create a new governing body

that will control the newly combined entity. When this is the case,

the carryover method of accounting is used. This method involves

the combination of the book values of the assets and liabilities of

the merging organizations as of the merger date. The main change

that this makes in accounting for not-for-profit mergers is that prior

to ASC 958-805, the merged entity was required to report their

combined operations retroactively rather than from the merger

date forward. The requirements of accounting for acquisitions are

more complex. Additionally, when an acquisition takes place, it

may be difficult to determine which of the combining entities is the

acquirer. Therefore, identification of the governing party requires

consideration of all aspects of the combination, particularly the

ability of one entity to control the selection of the combined entitys

governing board. Once the acquirer is determined, the value of the

acquired entity must be determined via the following steps.

1I All assets and liabilities must be inventoried. This may involve searching for additional items of value that were not previously included on the acquirees financial statements.

2I The Fair Value of each asset and liability must be determined based on the framework outlined in ASC 820: Fair Value Measurement.

3I If the sum of the Fair Value of the assets is greater than the transaction consideration, the acquirer recognizes contribution income. Conversely, if the transaction consideration exceeds the Fair Value of the assets acquired, the accounting differs depending on whether the acquirees operations are expected to be primarily supported by contributions and return on investment or by revenues in exchange for services provided or goods exchanged. Healthcare facilities fall into the latter category and in this case the excess is recorded as goodwill.

Because ASC 958-805 amends ASC 350 to make it applicable to

not-for-profit entities, opening balances for goodwill and intangible

assets and annual testing for impairment is now necessary. This

is a significant change in the financial reporting requirements of

not-for-profits and increases the need for careful valuation of

both tangible and intangible assets. In the case of not-for-profit

hospitals, intangible assets may not be material. nevertheless,

they should be considered. Example categories of intangible

assets common in healthcare are:

n Certificate of Need (CON) and/or License

n Essential documents

n Technology and software

n Noncompete agreements

n Contracts

n Practices and procedures

n Goodwill

It is important that not-for-profit healthcare facilities comply with

these recently imposed requirements. noncompliance can hurt

healthcare organizations in a number of ways, including hindering

their ability for future mergers and acquisitions (which are

becoming increasingly attractive under the current economic and

political environment). Additionally, if auditors realize that a not-

for-profit is not complying, they can issue a qualified report that

could potentially impact the credit rating of the health system and

limit the organizations ability to obtain financing (typically through

the tax-exempt bond market).

2013 18

Unique Real Estate Valuation Issues n n n

Healthcare organizations typically have substantial tangible assets,

including real estate holdings and medical equipment. For financial

reporting purposes, both types of tangible assets typically must

be valued. When it comes to the valuation of a health systems

real estate there are certain distinct characteristics that raise

valuation concerns.

Current real property appraisal theory includes consideration of

several appraisal approaches, including a cost approach, sales

comparison approach, and income capitalization approach.

A specific appraisal assignment may use one or more of these

valuation approaches based on the definition of value and the

quality and quantity of data available for the analysis. When

valuing hospitals and other healthcare facilities, the cost approach

(estimating the underlying land value plus the depreciated value of

the improvements) is often the most applicable approach. This is

because hospitals are considered special use properties, designed

specifically to provide healthcare services to the community. For

special purpose properties, the cost approach is often the most

appropriate method. Application of the sales comparison and

income capitalization approaches for a hospital would typically

reflect the value of the business enterprise, including significant

equipment and intangible assets. This is due to the fact that sales

of hospitals typically include the entire going-concern, not just

the real estate. Therefore, sales of hospitals may be useful for

estimating the value of the going-concern, but may not provide a

reasonable indication of the underlying real estate value. Likewise

with the income capitalization approach, the cash flows generated

by a hospital reflect the business of providing healthcare services,

not just rent for the real estate. Capitalizing a hospitals cash flow

may provide an indication of the going-concern value, but may not

provide a reasonable indication of the underlying real estate value.

For non-clinical buildings such as medical office, application of

the sales comparison and income capitalization approaches may

be appropriate, as these properties are more similar to traditional

real property types.

Based on the preceding, when appraising a hospital campus in

compliance with ASC 958-805, it is typically most appropriate

for the primary real property assets (i.e. main hospital and clinical

buildings) to be valued on a cost approach, while the ancillary non-

clinical buildings are valued via a sales comparison and/or income

capitalization approach.

In the application of the cost approach, it is common for hospital

buildings, especially older facilities, to suffer from functional

obsolescence. This is due to ever-changing market demands

and building standards/codes. Market demands have changed

dramatically in recent years. The old institutional feel of hospitals

is obsolete, and patients now prefer more hotel-like amenities,

including private rooms with flat-screen televisions, wireless

internet access, health clubs and spas, and high-quality food

service/restaurants. Building standards and code requirements

have changed significantly in the past decade in an effort to meet

changing demands, improve patient safety, increase operational

efficiency, and reduce costs. The two bodies governing this

change are the Joint Commission on Accreditation of Healthcare

Organizations (JCAHO) and the American Institute of Architects

(AIS). new standards and guidelines in the healthcare industry

involve many facility types, including general hospitals, outpatient

facilities, and surgical centers. These new guidelines exert

substantial pressure on existing hospitals to compete with the

latest standards to avoid becoming functionally obsolete. Some of

these changes include:

n New AIA guidelines for hospitals that require single-patient rooms for most new hospital construction. This requirement is driven by both market and clinical demand, as numerous studies have shown the rates of medical errors and the spread of infection drop dramatically in hospitals with private rooms versus shared rooms.

n Increased minimum size requirements for operating rooms (ORs) in hospitals. For example, general operating rooms are now required to have a minimum clear area of 400 square feet and minimum fixed or wall-mounted cabinets of 20 feet. This requirement is driven by changes in technology, which result in more equipment being utilized in operating room procedures thereby requiring larger OR spaces.

n As average length of stay decreases, more and more procedures are being done on an outpatient basis. Hospitals are constructing facilities with outpatient centers more frequently to reflect this shift in the industry. Older facilities originally designed for inpatient procedures tend to be obsolete, and the cost of retrofitting these buildings can be prohibitive.

In summary, new guidelines and standards of the JCAHO and AIA

are creating a more competitive marketplace in the healthcare

industry. The hospitals that offer private patient rooms and larger,

more technologically advanced operating rooms experience higher

demand, better patient safety, increased operational efficiency,

and reduced costs. The value of dated hospitals that have not

catered to these changing industry norms is, consequently,

negatively affected. In fact, many health systems have embarked

upon the process of building replacement facilities for their

existing hospitals, often spending hundreds of millions to keep

pace with industry changes. With limited alternate use potential for

the hospitals that are replaced, the highest and best use for the old

buildings often calls for demolition and redevelopment of the site.

201319

Another consideration in the cost approach is the economic

viability of the hospital enterprise. If a separate valuation of the

hospital enterprise is completed, it may indicate the value of the

entire enterprise (the total assets of the business), is less than the

initial value indication for the tangible assets. In this situation, it

may be necessary to apply an economic obsolescence adjustment

to both the real and personal property, under the theory that there

is insufficient cash flow generated by the hospital enterprise to

support the underlying value of the tangible assets. Each situation

is unique, and the specifics of the transaction must be considered

before a final conclusion can be reached. Best practices also

suggest that for ASC 958-805 compliance, valuation professionals

should be on the same page with both the client and the auditors.

Good planning and communication on the front-end can ensure

that there are no surprises on the back-end.

Current Political and Economic Issues n n n

The current political and economic environment is presently

affecting and has the ability to further influence the shape of the

healthcare industry going forward. Items such as the passage of

The Patient Protection and Affordable Care Act and impending

budget crisis have brought healthcare to the forefront of political

discussion. Though much uncertainty remains, it is evident that the

future structure of the nations healthcare system will be affected

one way or the other.

Several recent reports from financial analysts state that the outlook

for not-for-profit hospitals in 2013 is dismal. Fitch Ratings Outlook

for 2013 discusses the ongoing pressure on hospital operations

due to a weak economy and scheduled decreases in hospital

pay under healthcare reform. During the recession, hospitals and

healthcare systems made an effort to reduce expenses and have

continued to do so through the slow recovery. However, it is likely

that these measures will cease to help deliver stable profits. Fitch

believes 2013 is likely to be the last year of stable performance,

as scarcer expense reduction opportunities and looming

reimbursement reductions threaten operating performance, the

report stated. The report goes on to say that health insurance

exchanges created by the healthcare reform bill, which would allow

middle- and low-income households to buy subsidized insurance

starting in 2014, would benefit hospitals, but development of these

exchanges seems to be behind schedule.

Additionally, a recent Moodys Investor Services outlook on

not-for-profit hospitals reports that hospitals will receive lower

payments for services from insurers in coming years as Medicare

cuts approximately $300 billion from hospital reimbursements.

Beyond these scheduled Medicare cuts and private insurer efforts

to temper premium growth, federal deficit reduction measures

and state budgetary challenges will all contribute to a decrease in

hospital revenue.

These potential challenges are creating a great amount of

uncertainty and risk within the industry. Many hospitals will take

precautionary measures in an attempt to lessen the fallout. This

will likely include an increase in merger and acquisition activity

in an effort to create economies of scale and curb costs; this, in

turn, will increase the need for not-for-profit healthcare systems to

comply with ASC 958-805.

Conclusion n n n

As indicated in the preceding discussion, the healthcare industry

continues to evolve, and the ever-changing environment is likely

to continue for the foreseeable future. new financial reporting

standards, distinct real estate valuation considerations, changing

market conditions, and risk created by current political and

economic circumstances have all affected the industry and

will continue to do so. Consequently, the need for valuation

professionals who understand the complexities of healthcare

and nuances of financial reporting requirements, and who have

the expertise to value all asset types (intangible, real estate, and

equipment) is critical.

John W. VanSanten, MAI, MRICS is a Managing Director in the

real estate practice within the Valuation & Financial Opinions

Group at Stout Risius Ross (SRR). He has more than 20 years of

experience in real estate valuations of all types of commercial and

special use properties, with a particular emphasis on healthcare

properties. Mr. VanSanten can be reached at +1.312.752.3384

or [email protected].

Jason J. Krentler, MAI, MRICS is a Director in the real estate

practice within the Valuation & Financial Opinions Group at

Stout Risius Ross (SRR). He is responsible for management,

client liaison, business development, and appraisal

production. Mr. Krentlers concentration is in real estate

valuation and advisory services, where he has 10 years of

national and international appraisal, review, and management

experience. Mr. Krentler can be reached at +1.248.432.1281

or [email protected].


Our services include:

Jay B. Wachowicz, CFA n [email protected] n +1.248.432.1288

n n Purchase price allocation and fresh start accountingn n Goodwill and long-lived asset impairment testingn n Valuation of stock options and stock grantsn n Fair Value measurement of financial assets and liabilitiesn n Real estate and machinery & equipment valuationn n Fair Market Value opinions for internal tax reorganizations and restructuringsn n Fairness opinionsn n Solvency and capital adequacy opinionsn n Private market financings (debt and equity)n n Sell side representation for corporate divestituresn n Litigation advisory services related to shareholder or commercial disputes

How do you satisfy the scrutiny from the capital markets, accounting and tax regulators, and your board?

Vesting of Founders StockJeff M. Mattson, Esq. Freeborn & Peters LLP [email protected]

21 2013

Guest Article

Founders of a startup are frequently surprised when venture

capital firms or other investors ask for vesting provisions to be

placed on the founders stock. The investors are seeking to

provide sufficient incentive for each founder to work through

the companys critical early formation and development phase.

If a founder leaves the startup early in the process, it would be

unfair to the other founders and the investors for the departing

founder to receive a free ride on the continuing efforts of

the other founders. The vesting terms cause a forfeiture of the

unvested shares, or a repurchase at a low cost, upon termination

of employment, thereby eliminating the free ride.

A typical vesting structure is a period of four years beginning

either upon the formation of the company or the closing of the

first round of outside financing, with a one-year cliff, meaning that

one-fourth of the stock vests on the first anniversary. Thereafter,

the stock vests ratably with one forty-eighth of the stock vesting

each month. In some cases, the stock instead vests annually with

one-fourth of the stock vesting on each anniversary. In either

case, the founder is 100% vested on the fourth anniversary.

The logic of this typical structure is that it takes a full year to

get through the formative stage and, thereafter, the value of the

company increases incrementally. The typical vesting schedule

tracks this common growth pattern, rewarding the founder

proportionately for services during these stages.

But, startups come in many shapes and sizes, and founders can

request and obtain variations from the four-year vesting schedule

in appropriate circumstances. Following are a few of the most

common reasons to adjust the vesting schedule:

1I Other Contributions. If a founder has contributed money, intellectual property, or other assets to the company, the stock issued in return for those contributions should be fully vested, because the value has been provided in full and is not contingent on the future services. Any remaining stock issued for services would still be subject to vesting.

2I Prior Service. If the VC investment is being made after the formation of the company, the founders frequently are able to obtain credit for the prior services. For example, if the VC investment is made one year after formation, the stock could be 25% vested upon closing the investment, and the remaining stock would be subject to a three-year vesting schedule.

3I Shorter Startup Period. If founders reasonably anticipate a shorter period to bring products or services to market, profitability, or sale of the company, then investors have a shorter risk period and the vesting schedule can be reduced commensurately.

222013

4I Track Record or Expertise. If a founder has a proven track record or expertise that is particularly needed by the company, that founder may be able to leverage this strength into a shorter vesting schedule. But dont overplay this hand. If the investor is convinced a founder is critical, the investor may decide that vesting is even more important to protect against the damage to the company if this key founder leaves the company.

Vesting stock commonly raises two additional issues: acceleration

of vesting and the tax treatment of vesting stock.

Founders should always ask for the vesting of their stock to

accelerate upon (a) a sale of the company or (b) a termination

of employment without cause. This formulation for vesting is

called single-trigger acceleration, because the acceleration is

triggered upon the occurrence of either one of the two events.

Investors usually want double-trigger acceleration, in which

acceleration only occurs if the founders employment is terminated

without cause following a sale of the company. Investors are

concerned that single-trigger acceleration will make the company

more difficult to sell because, if all stock vests upon sale, buyers

will be unwilling to take the risk of founders leaving the company

shortly following the sale.

Finally, vesting stock creates a tax trap that first-time founders do

not expect. The tax code treats the grant of stock to a company

officer or employee as compensation for services rendered. The

founder is required to recognize income equal to the value of the

stock. When a company is initially formed, the stock usually has

no value, so the taxable income is $0. But, if vesting is placed on

the stock, IRS regulations deem the stock to be granted on the

date of vesting. If the companys value increases over time, as

anticipated, then the stock gains greater and greater value upon

each vesting date and the founder must recognize income on

each vesting date. If the startup goes well, this income is quite

significant, resulting in substantial income tax at a time when the

founder may not have cash available to pay the tax.

Generally, founders can mitigate the previously referenced tax

costs by filing an 83(b) election with the IRS. The 83(b) election

treats the stock, for tax purposes, as if there is no vesting, thereby

eliminating the taxable event upon vesting. But, be careful with

this issue. The 83(b) election must be filed within 30 days of

grant; no extensions are permitted; the election applies only if the

stock is issued in connection with the performance of services;

and the potential tax trap could be huge if you fail to file in the

30-day period. Founders facing this situation should consult

with knowledgeable tax counsel to determine the availability and

effects of an 83(b) election.

Jeff M. Mattson, Esq. is a Partner in and Co-Leader of the Corporate

Practice Group at Freeborn & Peters LLP. His expertise includes

mergers and acquisitions, entity formation, private placements, and

other general corporate matters. Mr. Mattson can be reached at

+1.312.360.6312 or [email protected].


Bridging the GAAP to Tax

Marc C. Asbra, CFA [email protected]

23 2013

While the capital markets, economic conditions, political

atmosphere, and numerous other factors impact commercial

transactions in any given year, mergers and acquisitions

generally remain a predominant tactic for driving corporate

growth and return on investment. There were roughly 15,000

M&A transactions in the U.S. during 2012, representing over

$830 billion of value.1

A substantial majority of these transactions require the buyer

to allocate the purchase price for financial reporting purposes

pursuant to Financial Accounting Standards Board Accounting

Standards Codification Topic 805, Business Combinations (ASC

805). In brief, acquirers must perform a purchase price allocation

(PPA) based on the Fair Values of the targets current, tangible, and

identifiable intangible assets. The residual is recorded as goodwill.

Ever since the elimination of the pooling method over a decade

ago, C-suite executives, board members, financial advisors,

securities analysts, and investors have become well versed in the

topic of acquisition accounting due to its effect on the acquirers

GAAP earnings following the transaction. The portion of purchase

price allocated to intangible assets and goodwill has particular

importance, as the post-transaction amortization periods for

acquired intangible assets can range anywhere from one to 20

years, while goodwill produces no amortization expense. not

surprisingly, the Securities and Exchange Commission (SEC)

and other regulators have also demonstrated a keen interest in

acquisition accounting.

PPA for Financial Reporting Purposes n n n

The transaction price generally establishes a Fair Value of the

targets assets as a whole, but it is silent as to the sources of such

value. There can be numerous sources, such as a cost effective

manufacturing process, a unique patent portfolio, innovative

products based on proprietary technologies, a well-known brand

name that evokes customer loyalty, a defensible market share

due to long-term customer contracts or relationships, or an

exceptional approach to running the business.

At a fundamental level, the analysis performed for the PPA

deconstructs the targets business in an effort to understand

the critical value drivers and, importantly, determine the

Fair Values of the intangible assets that meet the GAAP

requirements for separate identification. The analysis commonly

includes the attribution of the targets company-wide projected

earnings or cash flows to each source of value technology,

brand name, customer contracts, business processes, etc.

The attribution process is often very detailed and can involve

extensive financial modeling.

As required by ASC 805, the PPA analysis is performed on

the basis of the targets reporting units or, if the target has

only a single reporting unit, on a company-wide basis. The

PPA analysis is typically not performed on a legal entity basis,

as the ownership distinction is generally not essential for

financial reporting purposes. The issue of ownership tends to

reside in the world of tax. 1 Source: S&P Capital IQ. Represents announced transactions involving a change of control.

242013

Tax Implications n n n

The interest in PPA results for tax reporting purposes generally pales

in comparison to its EPS-driven financial reporting counterpart.

Unless a transaction is structured as a taxable acquisition of the

targets assets, or a taxable purchase of the targets stock with

an Internal Revenue Code (IRC) Section 338 election, the acquirer

assumes carryover tax basis in the acquired assets. none of the

asset step-ups, identifiable

intangible assets, or

goodwill recognized in the

PPA for financial reporting

purposes is deductible for

tax purposes. In transactions

where the acquirer assumes

a stepped-up basis in

the targets assets, all of

the intangible assets and

goodwill are amortized

ratably over the statutory

15-year period per IRC

Section 197.

The tide turns quickly when

an M&A transaction has material tax consequences to the buyer

or seller. The companys tax department and external tax advisors

engage in extensive diligence and planning. While it might be

tempting to isolate these professionals until they determine the

most tax-efficient structure for the transaction or post-integration

plan, in doing so the acquirer would forego opportunities to

leverage Fair Value measurements done for financial reporting

purposes within their tax-planning initiatives.

One such situation can arise when an M&A transaction involves

a target that conducts business through multiple legal entities.

For tax-planning purposes, it may be necessary to allocate the

purchase price to the targets legal entities, as illustrated in the

following example.

Valuation of ABC Legal Entities n n n

ABC Company is a privately held engineering and construction

(E&C) company. The company began its operations in the

Southeast and since expanded into other regions across the

U.S. Separate legal entity subsidiaries were created to coincide

with ABCs geographic expansion. While the founding principal

holds (directly or indirectly) controlling interests in each of the

companys subsidiaries, different key management personnel own

minority positions.

ABC sold its assets on December 31, 2012 to a financial

sponsor for an aggregate purchase price of $150 million, which

was determined based on a multiple of 5.0x the companys

consolidated EBITDA of $30 million. As shown in Table 1 below,

ABC is compr

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