1204002 Informal Interpretation

Michael Verne

  – Agree.


From: (redacted)
Sent: Thursday, April 05, 201212:13 PM
To: Verne, B. Michael; Walsh, Kathryn

Subject:Question Regarding Valuation

Mikeand Kate,

Ihope all is well with you both.

Ihave what I think is a straightforward analysis, but as always, wouldappreciate your confirmation (or corrections).

Forpurposes of this hypothetical, let's assume the parties meet the applicablesize-of-person thresholds. Buyer plans to acquire voting securities, non-votingsecurities, and options of Target. Prior to closing, the options will beconverted to non-voting securities. The non-voting securities give theshareholders the right to vote on a change of control of the Target, but do notgive the shareholders the right to vote for directors of the board. There is abase purchase price for all the securities of $60 million, and shareholders ofthe voting and non-voting securities will receive the same amount of cashconsideration.

Thenumber of shares in each class are as follows:

Voting = 10 million

Non-Voting = 2 million

Options (to be converted tonon-voting) = 500,000

Takingthe base price of $60 million and dividing it by the total number of shares(i.e., 12,500,000 shares/options) gives us a per share price of $4.80.

Forpurposes of determining size-of-transaction, we would exclude the non-votingshares and options, which means the base price would be the number of votingshares (10 million) multiplied by the per share consideration of $4.80 for atotal of $48 million.

Perthe transaction agreement, additional adjustments will be made to the baseprice including:

Working capitaladjustment (yet to be determined, and may not occur at all if Target hits thepre-determined working capital target);

A deduction in theconsideration for third-party indebtedness (approximately $5 million);

A deduction in theconsideration for stockholder indebtedness (approximately $3 million), with an offsettingaddition to the consideration in the same amount (the purpose of this is toensure the stockholders with the indebtedness effectively pay back theirindebtedness, but the stockholders without the indebtedness are not"penalized" by getting reduced consideration); the net effect on theconsideration of this deduction/addition is $0;

A contingent earnoutbetween $5 million and $25 million, but that Buyer reasonably expects willtotal $15 million.

Applyingthese adjustments to the base price of the voting securities (with theexception of the yet-to-be-determined working capital adjustment), and assumingthe contingent earnout is not so speculative as to warrant a fair marketvaluation, the size-of-transaction would be approximately $58 million ($48m-$5m +$0m +$15m).

Ifthe working capital adjustment and contingent earn out are in fact toospeculative to be reasonably estimated, the acquisition price would beundetermined, and the Buyer would need to do a fair market valuation of thevoting shares to be acquired (excluding the non-voting shares).

Pleaseconfirm that in determining the size-of-transaction, the non-voting shares andoptions that do not include a present right to vote for members of Target'sboard of directors should be excluded. Also, please confirm that it isappropriate for the Buyer to include a reasonable estimate of the workingcapital adjustment and contingent earnout when determining thesize-of-transaction. However, if Buyer cannot reasonably estimate the workingcapital adjustment and/or the contingent earnout, the acquisition price is notdetermined, and Buyer needs to do a fair market valuation of the voting shares(excluding the non-voting shares) to be acquired pursuant to Rule 801.10.

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