An Overview of Leveraged Buyouts Chris Droussiotis, Executive Director

An Overview of

Leveraged Buyouts

Chris Droussiotis, Executive Director

Head of the Leverage & Sponsor Group

June 2013

Table of Contents

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1. Leverage Buyouts (LBO)A. DefinitionB. HistoryC. Market evolution

2. Financing an LBO / Capital MarketsA. Senior DebtB. Subordinated Debt C. EquityD. Debt Capacity

3. Loan SyndicationA. Definition (Primary / SecondaryB. Market Overview / Market EvolutionC. Investor Base / CLOs, Loan Funds and

Banks

4. Understanding Term & ConditionsA. Money TermsB. Non-Money TermsC. Other Terms

5. Loan PricingA. Loan Pricing / Spread / OID / LIBOR FloorsB. Bond Pricing YTM, YTC, YTWC. Equity Return Analysis (DCF)

6. Example of a Large Syndication: Harrahs

A leveraged buyout (or LBO, or highly leveraged transaction (HLT) occurs when an investor, typically a financial sponsor acquires a controlling interest in a company's equity and where a significant percentage of the purchase price is financed through leverage (Debt).

The Debt raised (by issuing bonds or securing a loan) is ultimately secured upon the acquisition target and also looks to the cash flows of the acquisition target to make interest and principal payments.

Acquisition debt in an LBO is usually non-recourse to the financial sponsor and to the equity fund that the financial sponsor manages.

The amount of debt used to finance a transaction as a percentage of the purchase price for a leverage buyout target, varies according to the financial condition and history of the acquisition target, market conditions, the willingness of lenders to extend credit. Typically the debt portion of a LBO ranges from 50%-85% of the purchase price, but in some cases debt may represent upwards of 95% of purchase price.

To finance LBO's, private-equity firms usually issue some combination of syndicated loans and high yield bonds.

Leveraged Buyouts Definition/Description

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The first leveraged buyout may have been the purchase of two companies: Pan-Atlantic and Waterman companies (steamship companies) in 1955 by McLean Industries.

McLean borrowed $42 million and raised an additional $7 million through an issue of preferred stock. When the deal closed, $20 million of Waterman cash and assets were used to retire $20 million of the loan debt. The Debt raised (by issuing bonds or securing a loan) is ultimately secured upon the acquisition target and also looks to the cash flows of the acquisition target to make interest and principal payments.

The use of publicly traded holding companies as investment vehicles to acquire portfolios of investments in corporate assets was a relatively new trend in the 1960s, popularized by the likes of Warren Buffett via Berkshire Hathaway and Victor Posner via DWG Corporation.

The leveraged buyout boom of the 1980s was conceived by a number of corporate financiers, most notably Jerome Kohlberg, Jr. and later his protégé Henry Kravis and his cousin George Roberts – both working for Bear Stearns – to create KKR. In 1989, KKR closed in on a $31.1 billion dollar takeover of RJR Nabisco. It was, at that time and for over 17 years, the largest leverage buyout in history. The event was chronicled in the book (and later the movie), Barbarians at the Gate: The Fall of RJR Nabisco.

Drexel Burnham Lambert was the investment bank most responsible for the boom in private equity during the 1980s due to its leadership in the issuance of high-yield debt.

Mega Deals of 2005-2007: The combination of decreasing interest rates, loosening lending standards, creation of CLOs and regulatory changes for publicly traded companies (specifically the Sarbanes-Oxley Act.) would set the stage for the largest boom private equity had seen.

Leveraged Buyouts History & Market Evolution

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Leveraged Buyouts – Enhancing Equity Returns

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Your Business

ASSETS:

$10 million

LIABILITIES:

$0 (No Debt)

EQUITY:

$10 million

Balance Sheet

ROA = 10%

ROE = 10%

EBIT : $1.5 million

Interest Exp.: $ 0 million

Pretax Income: $1.5 million

Taxes (33%): $0.5 million

Net Income: $1.0 million

Income Statement

EBIT: $1.5 million

Interest Exp.: $ 0.9 million

Pretax Income: $ 0.6 million

Taxes (33%): $ 0.2 million

Net Income: $ 0.4 million

LBO: NewCo

Income Statement

ASSETS:

$10 million

LIABILITIES:

$9 million

EQUITY:

$1 million

Balance Sheet

ROA = 10%

ROE = 40%

The offer: $10mm (10 x Net Income) borrowed $9 million (90%) at 10%

Leveraged Buyouts – Enhancing Equity Returns

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Your Business

ASSETS:

$10 million

LIABILITIES:

$0 (No Debt)

EQUITY:

$10 million

Balance Sheet

ROA = 10%

ROE = 10%

EBIT : $1.5 million

Interest Exp.: $ 0 million

Pretax Income: $1.5 million

Taxes (33%): $0.5 million

Net Income: $1.0 million

Income Statement

EBIT: $1.50 million

Interest Exp.: $1.08 million

Pretax Income: $ 0.42 million

Taxes (33%): $ 0.14 million

Net Income: $ 0.28 million

LBO: NewCo

Income Statement

ASSETS:

Purchase: $10 million

Goodwill: $ 2 million

Total: $12 million

LIABILITIES:

$10.8 million

EQUITY:

$ 1.2 million

Balance Sheet

ROA = 10% (tang)

ROE = 23%

The offer: $12 mm (12 x Net Income) borrowed $10.8 million (90%) at 10%

20% Premium

Capital Markets: Types of Financing

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Senior Debt (Bank Loan or Leverage Loan)

Ranks ahead of all other debt and equity capital in the business

Bank loans are typically structured in up to three tranches: Revolver, TL A and TL B.

The debt is usually secured on specific assets of the company, which means the lender can automatically acquire these assets if the company breaches its obligations under the relevant loan agreement; therefore it has the lowest cost of debt.

Typical Maturity 5-7 years Senior Debt represent 45-60% of total Capital

Senior Debt Multiples represent 3.0x – 4.0x of historic EBITDA

Revolver and TL A (called Pro-rata facilities) are provided by traditional banks

Term Loan B (called institutional facility) is provided by non-banking institutions (CLOs, Insurance Co., Funds)

Usually offers the lowest cost of funding Prepayable at no or little cost Deep established market in the U.S which can accommodate large transactions Private market and therefore less exposed to volatile market conditions No equity dilution

Pros Requires periodic amortization out of free cash flows, therefore this instrument may not be suitable for companies consuming cash for some years Strict maintenance covenants are tightly monitored, usually on a quarterly basis (eg total leverage, interest cover, fixed charge cover ratio, etc) Full security required in most cases

Cons


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Subordinated Debt (Mezzanine)

Ranks behind senior debt in order of priority on any liquidation.

The terms of the subordinated debt are usually less stringent than senior debt.

Repayment is usually required in one ‘bullet’ payment at the end of the term. Typical maturity is 8-10 years

Since subordinated debt gives the lender less security than senior debt, lending costs are typically higher.

An increasingly important form of subordinated debt is the high yield bond, often listed on US markets.

They are fixed rate, publicly traded, long-term securities with a looser covenant package than senior debt though they are subject to stringent reporting requirements.

High yield bonds are not prepayable for the first five years and after that, they are prepayable at a premium (Call premiums)

SEC requires the Issuer of these bonds to be rated by two independent agencies (Moody’s and S&P)

Subordinated Debt represent 15-25% of total Capital

Total Debt (including both the Senior and Sub debt represent 5.0x – 6.0x of historic EBITDA.

Private Equity

Ranks at the bottom of the “waterfall” in order of priority on any liquidation.

Equity represent 20-35% of total Capital


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Estimate Debt Capacity

The next step is to estimate the amount of debt that the company can take on. The financial statements should make provisions for interest and debt costs. The company can only bear debt to the extent that it has available cash flows. Note that all existing debt will need to be refinanced. When modelling (Equity or Debt investors) the financing assumptions used are according to market conditions, industry characteristic and company specific issues. Set out below are some parameters that will influence financing considerations for the model:

Minimum interest cover (times) Total debt/EBITDA (times) Senior debt repayment (in years) Mezzanine debt repayment (in years) Senior debt interest rate Subordinated interest rate Mezzanine finance exit IRR


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Example:

XYZ Company trades at NYSE at $15 with 20 million shares and has $300 million of Debt, $100 of Cash and $100 mm of EBITDA, so

Trading Enterprise Value (EV) = (Equity at $15 x 40 million shares) + $300 mm Debt – $ 100 mm Cash = $800 mm

or 8.0x EBITDA trading multiple ( EV / EBITDA)

The PE firm are in the process of tendering for all the shares of XYZ. To ensure a success of acquiring all the shares, they thinking of offering 33% premium to the existing trading level stock, or tendering for the stock at $20 per share putting he EV at $1 billion - ($20 x 40 mm shares ) + $300 mm Debt - $100mm Cash = $1 billion

Transaction Sources & Uses

Sources Uses

Capacity Amount % Cap

Senior Debt 4.0x 400.00$ 40.0% Purchase of Stock 800.0

Subordinated Debt 6.0x 200.00$ 20.0% Refinance of Debt 300.0

Equity 400.00$ 40.0% Cash (100.0)

Total Sources 10.0x 1,000.0 100.0% Total Uses 1,000.0

EBITDA 100.00$ mm

The PE firm will need to run their own LBO Analysis to see if $1 billion acquisition makes sense given the Debt Capacity and improvement of EBITDA in the next 3-5 years.

A syndicated loan is one that is provided by a group of lenders and is structured, arranged, and administered by one or several commercial or investment banks known as Arrangers.

Arrangers serve the investment-banking role of raising investor dollars for an issuer in need of capital.

Loan Syndication Background & History

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The issuer pays the Arranger a fee for this service, and this fee increases with the complexity and risk factors of the loan.

In the Mid-1980’s when the larger buyouts needed bank financing, the syndicated loan market became the dominant way for issuers to tap banks and other institutional capital providers for loans.

In the late 90s to early 2000’s hundreds of Collateral Loan Obligation funds (CLO’s) were created and joined the loan syndication process. These funds were referred to as non-bank institutions or institutional investors. These institutional investors played a key role in the exponential growth of the Mega LBO deals seen in 2005-2007.

By 2007, nearly 75% of the loans were provided by non-banks, versus less than 20% 10 years earlier. The Fall of 2007 – the end of liquidity in the U.S Syndication market – Traditional Banks had to step up in the months and years to follow the liquidity crisis.

For two years after the crisis (2007-2009), the syndication market has completely changed; Was more cautious, new language was added in the syndication agreements between the banks and the customers to protect against market risk

Starting in the summer of 2010 through today, the syndication markets started to loosen up again as the liquidity in the loan market has come back significantly. In 2010, the HY bond market issuance had the best year ever.

Two Markets Served

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Investment Grade Loan Market

• Rated BBB- and Higher (Corporate)

• Arrangers hold Higher Exposure ($200 million +)

• The majority of the Syndicate are traditional banks

Leveraged Loan Market

• Rated BB+ and Lower (Corporate)

• Arrangers hold Lower Exposure – thus the need to syndicate

• The majority of the Syndicate are non-banks (Financial institutions)

Leverage Loan Market purpose:

• Leverage Buyouts (LBO)

• Acquisitions using substantial debt

• Refinancing

Two Markets Served in the U.S.

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Investment Grade Loan Market Leveraged Loan Market (BB+ and below)

$715 Billion

$229 Billion

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

19

90

199

11

99

219

93

19

94

199

51

99

619

97

19

98

199

92

00

02

00

120

02

20

03

20

04

200

52

00

62

007

20

08

20

09

201

0

I-G

rad

e V

olu

me

($

Bils

.)

AAA AA A BBB$535 Billion

Extremely high liquidity in the market gave banks confidenceto underwrite larger and larger deals…

$0

$5

$10

$15

$20

$25

$30

$35

$40

$ in

Bill

ions

OtherHigh YieldLeveraged Loan

Leveraged Loan$5.0

$8.0

$11.3

$22.3

$28.4

$33.0

$37.9

Hi Yield $3.0 Leveraged Loan$11.3 Leveraged Loan

$9.0

Hi Yield $6.03

Other (CMBS) $7.25

Leveraged Loan$15.185

Hi Yield $13.22

Leveraged Loan$21.7

Hi Yield $11.3

Leveraged Loan$26.65

Hi Yield $11.25

28 Mar 05 20 Nov 05 2 Oct 0624 Jul 06 26 Feb 07 30 Jun 07

Source: LoanConnector

Loan Syndication Market Overview (Continued)

The Exponential Surge in Supply of Syndicated Loans was driven by large Leveraged Buyouts starting in 2005 thru the summer of 2007

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Institutional Investors through June 2007 dominated the market

Over time, institutional investors have replaced banks as lenders with over 75% of demand coming from institutional investors as of LTM 6/30/07

Source: Deutsche Bank

0%

20%

40%

60%

80%

100%

94 95 96 97 98 99 00 01 02 03 04 05 06

LTM 6/

30/0

7

(% o

f Inv

esto

r B

ase)

0%

20%

40%

60%

80%

100%

(% Investor B

ase)

U.S. Banks Non-U.S. BanksFinance Co. / Securities CLOs / Hedge Funds / High-Yield FundsInsurance Co. % Banks

Loan Syndication Market Overview (Continued)

Loan Syndication Participants:

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Before (LTM June 30, 2007(1)) After (2nd Half 2007(2)) As of 12/05/07

Investor Landscape has changed

CLOs

Banks

Other

Hedge Funds / HY

Primary Issuance

Demand Supply

($ in Billions)

Sources:

(1) Standard & Poor’s Leveraged Lending Review 2Q07

(2) Demand assumptions: Banks and Other at 35% consistent with LTM 6/30/07; CLO, Hedge Fund and New Capital amounts Wall Street estimatesSupply assumptions: Primary Issuance based on current estimated forward calendar; Liquidation / Collateral Calls amounts Wall Street estimates

(3) Finance Companies, Insurance Companies, Prime Rate Funds

(4) Standard & Poors LCD News 12/5/07

(5) Grossed up for ordinary issuance

(3)

Liquidation / Collateral Calls

Primary Issuance (5)

CLOs

Banks

DemandSupply

(3)

Other

$95 (15%)

$120 (19.3%)

$95 (15%)

$310 (50%)

$620

$300

$50

$50 (14.3%)

$50 (14.3%)

$10 (3.5%)

$620 $620

$350

$162 B (46.3%)Capital Required to Absorb Excess Supply

$350

Loan Syndication Market Overview (Continued) – Lessons LearnedThe Leverage Loan Syndication Supply and Demand Imbalance

Hedge Funds / HY

$33 (9.4%)

Cross-over Investor / Distress Buyer / Opportunity Funds

$45 (14.5%)

(2)(2)

(4)

16

The Secondary Loan Market took a plunge as a result of oversupply at the time of financial crisis.

17

New Issue Loans with LIBOR Floor, higher Spread pricing and tighter structures post 2007

50

60

70

80

90

100

110

Underwritten deal

Best-efforts syndication

Club deal

Types of Loan Syndication Formats

18

Underwritten deal

Arrangers guarantee the entire commitment, then syndicate the loan to reduce their exposure.

If the arrangers cannot fully subscribe the loan, they are forced to absorb the difference.

Reasons for Arrangers to underwrite:

• Offering an underwritten loan can be a competitive tool to win mandates.

• Underwritten loans usually require higher fees New Terms:

• “Flex Language” • Memorandum of Understanding (MOU)

Types of Loan Syndication Formats (Continued)

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Best-efforts syndication

The Arranger commits to underwrite less than the entire amount of the loan.

If the loan is undersubscribed, the deal may not close unless the terms/pricing/structure are changed.

Best-efforts syndications were used for risky borrowers or for complex transactions.


20

Club deal

Pre-marketed to a group of issuer’s or equity sponsor’s relationship lenders.

Typically a smaller loan (usually $25 million to $200 million but as high as $500 million)

The arranger is generally a first among equals, and each lender gets a full cut of the fees.


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The Loan Syndication Process

Issuer /CompanyLead Arranger Bank

Administrative Agent

Bookrunner Bank #1

Syndication Agent

Bookrunner Bank #2

Documentation AgentFirst Tier

Co-Mgr

Bank #1

Co-Mgr

Bank #2

Co-Mgr

Bank #3

Co-Mgr

Bank #4

Co-Mgr

Bank #5

Co-Mgr

Bank #6

“Retail” Level

Second Tier

Bookrunner Bank #3

Documentation Agent

Bank or Institution

Bank or Institution

Bank or Institution

Bank or Institution

Bank or Institution

Bank or Institution

Bank or Institution

Bank or Institution

Bank or Institution

Bank or Institution

Bank or Institution

Bank or Institution

Bank or Institution

Bank or Institution

Bank or Institution

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The issuer or Company solicits bids from Arrangers. Arrangers will outline their syndication strategy and their view on the way the loan will price in market.

Issuer gives the mandate to one or more Arrangers (Co-Arrangers) The arranger will prepare an information memo (IM) describing the terms of the transactions.

The IM typically will include: Executive Summary Investment Considerations Summary of Terms and Conditions (Term Sheet) Transaction Overview Company Management and Equity Sponsor Overview Industry Overview Financial Model Timing for commitments, closing, as well as fees on level of commitments

Bank meeting is scheduled at which potential lenders hear the management and the Investor group.

A deadline is given for the banks to send their commitment levels subject to final documentation

Each Bank analyzes the deal’s credit and assess the pricing (RORA). Each Issuer is assigned an internal rating.

The Arranger collects all commitments – different amounts from each Bank

Allocations are given and Legal Documentation is sent for their final review.

If the Deal is Oversubscribed, the allocation of each bank will most likely be reduced If the Deal is Undersubscribed, depending on the FLEX language, the pricing could be Flexed up.

After Review of Legal Documentation by each lender and signatures are sent, the Deal closes and funds.

The Loan Syndication Process (Continued)

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Typical Leveraged Deal Term Sheet / Credit Agreement

1. Parties to the Credit Agreement:

Borrower

Holding Company

Guarantor / Parent and Subsidiaries’ Guarantee

Agent Banks

Administrative Agent

Collateral Agent

Syndication Agent

Documentation Agent

Law Firms representing the Borrower and Agent Banks

2. Description of the Transaction / Purpose of the Loan (s)

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3. Money Terms:

Amount / Tranches

Revolving Credit

Term Loans

Pricing

Interest Rate / Margin over LIBOR

Commitment Fees on unfunded portion

Maturities

Amortization Schedule (set principal payments)

Need 100% Vote from the syndicate banks to amend these terms

Typical Leveraged Deal Term Sheet / Credit Agreement (Continued)

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4. Non-Money Terms:

Financial Covenants

Negative Covenants

Affirmative Covenants

Need Majority Vote (typical 51%) from the syndicate banks to amend these terms


26

Typical Financial Covenants

Typical Negative Covenants

Maximum Leverage Ratio (Total Debt / EBITDA)

Maximum Senior Leverage Ratio (Bank Debt / EBITDA

Minimum Coverage Ratio (EBITDA / Interest

Minimum Fixed Charge Ratio (EBITDA – Capex – Taxes ) / Interest + Principal Payments)

Maximum Capital Expenditures

Minimum Tangible Net Worth

Limitations on Additional Debt

Limitations on Asset Sales / Mergers & Acquisitions / Sale/leaseback transactions

Limitations of Dividends / Investments

Limitation on Liens / Negative Pledges

Excess Cash Sweep

Limitations of Change of Ownership


New Terminology in 2006 and 2007:

Covenant Lite Structures (“Covy lite”)

Incurrence Tests Vs Maintenance Tests

New Terminology in 2006 and 2007:

“Green Shoe”

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5. Other Terms & Conditions:

Security / Liens / Guarantees

Mandatory Prepayments

Optional Prepayments / Call Protection

Financial Reporting / Maintaining Corporate Existence (“Affirmative Covenants”)

Representation and Warranties

Conditions Precedent at Closing

Events of Default

Assignments and Participations / Secondary Sales

Waivers and Amendments

Indemnification

Cross Default

Material Adverse Clause (MAC)

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Other Terminology to the Credit Agreement

LIBOR Floor

Original Issuer Discount (OID)

Margin Spread

A typical calculation of Loan Yields in the secondary market for loans:

LIBOR or LIBOR Floor + Margin Spread + (100-OID)/4* years = Loan Yield

*market convention is to use 4 years as it represents the average life

Example:

LIBOR Floor = 1.00%

Margin Spread = 400 basis points (or 4.00%)

OID = 98

Then the Loan Yield is calculated to:

1.0% + 4.0% + [(100 – 98)/100]/4 = 5.0% + (2.0% / 4) = 5.0% + 0.5% = 5.5% Yield

Senior Debt / Loan Pricing

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High Yield Bond Pricing

30

Concepts:

Face Value / Par Value ($1,000) Market Value quoted as a % of Face Value (priced at 98 or 98% of $1,000)

Coupon Payments / Coupon (Interest Rate) Semi Annual Payments (interest payments) Callable / Non-Callable Bonds YTM, YTC, YTW

BV= 1,000.00 100 Face ValueMV= 850.00 85 PriceCoupon= 8%n= 10 years

Year Call Price YTC/YTM 0 1 2 3 4 5 6 7 8 9 10

Year 1 = 105 32.9% (850.00) 1,130.00 Year 2 = 104 19.6% (850.00) 80.00 1,120.00 Year 3 = 103 15.5% (850.00) 80.00 80.00 1,110.00 Year 4 = 102 13.5% (850.00) 80.00 80.00 80.00 1,100.00 Year 5 = 101 12.4% (850.00) 80.00 80.00 80.00 80.00 1,090.00 Year 6-10 = 100 10.5% (850.00) 80.00 80.00 80.00 80.00 80.00 80.00 80.00 80.00 80.00 1,080.00

Yield to Maturity Vs Yield to Call

Other Bond Concepts:

Duration & Convexity Convertible Bonds

Equity IRR Analysis

31

ALEXANDRIA HOTEL PROPERTYLBO Equity Analysis using CAPM

TRANSACTION SOURCES & USES

Sources:

Debt Capacity

(EBITDA x)Amount % Capital

Expected Return

Expected Return

(After Tax)

WACC (After Tax)

EBITDA Multiple

Bank Loan 2.5x 50,000,000 40.5% 5.660% 3.622% 1.47% 2.5xMezzanine Note 30,000,000 24.3% 9.000% 5.760% 1.40% 1.5x Total Debt 4.0x 80,000,000 64.7% 2.86% 4.0x

Equity 43,600,000 35.3% 20.00% 20.00% 7.05% 2.2x Total Sources 123,600,000 100.0% 9.92% 6.2x

Uses:

1st Year'sEBITDAMultiple

Amount

% of Total Uses

WACD = 4.424%

Purchase Price (EV - including Debt) 6.0x 120,000,000 97.1%

Transaction Fees & Expenses 3.0% 3,600,000 2.9% Tax Rate= 36.0% Total Uses 123,600,000 100.0%

COST OF DEBT AND EQUITY CALCULATIONS

3M-LIBOR Assumptions

Loan Spread Initial All -In Decile Mkt Cap $MM Risk Prem.

0.60% 4.00% 4.60% 1 524,351 7.03%

2 10,344 8.05%9.00% 3 4,144 8.47%

4 2,177 8.75%

5 1,328 9.03%6-year Treasury Note [ rf ] 1.95% 6 840 9.18%Beta for Publicly Traded Hotel [ β ] 1.633x 7 538 9.58%Equity Premium [ Pe ] 11.05% 8 333 9.91%Firm Specific Risk Premium [e] 0.0% 9 193 10.43%Cost of Equity 20.00% 10 85 11.05%

Equity Risk Premiums (1926-2006)(CAPM Model)

COST OF EQUITY CALCULATIONE (re) = rf + β . Pe + e

COST OF MEZZANINE NOTE CALCULATION

COST OF BANK DEBT CALCULATION(Floaring Rate)

Equity IRR Analysis

32

DEBT ASSUMPTIONS & RETURN ANALYSIS

Bank Loan Information Debt IRR Terms 2010 2011 2012 2013 2014 2015 2016Amount Outstanding (End of Year) 50,000,000 47,000,000 42,000,000 37,000,000 31,000,000 24,000,000 15,000,000 - Schedule Principal Payments 7 years 3,000,000 5,000,000 5,000,000 6,000,000 7,000,000 9,000,000 15,000,000 Interest Payment (Calc based on last Year's Outs) 5.66% 2,300,000 2,397,000 2,352,000 2,442,000 2,046,000 1,584,000 990,000 Total Financing Payment 5.660% (50,000,000) 5,300,000 7,397,000 7,352,000 8,442,000 9,046,000 10,584,000 15,990,000

Interest Rate 4.60% 5.10% 5.60% 6.60% 6.60% 6.60% 6.60% LIBOR RATE 0.60% 0.60% 1.10% 1.60% 2.60% 2.60% 2.60% 2.60% LIBOR Rate Increase Assumptions 0.00% 0.50% 0.50% 1.00% 0.00% 0.00% 0.00%

Corporate Bond InformationAmount Outstanding 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000 Schedule Principal Payments 10 Years - - - - - - - Interest Payment (Calc based on last Year's Outs) 9.00% 2,700,000 2,700,000 2,700,000 2,700,000 2,700,000 2,700,000 2,700,000 Total Financing Payment 9.000% (30,000,000) 2,700,000 2,700,000 2,700,000 2,700,000 2,700,000 2,700,000 2,700,000

Total Financing 8,000,000 10,097,000 10,052,000 11,142,000 11,746,000 13,284,000 18,690,000 Total Debt Outstanding 77,000,000 72,000,000 67,000,000 61,000,000 54,000,000 45,000,000 30,000,000

Equity IRR Analysis

33

CASH FLOW & EQUITY RETURN ANALYSIS

Company Projections Operating Entry Year Year 1 Year 2 Year 3 Year 4 Year 5 Exit YearAssump. 2009 2010 2011 2012 2013 2014 2015 2016

Revenues 5.00% growth 40,000,000 42,000,000 44,100,000 46,305,000 48,620,250 51,051,263 53,603,826 Cost of Revenues 35.0% % of Revenue (14,000,000) (14,700,000) (15,435,000) (16,206,750) (17,017,088) (17,867,942) (18,761,339) Operating Costs 15.0% % of Revenue (6,000,000) (6,300,000) (6,615,000) (6,945,750) (7,293,038) (7,657,689) (8,040,574) EBITDA 50.0% 20,000,000 21,000,000 22,050,000 23,152,500 24,310,125 25,525,631 26,801,913 Less Depreciation 3.00% % of Revenue (1,200,000) (1,260,000) (1,323,000) (1,389,150) (1,458,608) (1,531,538) (1,608,115) Less Amortization of Fees 7 years (514,286) (514,286) (514,286) (514,286) (514,286) (514,286) EBIT 18,285,714 19,225,714 20,212,714 21,249,064 22,337,232 23,479,808 25,193,798 Less Interest (Unlevered for DCF Analysis) - - - - - - - EBT 18,285,714 19,225,714 20,212,714 21,249,064 22,337,232 23,479,808 25,193,798 Less Taxes (adj out Interest Exp) 36.0% % of EBT (6,582,857) (6,921,257) (7,276,577) (7,649,663) (8,041,403) (8,452,731) (9,069,767) Plus Depreciation & Amortization 1,714,286 1,774,286 1,837,286 1,903,436 1,972,893 2,045,824 1,608,115 Less Working Capital 1.00% % of Revenue (400,000) (420,000) (441,000) (463,050) (486,203) (510,513) (536,038) Less Capex 3.00% % of Revenue (1,200,000) (1,260,000) (1,323,000) (1,389,150) (1,458,608) (1,531,538) (1,608,115) Cash Flow Before Financing (CFBF) 11,817,143 12,398,743 13,009,423 13,650,637 14,323,912 15,030,850 15,587,992

Less Financing ( P + I ) (8,000,000) (10,097,000) (10,052,000) (11,142,000) (11,746,000) (13,284,000) (18,690,000) Equity Cash Flows 3,817,143 2,301,743 2,957,423 2,508,637 2,577,912 1,746,850 (3,102,008)

Terminal Value EBITDA Multiple Method (initial purchase multiple)Growth 6.0x 153,153,788

Perpetuity Method (using WACC + growth) 3.50% 9.92% 242,876,485

Average Terminal Value 198,015,136

Debt Outstanding 45,000,000 Equity Value (TV - Debt) 153,015,136

Equity Cash Flows (43,600,000) 3,817,143 2,301,743 2,957,423 2,508,637 2,577,912 154,761,986

x x x x x x$ 1 PV Table (Expected Equity Rate) 20.00% 0.8333398 0.6944552 0.5787172 0.4822680 0.4018931 0.3349135

PV Table (Expected Equity Rate) 60,568,712 3,180,977 1,598,457 1,711,511 1,209,835 1,036,045 51,831,886

Initial Investment (43,600,000) Equity Return Scenarios Given Different EBITDA MultiplesNPV= 16,968,712 5.5x 6.0x 6.5x 7.0x

IRR= 27.5% 35.9% 27.5% 21.8% 17.6%

Equity IRR Analysis

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EBITDA Purchase MultiplesIRR= 27.5% 5.5x 6.0x 7.0x 9.0x

5.00% 35.86% 27.49% 17.61% 8.33%5.50% 36.76% 28.33% 18.38% 9.02%6.00% 38.52% 30.00% 19.92% 10.38%6.50% 41.11% 32.45% 22.16% 12.37%7.00% 44.48% 35.62% 25.07% 14.95%7.50% 48.55% 39.46% 28.59% 18.07%8.00% 53.29% 43.92% 32.66% 21.70%8.50% 58.64% 48.94% 37.26% 25.81%9.00% 64.57% 54.52% 42.36% 30.36%9.50% 60.08% 52.03% 46.24% 41.83%

Rev

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e G

row

th R

ates

EQUITY SCENARIO TABLE

Example of a Large Syndicated Loan Harrah’s Entertainment

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TRANSACTION OVERVIEW

On December 19, 2006, Harrah’s Entertainment Inc. (“Harrah’s” or the “Company”) announced that it had entered into an agreement to be acquired by affiliates of Apollo Management (“Apollo”) and TPG Capital (“TPG”) in a transaction valued at approximately $31.2 billion (including estimated fees and expenses)

Harrah’s Entertainment, based in Las Vegas, Nevada, is the world’s largest and most geographically diversified gaming company, operating 50 casinos in six countries, with the #1 or #2 market share in almost every major gaming market in the U.S.

At the time of the acquisition, Harrah’s generated LTM 9/30/07 Net Revenues and Pro Forma Adjusted EBITDA of $10.6 billion and $2.9 billion, respectively.

Harrah’s Operating Company (“HOC”) owns or manages 43 of the 50 Harrah’s Entertainment casinos and generated LTM 9/30/07 Net Revenues and Pro Forma Adjusted EBITDA of $8.0 billion and $2.0 billion, respectively

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TRANSACTION SOURCES & USES

SOURCES: USES:TERM L+ RATE COMM $ AMT % CAP $ AMT

Revolver 6 3.00% 7.25% 2,000.0 0.0 0.0% Purchase Shares 17,291.0New Term Loan-B 7 3.00% 7.25% 7,250.0 7,250.0 23.2% Extra Cash 642.0 Total Bank Debt 9,250.0 7,250.0 23.2%Existing Senior Debt 8 6.70% 4,624.0 14.8% Refinance Existing Debt 7,582.0CMBS 5 7.50% 6,500.0 20.8% Fees & Expenses 1,106.0Senior Unsecured Notes 10 10.75% 5,275.0 16.9% Rollover Debt 4,624.0Senior Unsecured Notes (PIK) 10 10.75% 1,500.0 4.8% Total Senior Sources 25,149.0 80.5% Total Uses 31,245.0

Senior Sub Debentures 0 0.00% 0.0 0.0% Sources - Uses 0.0Junior Sub Debentures 0 0.00% 0.0 0.0% Total Junior Sources 0.0 0.0%

New Preferred Stock 10 10.00% 2,000.0 6.4%New Common Equity 4,096.0 13.1% Total Equity 6,096.0 19.5%Total Sources 31,245.0 100.0%

ASSUMED LIBOR (1/2008) 4.25%

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STRUCTURE – TOO LEVERAGE??

Pro Forma Capitalization Pro Forma % of 2007($ in MM) At Close Total Cap EBITDA$2B Revolver -$ 0.0% 0.0xTerm Loan B 7,250.0 31.4% 3.6x

Bank Debt 7,250.0$ 31.4% 3.6x

Sr unsecured cash-pay 5,275 22.9% 2.6xSr unsecured PIK toggle 1,500 6.5% 0.7x

Total Senior Debt 14,025.0$ 60.8% 6.9x

Rollover of existing debt 4,624.0 20.0% 2.3x

Total Debt 18,649.0$ 80.8% 9.2x

Contributed Equity 4,422.3 19.2%Total Capitalization 23,071.3$ 100.0%Source: SMBC analysis

Adjusted 2007 EBITDA 2,037.0$

Aggressive Structure??

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CORPORATE STRUCTURE

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SUMMARY OF TERMS – SENIOR CREDIT FACILITY

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SYNDICATION PROCESS – WRONG TIMING FOR AN UNDERWRITTEN DEAL???

The general syndication of Harrah's was launched 1/15/2008 with a bank meeting in New York. Over 1,000 bankers attended the general syndication meeting with commitments requested by 1/29/2008.

Unfortunately, given the: i) global correction in the financial markets on the week of January 21, 2008, ii) dramatic widening of high yield credit spreads and iii) reduction in the 3-month Libor Rate by at least 120 bps that followed, the secondary market loan prices pulled back materially and bank investors started to demand a much higher All-In Yield (about L+ 500) on primary market transactions, like Harrah's. Investors were demanding All-In Yield of between L+ 450 - 500 to commit/purchase Harrah's Term Loan B. Since the offered TLB margin spread was L+300, investors were demanding a discount (OID) of between 92-93 (compared to the original OID offer of 96.5) from the Underwriters/Arrangers. Following the failed syndication, Arrangers in order to reduce their exposure, were offering Harrah's TLB with an OID in the low 90's.

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SYNDICATION PROCESS – WRONG TIMING FOR AN UNDEWRITTEN DEAL?? (continued)

At the time, given such low demand, it was reported that Credit Suisse started to quietly syndicate their exposure prior to the commitment deadline (1/29/2008), independent of the other Arrangers. As a consequence, each of the Arrangers started to syndicate their own exposure to their own investors offering as low as 90's OID to syndicate their exposure.

After that incident, there was a new agreement made between the Arrangers called The Memorandum of Understanding (MOU) where it prohibits one arranger to sell their exposure within an agreeable period (6 months after the commitments are due) without the consent of the other Arrangers.

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An Overview of Leveraged Buyouts Chris Droussiotis, Executive Director

Documents

acquisition debt

leverage debt

loan debt

acquisition target

leverage buyout target

debt portion

cases debt

purchase price