North Village Private Equity Case Analysis

To: North Village Investment Committee (IC) Che Wei (Jonathan) Tsao
From: Esther Lee
Date:
RE: Financing Options & Covenants for AlarmServe Inc. (AS)
1
Executive Summary
Upon analyzing the three different financing options (unlevered, moderate leverage & high
leverage), I recommend we purchase AS with moderate leverage. In this financing structure, AS
will have a total capitalization of $51M, comprised of $3.38M operating line, $13.64M senior
debt, $4.25M subordinated debt, and $12.76M equity contribution (Appendix 1). This capital
structure represents a 6x pro forma 2009 EBITDA and 2.5x total leverage. We set covenant
levels using base case analysis, at 0.5x above total debt/EBITDA ratio, with 0.2x leverage step-
down per year (Appendix 7). We also set a minimum 2x EBITDA/Interest ratio. With
prospective exit at 6x 2014 EBITDA, we attain an IRR of 23.4%, greater than our 20% hurdle.
Projections
Operating
Although we have identified that AS will be a good investment with growing revenues, I am
worried that the current deteriorating Canadian economic landscape can potentially cause our
revenue to fall as much as 6% in 2010. As such, I ran both stress and base case analysis (seen in
appendix 2) to determine the leverage and covenants we should assume for this investment.
Debt Schedule
I’ve included an operating line in all financing options and utilized it as cash sweep. For the two
leverage scenarios: senior debt will have a term of 5 years with mandatory amortization of
$3M/year after Y1 and remainder of principal payable as bullet (during exit) and subordinated
debt with term of 8 years payable as a bullet.
Various Financing Options (See Appendix 1, 2, 3 & 4)
Unlevered Scenario
I ran an unlevered buyout to determine the implications of leverage using base case assumptions.
I found that with no leverage, we expect an IRR of 17.9% that is below our 20% hurdle.
Moderate Leverage Scenario
Since we can’t attaint the hurdle with no leverage, I looked into two different financing options
that require taking on debt. At moderate leverage, we will assume a total leverage of 2.5x, with
2x senior (with operating line) and 0.5x subordinated leverage. We expect interest rate to be 6%
on senior debt, 12% on subordinated debt, and 3% spread on operating line with prime rates at
2% throughout our projection. Under this scenario, we will have covered ~80% of our debt with
only $4.3M of total debt left in our balance assuming exit in 2014. AS will be able to reach net
cash of $1.07M in 2014 and will make optional repayments to both its senior and subordinated
debt in 2013, as it decreases the amount of our total interest expense. Moreover, assuming 6x
2014 EBITDA exit valuation, AS will have an equity value of $85.1M which represents a 23.4%
IRR and a 2.85x MOIC.
High Leverage Scenario
In this structure, we assume a total leverage of 4.5x, 3x senior leverage, and 1.5x subordinated
leverage. We expect interest rate to be 8% on senior debt, 15% on subordinated debt, and
3% spread over prime rates for our revolver. Due to high leverage, our interest expense is
significantly higher as seen in our interest coverage ratio comparisons in appendix 7. Moreover,
not only will there be no FCF after mandatory amortization during the projections, we will have
to increase our revolver balance every year to cover the negative balance, with significant
increase in 2014 due to our bullet payment of senior debt of $13.14M. As such, we will have

2
only covered ~14% of our total debt with $33.3M of total debt left in balance during exit.
However, due to a much lower initial equity contribution of $12.76M, AS will have an equity
value of $55M at exit that represents a 33.9% IRR and a 4.3x MOIC.
Covenants (see Appendix 5, 6 & 7)
As both leverage scenarios exceed our hurdle, I set up covenants at 0.5x over base case analysis
with 0.2x step down per year for Total Debt/EBITDA ratio and a minimum 2.0x interest
coverage ratio for all periods. I ran a covenant stress test to see which financing structure will
survive the stress case assumptions.
Debt/EBITDA
Moderate Leverage: I set initial debt/EBITDA ratio covenant at 2.4x with 0.2x step down per
year. Upon running a stress test, I found that we would breach covenant in the first three years of
projections. However, as we aren’t amortizing our senior debt until year 2 of projections, our
debt levels will be relatively unchanged until 2011. Moreover, since we projected 2010 revenues
to fall by 6%, our EBITDA will only recover to pre-2010 levels in 2012. As such, we will meet
covenant in 2013 and 2014, as revenue growth and EBITDA margins start to stabilize. It should
also be noted that none of the covenants would be breached if we only measured the ratio for
senior debts, as no mandatory amortization is required for the subordinated loans.
High Leverage: I set initial covenant at 4.2x with 0.2x step down per year. In this leverage
scenario, I found that all covenants are breached due to the reduction of EBITDA in 2010. As
such, it seems like the chances of a high leverage buyout is unlikely.
EBITDA/Total Interest
Moderate Leverage: Even with a 6% drop in revenue in 2010 and lower gross margin, our
EBITDA levels remain high enough through the projections to maintain over 2x interest
coverage ratio. In fact, I also looked at EBITDA(less Capex)/Interest Expense and EBITDA(less
Capex & change in NWC)/Interest Expense, and I found that covenant levels will only drop
below our 2.0x minimum in 2010 & 2011. As EBITDA margins and revenue growth begin to
stabilize in 2013, all minimum interest coverage ratios will be met.
High Leverage: Since we are taking on significantly more debt, we are naturally incurring a
much higher interest expense. As such, we are unable to meet the 2x EBITDA/interest covenant
during 2010 & 2011 even in our base case analysis. Nevertheless, since the interest coverage
ratio for 2010 & 2011 is not far off the 2x covenant level, I believe our sponsors will be willing
to accept a lower covenant level during those years. Regardless, after stress test, we find that all
covenants are breached except in 2014 since only senior debt is amortized while we continue to
withdraw money from our operating line while subordinated debt remains the same.
Recommendation
I recommend our IC to purchase AS with moderate leverage, as it will generate 23.4% IRR. I
rejected the high leverage buyout, as AS won’t be able to cover the high interest expense at
expected covenant levels especially if we see revenues to drop in 2010. Moreover, even in base
case analysis, we never reach net cash and will have to draw from our operating line every year
to remain solvent. However, I understand that we still breach Debt/EBITDA covenants with
moderate leverage from 2010 to 2012. As such, I recommend negotiating for higher debt
covenant levels, starting at 3x (0.5x over buyout debt levels) with 0.2x step down, as we aren't
amortizing the senior debt until 2011. With higher covenant levels, we expect the strong growth
prospects of AS to hedge against economic risks while yielding great returns.

3
Cash Flow Analysis 2010E 2011E 2012E 2013E 2014E
Operating Activities
Net Income 3.24 4.00 4.86 5.82 6.85
Depreciation 3.33 3.53 3.73 3.94 4.15
Chg Net WC 0.08- 0.22- 0.23- 0.24- 0.25-
Cash from Ops 6.49 7.31 8.36 9.52 10.75
Investing Activities
CAPEX 4.41- 4.63- 4.86- 5.10- 5.35-
Financing Activities
Change in Revolver 2.08- 0.32 0.50- 1.11- -
Change in Senior Debt - 3.00- 3.00- 3.31- 4.33-
Change in Subordinated Debt
Cash Flow from Financing 2.08- 2.68- 3.50- 4.42- 4.33-
Beg Cash - 0.00 0.00- 0.00- 0.00
Net Change 0.00 0.00 0.00- 0.00 1.07
Ending Cash 0.00 0.00 0.00- 0.00 1.07
Appendix 1: Purchase Analysis
Appendix 2: Scenario Analysis
Appendix 3: Base Case Moderate Leverage – Cash Flow Analysis & Debt Schedule
Purchase Analysis
Unlevered Moderate High 2 2009 EBITDA $8.5 Senior Leverage 1.60 x EBITDA
Sources of Funds 1 2 3 EBITDA Multiple 6.0x Term 5 years
Revolving Credit Facility Size 3.38 3.38 3.38 EV $51.0 Sub Debt Leverage 0.5 x EBITDA
Revolving Credit Facility Draw 3.38 3.38 3.38 Less: Existing Debt $5.0
Senior Debt - 13.64 22.14 Implied Equity Purchase Price $46.0 Interest Rates
Subordinated Debt - 4.25 12.76 Revolver 5%
Equity Contribution 47.7 29.77 12.76 Senior Loan 6%
Total Sources 51.03 51.03 51.03 Purchase Price $51.0 Mandatory Repayment 22%
17.011192 25.516788 Less: Existing Debt 5.00- Subordinated Loan 12%
Use of Funds Plus: Exisiting Cash -
Equity Purchase Price $46.0 $46.0 $46.0 Equity Offer Value 46 Bank Operating Line Coverage
Repay Existing Bank Debt 5 5 5 Existing Goodwill - A/R 75%
Total Use $51.0 $51.0 $51.0 Less: Book Value Acquired 17.30 Inv. 50%
New Goodwill 28.73
Financing Structure TRANSACTION ASSUMPTIONS
Goodwill Calculation
Leverage Assumption
Scenario Analysis - IS & CF Assumptions 1
Base 1
Sales Growth % 5% 5% 5% 5% 5%
GM % 78% 78% 78% 78% 78%
CAPEX (% of Sales) 13% 13% 13% 13% 13%
Stress Case 2
Sales Growth % -6% 3% 3% 3% 5%
GM % 75% 75% 76% 77% 78%
CAPEX (% of Sales) 13% 13% 13% 13% 13%
Debt Schedule 2009 Adj. 2009PF 2010E 2011E 2012E 2013E 2014E
Prime Rate 2% 2% 2% 2% 2%
Cash Flow from Operating Activities 6.49 7.31 8.36 9.52 10.75
Cash Flow from Investing Activities 4.41- 4.63- 4.86- 5.10- 5.35-
Cash Available for Debt Repayment 2.08 2.68 3.50 4.42 5.40
Total Mandatory Repayments - 3.00- 3.00- 3.00- 3.00-
Cash From Balance Sheet 0.00 0.00 0.00- 0.00 1.07
Cash Available for Optional Debt Repayment 2.08 0.32- 0.50 1.42 3.47
Revolver
Beginning Revolver Balance 3.38 1.29 1.61 1.11 -
(Paydown) / Drawdown 2.08- 0.32 0.50- 1.11- -
Ending Revolver Balance 1.29 1.61 1.11 - -
Interest Expense 0.23 0.15 0.14 0.06 -
Senior Debt
Senior Debt Beginning Balance 13.64 13.64 10.64 7.64 4.33
Mandatory Payment 3.00- 3.00- 3.00- 3.00-
Optional Payment - - - 0.31- 1.33-
Senior Ending Balance 13.64 10.64 7.64 4.33 -
Interest Expense 1.64 1.46 1.10 0.72 0.26
Subordinated Debt
Subordinated Debt Beginning Balance 4.25 4.25 4.25 4.25 4.25
(Paydown) / Drawdown - - - 0.31- 3.00-
Subordinated Debt Ending Balance 4.25 4.25 4.25 4.25 4.25
Interest Rate 12% 12% 12% 12% 12%

4
Appendix 4: Base Case High Leverage – Cash Flow Analysis & Debt Schedule
Appendix 5: Leverage Analysis & Covenant Stress Test
Debt Schedule 2009 Adj. 2009PF 2010E 2011E 2012E 2013E 2014E
Prime Rate 2% 2% 2% 2% 2%
Cash Flow from Operating Activities 4.09 4.77 5.73 6.78 8.16
Cash Flow from Investing Activities 4.41- 4.63- 4.86- 5.10- 5.35-
Cash Available for Debt Repayment 0.32- 0.15 0.88 1.68 2.80
Total Mandatory Repayments - 3.00- 3.00- 3.00- 13.14-
Cash From Balance Sheet 0.00- 0.00 0.00 0.00- 0.00-
Cash Available for Optional Debt Repayment 0.32- 2.85- 2.12- 1.32- 10.34-
Revolver
Beginning Revolver Balance 3.38 3.69 6.55 8.67 9.99
(Paydown) / Drawdown 0.32 2.85 2.12 1.32 10.34
Ending Revolver Balance 3.69 6.55 8.67 9.99 20.33
Senior Debt
Senior Debt Beginning Balance 22.14 22.14 19.14 16.14 13.14
Mandatory Payment 3.00- 3.00- 3.00- 13.14-
Optional Payment - - - - -
Senior Ending Balance 22.14 19.14 16.14 13.14 -
Subordinated Debt
Subordinated Debt Beginning Balance 12.76 12.76 12.76 12.76 12.76
(Paydown) / Drawdown - - - - -
Subordinated Debt Ending Balance 12.76 12.76 12.76 12.76 12.76
Interest Rate 15% 15% 15% 15% 15%
Cash Flow Analysis 2010E 2011E 2012E 2013E 2014E
Operating Activities
Net Income 0.83 1.46 2.23 3.09 4.25
Depreciation 3.33 3.53 3.73 3.94 4.15
Chg Net WC 0.08- 0.22- 0.23- 0.24- 0.25-
Cash from Ops 4.09 4.77 5.73 6.78 8.16
Investing Activities
CAPEX 4.41- 4.63- 4.86- 5.10- 5.35-
Financing Activities
Change in Revolver 0.32 2.85 2.12 1.32 10.34
Change in Senior Debt - 3.00- 3.00- 3.00- 13.14-
Change in Subordinated Debt
Cash Flow from Financing 0.32 0.15- 0.88- 1.68- 2.80-
Beg Cash - 0.00- 0.00- 0.00 0.00
Net Change 0.00 0.00- 0.00- 0.00 0.00
Ending Cash 0.00 0.00- 0.00- 0.00 0.00
Base Case - Moderate Leverage Scenario Stress Case - Moderate Leverage Scenario
Key Statistics Key Statistics
2010 2011 2012 2013 2014 2010 2011 2012 2013 2014
Summary Statistics Summary Statistics
Debt/EBITDA 1.86x 1.45x 1.05x 0.63x 0.29x Debt/EBITDA 2.84x 2.56x 2.15x 1.74x 1.25x
Not to be above 2.4x 2.2x 2.0x 1.8x 1.6x Not to be above 2.4x 2.2x 2.0x 1.8x 1.6x
ok ok ok ok ok no no no ok ok
Senior Debt + Revolver/EBITDA 1.45x 1.08x 0.70x 0.32x 0.00x Senior Debt + Revolver/EBITDA 2.25x 2.02x 1.66x 1.29x 0.86x
ok ok ok ok ok ok ok ok ok ok
EBITDA/Interest 4.34x 5.37x 7.12x 10.55x 19.11x EBITDA/Interest 2.97x 3.31x 3.94x 4.85x 6.56x
Not to be less than 2.00x 2.00x 2.00x 2.00x 2.00x Not to be less than 2.00x 2.00x 2.00x 2.00x 2.00x
Internal Rate of Return Internal Rate of Return
at a 6.0x exit in 2014 23.4% at a 6.0x exit in 2014 11.7%
Base Case - High Leverage Scenario Stress Case - High Leverage Scenario
Key Statistics Key Statistics
2010 2011 2012 2013 2014 2010 2011 2012 2013 2014
Summary Statistics Summary Statistics
Debt/EBITDA 3.7x 3.4x 3.0x 2.7x 2.2x Debt/EBITDA 5.5x 5.4x 5.0x 4.6x 4.0x
ok ok ok ok ok no no no no no
Senior Debt + Revolver/EBITDA 2.5x 2.3x 2.0x 1.7x 1.4x Senior Debt + Revolver/EBITDA 3.7x 3.7x 3.5x 3.3x 2.8x
EBITDA/Interest 1.78x 1.98x 2.26x 2.61x 3.28x EBITDA/Interest 1.24x 1.31x 1.46x 1.63x 2.01x
Not to be less than 2.00x 2.00x 2.00x 2.00x 2.00x Not to be less than 2.00x 2.00x 2.00x 2.00x 2.00x
no no ok ok ok no no no no ok
Internal Rate of Return Internal Rate of Return
at a 6.0x exit in 2014 34.0% at a 6.0x exit in 2014 11.2%

5
Appendix 6: Base Case – Summary of Relevant Financial Statistics & IRR Calculations
Moderate Leverage
Income Statement Statistics 2010 2011 2012 2013 2014
Revenue $33.9 $35.6 $37.4 $39.2 $41.2
EBITDA 10.3 11.3 12.4 13.5 14.7
Net Income 3.2 4.0 4.9 5.8 6.9
Taxes 1.4 1.7 2.1 2.5 2.9
Revenue Growth 5.0% 5.0% 5.0% 5.0% 5.0%
EBITDA Margin 30.5% 31.9% 33.2% 34.5% 35.7%
EBITDA Growth 21.5% 9.8% 9.4% 9.0% 8.7%
Balance Sheet / Cash Flow Statistics
Cash $0.0 $0.0 ($0.0) ($0.0) $1.1
Total Debt 19.2 16.5 13.0 8.6 4.3
Revolver 1.3 1.6 1.1 0.0 0.0
Senior Debt 13.6 10.6 7.6 4.3 0.0
Subordinated Loan 4.3 4.3 4.3 4.3 4.3
Capex (4.4) (4.6) (4.9) (5.1) (5.4)
(Increase) Decrease in W/C (0.1) (0.2) (0.2) (0.2) (0.3)
Leverage Ratios
Total Debt / EBITDA 1.86x 1.5x 1.0x 0.6x 0.3x
Revolver / EBITDA 0.1x 0.1x 0.1x 0.0x 0.0x
Senior Debt / EBITDA 1.3x 0.9x 0.6x 0.3x 0.0x
Subordinated Loan / EBITDA 0.4x 0.4x 0.3x 0.3x 0.3x
Interest Coverage Statistics
EBITDA / Interest Expense 4.3x 5.4x 7.1x 10.5x 19.1x
EBITDA - Capex / Interest Expense 2.5x 3.2x 4.3x 6.6x 12.2x
EBITDA - Capex - ∆ W/C / Interest Expense 2.5x 3.1x 4.2x 6.4x 11.8x
SALE OF COMPANY IN 2014
Closing Date 31-Oct-14 IRR to Financial Sponsor 2009 2010 2011 2012 2013 2014
Initial Equity Investment ($29.8) $0.0 $0.0 $0.0 $0.0 $0.0
2014 EBITDA $14.7 Dividends 0.0 0.0 0.0 0.0 0.0 0.0
EBITDA Multiple 6.0x Proceeds at Sale 0.0 0.0 0.0 0.0 0.0 85.1
Transaction Value $88.3 Total Cash Flows to Sponsor ($29.8) $0.0 $0.0 $0.0 $0.0 $85.1
Less: Total Debt (4.3) IRR Calculation 23.4%
Plus: Cash Balance 1.1
Equity Value $85.1
High Leverage
Revenue $33.9 $35.6 $37.4 $39.2 $41.2
EBITDA 10.3 11.3 12.4 13.5 14.7
Net Income 0.8 1.5 2.2 3.1 4.3
Taxes 0.4 0.6 1.0 1.3 1.8
Revenue Growth 5.0% 5.0% 5.0% 5.0% 5.0%
EBITDA Margin 30.5% 31.9% 33.2% 34.5% 35.7%
EBITDA Growth 21.5% 9.8% 9.4% 9.0% 8.7%
Cash ($0.0) ($0.0) $0.0 $0.0 ($0.0)
Total Debt 38.6 38.4 37.6 35.9 33.1
Revolver 3.7 6.5 8.7 10.0 20.3
Senior Debt 22.1 19.1 16.1 13.1 0.0
Capex (4.4) (4.6) (4.9) (5.1) (5.4)
(Increase) Decrease in W/C (0.1) (0.2) (0.2) (0.2) (0.3)
Leverage Ratios
Plus: Cash Balance (0.0)
Equity Value $55.2
IRR Analysis
IRR Analysis

6
Appendix 7: Stress Case – Summary of Relevant Financial Statistics & IRR Calculations
Moderate Leverage
Revenue $30.3 $31.2 $32.2 $33.1 $34.8
EBITDA 7.3 7.8 8.7 9.6 10.9
Net Income 1.1 1.4 2.0 2.7 3.8
Taxes 0.5 0.6 0.9 1.2 1.6
Revenue Growth -6.0% 3.0% 3.0% 3.0% 5.0%
EBITDA Margin 24.0% 25.0% 26.9% 28.8% 31.3%
EBITDA Growth -14.3% 7.1% 11.0% 10.3% 13.9%
Cash ($0.0) $0.0 $0.0 ($0.0) ($0.0)
Total Debt 20.7 20.0 18.7 16.6 13.7
Revolver 2.8 5.1 6.8 7.7 7.8
Senior Debt 13.6 10.6 7.6 4.6 1.6
Capex (3.9) (4.1) (4.2) (4.3) (4.5)
(Increase) Decrease in W/C 0.1 (0.1) (0.0) (0.0) (0.1)
Leverage Ratios
Plus: Cash Balance 0.0
Equity Value $51.6
High Leverage
Revenue $30.3 $31.2 $32.2 $33.1 $34.8
EBITDA 7.3 7.8 8.7 9.6 10.9
Net Income (1.3) (1.1) (0.6) 0.0 1.2
Taxes (0.6) (0.5) (0.3) 0.0 0.5
Revenue Growth -6.0% 3.0% 3.0% 3.0% 5.0%
EBITDA Margin 24.0% 25.0% 26.9% 28.8% 31.3%
EBITDA Growth -14.3% 7.1% 11.0% 10.3% 13.9%
Cash ($0.0) $0.0 $0.0 ($0.0) ($0.0)
Total Debt 40.1 42.0 43.2 43.9 43.6
Revolver 5.2 10.1 14.3 18.0 30.8
Senior Debt 22.1 19.1 16.1 13.1 0.0
Capex (3.9) (4.1) (4.2) (4.3) (4.5)
(Increase) Decrease in W/C 0.1 (0.1) (0.0) (0.0) (0.1)
Leverage Ratios
Plus: Cash Balance (0.0)
Equity Value $21.7
IRR Analysis
IRR Analysis

North Village Private Equity Case Analysis

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