Carter International Carter had a long history in the hotel business The Carter name was recognized internationally as synonymous with quality accommodations Its flagship hotels were the Carter Plaza in New York, the Carter Beverly in Los Angeles, California, and the Carter Ashelworth and Carter Westminster in London Carter owned and operated additional hotel properties in Australia, Great Britain, New Zealand, Turkey, and the United States, and two casino properties in Las Vegas, Nevada In total, Carter maintained 79,000 rooms with an average occupancy of 71 Management had previously sought to sell off Carters gambling segment, but the new management team was now pushing to increase Carters participation in this growth segment Carters new president and CEO, Jane Scarret, had recently taken over from longtime CEO Francis Carter Hellman, a member of one of Carters founding families Carter Hellman remained the chair, and 25 of Carters 45 million shares of stock was owned by officers and directors (some of whom were family members) Scarret was well regarded in the financial community According to one analyst, Scarret brought the reputation of an astute finance person who would be able to create value enhancing initiatives for the company Carters recent share price of $100 seemed to reflect this market confidence in Scarret Page 646 The hotel industry had experienced strong performance as of late An equity analyst summarized the state of the industry in the United States Demand for rooms stateside are apt to remain favorable in 2016, as economic expansion and high employment augurs well for leisure and corporate travel Although companies will be hard pressed to continue to increase average daily rates at a pace comparable to those of recent years, high occupancy levels should give lodgers more pricing power There is a caveat Six straight years of auspicious operating conditions have resulted in greater hotel construction activity, with sector behemoths Marriott International and Hilton Worldwide accounting for a significant portion of the sectors development pipeline 1 Some acquisition activity in the industry was in progress Marriott had recently announced an offer to purchase rival Starwood Hotels for $12 billion, representing an enterprise value to EBITDA ratio of about 9 5 times The Gaming Industry The worldwide gaming industry had experienced spectacular growth over the past 30 years, but its future was less certain The ongoing aging of the population in developed markets meant that a growing portion of the population was looking for relatively passive activities with attractive amenities Increasingly, the public found casino gambling to be an acceptable form of entertainment In the United States, access to legalized gambling had increased greatly since the 1980s as states and localities looked to stimulate both business and tax revenues There was some concern about saturation in the gaming markets, and that increased competition would bring margin compression Some evidence showed that newer casinos had been failing financially Internet gambling had grown dramatically in popularity over the past 20 years The U S government regulated Internet gambling, and both interstate and international transactions remained illegal Gambling activity in gaming ventures in Las Vegas continued to be strong Internationally, there had been massive investment and success in Macao, and currently most of the worlds largest casinos were located in that special administrative region of China With the recent tightening of Chinese government regulation, it was clear that gaming demand in Macao was softening The reduced attendance was particularly evident among the high roller gamblers The market contraction in Macao had had a particularly strong effect on those firms that were heavily invested there Stock prices for gaming companies that were heavily invested in Macao (i e , Las Vegas Sands and Wynn Resorts) were down 20 to 50 in the past year Exhibit 49 2 provides financial summary data on the participants in both the hotel and gaming industries EXHIBIT 49 2 Financial Summary Data on Companies in the Hotel and Gaming Industry (financial statement data as of 2015 in millions) Sources Value Line Investment Survey, Mergent Bond Record, and author estimates Some observers believed that the gaming industry was ripe for consolidation There were rumors that gaming companies as well as hotel concerns were on the hunt for gaming acquisitions as the industry was reaching maturity Analysts believed that adequate capital resources would be critical to companies that were going to see their way through this new phase of the casino business Page 647 Hope Enterprises Hope owned and operated three world class casino hotel resorts in Atlantic City and Las Vegas, a dockside casino and hotel in Florence, Mississippi, and a riverboat casino in New Orleans, Louisiana Exhibits 49 3 and 49 4 provide financial information on Hope According to one analyst EXHIBIT 49 3 Income Statement for Hope Enterprises (dollars in millions, except per share figures) Source Created by author EXHIBIT 49 4 Balance Sheet for Hope Enterprises (dollars in millions) Source Created by author Hope is considered a prime acquisition target because of the strategic location of its holdings and the kind of customers it attracts The company controls two casinos in Atlantic City, a market that was ignored by some major gambling companies for years but is now booming, prompting a scramble to acquire key locations there Hope also controls a Las Vegas casino, and its properties serve midmarket gamblers who usually do not patronize high roller casinos such as Carters Las Vegas Palace Increasingly analysts suggested that independent casino businesses like Hope needed to partner with larger hotel concerns to remain viable Deal Considerations From early on, Scarret had made it very evident that she wanted Carter to be an important player in the casino business The question was not whether Carter would make a gaming acquisition but rather when and who Although Hope represented an attractive deal candidate, Smith knew that there were other targets under consideration Yesterday a team had begun investigating the economics of Hope and how the merged entities might look Overall, the view of the group was that growth in the industry would continue to keep ahead of broad economic growth for the next five years and then ease down to pace with the general economy in the years beyond A contracting of economic expectations was a theme for the beginning of 2016 World stock markets were down as investors processed the economic uncertainty associated with depressed commodity prices (oil prices were at a 10 year low), a slowing of the Chinese economy (Chinese GDP growth was at a five year low), and a volatile U S presidential election Exhibit 49 5 provides information on financial market conditions EXHIBIT 49 5 Financial Market Conditions Sources Bloomberg, Value Line Investment Survey, and author estimates The motivations for the deal were several First, Hope looked like a bargain The stock price had continued to drift down during the past year and now traded at a price to earnings ratio of under 10 times Second, Hope was well run Hope management was well respected in the industry An acquisition would allow Carter to retain a talented management team But this would not be a business turnaround acquisition Third, Hope was small Hopes small size meant that Carter could add value by providing scale opportunities on both the cost and revenue sides The team thought Hopes margins would be substantially improved by taking advantage of Carters existing expertise in the industry and exploiting several scale economies It also believed that revenue would be accelerated for the next few years by leveraging Carters brand, its loyalty program, and its reservation system into greater customer volume, although not necessarily higher prices The merger was expected to keep Hopes balance sheet largely unaffected Hopes cash balance, while large, was about normal for a well run gaming company and was not expected to be altered The team didnt expect to see any material merger efficiencies across Hopes assets Page 648 There was some debate regarding whether Carter should use debt or equity to finance the $1 billion of cash that was expected to be needed for the acquisition Joakim Nilsen, a longtime member of the companys treasury staff, noted that there was significant pride and borrowing cost advantage in Carters credit rating Carters A rating was the highest credit rating among all the major U S hotel companies, and Pearson was concerned that the credit rating would be compromised if the $1 billion payment was made using debt financing On the other hand, Trishala Shankar, the newest and youngest member of the treasury staff, argued that Carter was far too conservative in its use of debt capital and claimed that an acquisition provided an excellent opportunity for Carter to better leverage its balance sheet Initial discussions with Carters investment bank provided a sense of the borrowing terms for a five year $1 billion Carter bond The bank expected the offering would be issued at par if the coupon was set at either 4 7 in U S dollars or 4 3 in British pounds Shankar believed strongly enough about the need to use more debt capital that she recommended that, even if the Hope acquisition fell through, Carter proceed with the debt issuance and use the proceeds to repurchase shares Her primary argument was based on the ability of debt to shield the company from its high 40 tax rate The team recognized that other suitors for Hope might appear, and that Carter would need to be thoughtful in its bidding strategy It was thought there were other potential acquirers for which the synergy gains with Hope were expected to be even larger than what might be achieved with Carter Maybe the lack of bidding activity suggested that Hope was in fact overpriced Alternatively, Hope had traded for more than $30 a share a few years before the recent slide that led to the current $15 price Could Hopes stock price rebound if Carter didnt act now With 65 million shares outstanding for Hope, such a change in price represented a large swing in value 2 To be successful and with such an important decision on the line, Chris Smith knew that he needed more than hope Page 649 EXHIBIT 49 6 Financial Projections for Hope Enterprises (dollars in millions) How do the companies fit What are the expected synergies What is your stand alone valuation of Carter Should there be concerns about losing its investment grade rating How do the company's financial ratios compare with those of other industrial firms in 2002 How would those ratios change if the company borrowed $800Million, for example, to purchase a company If company decides to go forward with the acquisition, how should they offer to structure the deal Are they likely to want a cash deal or a stock for stock deal, in your opinion TO Chris Smith FROM Jane Scarret SUBJECT Hope Enterprises DATE February 1, 2016 As we discussed yesterday, the operating committee will be meeting tomorrow to consider an acquisition offer for Hope Enterprises Please draft a recommendation covering the issues below Thanks for doing this I look forward to your thoughts Jane Top of mind questions 1 Hope's stock price is down substantially Do you think $15 represents an abnormal buy ing opportunity Please use the seven year forecast we discussed yesterday as a base case in your valuation (Exhibit 49 6) 2 Quantify the value that Carter brings to Hope The purpose of your valuation is to educate the team on figures that will be helpful in developing a bidding strategy There is a con sensus that Hope would get a healthy bump in both revenue growth and operating mar gin The view is that an acquired Hope would achieve Annual revenue growth expansion of five percentage points starting in 2017 (e g , revenue growth in 2017 expanding from 7 in the base case to 12 in the merger scenario Future years would get similar bumps in revenue growth ) A 30 to 50 reduction in Hope's general and administrative expenses starting in 2017 There is some discussion about whether these gains should be included beyond 2021 We would appreciate your perspective on the value implications of this decision Also, how important is the realization of each of these two gains in the value of the merger 3 Assuming we make an all cash offer, we will have to do some external financing How should the team think about the choice of debt versus equity financing Should we rethink Carter's capital structure mix 4 Niles Bardsley talked to our investment bankers who suggested we fund the deal with five year U S dollar bonds at 4 7 As an intriguing alternative, the bankers said that the five year borrowing rate would be less in British pounds at 4 3 I generally don't con sider financing operations in currencies other than U S dollars, but I'd like you to consider whether you find British pound debt to be advantageous Company Hotel Rooms (thousands) Gaming Space (thousands of sq ft ) Operations Las Vegas Sands 20 1,900 MGM Resorts 52 2,200 3 NA Penn National Gaming Wynn Resorts Choice Hotels 1 300 500 Hilton Worldwide 715 Casino resorts in Macao, Singapore, and United States 15 casino resorts in the United States and a stake in a casino in Macao 26 gaming facilities in United States Company facilities feature 26,000 gaming machines Casino resorts in the United States and Macao Hotels under the Comfort Inn, Comfort Suites, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites names Hotel and resorts worldwide under the Hilton, Conrad, Embassy Suites, Hilton Garden Inn, Hampton Inn, and Homewood Suites names Hotel, resort, and vacation housing worldwide Operates hotels, resorts, and movie theatres in the United States Operates or franchises hotels and resorts world wide under the Marriott, Courtyard, Residence Inn, Ritz Calrton, and Renaissance names Hotels under the Sheraton, Le Meridien, Westin, St Regis, and W names Hotels under the Wyndham, Ramada, Days Inn, and Super 8 names Also a major operator of vacation time share properties 155 Hyatt Hotels Marcus NA 714 Marriott International Starwood Hotels 350 NA Wyndham Worldwide 2014 2015 460 8 112 0 1112 92 2 776 2 38 1 738 1 493 1 119 9 118 8 96 9 828 7 40 8 787 9 Revenue Casino Rooms Food and beverage Other Gross Revenue Promotional Allowances Net Revenue Expenses Casino Rooms Food and Beverage Other General and Administrative Depreciation and Amortization Total Expenses Operating Income Interest Expenses Income before Taxes Provision for Income Taxes Net Income 177 9 42 0 89 3 46 1 156 2 42 4 553 9 188 6 45 0 94 8 51 0 162 0 45 3 586 7 184 2 201 2 55 7 44 4 156 8 128 5 38 1 44 3 90 4 112 5 Dec 2014 Dec 2015 63 6 35 3 12 1 12 9 10 3 134 3 67 8 36 9 13 1 14 5 10 8 143 0 954 5 893 8 40 3 165 5 1,233 8 42 4 161 8 1,301 7 Assets Cash and cash equivalents Receivables less allowance for doubtful accounts Deferred income tax benefits Prepayments and other Inventories Total current assets PP E, net Deferred costs and other Other assets Total assets Liabilities and stockholders' equity Accounts payable Construction payables Accrued expenses Current portion of long term debt Total current liabilities Long term debt Other liabilities Deferred income taxes Total liabilities Common stock Additional paid in capital Retained earnings Total stockholders' equity Total liabilities and stockholders' equity 33 5 16 4 27 8 14 8 71 1 12 5 126 3 79 0 9 4 138 4 702 9 18 2 12 9 860 3 693 5 22 7 14 4 869 0 32 7 214 4 126 3 373 5 1,233 8 32 7 214 4 185 6 432 7 1,301 7 Maturity 1 year 2 year 3 year 4 year 5 year 30 year Market Bond Yields January 2016 USD GBP Government Bond Yields 0 47 0 23 0 67 0 34 0 78 0 47 0 98 0 55 1 16 0 77 2 75 2 37 Corporate Bond Yields 3 97 4 16 4 38 5 46 6 10 6 90 Aaa A Baa Ba B 5 0 Market Risk Premium Consensus premium used within Carter Foreign Exchange Rates US Dollar to British Pound (USD GBP) Economic Indicators for the United States 1 44 Five Year Forecast Annual real GDP growth Annual GDP Deflator (Inflation) National Unemployment Rate 2 9 2 7 5 0 2016 2017 2018 2019 2020 2021 2022 7 0 52 0 20 62 5 0 95 7 0 53 0 20 66 5 0 97 6 0 54 0 20 66 5 0 97 5 0 56 0 20 66 5 0 97 3 0 58 0 20 66 5 0 97 Revenue growth Cost of goods sold revenue General and admin revenue NWC turnover PPE turnover Revenue Cost of goods sold Depreciation expense Gross profit General and admin Operating profit 7 7 0 50 0 51 0 20 0 20 55 5 58 8 0 86 0 90 843 902 422 460 51 54 371 388 169 180 202 208 965 502 57 406 1,033 547 57 428 207 222 1,095 591 58 446 219 227 1,150 644 60 446 1,184 687 63 434 237 198 193 213 230 216 TO Chris Smith FROM Jane Scarret SUBJECT Hope Enterprises DATE February 1, 2016 As we discussed yesterday, the operating committee will be meeting tomorrow to consider an acquisition offer for Hope Enterprises Please draft a recommendation covering the issues below Thanks for doing this I look forward to your thoughts Jane Top of mind questions 1 Hope's stock price is down substantially Do you think $15 represents an abnormal buy ing opportunity Please use the seven year forecast we discussed yesterday as a base case in your valuation (Exhibit 49 6) 2 Quantify the value that Carter brings to Hope The purpose of your valuation is to educate the team on figures that will be helpful in developing a bidding strategy There is a con sensus that Hope would get a healthy bump in both revenue growth and operating mar gin The view is that an acquired Hope would achieve Annual revenue growth expansion of five percentage points starting in 2017 (e g , revenue growth in 2017 expanding from 7 in the base case to 12 in the merger scenario Future years would get similar bumps in revenue growth ) A 30 to 50 reduction in Hope's general and administrative expenses starting in 2017 There is some discussion about whether these gains should be included beyond 2021 We would appreciate your perspective on the value implications of this decision Also, how important is the realization of each of these two gains in the value of the merger 3 Assuming we make an all cash offer, we will have to do some external financing How should the team think about the choice of debt versus equity financing Should we rethink Carter's capital structure mix 4 Niles Bardsley talked to our investment bankers who suggested we fund the deal with five year U S dollar bonds at 4 7 As an intriguing alternative, the bankers said that the five year borrowing rate would be less in British pounds at 4 3 I generally don't con sider financing operations in currencies other than U S dollars, but I'd like you to consider whether you find British pound debt to be advantageous Company Hotel Rooms (thousands) Gaming Space (thousands of sq ft ) Operations Las Vegas Sands 20 1,900 MGM Resorts 52 2,200 3 NA Penn National Gaming Wynn Resorts Choice Hotels 1 300 500 Hilton Worldwide 715 Casino resorts in Macao, Singapore, and United States 15 casino resorts in the United States and a stake in a casino in Macao 26 gaming facilities in United States Company facilities feature 26,000 gaming machines Casino resorts in the United States and Macao Hotels under the Comfort Inn, Comfort Suites, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites names Hotel and resorts worldwide under the Hilton, Conrad, Embassy Suites, Hilton Garden Inn, Hampton Inn, and Homewood Suites names Hotel, resort, and vacation housing worldwide Operates hotels, resorts, and movie theatres in the United States Operates or franchises hotels and resorts world wide under the Marriott, Courtyard, Residence Inn, Ritz Calrton, and Renaissance names Hotels under the Sheraton, Le Meridien, Westin, St Regis, and W names Hotels under the Wyndham, Ramada, Days Inn, and Super 8 names Also a major operator of vacation time share properties 155 Hyatt Hotels Marcus NA 714 Marriott International Starwood Hotels 350 NA Wyndham Worldwide 2014 2015 460 8 112 0 1112 92 2 776 2 38 1 738 1 493 1 119 9 118 8 96 9 828 7 40 8 787 9 Revenue Casino Rooms Food and beverage Other Gross Revenue Promotional Allowances Net Revenue Expenses Casino Rooms Food and Beverage Other General and Administrative Depreciation and Amortization Total Expenses Operating Income Interest Expenses Income before Taxes Provision for Income Taxes Net Income 177 9 42 0 89 3 46 1 156 2 42 4 553 9 188 6 45 0 94 8 51 0 162 0 45 3 586 7 184 2 201 2 55 7 44 4 156 8 128 5 38 1 44 3 90 4 112 5 Dec 2014 Dec 2015 63 6 35 3 12 1 12 9 10 3 134 3 67 8 36 9 13 1 14 5 10 8 143 0 954 5 893 8 40 3 165 5 1,233 8 42 4 161 8 1,301 7 Assets Cash and cash equivalents Receivables less allowance for doubtful accounts Deferred income tax benefits Prepayments and other Inventories Total current assets PP E, net Deferred costs and other Other assets Total assets Liabilities and stockholders' equity Accounts payable Construction payables Accrued expenses Current portion of long term debt Total current liabilities Long term debt Other liabilities Deferred income taxes Total liabilities Common stock Additional paid in capital Retained earnings Total stockholders' equity Total liabilities and stockholders' equity 33 5 16 4 27 8 14 8 71 1 12 5 126 3 79 0 9 4 138 4 702 9 18 2 12 9 860 3 693 5 22 7 14 4 869 0 32 7 214 4 126 3 373 5 1,233 8 32 7 214 4 185 6 432 7 1,301 7 Maturity 1 year 2 year 3 year 4 year 5 year 30 year Market Bond Yields January 2016 USD GBP Government Bond Yields 0 47 0 23 0 67 0 34 0 78 0 47 0 98 0 55 1 16 0 77 2 75 2 37 Corporate Bond Yields 3 97 4 16 4 38 5 46 6 10 6 90 Aaa A Baa Ba B 5 0 Market Risk Premium Consensus premium used within Carter Foreign Exchange Rates US Dollar to British Pound (USD GBP) Economic Indicators for the United States 1 44 Five Year Forecast Annual real GDP growth Annual GDP Deflator (Inflation) National Unemployment Rate 2 9 2 7 5 0 2016 2017 2018 2019 2020 2021 2022 7 0 52 0 20 62 5 0 95 7 0 53 0 20 66 5 0 97 6 0 54 0 20 66 5 0 97 5 0 56 0 20 66 5 0 97 3 0 58 0 20 66 5 0 97 Revenue growth Cost of goods sold revenue General and admin revenue NWC turnover PPE turnover Revenue Cost of goods sold Depreciation expense Gross profit General and admin Operating profit 7 7 0 50 0 51 0 20 0 20 55 5 58 8 0 86 0 90 843 902 422 460 51 54 371 388 169 180 202 208 965 502 57 406 1,033 547 57 428 207 222 1,095 591 58 446 219 227 1,150 644 60 446 1,184 687 63 434 237 198 193 213 230 216

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Carter International Carter had a long history in the hotel business. The Carter name was recognized internationally as synonymous with quality accommodations. Its flagship hotels

Carter International

Carter had a long history in the hotel business. The Carter name was recognized internationally as synonymous with quality accommodations. Its flagship hotels were the Carter-Plaza in New York, the Carter-Beverly in Los Angeles, California, and the Carter-Ashelworth and Carter-Westminster in London. Carter owned and operated additional hotel properties in Australia, Great Britain, New Zealand, Turkey, and the United States, and two casino properties in Las Vegas, Nevada. In total, Carter maintained 79,000 rooms with an average occupancy of 71%. Management had previously sought to sell off Carters gambling segment, but the new management team was now pushing to increase Carters participation in this growth segment.

Carters new president and CEO, Jane Scarret, had recently taken over from longtime CEO Francis Carter-Hellman, a member of one of Carters founding families. Carter-Hellman remained the chair, and 25% of Carters 45 million shares of stock was owned by officers and directors (some of whom were family members). Scarret was well regarded in the financial community. According to one analyst, Scarret brought the reputation of an astute finance person who would be able to create value-enhancing initiatives for the company. Carters recent share price of $100 seemed to reflect this market confidence in Scarret. Page 646

The hotel industry had experienced strong performance as of late. An equity analyst summarized the state of the industry in the United States:

Demand for rooms stateside are apt to remain favorable in 2016, as economic expansion and high employment augurs well for leisure and corporate travel. Although companies will be hard pressed to continue to increase average daily rates at a pace comparable to those of recent years, high occupancy levels should give lodgers more pricing power. There is a caveat. Six straight years of auspicious operating conditions have resulted in greater hotel construction activity, with sector behemoths Marriott International and Hilton Worldwide accounting for a significant portion of the sectors development pipeline.¹

Some acquisition activity in the industry was in progress. Marriott had recently announced an offer to purchase rival Starwood Hotels for $12 billion, representing an enterprise-value-to-EBITDA ratio of about 9.5 times.

The Gaming Industry

The worldwide gaming industry had experienced spectacular growth over the past 30 years, but its future was less certain. The ongoing aging of the population in developed markets meant that a growing portion of the population was looking for relatively passive activities with attractive amenities. Increasingly, the public found casino gambling to be an acceptable form of entertainment. In the United States, access to legalized gambling had increased greatly since the 1980s as states and localities looked to stimulate both business and tax revenues. There was some concern about saturation in the gaming markets, and that increased competition would bring margin compression. Some evidence showed that newer casinos had been failing financially.

Internet gambling had grown dramatically in popularity over the past 20 years. The U.S. government regulated Internet gambling, and both interstate and international transactions remained illegal. Gambling activity in gaming ventures in Las Vegas continued to be strong. Internationally, there had been massive investment and success in Macao, and currently most of the worlds largest casinos were located in that special administrative region of China. With the recent tightening of Chinese government regulation, it was clear that gaming demand in Macao was softening. The reduced attendance was particularly evident among the high-roller gamblers. The market contraction in Macao had had a particularly strong effect on those firms that were heavily invested there. Stock prices for gaming companies that were heavily invested in Macao (i.e., Las Vegas Sands and Wynn Resorts) were down 20% to 50% in the past year. Exhibit 49.2 provides financial summary data on the participants in both the hotel and gaming industries.

EXHIBIT 49.2 | Financial Summary Data on Companies in the Hotel and Gaming Industry (financial statement data as of 2015 in millions) Sources: Value Line Investment Survey, Mergent Bond Record, and author estimates.

Some observers believed that the gaming industry was ripe for consolidation. There were rumors that gaming companies as well as hotel concerns were on the hunt for gaming acquisitions as the industry was reaching maturity. Analysts believed that adequate capital resources would be critical to companies that were going to see their way through this new phase of the casino business. Page 647

Hope Enterprises

Hope owned and operated three world-class casino-hotel resorts in Atlantic City and Las Vegas, a dockside casino and hotel in Florence, Mississippi, and a riverboat casino in New Orleans, Louisiana.Exhibits 49.3 and 49.4 provide financial information on Hope. According to one analyst:

EXHIBIT 49.3 | Income Statement for Hope Enterprises (dollars in millions, except per-share figures) Source: Created by author.

EXHIBIT 49.4 | Balance Sheet for Hope Enterprises (dollars in millions) Source: Created by author.

Hope is considered a prime acquisition target because of the strategic location of its holdings and the kind of customers it attracts. The company controls two casinos in Atlantic City, a market that was ignored by some major gambling companies for years but is now booming, prompting a scramble to acquire key locations there. Hope also controls a Las Vegas casino, and its properties serve midmarket gamblers who usually do not patronize high-roller casinos such as Carters Las Vegas Palace.

Increasingly analysts suggested that independent casino businesses like Hope needed to partner with larger hotel concerns to remain viable.

Deal Considerations

From early on, Scarret had made it very evident that she wanted Carter to be an important player in the casino business. The question was not whether Carter would make a gaming acquisition but rather when and who. Although Hope represented an attractive deal candidate, Smith knew that there were other targets under consideration.

Yesterday a team had begun investigating the economics of Hope and how the merged entities might look. Overall, the view of the group was that growth in the industry would continue to keep ahead of broad economic growth for the next five years and then ease down to pace with the general economy in the years beyond. A contracting of economic expectations was a theme for the beginning of 2016. World stock markets were down as investors processed the economic uncertainty associated with depressed commodity prices (oil prices were at a 10-year low), a slowing of the Chinese economy (Chinese GDP growth was at a five-year low), and a volatile U.S. presidential election. Exhibit 49.5provides information on financial market conditions.

EXHIBIT 49.5 | Financial Market Conditions Sources: Bloomberg, Value Line Investment Survey, and author estimates.

The motivations for the deal were several. First, Hope looked like a bargain. The stock price had continued to drift down during the past year and now traded at a price-to-earnings ratio of under 10 times. Second, Hope was well run. Hope management was well respected in the industry. An acquisition would allow Carter to retain a talented management team. But this would not be a business-turnaround acquisition. Third, Hope was small. Hopes small size meant that Carter could add value by providing scale opportunities on both the cost and revenue sides. The team thought Hopes margins would be substantially improved by taking advantage of Carters existing expertise in the industry and exploiting several scale economies. It also believed that revenue would be accelerated for the next few years by leveraging Carters brand, its loyalty program, and its reservation system into greater customer volume, although not necessarily higher prices. The merger was expected to keep Hopes balance sheet largely unaffected. Hopes cash balance, while large, was about normal for a well-run gaming company and was not expected to be altered. The team didnt expect to see any material merger efficiencies across Hopes assets. Page 648

There was some debate regarding whether Carter should use debt or equity to finance the $1 billion of cash that was expected to be needed for the acquisition. Joakim Nilsen, a longtime member of the companys treasury staff, noted that there was significant pride and borrowing-cost advantage in Carters credit rating. Carters A rating was the highest credit rating among all the major U.S. hotel companies, and Pearson was concerned that the credit rating would be compromised if the $1 billion payment was made using debt financing.

On the other hand, Trishala Shankar, the newest and youngest member of the treasury staff, argued that Carter was far too conservative in its use of debt capital and claimed that an acquisition provided an excellent opportunity for Carter to better leverage its balance sheet. Initial discussions with Carters investment bank provided a sense of the borrowing terms for a five-year $1 billion Carter bond. The bank expected the offering would be issued at par if the coupon was set at either 4.7% in U.S. dollars or 4.3% in British pounds. Shankar believed strongly enough about the need to use more debt capital that she recommended that, even if the Hope acquisition fell through, Carter proceed with the debt issuance and use the proceeds to repurchase shares. Her primary argument was based on the ability of debt to shield the company from its high 40% tax rate.

The team recognized that other suitors for Hope might appear, and that Carter would need to be thoughtful in its bidding strategy. It was thought there were other potential acquirers for which the synergy gains with Hope were expected to be even larger than what might be achieved with Carter. Maybe the lack of bidding activity suggested that Hope was in fact overpriced. Alternatively, Hope had traded for more than $30 a share a few years before the recent slide that led to the current $15 price. Could Hopes stock price rebound if Carter didnt act now? With 65 million shares outstanding for Hope, such a change in price represented a large swing in value.²

To be successful and with such an important decision on the line, Chris Smith knew that he needed more than hope. Page 649

EXHIBIT 49.6 | Financial Projections for Hope Enterprises (dollars in millions)

How do the companies fit? What are the expected synergies?
What is your stand-alone valuation of Carter?
Should there be concerns about losing its investment-grade rating? How do the company's financial ratios compare with those of other industrial firms in 2002? How would those ratios change if the company borrowed $800Million, for example, to purchase a company?
If company decides to go forward with the acquisition, how should they offer to structure the deal? Are they likely to want a cash deal or a stock-for-stock deal, in your opinion?

image text in transcribed

TO: Chris Smith FROM: Jane Scarret SUBJECT: Hope Enterprises DATE: February 1, 2016 As we discussed yesterday, the operating committee will be meeting tomorrow to consider an acquisition offer for Hope Enterprises. Please draft a recommendation covering the issues below. Thanks for doing this. I look forward to your thoughts. Jane . Top of mind questions: 1. Hope's stock price is down substantially. Do you think $15 represents an abnormal buy- ing opportunity? Please use the seven-year forecast we discussed yesterday as a base case in your valuation (Exhibit 49.6). 2. Quantify the value that Carter brings to Hope. The purpose of your valuation is to educate the team on figures that will be helpful in developing a bidding strategy. There is a con- sensus that Hope would get a healthy bump in both revenue growth and operating mar- gin. The view is that an acquired Hope would achieve: Annual revenue growth expansion of five percentage points starting in 2017 (e.g., revenue growth in 2017 expanding from 7% in the base case to 12% in the merger scenario. Future years would get similar bumps in revenue growth.) A 30% to 50% reduction in Hope's general and administrative expenses starting in 2017. There is some discussion about whether these gains should be included beyond 2021. We would appreciate your perspective on the value implications of this decision. Also, how important is the realization of each of these two gains in the value of the merger? 3. Assuming we make an all-cash offer, we will have to do some external financing. How should the team think about the choice of debt versus equity financing? Should we rethink Carter's capital structure mix? 4. Niles Bardsley talked to our investment bankers who suggested we fund the deal with five-year U.S. dollar bonds at 4.7%. As an intriguing alternative, the bankers said that the five-year borrowing rate would be less in British pounds at 4.3%. I generally don't con- sider financing operations in currencies other than U.S. dollars, but I'd like you to consider whether you find British pound debt to be advantageous. Company Hotel Rooms (thousands) Gaming Space (thousands of sq. ft.) Operations Las Vegas Sands 20 1,900 MGM Resorts 52 2,200 3 NA Penn National Gaming Wynn Resorts Choice Hotels 1 300 500 Hilton Worldwide 715 Casino resorts in Macao, Singapore, and United States. 15 casino resorts in the United States and a stake in a casino in Macao 26 gaming facilities in United States. Company facilities feature 26,000 gaming machines. Casino resorts in the United States and Macao. Hotels under the Comfort Inn, Comfort Suites, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites names. Hotel and resorts worldwide under the Hilton, Conrad, Embassy Suites, Hilton Garden Inn, Hampton Inn, and Homewood Suites names. Hotel, resort, and vacation housing worldwide. Operates hotels, resorts, and movie theatres in the United States. Operates or franchises hotels and resorts world- wide under the Marriott, Courtyard, Residence Inn, Ritz Calrton, and Renaissance names. Hotels under the Sheraton, Le Meridien, Westin, St. Regis, and W names. Hotels under the Wyndham, Ramada, Days Inn, and Super 8 names. Also a major operator of vacation time-share properties. 155 Hyatt Hotels Marcus NA 714 Marriott International Starwood Hotels 350 NA Wyndham Worldwide 2014 2015 460.8 112.0 1112 92.2 776.2 -38.1 738.1 493.1 119.9 118.8 96.9 828.7 -40.8 787.9 Revenue Casino Rooms Food and beverage Other Gross Revenue Promotional Allowances Net Revenue Expenses Casino Rooms Food and Beverage Other General and Administrative Depreciation and Amortization Total Expenses Operating Income Interest Expenses Income before Taxes Provision for Income Taxes Net Income 177.9 42.0 89.3 46.1 156.2 42.4 553.9 188.6 45.0 94.8 51.0 162.0 45.3 586.7 184.2 201.2 55.7 44.4 156.8 128.5 38.1 44.3 90.4 112.5 Dec 2014 Dec 2015 63.6 35.3 12.1 12.9 10.3 134.3 67.8 36.9 13.1 14.5 10.8 143.0 954.5 893.8 40.3 165.5 1,233.8 42.4 161.8 1,301.7 Assets Cash and cash equivalents Receivables less allowance for doubtful accounts Deferred income tax benefits Prepayments and other Inventories Total current assets PP&E, net Deferred costs and other Other assets Total assets Liabilities and stockholders' equity Accounts payable Construction payables Accrued expenses Current portion of long-term debt Total current liabilities Long-term debt Other liabilities Deferred income taxes Total liabilities Common stock Additional paid-in capital Retained earnings Total stockholders' equity Total liabilities and stockholders' equity 33.5 16.4 27.8 14.8 71.1 12.5 126.3 79.0 9.4 138.4 702.9 18.2 12.9 860.3 693.5 22.7 14.4 869.0 32.7 214.4 126.3 373.5 1,233.8 32.7 214.4 185.6 432.7 1,301.7 Maturity 1 year 2 year 3 year 4 year 5 year 30 year Market Bond Yields-January 2016 USD GBP Government Bond Yields 0.47% 0.23% 0.67% 0.34% 0.78% 0.47% 0.98% 0.55% 1.16% 0.77% 2.75% 2.37% Corporate Bond Yields 3.97% 4.16% 4.38% 5.46% 6.10% 6.90% Aaa A Baa Ba B 5.0% Market Risk Premium Consensus premium used within Carter Foreign Exchange Rates US Dollar to British Pound (USD/GBP) Economic Indicators for the United States 1.44 Five Year Forecast Annual real GDP growth Annual GDP Deflator (Inflation) National Unemployment Rate 2.9% 2.7% 5.0% 2016 2017 2018 2019 2020 2021 2022 7% 0.52 0.20 62.5 0.95 7% 0.53 0.20 66.5 0.97 6% 0.54 0.20 66.5 0.97 5% 0.56 0.20 66.5 0.97 3% 0.58 0.20 66.5 0.97 Revenue growth Cost of goods sold/revenue General and admin/revenue NWC turnover PPE turnover Revenue Cost of goods sold Depreciation expense Gross profit General and admin Operating profit 7% 7% 0.50 0.51 0.20 0.20 55.5 58.8 0.86 0.90 843 902 422 460 51 54 371 388 169 180 202 208 965 502 57 406 1,033 547 57 428 207 222 1,095 591 58 446 219 227 1,150 644 60 446 1,184 687 63 434 237 198 193 213 230 216 TO: Chris Smith FROM: Jane Scarret SUBJECT: Hope Enterprises DATE: February 1, 2016 As we discussed yesterday, the operating committee will be meeting tomorrow to consider an acquisition offer for Hope Enterprises. Please draft a recommendation covering the issues below. Thanks for doing this. I look forward to your thoughts. Jane . Top of mind questions: 1. Hope's stock price is down substantially. Do you think $15 represents an abnormal buy- ing opportunity? Please use the seven-year forecast we discussed yesterday as a base case in your valuation (Exhibit 49.6). 2. Quantify the value that Carter brings to Hope. The purpose of your valuation is to educate the team on figures that will be helpful in developing a bidding strategy. There is a con- sensus that Hope would get a healthy bump in both revenue growth and operating mar- gin. The view is that an acquired Hope would achieve: Annual revenue growth expansion of five percentage points starting in 2017 (e.g., revenue growth in 2017 expanding from 7% in the base case to 12% in the merger scenario. Future years would get similar bumps in revenue growth.) A 30% to 50% reduction in Hope's general and administrative expenses starting in 2017. There is some discussion about whether these gains should be included beyond 2021. We would appreciate your perspective on the value implications of this decision. Also, how important is the realization of each of these two gains in the value of the merger? 3. Assuming we make an all-cash offer, we will have to do some external financing. How should the team think about the choice of debt versus equity financing? Should we rethink Carter's capital structure mix? 4. Niles Bardsley talked to our investment bankers who suggested we fund the deal with five-year U.S. dollar bonds at 4.7%. As an intriguing alternative, the bankers said that the five-year borrowing rate would be less in British pounds at 4.3%. I generally don't con- sider financing operations in currencies other than U.S. dollars, but I'd like you to consider whether you find British pound debt to be advantageous. Company Hotel Rooms (thousands) Gaming Space (thousands of sq. ft.) Operations Las Vegas Sands 20 1,900 MGM Resorts 52 2,200 3 NA Penn National Gaming Wynn Resorts Choice Hotels 1 300 500 Hilton Worldwide 715 Casino resorts in Macao, Singapore, and United States. 15 casino resorts in the United States and a stake in a casino in Macao 26 gaming facilities in United States. Company facilities feature 26,000 gaming machines. Casino resorts in the United States and Macao. Hotels under the Comfort Inn, Comfort Suites, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites names. Hotel and resorts worldwide under the Hilton, Conrad, Embassy Suites, Hilton Garden Inn, Hampton Inn, and Homewood Suites names. Hotel, resort, and vacation housing worldwide. Operates hotels, resorts, and movie theatres in the United States. Operates or franchises hotels and resorts world- wide under the Marriott, Courtyard, Residence Inn, Ritz Calrton, and Renaissance names. Hotels under the Sheraton, Le Meridien, Westin, St. Regis, and W names. Hotels under the Wyndham, Ramada, Days Inn, and Super 8 names. Also a major operator of vacation time-share properties. 155 Hyatt Hotels Marcus NA 714 Marriott International Starwood Hotels 350 NA Wyndham Worldwide 2014 2015 460.8 112.0 1112 92.2 776.2 -38.1 738.1 493.1 119.9 118.8 96.9 828.7 -40.8 787.9 Revenue Casino Rooms Food and beverage Other Gross Revenue Promotional Allowances Net Revenue Expenses Casino Rooms Food and Beverage Other General and Administrative Depreciation and Amortization Total Expenses Operating Income Interest Expenses Income before Taxes Provision for Income Taxes Net Income 177.9 42.0 89.3 46.1 156.2 42.4 553.9 188.6 45.0 94.8 51.0 162.0 45.3 586.7 184.2 201.2 55.7 44.4 156.8 128.5 38.1 44.3 90.4 112.5 Dec 2014 Dec 2015 63.6 35.3 12.1 12.9 10.3 134.3 67.8 36.9 13.1 14.5 10.8 143.0 954.5 893.8 40.3 165.5 1,233.8 42.4 161.8 1,301.7 Assets Cash and cash equivalents Receivables less allowance for doubtful accounts Deferred income tax benefits Prepayments and other Inventories Total current assets PP&E, net Deferred costs and other Other assets Total assets Liabilities and stockholders' equity Accounts payable Construction payables Accrued expenses Current portion of long-term debt Total current liabilities Long-term debt Other liabilities Deferred income taxes Total liabilities Common stock Additional paid-in capital Retained earnings Total stockholders' equity Total liabilities and stockholders' equity 33.5 16.4 27.8 14.8 71.1 12.5 126.3 79.0 9.4 138.4 702.9 18.2 12.9 860.3 693.5 22.7 14.4 869.0 32.7 214.4 126.3 373.5 1,233.8 32.7 214.4 185.6 432.7 1,301.7 Maturity 1 year 2 year 3 year 4 year 5 year 30 year Market Bond Yields-January 2016 USD GBP Government Bond Yields 0.47% 0.23% 0.67% 0.34% 0.78% 0.47% 0.98% 0.55% 1.16% 0.77% 2.75% 2.37% Corporate Bond Yields 3.97% 4.16% 4.38% 5.46% 6.10% 6.90% Aaa A Baa Ba B 5.0% Market Risk Premium Consensus premium used within Carter Foreign Exchange Rates US Dollar to British Pound (USD/GBP) Economic Indicators for the United States 1.44 Five Year Forecast Annual real GDP growth Annual GDP Deflator (Inflation) National Unemployment Rate 2.9% 2.7% 5.0% 2016 2017 2018 2019 2020 2021 2022 7% 0.52 0.20 62.5 0.95 7% 0.53 0.20 66.5 0.97 6% 0.54 0.20 66.5 0.97 5% 0.56 0.20 66.5 0.97 3% 0.58 0.20 66.5 0.97 Revenue growth Cost of goods sold/revenue General and admin/revenue NWC turnover PPE turnover Revenue Cost of goods sold Depreciation expense Gross profit General and admin Operating profit 7% 7% 0.50 0.51 0.20 0.20 55.5 58.8 0.86 0.90 843 902 422 460 51 54 371 388 169 180 202 208 965 502 57 406 1,033 547 57 428 207 222 1,095 591 58 446 219 227 1,150 644 60 446 1,184 687 63 434 237 198 193 213 230 216