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Anacomp, Inc.

TEAM MEMBERS Ben Yim Edmund Mok Randall Kao. Anacomp, Inc. Forecasting & Valuation. Agenda. 1. Company Background. 2. Business Strategy/Porter Analysis. 3. Separate Entity (RTS Associates). 4. Adjustments. 5. Forecasting/Valuation. 4. Subsequent Developments. Company Background.

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Anacomp, Inc.

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  1. TEAM MEMBERS Ben Yim Edmund Mok Randall Kao Anacomp, Inc. Forecasting & Valuation

  2. Agenda 1. Company Background 2. Business Strategy/Porter Analysis 3. Separate Entity (RTS Associates) 4. Adjustments 5. Forecasting/Valuation 4. Subsequent Developments

  3. Company Background • Anacomp, Inc. is a computer software company founded by Ronald Palamara in 1969 and is based in Indianapolis, Indiana • Services offered: • design & implementation of computer software systems • management of customer’s computer facilities • operation of customer data centers • data processing & microfilming • Anacomp Inc. Corporation established separate entity, RTS Associates in 1979 • Release its First Annual Report in September 10, 1982 after listed on the NYSE

  4. Computer Service Industry • Expected industry growth rate from 1981 to 1986 is 23% each year • In 1981 computer service revenue totaled $18.9 billion, up 23% from $15.4 billion in the previous year • Three major segment in computer service industry: • Processing services (57% of total revenue in 1981) • Professional services (23% of total revenue 1981) • Software product (20% of total revenue 1981)

  5. Business / Company Strategy • Leading supplier of software and services in banking industry • First-Mover-Advantage • Design and implementation of computer software systems • Management of customers’ computer facilities • Operate customers’ data centers • Data processing and microfilming services • Sold micrographic equipment • Licensed software products

  6. Rivalry Among Existing Firms Threat of Substitute Products Threats of New Entrants Industry Growth Concentration Differentiation Switching costs Scale/Learning economies Fixed-Variable costs Excess capacity Exit barrier Scale economies 1st mover advantage Distribution access Relationships Legal barriers Relative price and performance Buyer’s willingness to switch Bargaining Power of Suppliers Bargaining Power of Buyers Switching costs Differentiation Importance of product for cost and quality Number of suppliers Volume per supplier Switching costs Differentiation Importance of product for cost and quality Number of buyers Volume per buyer Industry Structure & Profitability (Porter 5 Forces) DEGREE OF ACTUAL AND POTENTIAL COMPETITION Industry Profitability BARGAINING POWER IN INPUT AND OUTPUT MARKETS

  7. Porter Analysis Rivalry Among Existing Firms: High • 5000 companies in the computer service industry in 1982 • Active competition each of the areas of Anacomp’s services: • computer service area • manufacturers of mainframe computers • companies developing in-house computers service capabilities Threat of New Entrants: High • There is minimal barriers to new entrants Threat of Substitute Products: High • There are 5000 companies in the computer services industry in 1982 • Like Oracle, Microsoft

  8. Porter Analysis Bargaining Power of Buyers (buyer power): High • Anacomp is selling the products to banks only. (The Buyer power is strong) Bargaining Power of Suppliers: Medium • Limited number of qualified IT personnel in the industry during the 1980’s

  9. Additional Risks • Regulatory and technology changes • Reliability and timeless of the services and product provided • Uncertainty about the success and failure of the final product

  10. Parent Corporation (publicly reported financial statements) 1 3 Separate Entity (privately reported financial statements) Additional Financing from Third Party Banks Limited Partners Bond Markets Stock Markets How an Entity is Established apart from Primary Operation of a Corporation • Corporation establishes separate entity; provides initial funding • Additional funding from third parties • R&D expenses incurred by parent corporation • 4. a) Parent corporation bills separate entity for R&D expenses plus profit; • b) Rights to R&D works transferred to separate entity • 5. a) Parent corporation buys assets of separate entity for cash payment; • b) Rights to R&D work transferred to parent corporation 4 a) 5 a) 4 b) R&D expenses incurred 2 5 b)

  11. 3 1 • Additional Financing from Third Party • Partners: $1.444-million • Bank Loan: $3.25-million • Anacomp Loan: $2.2-million • Additional Loan: $1.5-million RTS Associates ANACOMP® RTS Associates the Separate Entity • RTS Associates established November 1979 (initial funding unknown) • Additional funding from third parties • R&D expenses incurred by Anacomp, Inc. charged to RTS Associates R&D expenses incurred 2

  12. RTS Associates ANACOMP® RTS Associates the Separate Entity • a) RTS Associates pays $6-million to Anacomp® (development fee) • b) Rights to R&D works transferred to RTS • a) Anacomp® purchase software system • i) CIS: $16-million • (actual cost: $6-million + $1.5-million) • ii) BANKSERV® 1000: $2.3 - million • b) Rights to R&D work transferred to Anacomp, Inc. 4 a) 5 a) 4 b) 5 b)

  13. RTS Associates ANACOMP® RTS Associates a Separate Entity • Anacomp does not consolidate RTS • Anacomp’s expenses are offset by payments from RTS • All debt and expense of software are in general ledger of RTS • Financial statement of RTS are not reported separately SEVERE CONFLICT OF INTEREST!!! • Top managers of Anacomp, Inc. are also part owners of RTS Associates • Partners: $1.444-million • Purchase CIS: $16-million • (actual cost: $6-million + $1.5-million)

  14. Current Situation Case: • A new development of software called Continuous integrated system (CIS) for the major financial institutions. • The company had entered an agreement in November 1979 with a limited partnership, RTS associates. • Anacomp will develop the CIS system on behalf of the partnership

  15. Adjustment • Anacomp is reporting billing to limited partnerships as revenue on the income statement (P13) => Anacomp is transferring certain amount of debt to RTS and report that as revenue of the company. In actual, it is not appropriate (Assume revenue reduction of 20%)

  16. Adjustment • When Anacomp buy back the software, CIS, from RTS, it seems like the software is overpriced. The initial investment of the software is about $6 millions plus administration and expenses but Anacomp buy back at $16 million => There may be some conflict of interest as a couple of the Officers and Directors in Anacomp also invest in the partnership agreement, Anacomp may overpay the product (write down assumed asset of 30%)

  17. Adjustment • In the financial statement, Goodwill is amortized over 40 years (P16) => For a high tech company, it appears to be too long. It should be amortize over 7 years

  18. Adjustment • In the financial statement, Software purchase is amortized over 5 to 10 years (P16) => For a high tech company, it appears to be too long. It should be amortize over 4 years

  19. Adjustment • Debt capital raise from limited partnership to develop other software does not appear in the Balance Sheet. (P18-19) => The estimate debt raise from the limited partnership are as follow: EFT, CEFT, CBS, CIBS

  20. Adjustment • The total debt should included payment under lease as lease is a form of borrowing => Assume interest rate incurred for borrowing is about 14% and the present value of annuity over 5 years is 3.433* (P23)

  21. Adjustment Break to do the ADJUSTMENT

  22. Adjustment Adjustments

  23. Adjustment Anacomp, Inc. Accounting Adjustment in 1982

  24. Condensed Financial Statements Unadjusted Balance Sheet

  25. Condensed Financial Statements Unadjusted Income Statement

  26. Condensed Financial Statements Adjusted Balance Sheet 1,2,3,4,6 5,6 1,2,3,4,5

  27. Condensed Financial Statements Adjusted Income Statement 1 3,4

  28. Condensed Financial Statements Total Cash Flow Analysis Not consistent with reported net income! Borrow money to pay dividends! -ve (Must borrow to make investments!)

  29. Dupont Ratio Analysis Unadjusted Dupont Adjusted Dupont

  30. Forecast Assumptions • Drivers • Sales Growth • NOPAT Margin (Net Operating Profits After Taxes/Sales) • After-Tax Net Interest Rate on Debt • Net Operating Working Capital/Sales • Net Operating Long-Term Assets/Sales • Net Debt/Net Capital • Cost of Equity

  31. Forecast Assumptions • Sales Growth • High-Tech Industry – Extensive R&D • Optimistic = Extremely High Sales • Capitalize on development projects with EFT, CEFT, CBS, and CIBS • Assume 200.0% Sales Growth • Pessimistic = Extremely Low Sales • R&D projects under development could potentially be unrealized • Assume 50.0% Sales Growth – based on historical results (i.e. status quo) • Terminal Year • Assume 7.5% Sales Growth – Average Economic Sales Growth

  32. Forecast Assumptions • NOPAT Margin • Optimistic • Assume 20.0% • High NOPAT margin due to high sales • Most costs already incurred through product development • May incur some distribution & tailoring costs • Pessimistic • Assume 6.5% • Typically increase by historical amount for a couple periods before leveling off • Terminal Year • Assume 5.0% - Average Economic NOPAT

  33. Forecast Assumptions • After-Tax Net Interest Rate on Debt • Assume 5% • Net Interest Rate = Interest x (1 – Tax) • Interest Rate for 1980’s is 10% • Anacomp Tax rate is 50% • Net Operating Working Capital/Sales • Assume 25.0% • Based on historical – capital structure will not tend to change significantly

  34. Forecast Assumptions • Net Operating Long-Term Assets/Sales • Optimistic = 20.0% • Software already developed • Assume 50% for Optimistic & Pessimistic for simplicity based on historical values • Net Debt/Net Capital • Assume 50% • -ve value = more cash than debt • +ve value = more debt than cash

  35. Forecast Assumptions • Cost of Equity • Assume 14.0% • Reasonable estimate size of Anacomp and time period

  36. Forecast Results - Optimistic

  37. Forecast Results - Pessimistic

  38. Valuation • Discounted Abnormal Earnings • Present value of forecasted earnings • Manager’s estimates included in forecasts • Advantages • Accurate estimates provided mangers choose appropriate accounting methods • Disadvantages • Inappropriate accounting methods result in noise • Discounted Cash Flow Analysis • Present value of forecasted cash flows • Inside information of managers ignored • Advantages • Inappropriate accounting methods smoothed • Disadvantages • If accounting methods appropriate, omits valuable inside information from managers • Valuation Based on price Multiples • Values firm based on comparison to other similar firms • Advantages • Market valuation • Disadvantages • Market may not be efficient • Should be compared with other valuation models

  39. Valuation Optimistic Pessimistic • Negative Valuation – 2 Interpretations • 1. Limitations of the spreadsheet • 2. Anacomp not worth the price! • Reference Dot.Com companies • Price Earnings Method – Valuation based on the market • Is the market correct, or are we correct? • Options Pricing Method – May be a better method for valuation • Based on the probability of success of the company • Commonly used in valuation of bankrupt companies – e.g. Delphi

  40. Subsequent Developments Anacomp, Inc. – Fiscal 1983 • Revenues: $172.20-million • Losses: $ 3.96-million (or $0.38 per share) • Stock price: $ 10.50 • Major developments during year: • Announced modifications to CIS (Continuous Integrated System) & would be installed ‘shortly’ at Provident National Bank of Philadelphia. • Anacomp attributed losses for the year to decline in development fee revenues from R&D partnerships & no new license revenues from banks. • Company stock price high: $22.00 • Year end stock price: $18.00 • Stock price at end of 1982 fiscal year: $10.50

  41. Subsequent Developments Anacomp, Inc. – Fiscal 1984 • Revenues: $132-million • Losses: $116-million (or -$9.84 per share) • Stock price: $ 2.75 (-$7.75 difference from 1982) • Company announced dividend omission (halted) • Major developments during year: • CIS (Continuous Integrated System) filed customer tests. Anancomp announced major design changes were required to fix the problems. • License fee revenues dry up • Modified 1983 statements: ◊ Receivables:  $15-million ◊ Capitalized Software:  $31-million   Net Worth: -$23.7-millon • Anacomp auditors issue a qualified audit opinion for 1984 fiscal statements

  42. What is happening now May 19, 2006 • Market Capital: $ 55.44M USD • Revenue: $163.02M USD • Net Income: -$ 54.13M USD • EPS: -$ 14.654 USD • Current Stock Price: $15.00 USD (ANCPA.PK)

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