Bailout.consulting.brevini

Silvia Baiocco
Andrea Granelli
Alessandro Grassano
Gian Marco Lago
Giulio Laudani

Bailout Consulting

1. Analysis of the company:
I. Group of reference
II. History
III. Strategic Business Units
2. Analysis of the industry:
I. Porter’s five forces model
II. SWOT analysis
3. ROIC expectations:
I. Assumptions
II. Results

Brevini India and Brevini Finland Brevini South Africa

Brothers Renato, Luciano, and Type Approval Certificate
Corrado Brevini establish FRATELLI
BREVINI in Reggio Emilia.

Brevini Power Transmission
Brevini UK, Brevini Svenska,
division
Brevini Espana, and Brevini
Canada

1960 1970 1980 1990 2000 2009

New production plant in
Brevini China, Korea, South- China
east Asia (Singapore), Brevini
Brevini France, Australia, and New Zealand.
Brevini USA Brevini Latino Americana in Acquisition of the German
Brevini in Germany Brazil. company “P.I.V. Antrieb
Werner Reimers”

SBU MAIN CUSTOMER DISTRIBUTION GEOGRAPHIC PRODUCT LINES/ SERVICES
TYPE CHANNEL AREAS

Planetary gear units for
Brevini Riduttori Energy Direct-distribution Worldwide industrial applications and
mobile machines

Parallel and right-angle shaft
Material Handling
PIV Drives Direct-distribution Worldwide gear units and speed
Transport
variators

Hoisting and
Brevini Winches Construction Direct-distribution Worldwide
recovery systems

New compact gear units for
Waste Water /
Piv Posiplan Direct-distribution Worldwide shaft-mounted
Recycling
industrial applications

Revenue by family in 2009

Agricolture

 Brevini Power Transmission
7% 5% Industrial Equipment
8%

operates in the Industrial
Material Transport
19%
9% Construction

Machinery sector (NACE 2811) Marine/Port Infrastruture

Mining
11%
15%
Energy

Plastic/rubber
12%
14% Recycling

Sourced by Brevini Power Transmission website

Geographic distribution in 2009

12%
23%
Italia
18% UE (ex-Italy)
Asia-Pacifico
America

47%

Sourced by Brevini Power Transmission website

Buyer Power: Moderate Supplier Power: Moderate
•Brand reputation is of negligible value in this market •Suppliers operate in the Commodity sector, so they have
•Buyer power is weakened by the substantial number very low power due to low differentiation of products
of buyers in this market, but a big part of the revenues •Raw materials purchasing carries prices volatility and
Competitive aggressiveness: Moderate
comes from a small number of big commissions exchange rate risk
•There is the possibility to easily switch due to the high •In the last 20 years there has been an increasing level of
goods standardization, except for the engine sub-sector prices due to the continuous global economic
•The market is mature and it shows a global slow growth rate growth, sustained by high demand from China and
other emerging economies
(1,6%), but there are differences between the different geographic area
and sub-sector. Competitive aggressiveness:
•The concentration in the market is low, the top 5 player account for
the 12% of the overall market
Threat of new entry: Low
•There is an high cost to convert theThreats of substitution: Moderate the
production, this increase
•High level of fixed costs and capital to stay in the market as long as exist but used-products sold
competitors attitude investment •Substitutes as such do not possible
•Economies of scale privately may be considered as an alternative. This would
•Government regulations and high level of intellectual be cheaper than buying brand new products; however, the
property machinery is unlikely to be under any kind of warranty if
sold privately which may pose a high risk to buyers as the
•Recent poor growth in the market
machines are expected to work in difficult heavy-duty
environments

Revenue by geographic area
Market segmentation
2%

16%
36%
28% 38% 23%

25%

Engine, Turbine and Related
32%
Wood and Plastic Process

Americas Asia-Pacific
Metalworking
Europe Rest of the world Other Purpose

Sourced by DataMonitor

Strengths: Weaknesses:
•Capability to exploit economies of scale •The firm is auto-financing,: exploiting its operating
•A flexible structure cash flows
•The main good is highly appreciated by the market •It is a family-owned business  are they good
because of lower prices with respect to traditional manger on the long run?
technologies possibility of configuration according to
the costumer’s needs and high versatility
•Innovating technologies and strong investment in
R&S

Opportunities: Threats:
•The recent investment in USA and China could allow •The recent crisis could lead to a new phase of
the company to capture the higher expected growth aggregation between companies
of those markets
•The EU environmentally friendly legislation can boost
Brevini’s growth

 After analysing the market and our
company, we identified 4 competitors which
operate in the same market and whose
businesses are tightly connected to
Brevini’s
 Using the historical data available for our
competitors, we built a statistical periodic
fit with the least squares method
and, hence, we were able to determine the
future ROICs for those companies

BREVINI POWER
MAN SE OKUMA MITSUBISHI KAWASAKI
TRANSMISSION

2008 2009 2008 2009 2008 2009 2008 2009 2008 2009

Net
0.359 0.224 14.945 12.026 1.354 1.272 28.096 29.610 13.167 11.741
Sales

EBITA 0.037 0.012 1.643 0.613 0.189 0.091 1.180 0.917 0.671 0.246

NOPLAT 0.026 0.008 1.150 0.429 0.132 0.064 0.826 0.642 0.470 0.172

ROIC 20.43% 6.83% 9.41% (8.92%) 21.86% 8.29% 12.43% 12.05% 8.77% 2.77%

ROE 20.16% 6.93% 23.03% (5.35%) 16.39% 3.80% 4.30% 1.95% 11.22% 4.04%

ROA 12.46% 4.51% 9.00% (1.35%) 14.31% 6.15% 2.31% 1.68% 5.03% 1.12%

Kawasaki MAN SE

Mitsubishi Okuma

◦ We applied the ROIC trend deduced from our
competitors to Brevini, keeping in mind that:

• We have expected a constant growth rate for the IC, which is explained
by Brevini’s will to bust its production and geographical expansion

 The parameters of this function respond to the qualitative sentiments
that have been presented in our SWOT analysis

 We have assumed an higher “pro-cyclical” movement than most of the
other competitors and a more flexible capital structure, which has
allowed Brevini to reduce the negative effect of the revenue contraction
 this has lead to an upward asymmetrical behavior

1. Enterprise DCF
I) WACC estimate
a) Capital structure : target structure, D (book value), E (iteration
method)
b) Ke  Capital Asset Pricing Model
c) Kd  Spread approach
II) Free Cash Flow estimate
a) Time frames : scenarios
b) Main assumptions
III) Results
IV) Sensitivity analyses
2. Economic profit

◦ The key element of DCF and how we have estimated
them:
 Ke: we have used a Market model, based on the CAPM
WACC

 Kd: we have used the Debt ratio to find the
appropriate rating and the cost of debt.
 We have analyzed the historical path of the main
financial items to find out the relationship between
them and any existing trend.
FCF

 We have estimated the revenues growth rate through a
three period model that describes our qualitative
judgment on the company.

 Capital structure :
◦ Our target has been the characteristic median Debt-to-Equity
ratio in the industrial machinery market, which is about 14%
(source: McKinsey)
◦ This goal is too far from the present structure, so we have
developed a correction in the DCF model, to better fit our
hypothesis with those of the model
◦ The company is not financially distressed, therefore the book
value of the net debt can be a good proxy of its market value
◦ The market equity value has been calculated through an iteration
◦ Our solution has been to develop a changing structure
from 2010 to 2014, which has lead to a variable
WACC, due to changes in Ke, Kd and weights

o Ke has been calculated using the formula:

Risk free + Beta*Mkt premium

o The risk free chosen is an equally weighted blend
between the most recent German and Italian 10y zero
coupon bonds rate, because the company is mainly
exposed in those two countries
o The market risk premium has been taken from the
paper by Fernandez. It is an average between the
German and Italian ones for the same reason as before
o The marginal tax rate chosen is 30%

 We have chosen our comparables
◦ The criteria used have been: similar Business and
MRO LN
Man se Kawasaki Okuma Mitsubishi
Geographic Area
 We have built a table to find out the sector
unlevered beta (Hamada formula)
◦ The weights used have beenUNLEVERED WEIGTH
COMPARABLES BETA LEVERED NET DEBT EQUITY (MKT CAP) (tot.Mkt cap/MktNORMAL
BETA
WEIGHT i)

Man SE
and then normalized. These weights allow us to
1,557 € 2.634,00 € 5.538,87 1,17 322% 4,01%
give more importance to the smallest companies
Okuma 1,434 - € 32,17 € 617,95 1,49
in our portfolio
2889% 35,98%

Mitsubishi 0,958 € 9.657,82 € 8.302,72 0,53 215% 2,68%
◦ The Betas for the comparables have been
Kawasaki 0,729 € 3.117,09 € 2.949,44 0,42
calculated using the 2004-2009 interval, monthly
605% 7,54%

frequency, and the MSCI World Index
MRO LN 1,598 € 362,49 € 446,49 1,02 3999% 49,79%

Weighted Average 1,14 8031% 100,00%

 We have re-levered the beta of the sector:

◦ We have estimated a debt/equity structure trend
converging to a target structure in 2025
◦ The target structure has been decided using the average of
the steadiest comparables
◦ Assuming a slow approach to the target value, we have
developed a variation to the DCF model. Mainly, we re-
levered the beta using different target D/E between 2010
and 2014

Risk free + Beta*Mkt premium

Risk free 4,06%

Market premium 5,85%

2009 2010 (E) 2011 (E) 2012 (E) 2013 (E) 2014 (E)

Brevini Beta 1,86 1,53 1,52 1,44 1,49 1,43

Net Debt 48,0% 33,2% 33,1% 28,3% 31,2% 27%

Equity 52,0% 66,8% 66,9% 71,7% 68,8% 73%

2009 2010 (E) 2011 (E) 2012 (E) 2013 (E) 2014 (E)

Ke 15% 13,02% 13% 12,54% 12,81% 12,42%

 Kd: we have estimated a change in the rating of
our company, following our expectations:

◦ We have assumed a variable interest expense linked to
the German and Italian 5y bonds + the premium
corresponding to its rating (Spread Approach, though
Interest Coverage Ratio calculation)
◦ We have taken into account the possible future
monetary policy, which is going to cause the increase
of the risk free rate, but at the same time our rating
will improve and, so, the spread reduce. In
conclusion, we hypnotised a stable level of Kd of
5.5%, considering the result of the two opposite effects

2010(E) 2011 (E) 2012 (E) 2013 (E) 2014 (E) 2015(E)

10,58% 10,58% 10,60% 10,59% 10,61% 10,50%

Betas

Mkt p. 1,15 1,35 1,55
5,25% 9,12% 9,12% 9,95%
5,85% 9,67% 9,67% 10,58%
6,45% 10,21% 10,21% 11,22%

The chart above is a sensitivity analysis on the WACC. The row
represents a standard deviation range from the beta value used, the
column is a range of possible market premiums.

1. We have divided our model into three time periods:
◦ 2010-2014  We have built an IS & BS by estimating each item
◦ 2015-2024  By estimating Key drivers
◦ 2025-infinity  We have computed a terminal steady growth rate using
macroeconomical inputs
2. We have chosen different tools to implement our
proxies for each period, the ratio for each of them is:
◦ In the first period, we have less uncertainty, so we have felt
confident enough to develop three scenarios with a
considerably low standard deviation
◦ In the second period, due to higher uncertainty, we have
developed three scenarios with a higher volatility
◦ In the last period, we have relied on the general accepted
belief that the firm will reach a certain stability and will
follow the global growth rate

 We have set up three different scenarios:
◦ The Normal case will assume that the firm will follow its forecast growth
path, which has been estimated through a periodic function based on
historical data
◦ The Best scenario is going to assume that the firm’s revenues will have
the same growth rate as the market when the economy faces a
downturn, while it will keep its forecast growth in positive economic
conditions.
◦ The Worst scenario will assume that the firm will keep behaving as
forecast in negative conditions and will not be able to outperform the
market growth in positive circumstances and, therefore, as a proxy, we
have chosen the market growth rate itself as the path that it will follow.

 The Revenue has been forecast by means of a statistical
periodic fit: we have found the periodic function that
approximates the data we had with the least squares method

 The properties of the function we obtained confirmed the
qualitative analysis of the revenue’s growth:

◦ The minimum of the function is in 2011, it grows to reach the
pre crisis level until 2013 and it reaches the maximum in 2014

2010 (E) 2011(E) 2012 (E) 2013 (E) 2014 (E)
Revenue 202.280 185.532 239.336 315.325 361.362
% (t+1-t)/t -8,19% -8,28% 29% 31,75% 14,6%

600000

400000
Normal

200000 Worst
Best
0

2008 2009 2010 2011 2012 2013 2014
 The expected CAGR of the three scenarios is 0,042% with a
variance of 20%
CAGR Probabilities
Best case 6% 2/7
Worst case -11% 1/7
Normal case 1% 4/7

 During this period, Brevini will experience a “transition”
phase which will lead to a steady growth level
 We have set up three different scenarios:
◦ The Best scenario is going to assume an higher growth rate in
comparison to the market  the company will be able to increase both
its production and geographical coverage
◦ The Normal case will assume a continuous growth path at a rate lower
than previously, but still higher than the market average
◦ The Worst one will assume the failure of the company to achieve a
satisfying competitive advantage  it will reach a steady state level at
the beginning of the period
 Our work has been lead both by qualitative and quantitative
analysis:
◦ The qualitative argument is based on the capability to retain extra-
earning thanks to competitive advantage
◦ The quantitative analysis is based on the shift of the geographical
exposure and global growth expectation

 We have taken the expected value of the
compound annual growth rate of our three
scenarios
About 7,7% with a variance of 80,91%
It means that the company will double its size in 10 years

CAGR Probabilities
Scenario 1 (best) 15% 14%
Scenario 2 (normal) 7% 57%
Scenario 3 (worst) 4,5% 29%

 “Brevini Group’s industrial plans include substantial
investments [...] because our growth depends on
our presence around the globe […]. We are looking
beyond the crisis and focusing on the recovery that
will arrive,” said Renato Brevini, President of Brevini
Power Transmission
 From this we have deduced that the company will
increase its production and its investments starting
from 2012

 We have assumed an “exotic” function for the COGS, whose parameters
have been set to capture a loss of efficiency due to a revenue
contraction in 2010-11 (less scale efficiency) and then a normalization
in the remaining years

 We have linked SGA growth to the COGS for 2/3 and to an intrinsic
growth for 1/3, following the expected business plan

 “Other Revenues” is composed of two parts: one correlated to sales for
2/3 and the other independent and pretty steady through time

 Operating cash represents the minimum amount of cash necessary
for daily business  it has been assumed as a fixed percentage of
revenues

 Inventories are defined as a percentage of revenues  We have
assumed a reduction in production and a disbanding of its inventories
for 2010-11, on the other hand in 2012 there will be an increase to
anticipate the higher revenue-growth expectation

 A positive net change has been estimated for Receivables and
Payables. We have also considered a renewed investment in WC to mach
the increase in revenue in 2012-2014.

 Net PPE is defined as a % of revenue, our estimate consistently matches our
hypothesis on the Invested capital trend

 Our estimate on the Debt repayment converges to the target value, as
forecast through our assumptions on the Debt ratio

 We have chosen to have a positive trend in PPE, independently from the
revenue growth, due to our strong confidence on the IC hypothesis.

 To define the Debt position we have also tried to:
◦ Bound the excess cash into a coherent interval
◦ Ensure enough liquidity availability to sustain the CAPEX and new building
expense
2010 (E) 2011(E) 2012 (E) 2013 (E) 2014 (E)
%PPE 26% 28% 32% 30% 32%
Debt Rep. (5.000) (4.000) (6.000) 17.000 (6.000)

Present geographical Target geographical
distribution distribution
America America
12% 20%
23% 30%
18% Asia- Italy
Pacific 12%

47% UE ex UE ex
38%
Italy Italy

We forecast Brevini’s revenue growth also considering the kind of
geographical expansion that we expect the company to follow
and, therefore, making a weighted average of the GDP of each area.

 We have assumed a unique case, in which the
company reaches a steady growth of
3%, following the global economy
 Our estimate has an upper limit to ensure a
terminal ROIC of about 15%, which is in line with
the sector average
 The implicit multiple of the terminal value is 7,9

PV FCF
 60 % of our Enterprise
2010 -14
€ 22.717,14
value depends on the
terminal value
2015-25
€127.587,03

Terminal value
€229.766,28  There isn’t any Non-
EV operating asset in our
€380.070,46
valuation, besides
Debt value
€ 87.771 excess cash
Equity value € 292.299,46

 The WACC range comes from the sensitivity
analysis made previously
 The column variable represents the terminal
growth rate

Wacc
9,58% 10,08% 10,58% 11,08% 11,58%
g
2,5% € 457.074,59 € 412.787,30 € 374.685,31 € 341.644,77 €312.792,54
3,0%
€ 466.979,37 €420.091,34 €380.070,46 € 345.600,54 €315.675,45
3,5%
€478.532,87 € 428.518,41 €386.224,91 € 350.084,01 €318.919,07

 The WACC range comes from the sensitivity
analysis made previously
 The column lines represent the revenue CAGR
of the 2015-24 estimate

Wacc
9,58% 10,08% 10,58% 11,08% 11,58%
CAGR
1,6% €356.297,02 €326.333,93 €300.016,00 €277.739,73 €257.788,76
7,67% €466.979,37 €420.091,34 €380.070,46 €345.600,54 €315.675,45
13,72% €641.169,10 €567.096,85 €504.528,45 €451.211,38 €405.427,37

PV of EP € 99.453  The relationship
between ROIC and
PV of Continuing
€104.908 WACC has been
value
negative only for
Invested capital
at start of € 175.709
the first 3 years of
forecast our valuation model
Enterprise value € 380.070
 The IC contribution
has been constantly
Equity value € 292.299 increasing in value

100%
 Source of value of the Economic profit is mainly the Initial
80%
IC, while the terminal value accounts for 27,37%. Our
60%
assumptions on the IC are consistent with our qualitative
IC0
belief of an
40% increase over time  even in the deepening of
the crisis the growth rate in the IC is higher than the
20% PV
revenue’s
0% Terminal value
 The chart below shows that the economic profit model is
less dependent on the terminal value hypothesis than the
Economic Enterprise
enterprise DCF one
profit DCF

Economic profit Enterprise DCF
Terminal Value 27,37% 60%
PV 26,05% 40%
IC0 46,05% -

Our ROIC expectations trend calculated
through the period function approximation
has been confirmed by the results obtained
through the enterprise DCF method.

I. Identification of the right comparables

II. Identification of the value drivers

III. Time framework

IV. Results

 WARNING: finding companies which have the same mix of
Brevini belongs to the classification NACE 2811, i.e. Manufacture of is
businesses, products and size and at the same time are listed,
engines impossible. Thereforeaircraft, vehicle and cycle engines.
almost and turbines, except the companies which have been picked
NACE 28 indicatesbelong to a very similar market –indicated by the
are those which manufacturers of machinery and equipment.
NACE classification-. Moreover, they either operate in the same
the company has areas or have a similar size.
geographical
been chosen as its
products are
complementary to
those of Brevini:
i.e. they tend to be
used together as a
unique component

the company
has been kept in
consideration since
the beginning of
the work as their
businesses are
tightly correlated

Direct multiple: EV/EBITDA Indirect multiple: EV/Sales

Less easily influenced by
different accounting and fiscal More commonly used in times
policies and, hence, more when the company is not achieving
difficult to manipulate or cause very positive margins or is facing a
misleading judgement turnaround moment

Source: Valuation Guide by
Borsa Italiana (2004)

When discussing about the time frame to consider, we had to keep in mind
that 2008 and 2009 were years afflicted by the financial crisis.

1. We started with the classical approach, which is using the last available
year, i.e. 2009. The values we obtained where excessively low. This can be
explained by the fact that this year has been considerably affected by the
financial crisis and the situation presented by most of the companies
worldwide, and in particular companies belonging to the industrial
machinery sector, does not do any justice to their real value.

2. We then tried to capture the value of the company by using forecast
data, which we found available only up to 2012. Unfortunately, the
economy is excessively negatively biased during this period, as we do not
expect any recovery before 2011, therefore the values we obtain are again
not doing any justice to the real value of the company.

3. It would have been more appropriate to use data from 2007, when the
company was able to show all its potential and external causes where not
affecting its activity, but unfortunately Brevini data were not available.

4. The ultimate chance we were left with was to consider data from 2008.
2008 financials are available, not too badly influenced by the financial
crisis and therefore sufficiently reliable.

Hamworthy Spirax-Sarco Okuma CVTech Comparables' average
Are these results consistent with the previous ones?
EV / EBITDA 08 7,26 8,41 5,02 4,79 6,37
EV / SALES 08 0,63 1,78 0,83 0,60 0,96
YES
Comparables' average Brevini
EV / EBITDA 08 6,37 48.152 EBITDA
EV / SALES 08 0,96 356.054 Sales

You have to take into account that the value we
calculated is slightly lower than the one we get
Brevini

through 1the discounted cash flow model and close
EV 306.732

to the value we obtain in our worst case scenario
EV2 341.693
Mean 324.212
because the unfortunate circumstances which hit
the economy cannot be completely avoided.

 Orbis and Amadeus  Balance sheet information
 DataStream  Risk free
 Central bank of key country and IMF  Growth
expectation on GDP
 Bloomberg  Betas, Mkt cap and Enterprise value
 Capital iQ  information about competitors
 Data Monitor  Information about the overall
market
 “Market Risk Premium used in 2010 by Analysts
and Companies: a survey with 2.400 answers”, P.
Fernandez and J. del Campo

After a careful analysis, we have come to the conclusion that
Brevini is a company that operates in a highly competitive
business which requires a great amount of fixed investments.
On the other hand, it has high growth potential, as it is
planning to expand geographically. Moreover, its products are
very versatile and, hence, can serve different purposes. It also
presents a high efficiency of production, which might come
even handier whether new plants were to be opened by
developing economies of scale . The financial crisis has had a
very negative impact on the company, but we expect a prompt
recovery. We have used different approaches to measure the
value and each time we created a set of assumptions that
were both realistic and thought through. We even tried to
adapt such methods to every specific circumstance. The
results we obtained were consistent and sound; therefore we
are confident enough that the value we got is pretty fair.

Bailout.consulting.brevini

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