1. Grand Junction Networks Fnce 451 – Prof. Jo Curt Collins Steve Ubelhoer Raju Yadati Vedamurthy Gangadhara

2. 2 FNCE 451 – Prof. Jo Agenda Background Non-Financial Considerations Valuations  NPV Method  Comparables Method  Real Option Method Summary & Conclusions

3. 3 FNCE 451 – Prof. Jo Background Grand Junction IPO  Have filed S-1  Range $12-14 per share  Goldman Sachs value at $16/share Acquisition by Cisco  Offering 5 million shares worth approx. $346M  Meeting Sep 16 1995 to decide fate

4. 4 FNCE 451 – Prof. Jo Non-Financial Issues – IPO Positives  More control for Charney’s management team  Hot IPO market for “switching” companies  Original Purpose - pride  Rapidly expanding market segment  Employees recruited on this basis Negatives  Illiquidity of stock  Pressure for management team  Will large customers buy from GJ?

5. 5 FNCE 451 – Prof. Jo Non-Financial – Acquisition Positives  Liquidity of Cisco shares  Less stress  Can still capitalize on segment growth  Better chance for technology to succeed Negatives  Previously set IPO expectations  Some employees not welcome  Management team becomes middle management

6. 6 FNCE 451 – Prof. Jo Net Present Value (NPV) Valuation method  Simple, easy to apply – widespread use  Estimate future cash flows / terminal value  Discount to present value Assumptions  Tax rate = 40%, previous losses ignored  Depreciation = ~$0  Expenses using % of Sales method  Debt = ~$0, Beta is “unlevered”  Expected return is on equity only: r e

7. 7 FNCE 451 – Prof. Jo Growth Rate & Expenses Other assumptions Growth rate & expenses using CAPM fairly high 27% Growth rate

8. 8 FNCE 451 – Prof. Jo NPV Final Value Total Rev. $157.60 M $171.55 M Terminal Value $140.97 M NPV $3.948 M Working Capital

9. 9 FNCE 451 – Prof. Jo NPV Sensitivity Best to interpret using a range of values 3-4x may be justified with Cisco’s resources 1. low 2. high 3. higher 4. highest 5. to justify offer

10. 10 FNCE 451 – Prof. Jo Comparables Method 1996 data often corrupted due to later M&A’s All numbers from case assumed corrected Other numbers taken from 10-k’s Similar companies separated into 3 categories:  Public  Recent private acquisitions  Recent IPOs Adjustment factor  Used in public and private valuations  Not used in IPO valuation

11. 11 FNCE 451 – Prof. Jo Comparables – Factors Factors Increasing IPO ValuePercentage Est. Higher level of control for IPO10% Illiquidity of IPO stock- 25% Expected market segment growth20% IPO/Switching Popularity15% TOTAL Adjustment Factor113.9%

12. 12 FNCE 451 – Prof. Jo Public Companies Bay Networks 3ComCiscoAscendCabletronValuation Adjusted Valuation Revenue (Actual) $99.9M$92.0M$215.3M$278.9M$71.2M$150.8M$171.6M Income (Actual) $18.1M$12.8M$17.9M$27.4M$8.2M$17.1M$19.5M Book Value $50.3M$73.2M$84.3M$56.8M$42.5M$64.7M$73.7M Revenue (Fcst) $289.5M$266.7M$624.0M$808.3M$206.4M$436.9M$497.5M Income (Fcst) $507.3M$357.6M$501.5M$766.0M$229.7M$479.5M$545.9M Weights.25.15.101.00 TOTAL$308.6M

13. 13 FNCE 451 – Prof. Jo Private Companies KalpanaCrescendoNewportSynerticsNiceComChipcomTOTAL Acq Cost ($MM) $198.9$81.9$82.9$107.3$58.5$720.6 Revenue$30.0$9.0$5.4$27.0$0.7$39.0 Multiple6.69.115.44.083.618.521.4 Valuation ($MM) $149.8$205.7$347.0$89.8$1888.7$417.6$280.0 Valuation w/ adjustment factor ($MM) $318.8

14. 14 FNCE 451 – Prof. Jo Recent IPOs Total shares currently – 18.3M 3 Bounces calculated  Alantec – 14.5%  Fore Systems – 48.4%  Average – 31.4% Low S-1 High S-1 G-S G-S + Alantec G-S + Fore G-S + average Price / share $12$14$16$18.31$23.75$21.03 Valuation ($MM) $220.2$256.9$293.6$336.0$435.8$385.9

15. 15 FNCE 451 – Prof. Jo Real Options Valuation method  Value choice between IPO and acquisition  Black-Scholes option pricing model  Captures value beyond NPV Assumptions  NPV used as “current stock price”  Used NPV assumptions  Maturity value = 3 months (.25 year)  “Strike price” is offer of $346 M  Standard deviation of 50%

16. 16 FNCE 451 – Prof. Jo Real Option Calculations 2. total value1. option value 4. max value3. min value

17. 17 FNCE 451 – Prof. Jo Real Option Sensitivity 1. low 2. high 3. highest

18. 18 FNCE 451 – Prof. Jo Worth More to 3COM? Both share the desktop switch market (50%) Market is expected to grow to $650 M GJ could be acquired by3COM Assumptions  Can capture 100% of the desktop switch market  Can use its monopoly to its advantage  Reduced cost structure after acquisition  Better profit margins  3COM has to meet or beat CISCO’s offer

19. 19 FNCE 451 – Prof. Jo New NPV – 3COM’s Perspective $259.79 M (old) $276.70 M (added) $536.49 M (new value) Cost reductions

20. 20 FNCE 451 – Prof. Jo Real Option – 3COM Acquisition $ 871.56 M Total Value

21. 21 FNCE 451 – Prof. Jo Other Real Options Take Grand Junction Public  Market growth estimates for 1997  Desktop ($650 M) and Fast Ethernet ($1.5 B)  Option value ~$128 M ($500.374 M total)  See Prof. Jo’s valuation on ERES Cisco’s option  Pull away from negotiations  “Abandonment” flexibility  Can be valued, but outside the scope Captures value beyond NPV & Comparables

22. 22 FNCE 451 – Prof. Jo Summary Fairness depends on  Method  Assumptions  Viewpoint Grand Junction’s viewpoint  Main issue: maximizing shareholder wealth  Recently acquired private companies - $318.8M  IPO Valuation w/ bounce - $385.9M  Additional benefits of IPO are marginal  Should accept offer, is fair & reasonable  Meet w/ key employees, announce at an “all-hands”

23. 23 FNCE 451 – Prof. Jo Conclusion Cisco’s viewpoint  Cares about total value of future CFs  Given current estimates, NPV = $140.97M  Need > 3x growth (from 27% to 93%) to reach $346M  Overpaying given current estimates  Growth may be reasonable given Cisco’s resources  Risk may be higher waiting until after IPO  3COM missed opportunity for advantage  Cisco should accept the offer as well Growth is King!