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LEVERAGE BUYOUT PROPOSAL FOR THE ACQUISITION OF CSL LIMITED

LEVERAGE BUYOUT PROPOSAL FOR THE ACQUISITION OF CSL LIMITED PROPOSAL

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TABLE OF CONTENTS

iiTABLE OF CONTENTS

A brief Business Overview 1

Identify the Reasons why CSL could be an Attractive Target 1

4Guiding Assumptions for the LBO Proposal

Proposed Financing Structure and Estimated Share Price for the LBO 5

7Income Statement Projections

7The LBO Transaction Summary

8The LBO Pro Forma Balance Sheet

9Projections for the LBO Assorted Financials

Sensitivity Analysis and Proposed Offering Price to the Shareholders of CSL 10

Bibliography 15

Appendices: Exhibits for the LBO Deal 16

16Exhibit 1: Starting Balance Sheet

16Exhibit 2: Income Statements Projections

17Exhibit 3: Revenue Generation Schedule

17Exhibit 4: The G&A expenses

17Exhibit 5: Summary Schedule for the LBO Financing Design

18Exhibit 6: LBO Transactional Summary

18Exhibit 7: The LBO’s Pro Forma Balance Sheet

19Exhibit 8: Projections for the LBO Full Income Statements

19Exhibit 9: The LBO Balance Sheet Projections

20Exhibit 10: The LBO Cash Flow Statement Projections

20Exhibit 11: The LBO Debt Schedule Projections

21Exhibit 12: CLS Ltd Historical Information – Step 1 of the Sensitivity Analysis

21Exhibit 13: CSL Ltd Historical Working Capital – Step 2 of the Sensitivity Analysis

22Exhibit 14: CSL Ltd Future Forecasts– Step 3 of the Sensitivity Analysis

22Exhibit 15: CSL Ltd Unlevered Free Cash Flow Forecasts– Step 4 of the Sensitivity Analysis

22Exhibit 16: CSL Ltd Target Capital Structure and Beta– Step 5 of the Sensitivity Analysis

23Exhibit 17: CSL Ltd Enterprise Value Computation– Step 6 of the Sensitivity Analysis

23Exhibit 18: CSL Ltd Calculation of WACC– Step 7 of the Sensitivity Analysis

24Exhibit 19: Exhibit 18: CSL Ltd Sensitivity Analysis Summary– Step 8 of the Sensitivity Analysis

24Exhibit 20: LBO Return Calculations

Leverage Buyout Proposal for the Acquisition of CSL Limited Proposal

A brief Business Overview

CSL Limited is a multi-national biotechnology company involved in the research, development, manufacturing and marketing different healthcare products aimed at improving human medical conditions (McCredie, 2014). This company plies in different goods such as blood plasma derivatives, anti-venon products, derivatives, and cell culture reagents that are important for different medical and genetic research process in addition to manufacturing applications (McCredie, 2014). After its privatization in 1994, by 2000 CSL Limited had already doubled its size through mergers one of the most notable one was the purchase of ZLP Bioplasma AG, a Swiss based company (McCredie, 2014).

This expansion also happened four years later by buying Aventis Behring, a Germany based medical company and this made CSL Ltd the second company in the whole of Australia to reach a share price of over $100 per share (McCredie, 2014). Seven years later, this robust growth and improvement was noted at a national level through its Thinking Kids Children’s Centre which was awarded with the Award of Most Outstanding Equal Employment Opportunities Initiative and this was not the whole story of this business. The latest acquisition for CSL Ltd was in 2014 when it bought Novartis’ influenza vaccine business at an estimated cost of $275 million and merged this branch with its bio-CSL operations (McCredie, 2014).

Identify the Reasons why CSL could be an Attractive Target

CSL Ltd is a very lucrative company that could be a very lucrative target for this LBO and promises good financial prospects for both businesses involved. There are many different reasons that support this notion. First of all, it has its stock trading on the Australian Securities Exchange under the stock code CSL and its Initial Public Offering was done in 1994 going for $2.30 per share. Today, the company’s stock is part of the S&P/ASX 50 Index. In terms of direct business performance, CSL Ltd requires that all its application purchased by its clients, have an annual renewal fee of $5.00 and has an average of 25% renewal of the licenses of the applications it sold the previous year and this works as the company’s recurrent revenue source (McCredie, 2014). For the purposes of this project, it is assumed that the renewals as a source of recurrent revenue happens for one extra year and the recurrent revenue at the firm on which this LBO proposal is based is dependent on the previous year’s renewed licenses for its business.

In addition to this, Opler & Titman (2010) provides a brief framework that guides the determination of what constitutes a good company able to successfully undergo an LBO and some of the guidelines that have been adequately met by CSL Ltd include the following:

  • Maturity of the Company – CSL Ltd is a mature company in the market as its current stock price indicated above trades in a lower amount compared to free cash flow of new companies. This makes it easier and ideal for the Private Equity Fund seeking to purchase the LBO at a lower cost when compared to the cash flow that the company produces every year which makes the deal potentially lucrative for investors (Opler & Titman 2010).

  • Debt-free Balance Sheet – it is important for investors to have the freedom to use ‘new debt’ as leverage to improve their investment through the acquisition and this cannot be sufficiently exploited when companies considered in the LBO already have a pre-existing high level of debt (Thackray 2009). The reason this is very important is that when there is a pre-existing debt prior to the LBO, it has to be financed first before any new debt can be undertaken to strengthen the investment. From the business performance of CSL Ltd, the company does not have a significant debt prior to this deal which makes it an ideal target for the LBO deal.

  • Strong Business Culture for Operations – management of any company is very critical to the success of its performance in the market. In this regard, a company with strong management capacity and culture makes it very ideal for LBO financing as there is relative calm among investors about the future of their investment (Thackray 2009). CSL Ltd is a well developed company with a good track record of its management culture and operational principles and these make it a very ideal target for the LBO transaction.

  • Market Strength and Competitive Advantage – it is important for a company seeking to enter into an LBO transaction to have a good competitive advantage in the market as it helps shield it from market forces that may cut into its profit margins and hence affect its cash flows. When this happens, the projections for progress and growth are also compromised and impacted in the negative (Wallace 2007). CSL Ltd having been in operation in the market for many years, it has established itself as a corporate business within the healthcare industry to reckon with and this makes it very attractive in partaking in this deal. Being the most promising bio-medical company in Australia with the highest revenue return in the previous fiscal year is exactly the kind of partner that investors would be looking to work with.

  • Steady Cash flows – CSL Ltd has steady cash flows from its different revenue streams within its broad business platform. Over time the company has improved its business fortunes through mergers and acquisitions that have served to further its financial standing within the market. Its cash flow streams are maintained at high levels and this makes it very instrumental for this LBO deal.

Guiding Assumptions for the LBO Proposal

The following are guiding assumptions important in the preparation of this LBO from CSL Ltd business point of view:

  • The cost for packaging of its products — $1.50 for every unit sold

  • Royalties that are paid to bio-medical patent owners working with CSL Ltd — $3.30 for every unit

  • Marketing expenses for the products — $3.00 for every unit

  • Expenses associated with fulfillment — $4.00 for every unit

  • Fees paid to other bio-medical companies owing to contractual agreements – 15% of sale of every unit

In addition to this, CSL Ltd has a 15% bad debt allowance to the gross total of its revenues. This represents the company’s sales cost in the case where it is not able to collect cash from its clients’ credit card companies (Wallace 2007). Exhibit 1 provides the starting balance sheet reflecting these assumptions and the ones presented below. In the spirit of offering this LBO, the following assumptions are taken as the basis of analysis and presentation:

  • Warehouse facilities and development property rent annually – $350,000

  • Fees for licenses for business and relevant governing bodies annually – $1.5 million

  • Salaries and benefits expenses annually – $1.75 million

  • Commissions paid for sales of products – 5% for all product and service sales

  • Administrative costs annually – $750,000

  • Salary for the Chief Executive Officer including bonuses annually – $1.25 million in addition to 3% of all sales

  • Federal rate tax costs annually – 35% with a state tax rate of 5% on the company’s EBT

Proposed Financing Structure and Estimated Share Price for the LBO

Using 2010 as CSL Ltd’s first year of the revenue forecast and considering that there was a 5% growth in units sold in the following year, a balance sheet is developed to guide this LBO. Like is the case for any basic LBO, there is a Senior Debt (Bank Debt) financing which is the lowest and cheapest option for financing instruments that are involved in the purchasing of the company via the LBO (Samuelson 2007). Given the strenuous investment and macroeconomic environment, the Private Equity fund (PE) is in a position to acquire CSL Ltd for the less expensive price of purchase of 5.0 x 2011 EBITDA paid in cash, and this is informed by the assumption that this deal is cash-free debt-free deal (Samuelson 2007). For this transaction, the following are the financial structure deliverables that are critical and important for the business deal:

  • Senior Revolving Credit Facility (RCF) – for this attribute, the LBO will have the following specifications: 3.0x 2011 EBITDA with the prospect of 2017 maturity and LIBOR+ 400 basis points (bps). There will also be a commitment fee of 0.50% for any eventual revolver capacity. This attribute is necessary for the business to ensure that there is enough funding for operation cash requirements for the business that CSL Ltd will continue engaging in (Jarrell 2002).

  • Subordinated Debt – for this attribute, the LBO will have the following specifications: 1.5×2011 EBITDA, which will be accompanied by a 12% annual interest divided as 4% PIK interest and 8% cash interest with the prospect of 2017 maturity. This will also require a $1 million annual amortization

  • Further attribute assumptions for this LBO financing structure – the existing management’s ownership before this LBO is assumed to be 10% it is expected that there will be a roll-over of 50% of its pre-tax exit proceeds from all the transactions that the company engages in. The minimum balance for the company read as Day 1 Cash is set at $ 5million which is the amount required to be footed by the Private Equity Fund (PEF) since this LBO transaction is a debt-free/cash-free deal (Jarrell 2002). All other funding requirements will be taken care of by the PEF.

For this LBO to functionally become operational, all other additional amounts of money beyond the $5 million minimum cash balance together with the amortization needed for every trance will be swept by PEF so as to provide a priority guideline. In other words, there will be a 100% cash flow sweep (Pannell 1997). The 2012 LIBOR will be 3.00% and is forecasted that it will be increasing by 25 basis points (bps) every year. With the M&A fee for the transaction set at $1.5 million, the Private Equity Fund will settle it once the deal has been closed. There will also be a financing syndication fee amounting to 1% of all the debt instruments used for the transaction and there will be amortization of this fee over a five-year straight-line schedule. The New Goodwill for the business is obtained by subtracting Book Value of Equity from the company’s Purchase Equity Value and there will be a 1% interest Income on average cash balance (Saltelli, Chan & Scott 2010).

Income Statement Projections

From the foregoing assumptions and provisions for this LBO, an integrated three-statement LBO model is presented depicting the exact nature of this business deal providing proportional adjustments to the closing balance sheet for CSL Ltd upon acquisition of this deal. Using the 2010 as the basis year for this transaction for revenue forecast, the EBITDA at the time was $25 million and there was an average growth of 5% in units sold by the business in the following year. In addition to this, there was an Upside Case of 5% growth in units every year and a 5% Downside Case decline in units sold every year after 2012 (Anson 2013). Exhibit 2 shows a Depreciation Schedule that assumed that there was a depreciation of PP&E worth $1 million every year and that the new Capital Expenditures that was worth $1.5 million will depreciate on a Five-Year, Straight-Line Basis every year (Anson 2013). In order to build the Debt Schedule to show the capital structure described for this LBO, average balances are used to calculate Interest Expenses other than PIK interest. The latter is calculated based on the starting year Subordinated Debt Balance instead of the annual average (Dresner & Kurt 2013). Exhibit 3 through to Exhibit 5 shows the various projections of related Revenue based on the details of the LBO, that showing the G&A Expenses for the LBO, and that of the Summary Schedule of the LBO based on the details provided herein for the deal.

The LBO Transaction Summary

This section of the proposal provides the transactional summary indicating the various specific attributes for the LBO in general. Among the key things indicated in this summary are Purchase Prices, Uses and Sources, and Goodwill calculations for this business deal. Exhibit 6 provides this summary where as has been indicated previously, this LBO is considered a debt-free/cash-free deal before the transaction of the deal which makes it simpler to compute and understand. This means that when there is no debt or cash, the value of the LBO is equal to the offer price (Dresner & Kurt 2013). As has been explained in the foregoing sections, the funding credit facility used for the LBO is 2.0×2011 EBITDA and the Subordinated debt is 1.5×2011 EBITDA. The remaining portion of the funding is expected to be provided by the Private Equity Fund knowing that the 5.0×2011 EBITDA is the value of the offer for the PEF. This figure is not that considered before the acquisition and the addition of financing fees as well as minimum cash balance and not the value before. When the latter condition is considered, then the value is 5.25 times as indicated in Exhibit 6.

From the details of the LBO deal, the management owns 10% of the business and the value of management rollover is computed as being half of the proceeds obtained from the selling of the company and this amounts to 5% of the offer price for the original LBO deal. The Private Equity Fund required for the deal is the amount solved for to know the amount of investment required to be approved by the Private Equity Fund Board. Mathematically, this figure is obtained by adding offer price, minimum cash, and fees figures and subtracting from this sum the debt instruments and management rollover equity (Dresner & Kurt 2013). According to Lemke, Lins, Hoenig & Rube (2013), a typical LBO transaction requires the total equity of the transaction to be between 30%-35% of the funding of the deal which is the case for this transaction as seen in exhibit 6.

The LBO Pro Forma Balance Sheet

Using the balance sheet provided in exhibit 1, a detailed pro forma balance sheet id produced as shown in exhibit 7. To begin with, given the nature of this LBO, this transaction does not have Pro Forma adjustments for refinancing debt or its cancellation and this is further contributed to by the fact that CSL Ltd does not have a significant debt prior to the deal. Given that the Private Equity Fund is financing the minimum cash balance required to maintain the business, the company’s cash increases by $5 million once the deal is closed. The cost of the deal issued with new debt instruments reflects the adjustment for the Debt Financing Fees required in order to take part in this LBO. This fee will be considered capitalized and amortized for a period of 5 years and will be done to reflect the new capital structure for the deal.

The Equity Adjustment shows the position that the equity taken originally is completely removed from the transaction and the adjustment amount shown in exhibit 7 is the difference between the new equity and that of the old equity for the company. The New Equity value as can be seen from the exhibit is equal to the sum total of the Private Equity Fund contribution and the management’s rollover subtracting from it the M&A fee charged for the LBO. This is considered an off-balance sheet cost (Lemke, Lins, Hoenig & Rube 2013).

Projections for the LBO Assorted Financials

Exhibits 8 (Projections for the LBO Full Income Statements), Exhibit 9 (The LBO Balance Sheet Projections), Exhibit 10 (LBO Cash Flow Statement Projections) and Exhibit 11 (Debt Schedule projections for the LBO) provide summaries for key financial attributes of this LBO. Of these projections, exhibit 11 is singled out because of the importance that this projections have on the whole LBO deal. It creates the circular reference defining the characteristic of this LBO giving an idea of how much debt needs to be paid throughout the LBO deal. In this calculation, the non-discretionary debt is the subordinate debt while the discretionary debt refers to the Senior Credit Facility and Subordinate date (Fraser-Sampson 2007).

Sensitivity Analysis and Proposed Offering Price to the Shareholders of CSL

Discounted Cash Flow (DCF) Model Analysis is the guiding concept used in discussing the sensitivity analysis for this LBO. This model helps understand the discounting of future cash flows to present value using a step-by-step approach.

  • Step 1: Historical Information – CSL Ltd’s assorted financial details including net sales, EBITDA, Amortization and Depreciation and total costs are entered in an excel workbook to sum up to EBIT as shown in exhibit 12. Using a taxation of 30%, the Capital Expenditure (Capex) are also entered into the workbook and after computation as seen in exhibit 12 to provide forecasts for EBITDA and sales forecasts used in subsequent steps of this analysis.

  • Step 2: Historical Working Capital – in the same workbook, CSL Ltd’s working capital is predicted using account receivables, inventory and prepaid expenses which represent the company’s total current costs. The company’s current liabilities are obtained from the addition of account payable and accrued liabilities and from these figures, the Net Working Capital is computed as shown in exhibit 13.

  • Step 3: Future Projections – this step helps understand business performance for the LBO. Since the business has previously had an organic growth of between 14 and 21 percent, its CAGR will be 16% and an EBITDA margin of between 13.5 and 15 percent. When the depreciation and amortization values and taxes are incorporated into this model, the Capex can be obtained as forecasted in exhibit 14.

  • Step 4: Unlevered Free Cash Flow Summaries – From exhibit 2, the summaries of estimated total current liabilities and the net working capital are used to compute the unlevered free cash flow as shown in exhibit 15.

  • Step 5: Target Beta and Capital Structure – following the details provided to the effect that CSL Ltd has a 30% debt to total capitalization and 70% of Equity to total capitalization that are used to determine the company’s capital structure. These are indicated in exhibit 16.

  • Step 6: Computation of Enterprise Value (Offering Price) – with the foregoing inputs entered into the DCF model, the offering price (enterprise value) can be computed as indicated in exhibit 17.

  • Step: 7 Computation for WACC – exhibit 18 shows these computations where the risk free rate and marketing risk premium taken to be 7.1% based on company records are entered in the workbook. For a company such as CSL Ltd, the size premium taken is 1.7% and the cost of debt and the borrowing rate from company records are also entered as shown in the exhibit.

  • Step 8: Summary of the DCF Sensitivity Analysis – exhibit 19, it can be seen that the valuation ranges for CSL Ltd which is found to be ranging between about 5000 and 6000. In order to attain this, the computed values of WACC and EBITDA percentage is entered into the workbook highlighted in dark blue and bold fonts.

The Potential Risks of the Proposed LBO

The following risks are potential challenges that can be anticipated for this LBO transaction as far as CSL Ltd and the Private Equity Fund Board are concerned:

  • Associated financial distress risks – this is the greatest challenge that this LBO, as is the case of any other LBO, poses to investors as it places the company at the risk of running bankrupt should something go wrong. In this regard, the Private Equity Fund board should be cautious on deciding on the percentage debt buyout leveraged for CSL Ltd so that they do not run the risk of running into economic distress (Fraser-Sampson 2007).

  • Associated Cost cutting risks – the concept of Cost cutting in LBO seeks to eliminate unnecessary costs as a way of maximizing cash flow and this when improperly done may cause inefficiencies placing the company’s long-term competitiveness at great jeopardy (Fraser-Sampson 2007). This is a similar challenge that CSL Ltd and other investors involved in this LBO must appreciate and be cautious of.

  • Associated risks of management changes – LBO processes may take on different approaches in some cases where it hostile, this may come with the replacement of top company executives which may compromise the proper management and running of the company. It is therefore important that the private equity fund Board tries as much as possible to retain CSL Ltd’s top management executives so as to benefit from their expertise and knowledge.

Possible Exit Strategies and the Potential Return to the LBO Investors

Given the high risks associated with LBO transactions, there are three main exit strategies that may provide a good way in which the Private Equity Fund sponsors may deal with eventual failures in the deal.

  • Initial Public Offering (LPO) Exit Strategy – this is the commonest way of exit when it is successfully executed for the target firm and would only be viable should the resulting company come out as a potential individual company (Fraser-Sampson 2007). When well executed, this strategy could provide cash for investors involved in the deal and is usually a very complex process that requires very astute planning and investigation of the market trends before being preferred (Wallace 2007).

  • Sale of the Business Exit Strategy – this is the simplest and easiest exit strategy that can be considered by the Private Equity Fund Board where they may decide to sell the business to a strategic buyer. This is under the assumption that such a strategic buyer would be better off with the business as compared to its current owner and it is the best strategy from the sponsor’s stand point since the board negotiates directly with the strategic buyer (Wallace 2007).

  • Subsequent LBO Exit Strategy – as a last resort, this may also be considered where the business is sold to another Private Equity Fund through a secondary LBO. This is not the best strategy and therefore should only be used as a last resort since the Private Equity Fund selling the business will be disadvantaged as it will have to undertake the deal under the bargaining power of the new sponsor (Wallace 2007).

As regards the potential return on investment for the LBO, the values are shown in exhibit 20. In this equity return schedule, the Exit Value of CSL Ltd is obtained by multiplying the EBITDA by different purchase multiples and this is denoted as the Transaction Enterprise Value (TEV). The equity value is obtained by subtracting the Net Debt from the TEV. In order to calculate the Internal Rate of Return (IRR) and the Multiple of Invested Capital (MIC) requires the use of correct Net Present Value discounted by the right number of years (Wallace 2007). For this case,

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For the case of a five year plan such as this LBO’s then, IRR can be computed as follows

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Bibliography

Anson, M. 2013. Handbook of Alternative Assets. New Jersey: John Wiley & Sons Inc.

Dresner, S. & Kurt, K. 2013. PIPEs: A Guide to Private Investments in Public Equity. Princeton, NJ: Bloomberg Press.

Fraser-Sampson, G. 2007. Private Equity as an Asset Class. Hoboken, NJ: John Wiley & Sons.

Jarrell, G. 2002. «Takeovers and Leveraged Buyouts». In David R. Henderson (ed.). Concise Encyclopedia of Economics (1st ed.). New York: Library of Economics and Liberty.

Lemke, T., Lins, G., Hoenig, K. & Rube, P. 2013. Hedge Funds and Other Private Funds: Regulation and Compliance. New York: Thomson West.

McCredie, D. 2014. The Fight Against Disease and CSL’s Seventy Year Contribution. Richmond: Dando McCredie.

Opler, T. & Titman, S. 2010. “The Determinants of Leveraged Buyout Activity: Free Cash Flow vs. Financial Distress Costs.” Journal of Finance, vol. 3, no. 5: pp. 123 – 132.

Pannell, J. 1997. “Sensitivity Analysis of Normative Economic Models: Theoretical Framework and Practical Strategies.” Agricultural Economics, 16: 139-152

Saltelli, A., Chan, K. & Scott, M. 2010. Sensitivity Analysis: Wiley Series in Probability and Statistics. New York: John Wiley and Sons.

Samuelson, R. 2007. «The Private Equity Boom». The Washington Post, March 15, 2007.

Thackray, J. 2009. «Leveraged buyouts: The LBO Craze Flourishes amid Warnings of Disaster». Euromoney, vol. 2, no. 5, pp. 198 – 206.

Wallace, A. 2007. «Nabisco Refinance Plan Set.» The New York Times, July 16, 2007.

Appendices: Exhibits for the LBO Deal

Exhibit 1: Starting Balance Sheet

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Exhibit 2: Income Statements Projections

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Exhibit 3: Revenue Generation Schedule

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Exhibit 4: The G&A expenses

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Exhibit 5: Summary Schedule for the LBO Financing Design

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Exhibit 6: LBO Transactional Summary

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Exhibit 7: The LBO’s Pro Forma Balance Sheet

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Exhibit 8: Projections for the LBO Full Income Statements

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Exhibit 9: The LBO Balance Sheet Projections

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Exhibit 10: The LBO Cash Flow Statement Projections

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Exhibit 11: The LBO Debt Schedule Projections

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Exhibit 12: CLS Ltd Historical Information – Step 1 of the Sensitivity Analysis

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Exhibit 13: CSL Ltd Historical Working Capital – Step 2 of the Sensitivity Analysis

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Exhibit 14: CSL Ltd Future Forecasts– Step 3 of the Sensitivity Analysis

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Exhibit 15: CSL Ltd Unlevered Free Cash Flow Forecasts– Step 4 of the Sensitivity Analysis

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Exhibit 16: CSL Ltd Target Capital Structure and Beta– Step 5 of the Sensitivity Analysis

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Exhibit 17: CSL Ltd Enterprise Value Computation– Step 6 of the Sensitivity Analysis

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Exhibit 18: CSL Ltd Calculation of WACC– Step 7 of the Sensitivity Analysis

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Exhibit 19: Exhibit 18: CSL Ltd Sensitivity Analysis Summary– Step 8 of the Sensitivity Analysis

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Exhibit 20: LBO Return Calculations

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