February 12, 2014 Tactical Research & GS SUSTAIN Does Consolidation Create Value? Equity Research The case for disruptive change Dreams of oligopoly Case studies of six industries: Investors should look for opportunities created by disruptive consolidation. Why? An oligopolistic market structure can turn a cut-throat, commodity industry into a highly profitable one through reduced competitive intensity, scale cost benefits, higher barriers to entry and more. (1) US Airlines (2) Global Beer (3) US Containerboard (4) Hard Disk Drives (5) DRAM (6) US Wireless Consolidation: The good kind of M&A M&A is often assailed as risky or valuedestroying. Our study indicates, however, that in situations where relatively undifferentiated providers are joining forces or taking out excess industry capacity, consolidation correlates with improvement in industry margins and returns. In each case, we investigate the industry’s path to consolidation and what the effects have ultimately been on the sector’s cycle-to-cycle margins, multiples, returns and stock performance. Putting Herfindahl on the toolbelt We leverage the Herfindahl-Hirschman Index (HHI) in our analysis as a crucial tool in monitoring consolidating industries in a uniform way. Robert D. Boroujerdi (212) 902-9158 robert.boroujerdi@gs.com Goldman, Sachs & Co. Derek R. Bingham (415) 249-7435 derek.bingham@gs.com Goldman, Sachs & Co. Samir Siddhanti (415) 249-7440 samir.siddhanti@gs.com Goldman, Sachs & Co. Christopher Wolf (212) 934-4221 christopher.wolf@gs.com Goldman, Sachs & Co. What’s the tipping point for stocks? Deals representing ~10% or more of industry Industries to watch share in our study commonly resulted in strong double-digit market-relative price outperformance for the remaining players in the Investors should be mindful of consolidation in a corporate environment that is short on growth and long on cash. Sectors to watch: Cable, Aggregates/Cement, Generic Pharma, Hospitals, Food and Trucking. subsequent 12 months. Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S. The Goldman Sachs Group, Inc. Global Investment Research February 12, 2014 Global Contents Overview: Does Consolidation Create Value? 3 US Airlines – Large deals sparked margin improvement; stock reaction came later 6 Global Beer – Local markets seeing global benefits from consolidation 8 US Containerboard – Slow and steady path has included transformational catalysts 10 HDD – Extreme consolidation via M&A has led to significant gains 12 DRAM – Consolidation more by atrophy; positive for the stocks, jury still out on margins 14 Wireless exception? – Unique industry dynamics can overwhelm consolidation benefits 16 A word on areas to watch 18 How to calculate a Herfindahl 20 Appendix 21 Disclosure Appendix 25 Analyst team contributors: Luca Cipiccia Mitch Collett Jason English Judy E. Hong Tom Kim LatAm Beverages, Food, Tobacco Beverages & Tobacco (Europe) Packaged Food Beverages & Tobacco (US) Transportaion luca.cipiccia@gs.com mitch.collett@gs.com jason.english@gs.com judy.hong@gs.com tom.kim@gs.com 55-11-3371-0727 44-20-7774-1060 212-902-3293 212-902-0490 212-902-6708 Matthew Niknam Alex Ovshey Jerry Revich, CFA Jami Rubin James Schneider, Ph.D. Telecommunication Services Paper and Forest Products Machinery & Engineering/Construction Pharmaceuticals Semiconductors matthew.niknam@gs.com alex.ovshey@gs.com jerry.revich@gs.com jami.rubin@gs.com james.schneider@gs.com 212-357-3372 212-902-6751 212-902-4116 212-357-7536 917-343-3149 Marcus Shin Bill Shope Brian Zimmerman Asia-Pacific Technology IT Hardware Healthcare Services marcus.shin@gs.com bill.shope@gs.com brian.zimmerman@gs.com 82-2-3788-1154 212-902-6834 212-902-5306 Goldman Sachs Global Investment Research 2 February 12, 2014 Global Overview: Does Consolidation Create Value? Investors should look for opportunities created by ‘disruptive consolidation’. Analyzing six industries, our study suggests that significant increases in industry concentration – whether via individual deals or waves of smaller deals – have typically been followed by improved profitability (i.e., margins and return on capital) and strong relative stock performance in commodity or near-commodity industries. Furthermore, we would argue that investors should be particularly watchful for consolidation events in a corporate environment that is short on growth and long on cash. Dreams of oligopoly. There is a natural pull toward consolidation among mature or maturing industries. An oligopolistic market structure can turn a cut-throat commodity industry into a highly profitable one. Oligopolistic markets are powerful because they simultaneously satisfy multiple critical components of sustainable competitive advantage – a smaller set of relevant peers faces lower competitive intensity, greater stickiness and pricing power with customers due to reduced choice, scale cost benefits including stronger leverage over suppliers, and higher barriers to new entrants all at once. We highlight six industries that have experienced meaningful consolidation over the last decade: US Airlines, Global Beer, US Containerboard, Hard Disk Drives (HDD), DRAM and US Wireless. In each case, we investigate the industry’s path to greater concentration and what the effects have ultimately been on the industry’s cycle-to-cycle margins, multiples, returns and stock performance. We focus mostly on commodity or near-commodity industries where industry structure is likely to have an outsized effect on competitors’ ability to control price. M&A that drives an industry toward oligopoly is the good kind. Although consolidation can occur through weak or obsolete companies closing their doors or exiting a business, the vast majority of industry change in our study has been driven by M&A. M&A is often assailed as a risky or value-destroying endeavor – e.g., management teams ‘empire building’, joining incompatible cultures or overpaying for growthy bolt-ons, to name a few common objections. Our work suggests, however, that in situations where relatively undifferentiated product offerings are joining forces or taking out excess industry capacity, consolidation is well correlated with improvement in sector margins and return on capital. ‘Disruptive consolidation’ is often required to get investor attention. In five of our six industries, we observed steady improvement in industry profitability as concentration levels crept higher. However, we note that more typically it is ‘disruptive consolidation’ – either a single very large deal or a spate of significant deals in a condensed timeframe – that has tended to result in large moves for the stocks. Deals representing ~10% or more of industry share in our study commonly resulted in strong doubledigit market-relative outperformance for the remaining leaders, both in the 12 months following deal announcements and in the 12 months following deal closure (Exhibit 1). Our study makes use of Herfindahl Indices (HHI), a standard measure of the consolidation level of an industry Observing the development of an industry’s Herfindahl-Hirschman Index can be a useful tool for monitoring consolidating industries. An industry’s Herfindahl-Hirshman Index (commonly shortened simply to ‘Herfindahl’ or HHI) serves as a standard and comparable gauge of consolidation levels. The US Department of Justice generally considers HHI levels of 1,500-2,500 to be consistent with moderately concentrated markets, and levels above 2,500 signifying high concentration. The score is calculated as the sum of the squares of the market shares of an industry’s competitors. Industries in our study had HHI starting points as low as 300 a decade ago (in the case of Global Beer) and ending points as high as 3,900 (Hard Disk Drives). Industries to watch for future consolidation. We argue that investors should be especially mindful of improvements to industry structure in the current environment where corporates are likely to be more reliant on M&A for growth given dampened global growth opportunities and record cash balances/low interest rates. While we don’t take a view on the likelihood of deals, our analyst Goldman Sachs Global Investment Research 3 February 12, 2014 Global teams have highlighted the following sectors where potential consolidation is reflected in our sectoral investment framework and departmental M&A rankings, including: Cable, Aggregates/Cement, Generic Pharma, Hospitals, Food and Trucking. Key Questions to Consider:  Is there an HHI tipping point for the stocks? We don’t identify an explicit HHI threshold that has consistently spurred industry stock performance, although in most cases of consolidation-catalyzed stock movement, we have observed a post-transaction level near or in excess of 2,000. Changes to industry structure that have been followed by significant stock outperformance in an industry have most commonly involved the acquisition or retirement of roughly 10% or more of industry share, or multihundred-point HHI moves (Exhibit 1).  Unique industry factors may create exceptions to the consolidation rule. Our study of the US Wireless industry demonstrates an exception to the rule of reliable correlation between increasing consolidation and stronger industry fundamentals and stock performance. In this case, elements unique to the Wireless industry have kept a lid on industry margins and greater investor enthusiasm in recent years even as market concentration has increased due to two factors: Firstly, the smartphone subsidy wave of the last several years has pressured margins. Secondly, the scale requirements of a national footprint and requisite spectrum position to be competitive in this industry have limited the true competitiveness of service providers outside of AT&T and Verizon. This has recently begun to change with T-Mobile and Sprint gaining or nearing the network quality and spectrum footprint necessary to be more aggressive versus the incumbent giants, thus arguably making the industry more competitive even as the HHI has continued to climb. Key Caveats to Consider:  Cases where large consolidation events were not followed by significant outperformance. Two cases stand out where prior notable deals did not get the stocks moving in a significant way. The first is in the US Airlines sector, where two prior deals representing similar capacity and similar HHI moves to American/US Air were completed earlier – Delta/Northwest in 2008 and UAL/Continental in 2010. Delta/Northwest was completed on the eve of the financial crisis in October 2008, making it difficult to draw stock conclusions over the time directly following. Enthusiasm over UAL/Continental was then likely swamped by sharply rising oil prices. Beyond being nearly double the size of these deals in dollar terms, the American/US Air deal also pushed the HHI over the 2,000 level from about 1,750 previously. The second case where a prior large deal did not appear to drive sector stock performance was the bankruptcy of Qimonda in early 2009, which took out nearly 10% of DRAM industry capacity. The remaining group performed roughly in line with the US market in the following year, but lagged in 2010 and 2011 before Micron/Elpida catalyzed significant outperformance thereafter. Although Qimonda going out of business improved the sector’s HHI by more than 350 points to over 2,000, it is perhaps not surprising that consolidation by business failure did not serve as a catalyst for investors to get more optimistic on the space.  Local or global markets? The example of Global Beer. Global Beer measures as considerably more fragmented than the other industries in our study. We calculated an industry starting point for Global Beer of about 300, which more than doubled to over 700 over the past decade. However, the market for beer brands more often tends to be local than global, making it not directly comparable with the HHI scores of other truly global or purely local markets in this study. In the case of our Beer study, the direction of the HHI is much more pertinent than the absolute level. In the following sections, we commit two pages to each of the six industries we have chosen in an effort to observe the impact of consolidation on the surviving players in each industry along a variety of vectors. Goldman Sachs Global Investment Research 4 February 12, 2014 Global Exhibit 1: Consolidation has led to meaningful margin improvement and stock outperformance among five of the six industries in our study Herfindahl (HHI) Margins 'Disruptive' consolidation event(s) Deal announced Deal closed Approx. % share consolidated thru deal (full yr prior) Relative stock performance*** 12 mos post 12 mos post announce. close (or to date) 2003* Current** Type 2003* Current** US Airlines 1,312 2,081 EBIT -0.7% 9.1% AMR/US Airways 14-Feb-13 9-Dec-13 9% +178% na Global Beer 276 725 EBIT 9.6% 19.1% InBev/Anheuser-Busch 11-Jun-08 18-Nov-08 8% +12% +33% International Paper/Temple-Inland 6-Jun-11 13-Feb-12 9% -11% +15% US Containerboard 818 1,589 EBITDA 10.0% 19.0% International Paper/Weyerhaeuser 17-Mar-08 4-Aug-08 16% -6% +12% Seagate/Samsung HDD 19-Apr-11 20-Dec-11 8% +30% +51% 7-Mar-11 8-Mar-12 4% +55% +17% 2-Jul-12 31-Jul-13 16% +64% +53% -- -- -- HDD 1,937 3,921 Gross 13.0% 23.9% Western Digital/Hitachi HDD DRAM 1,447* 3,002 Gross 34.8%* 28.2% Micron/Elpida US Wireless 1,414 2,934 EBITDA 28.1% 37.4% -- -- -- * Our study’s starting point for DRAM is 2006 ** For HHI: 2013 for Global Beer, US Containerboard and HDD; 2014E for Airlines, DRAM and US Wireless. For margins: 2013 for HDD and US Wireless; 2014E for US Airlines, US Containerboard and DRAM; 2015E for Global Beer *** Equal-weighted relative stock performance of remaining industry leaders vs. S&P 500 for US Airlines, US Containerboard, HDD and US Wireless; vs. MSCI ACWI for Global Beer and DRAM Source: Goldman Sachs Global Investment Research Goldman Sachs Global Investment Research 5 February 12, 2014 Global US Airlines – Large deals sparked margin improvement; stock reaction came later Significant industry consolidation driven by M&A. After recent consolidation over the past decade, the “big three” airlines – AMR, Delta and United – are projected to account for over three quarters of the US airlines industry in 2014, compared to just over 50% ten years ago. Consolidation has primarily been driven by M&A, as we have seen three of the largest deals in the sector’s history just in the past five years: Delta-Northwest ($7.3 bn), UAL-Continental ($6.5 bn) and AMR-US Airways ($13.1 bn). All three of the top players added significant market share through their purchases, as Northwest, Continental and US Airways represented approximately 10%, 11%, and 9% of industry revenues prior to takeover, respectively. The industry’s HHI is projected to rise from 1,312 in 2003 to 2,081 in 2014E. Operating margins and industry consolidation have been closely coupled. After years of shareholder value destruction, the industry’s steady march of consolidation was accompanied by more disciplined pricing as well as improving costs structures, aided by the latest rounds of bankruptcies. Exhibits 3 and 4 show the relationship observed between the sector’s HHI score and its operating margin and return on capital. While there were some notable deals prior to 2008, the inflection in the industry’s HHI came in 2009 following the first very large deal – Delta/Northwest – and industry margins have been climbing ever since. While margins were no doubt emerging from the recession’s trough in the wake of Delta/Northwest, they continued to march higher in excess of 2007’s prior peak as additional large deals followed, notably United/Continental, complemented by Southwest/AirTran, and finally followed by AMR/US Airways in 2013. Over this time frame, market-weighted operating margins rose from essentially 0% to an expected 7% expected in 2014 (GS estimates for covered names, consensus for non-covered names). Exhibit 2: US Airlines have seen significant M&A-driven consolidation Exhibit 3: …which has correlated with increased sector operating margins Market share overview HHI vs. 3-year rolling industry weighted operating margin 2014E (HHI = 2,081) 8% Southwest Airlines, 7.0% Other, 12.8% American Airlines, 20.5% American Airlines, 26.4% Southwest Airlines, 11.4% US Airways, 8.1% Continental Airlines, 10.4% United Airlines, 16.2% Delta Airlines, 24.6% Northwest Airlines, 11.9% Delta Airlines, 15.7% United Continental, 24.8% Sector operating margin (aggregate) 6% Other, 10.3% 2300 Oct 2008- Delta completes acq'n of Northwest for $7.3 bn. 2100 1900 4% 1700 2% 1500 0% 1300 1100 -2% -4% -6% 2003 Goldman Sachs Global Investment Research 900 700 500 2004 2005 2006 2007 2008 2009 2010 3-year rolling industry weighted operating margin Source: FactSet, Goldman Sachs Global Investment Research Dec 2013- AMR completes acq'n of US Airways Group for $13 bn. Oct 2010- UAL completes acq'n of Continental for $6.5 bn. Herfindahl-Hirschman index 2003 (HHI = 1,312) 2011 2012 2013E 2014E Herfindahl-Hirschman index Source: FactSet, Goldman Sachs Global Investment Research 6 February 12, 2014 Global One major deal can be a tipping point for sentiment. Margins and returns in the space have been on the mend for years as consolidation accelerated starting in 2008. But the stocks did not begin to outperform in a meaningful way until the most recent large deal in the space – at an enterprise value of $13 bn, AMR/US Air was the largest acquisition ever in the industry by enterprise value – nearly 2X the next largest deals (Delta / Northwest and UAL / Continental). In the full year prior to the deal’s completion, US Airways made up roughly 9% of industry revenues, pushing the HHI from close to 1,750 to an expected level of nearly 2,100 this year. The stocks had generally tracked the market coming out of the financial crisis, followed by a period of underperformance as oil prices jumped between late 2010 and spring 2011 when prices stabilized. Amid a backdrop of more stable oil prices, the group embarked on a significant period of stock outperformance beginning in late 2012 when reports began to emerge that American and US Air were in discussions. From that point through the present day, the stock prices of Delta, Southwest and UAL are up by over 135% on average, with AMR rising significantly more than that from a small base. This compares with a 33% rise for the S&P 500 over the same period. Exhibit 4: Return on capital has also ramped for the largest carriers Exhibit 5: American/US Air news was the key catalyst for the group HHI vs. 3-year rolling industry weighted CROCI US Airlines price performance (indexed) vs. S&P 500 14% Apr 2008- Delta announces intent to acquire Northwest 13% 2400 May 2010- UAL announces intent to acquire Continental 180 160 2200 12% Apr 2008- Delta announces intent to acquire Northwest Feb 2013- AMR officially announces intent to acquire US Airways May 2010- UAL announces intent to acquire Continental 140 1800 10% 1600 9% 8% 1400 Price return (indexed) 11% Herfindahl-Hirschman index Airlines sector CROCI (3-year rolling) 2000 120 100 80 60 40 7% 1200 6% Feb 2013- AMR announces intent to acquire US Airways 5% 4% 2003 July 2012- Press reports of potential AMR-US Airways merger surface 20 1000 0 800 2004 2005 2006 2007 2008 3-year rolling industry weighted CROCI 2009 2010 2011 2012 2013 Herfindahl-Hirschman index Companies included: Delta Airlines, Southwest Airlines, United Continental (AMR excluded because of lack of CROCI figures due to no GS coverage) Source: FactSet, Goldman Sachs Global Investment Research Goldman Sachs Global Investment Research US airline sector (equal weight) S&P 500 Companies included: American Airlines, Delta Airlines, Southwest Airlines, United Continental Source: FactSet, Goldman Sachs Global Investment Research 7 February 12, 2014 Global Global Beer – Local markets seeing global benefits from consolidation The Global Beer industry has undergone a steady process of consolidation. Ten years ago the global beer industry was highly fragmented with Anheuser-Busch’s 8.5% market share enough to make it the global leader. Since then, a steady process of consolidation via M&A has taken place – often focused around cost-cutting opportunities (e.g. the $60 bn merger of Anheuser-Busch and InBev completed in 2008) or geared towards acquiring attractive emerging market assets (e.g. Heineken’s $24 bn acquisition of Asia Pacific Breweries completed in 2012). Today’s AB InBev, with an estimated 21% market share, has been the driving force behind much of this consolidation. Interbrew’s acquisition of AmBev in 2004 created a new global leader, InBev, with 11% share and the subsequent Anheuser-Busch/InBev merger in 2008 again created a global leader, AB InBev, with 20% market share. Today’s top 5 companies represent more than 50% of the global market (versus 32% for the top 5 players in 2003), and the industry’s HHI has risen to 725 in 2013E from just 276 in 2003 (Exhibit 6). Operating margins have steadily trended higher. Realization of operating synergies and scale benefits in production and distribution (e.g. the MillerCoors joint-venture in the US), aggressive cost cutting (e.g. AB InBev’s recent acquisition of Grupo Modelo) and enhanced pricing power have helped drive a significant improvement in operating margins across the industry, especially for those at the top. Indeed, ABI’s industry-leading 32% operating margin in 2013E compares to just 14% and 23% for Interbrew and Anheuser-Busch, respectively in 2003. Similarly, SABMiller – the industry’s runner-up by market share (9.7% in 2013E) – has seen its operating margins improve from 14.9% in 2003 to 27.0% in 2013E. On an industry-weighted basis, EBIT margins have expanded nearly 800bps since 2003 to over 17% in 2013E. Exhibit 6: Global beer has seen consolidation amongst key players… Exhibit 7: …and the industry’s EBIT margins have improved Global market share HHI Index vs. rolling 3-year industry EBIT margins 2013E (HHI = 725) 20% Interbrew, 6.0% Others, 35.1% Heineken NV, 5.7% Others, 56.8% SABMiller, 9.7% AmBev, 4.0% Grupo Modelo, 2.6% Adolph Coors Co, 2.6% Tsingtao Asahi Brewery, Carlsberg, Breweries, 2.2% 2.0% 2.0% Asahi Group Holdings Ltd, 1.3% Kirin Holdings Co Ltd, 2.5% Beijing Molson Yanjing Coors Brewery, Brewing, 3.0% 3.2% Heineken, 9.2% Carlsberg, 5.7% China Tsingtao Resources Brewery, Enterprise, 4.1% 5.6% Sector operating margin (aggregate) SABMiller, 7.6% AnheuserBusch InBev, 20.6% 800 Nov 2008- InBev completes acquisition of AnheuserBusch for $59.6bn AnheuserBusch, 8.5% 18% 16% 700 Aug 2004- Interbrew completes acquisition of AmBev for $11.8bn 600 Jun 2013- AB InBev completes acquisition of Grupo Modelo for $20.1bn 14% 400 10% 8% 300 Oct 2005- SABMiller completes acquisition of Bavaria for $6.9bn 6% 200 2003 2004 2005 2006 2007 2008 2009 2010 3-year rolling industry weighted operating margin Source: Euromonitor, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 500 12% Herfindahl-Hirschman index 2003 (HHI = 276) 2011 2012 2013E 2014E 2015E Herfindahl-Hirschman index Source: Euromonitor, FactSet, Goldman Sachs Global Investment Research. 8 February 12, 2014 Global Valuation – from a discount to premium. Improved industry fundamentals have also translated into improved valuation multiples. In 2003 the median P/E multiple of today’s top 10 global beer companies (i.e. today’s entities as they stood at the time) was 14x, a nearly 20% discount to the MSCI ACWI’s 17x. Today, those same 10 companies have a median P/E of over 17x, nearly 1.3x that of the index. On an absolute basis, 9 out of 10 companies trade at a higher P/E multiple today than they did in 2003. On a relative basis, 8 out of 10 companies trade at a higher P/E than the MSCI ACWI today, versus just 2 out of 10 companies in 2003. Much of this market-relative multiple expansion came in the 2003-2006 period, prior to the Anheuser-Busch/InBev merger, while the roughly 30% valuation premium has held relatively constant since 2007. Improved fundamentals have driven strong stock performance. Outperformance across the global beer stocks has been pronounced as the industry consolidated. Since 2004, the group as a whole outperformed the MSCI ACWI by an average 185% (11% annualized) with 7 out of 10 stocks outperforming by more than 100% (based on price performance in USD). Interbrew, now AB InBev, has outperformed the MSCI ACWI by 425% over the same time period (18% annualized) as the company grew market share from 6% to 20%, primarily via M&A. Price increases (e.g. US beer prices are up 25% since 2003 according to the Bureau of Labor Statistics) and operating cost synergies have been contributing factors to this outperformance. P/E multiples stand at 17.4x today (group median) - below their 2006 peaks of 19.2x, but strong earnings growth has supported an additional 80% stock price appreciation from December-2006 levels on average, while the index is up merely 7% over the same time period. Exhibit 8: P/E multiples expanded relative to the MSCI AC World Index… Exhibit 9: … as global beer has seen strong outperformance since 2003 Ratio of sector median NTM P/E to MSCI AC World NTM P/E; Industry HHI Index Cumulative USD price performance of global beer vs. MSCI AC World Index Jun 2008- InBev announces intent to acquire Anheuser-Busch 1.5x Jun 2011- SABMiller announces intent to acquire Foster's Jun 2012- AB InBev announces intent to acquire Grupo Modelo 450 800 400 700 Mar 2004- Interbrew announces intent to acquire AmBev 600 1.2x 1.1x 500 1.0x Jan 2010 - Heineken announces intent to acquire FEMSA Cervesa 0.9x 0.8x 0.7x Jul 2005- SABMiller announces intent to acquire Bavaria Jan 2008- Heineken and Carlsberg announce intent to acquire Scottish & Newcastle 400 Jan 2010 - Heineken announces intent to acquire FEMSA Cervesa 300 250 Mar 2004- Interbrew announces intent to acquire AmBev Jun 2012- AB InBev announces intent to acquire Grupo Modelo 200 150 100 300 50 200 12/31/2003 Jul 2005- SABMiller announces intent to acquire Bavaria Jun 2008- InBev announces intent to acquire Anheuser-Busch Jun 2011- SABMiller announces intent to acquire Foster's 0 0.6x 12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007 12/31/2008 12/31/2009 12/31/2010 12/31/2011 12/31/2012 12/31/2013 Global beer market-relative NTM P/E (equal weight) Jan 2008- Heineken and Carlsberg announce intent to acquire Scottish & Newcastle 350 Price return (indexed) 1.3x Herfindahl-Hirschman index MSCI relative price to earnings (NTM) 1.4x 12/31/2004 12/31/2005 12/31/2006 12/31/2007 12/31/2008 12/31/2009 Global beer (equal weight) 12/31/2010 12/31/2011 12/31/2012 12/31/2013 MSCI AC World Index Herfindahl-Hirschman index Companies included: Anheuser-Busch InBev, SABMiller, Heineken NV, Carlsberg, China Resources Enterprise, Tsingtao Brewery Co., Molson Coors Brewing Company, Kirin Holdings, Asahi Group, Beijing Yanjing Brewery Companies included: Anheuser-Busch InBev, SABMiller, Heineken NV, Carlsberg, China Resources Enterprise, Tsingtao Brewery Co., Molson Coors Brewing Company, Kirin Holdings, Asahi Group, Beijing Yanjing Brewery Source: Euromonitor, FactSet, Goldman Sachs Global Investment Research. Source: FactSet, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 9 February 12, 2014 Global US Containerboard – Slow and steady path has included transformational catalysts US Containerboard has undergone significant consolidation via M&A. The late 1990’s saw two transformative deals in the US containerboard industry – Jefferson Smurfit’s $6.7 bn acquisition of Stone Container Corp in 1998, creating Smurfit-Stone Container, and International Paper’s $6.3 bn acquisition of Union Camp in 1999. The resulting top 3 producers – Smurfit-Stone, Weyerhaeuser and International Paper – accounted for roughly 40% market share at the time (based on production capacity) leaving the industry’s HHI near 800. International Paper continued to drive consolidation forward, purchasing Weyerhaeuser’s packaging business in 2008 for $6bn (the number two producer when acquired) and Temple-Inland for $4.2 bn in 2012 (the fourth largest producer when acquired) creating an industry-leading enterprise with roughly 33% share. Further, Rock-Tenn’s acquisition of Smurfit-Stone Container in 2011 and Packaging Corporation of America’s most recent acquisition of Boise in October 2013 has left the industry with 4 producers accounting for roughly 70% share and an HHI of nearly 1,600, twice that of a decade ago. (Exhibit 10). Supply discipline has bolstered EBITDA margins. The consolidation of production via M&A has led to capacity rationalization that has outpaced declining demand. Specifically, the 7% reduction in industry-wide capacity from 2003 to 2013, in context of a 5% decline in demand over the same time period, has led to tighter markets and improved pricing for industry players. Indeed, today’s containerboard prices (i.e. linerboard and corrugated medium) are roughly 90% higher than they were in 2003. As a result, industry-weighted EBITDA margins have shown a steady upward trend, moving from 10% in 2003 to 18% in 2013E (Exhibit 11). Further, the impact of major acquisitions on operating profitability has often been immediate, with International Paper’s containerboard EBITDA margins improving by 350bp and 240bp in the year following their Weyerhaeuser (2008) and Temple-Inland (2012) acquisitions, respectively. PCA, although less active in M&A, has also benefitted from the industry’s consolidation, seeing their containerboard EBITDA margins expand nearly 500bp from 15.7% in 2003 to 20.4% in 2013E. Exhibit 10: International Paper has driven much of the consolidation… Exhibit 11: …which has been met with improving EBITDA margins Containerboard industry market share (based on production capacity) HHI Index vs. 3-year rolling industry-weighted EBITDA margins 2013E (HHI = 1,589) 18% Other, 30.4% Other, 33.9% International Paper, 32.7% Weyerhaeuse r, 13.9% International Paper, 11.1% PCA, 5.4% TempleInland, 8.8% PCA, 8.0% GeorgiaPacific, 9.4% GeorgiaPacific, 10.0% Rock-Tenn, 18.8% Sector EBITDA margin (aggregate) SmurfitStone Container, 17.5% 1,800 Aug 2008- IP completes acquisition of Weyerhaeuser's containerboard business for $6bn 17% 1,600 16% 1,400 15% 14% 1,200 13% 1,000 12% Feb 2012- IP completes acquisition of TempleInland for $4.2bn 11% 600 9% 400 8% 2003 2004 2005 2006 2007 2008 2009 2010 2011 3-year rolling industry weighted EBITDA margin Source: Company data, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 800 10% Herfindahl-Hirschman index 2003 (HHI = 818) 2012 2013E 2014E Herfindahl-Hirschman index Source: Company data, Goldman Sachs Global Investment Research. 10 February 12, 2014 Global Returns have improved alongside EBITDA margins. Return metrics also improved as supply discipline led to pricing gains and more favorable supply/demand dynamics. International Paper, which drove of much of the consolidation, saw ROIC improve from 5.1% in 2003 to 27.2% in 2013 as their market share grew from 11% to nearly 33%. Similarly, Rock-Tenn’s and PCA’s ROIC improved from 9.8% and 3.4% in 2003 to 17.9% and 13.6% in 2013E, respectively. Across the top 3 containerboard companies, average ROIC in 2013E stands at 19.6%, more than 3x 2003’s average of just 6.1%. While acknowledging that return measures can be volatile from year-to-year in a cyclical industry, we note that rolling 3-year averages tell the same story, with the 3-year average ROIC for today’s top 3 players improving from 6.4% in 2003 to 18.8% in 2013E. (Exhibit 12). Containerboard stocks have outperformed after consolidation. From 2003 through 2008 the containerboard stocks (i.e. IP, PKG, RKT) performed roughly in-line with the S&P 500. However, this changed shortly after International Paper’s acquisition of Weyerhaeuser’s packaging business in late-2008 (which doubled IP’s market share). From 2009 through today IP, PKG and RKT provided an average 195% cumulative outperformance relative to the market. Acquisition announcements were often met with initial market skepticism, most notably for International Paper which underperformed immediately following the announcement of both its Weyerhaeuser and Temple-Inland acquisitions (i.e. IP -14% in March 2008 and -4% in June 2011). The more recent wave of consolidation (i.e. Rock-Tenn’s acquisition of Smurfit-Stone completed in May 2011 and IP’s acquisition of Temple-Inland completed in February 2012) appears to have reignited the rally across these stocks. Indeed, since 2012 the group has outperformed the S&P 500 by 55% as the industry benefitted from price increases. PKG, who has been less active in terms of M&A (until their recently completed acquisition of Boise), appears to have benefitted the most from the consolidation, outperforming the market by 115% since 2012 as it gained share from IP and RKT. (Exhibit 13). Exhibit 12: ROIC has also improved as the industry consolidated Exhibit 13: Strengthening EPS growth has driven outperformance Containerboard 3-year rolling ROIC vs. Industry HHI Index Cumulative price performance of containerboard sector vs. S&P 500 1,800 400 1,600 350 16% 1,400 14% 12% 1,200 10% June 2011- IP announces intent to acquire Temple-Inland 8% 6% 1,000 800 Jan 2011- Rock-Tenn announces intent to acquire Smurfit-Stone 4% 2% 0% 3-year rolling ROIC Herfindahl-Hirschman index Price return (indexed) 18% Mar 2008- IP announces intent to acquire Weyerhaeuser's containerboard business Herfindahl-Hirschman index Containerboard sector ROIC (3-year rolling) 20% June 2011- IP announces intent to acquire Temple-Inland 300 250 Mar 2008- IP announces intent to acquire Weyerhaeuser's containerboard business Jan 2011- Rock-Tenn announces intent to acquire Smurfit-Stone 200 150 100 600 50 400 0 US Containerboard Sector (equal weight) S&P 500 Companies included: International Paper, Packaging Corporation of America, Rock-Tenn Companies included: International Paper, Packaging Corporation of America, Rock-Tenn Source: FactSet, Company data, Goldman Sachs Global Investment Research. Source: FactSet, Company data, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 11 February 12, 2014 Global HDD – Extreme consolidation via M&A has led to significant gains HDD industry has undergone significant consolidation through M&A over the last decade. The Hard Disk Drive industry has only three remaining manufacturers today compared with seven in 2003. We note that there was significant consolidation prior to 2003, but we focus our study on the latest decade. Seagate and Western Digital are the remaining dominant pure plays with current market shares in excess of 40% each, with the stub coming from Toshiba. There have been several rounds of consolidation events since 2003 including Seagate’s $2.4 bn acquisition of Maxtor in 2006, Toshiba’s $304 mn acquisition of Fujitsu’s HDD business in 2009, Seagate’s acquisition of Samsung’s HDD division for $1.5 bn in 2011, and Western Digital’s acquisition of Hitachi’s HDD business (Viviti Technologies, formerly Hitachi Global Storage Technologies or HGST) for $ 4.4 bn in 2012. Long-run correlation between consolidation levels and margin in this commodity market. We observe in Exhibit 15 below how the industry’s gross margins have crept steadily higher along with the HHI as the sector consolidated. The most significant round of consolidation occurred during the 2011-2012 period with the Seagate/Samsung and Western Digital/HGST deals. Consequently, this period was marked by the steep slope of the HHI curve in 2012, and gross margins rose commensurately in 2012 and 2013. We note that the deals in this period coincided with the Thailand floods which severely limited supply and distorted market share for several quarters, providing an opportunity for prices to subsequently reset at higher levels. That said, industry return on capital does not appear to have caught up with the higher HHI yet (Exhibit 16) as it may take more time to scale cash flow to the consolidators’ capital base that has expanded due to large recent acquisitions. Exhibit 14: HDD has seen consolidation due to rounds of M&A Exhibit 15: Gross margins have been tightly coupled with HHI Market share based on HDD revenue HHI vs. industry-weighted gross margin 2013E (HHI = 3,921) 4500 25% 20% Fujitsu, 7.0% Western Digital, 44.2% Western Digital, 13.2% Seagate, 42.3% HGST, 20.0% Sector gross margin (aggregate) Seagate, 30.1% Maxtor, 18.4% May 2006- Seagate completes acq'n of Maxtor for $2.4bn. Toshiba, 13.6% Toshiba, 6.9% Oct 2009 - Toshiba acquires Fujitsu HDD Operations for $304mn. Mar 2012- Western Digital completes acq'n of HGST for $4.4bn. 4000 3500 3000 15% 2500 2000 10% Dec 2011- Seagate acquires Samsung Electronics HDD Operations for $1.5bn. 5% 1500 Herfindahl-Hirschman index 2003 (HHI = 1,937) Samsung, 4.2% 1000 500 0 0% 2004 2005 2006 2007 2008 2009 3-year rolling industry weighted gross margin 2010 2011 2012 2013 Herfindahl-Hirschman index Companies included: Maxtor (until 2006), Seagate, Western Digital. Source: IDC, Goldman Sachs Global Investment Research Goldman Sachs Global Investment Research Source: Company Data, Goldman Sachs Global Investment Research 12 February 12, 2014 Global HDD stocks have significantly outperformed in the wake of consolidation. The Seagate/Maxtor transaction in 2006 was a large deal for the industry, taking out roughly 15% of industry revenues and moving up the HHI up by about 500 points. The group performed well in the wake of this deal, outperforming the market in 2006, 2007 and the first half of 2008 before succumbing to the financial crisis. After the Western Digital/HGST and Seagate/Samsung deals in the 2011-2012 period was an even more significant change for the industry with roughly a quarter of industry capacity being consolidated in that timeframe as the sector’s HHI jumped up approximately 1,500 points. This step-function change in industry structure has been accompanied by outsized moves in the stocks, with Western Digital and Seagate up 172% and 216% since the beginning of 2012, respectively, versus the S&P 500 up 42%. Exhibit 16: Cash returns have not yet scaled to the expanded capital base Exhibit 17: HDD stocks have significantly outperformed the market in the wake of 2011’s consolidation wave HHI vs. industry average return on capital HDD stock performance (indexed)vs. S&P 500 40% 4500 Feb 2009 - Toshiba announces intent to acquire Fujitsu HDD Operations. Mar 2011- Western Digital announces intent to acquire HGST. Mar 2011Western Digital announces intent to acquire HGST. 500 April 2011- Seagate announces intent to acquire Samsung Electronics HDD Operations 3500 3000 25% 2500 20% Price return (indexed) 30% Dec 2005- Seagate announces intent to acquire Maxtor. 4000 Herfindahl-Hirschman index HDD sector ROIC (3-year rolling) 35% 600 400 300 Dec 2005- Seagate announces intent to acquire Maxtor. Feb 2009 - Toshiba announces intent to acquire Fujitsu HDD Operations. 200 2000 10% 12/31/2004 100 April 2011- Seagate announces intent to acquire Samsung Electronics HDD Operations. 15% 1500 0 1000 12/31/2005 12/31/2006 12/31/2007 12/31/2008 3-year rolling ROIC 12/31/2009 12/31/2010 12/31/2011 12/31/2012 12/31/2013 Herfindahl-Hirschman index Companies included: Maxtor (until 2006), Seagate, Western Digital HDD sector (equal weight) S&P 500 Companies included: Maxtor (until 2006), Seagate, Western Digital Source: Datastream, Goldman Sachs Global Investment Research Goldman Sachs Global Investment Research Source: Datastream, Goldman Sachs Global Investment Research 13 February 12, 2014 Global DRAM – Consolidation more by atrophy; positive for the stocks, jury still out on margins DRAM industry has consolidated as sub-scale players atrophied… The DRAM industry has consolidated with relatively little M&A activity as smaller players ceded share to the industry’s leaders over time. The market share of the top three producers – Samsung, Hynix and Micron – has increased from 52% in 2006 to 92% in 2014E, measured in bit shipments. There have been two major events in the consolidation of the industry in the past five years. The first was the bankruptcy of Qimonda, a German memory producer, in early 2009. Qimonda accounted for nearly 10% of industry supply, and its bankruptcy drove the industry’s HHI up 300 points. The next major consolidation event was the Elpida bankruptcy in early 2012, followed by the company’s announced acquisition by Micron in July of the same year. Elpida’s market share prior to its bankruptcy and acquisition were even larger than Qimonda’s (19% in 2011) leading to an HHI improvement of 600 points. … though the jury is still out on cycle-to-cycle margin benefits. As typical for the semiconductor industry, the DRAM market is characterized by significant cyclicality, making it more difficult to gauge what effects consolidation has had on margins as a result of consolidation in recent years. We observe in Exhibit 19 that latest trough margins observed in 2012 were higher than the prior trough three to four years previously. Whether the next peak of the cycle will be higher than the last peak is a subject of debate. Our sector team believes industry margins are likely to peak in 2014, as the industry is benefiting cyclically from a lack of new supply added over the past two years, as well as from temporary supply disruption due to a fire at Hynix’s factory in September 2013. Although some investors believe the industry will sustain margins at or above current levels due to industry consolidation, we anticipate a cyclical retracement as temporary supply shortages abate – though we do believe the industry can achieve higher crosscycle margins than in prior cycles. Exhibit 19: Due to cyclicality it is not yet clear whether industry margins have structurally improved… Exhibit 18: Industry has consolidated largely independent of M&A DRAM market share based on bit shipments HHI vs. industry weighted gross margin 2006 (HHI = 1,447) 2014E (HHI = 3,002) 45% Other, 4.5% 3500 40% 35% Other, 7.7% 3000 Promos, 5.2% Nanya/Inotera, 7.6% Samsung, 38.1% Micron, 23.6% Micron, 10.2% Hynix, 17.6% Jan 2009 Qimonda files for bankruptcy 25% 2500 20% 15% 2000 10% July 2013Micron completes acq'n of Elpida for $2.6bn. 5% 0% Elpida, 11.1% Hynix, 30.5% Qimonda, 13.0% Herfindahl-Hirschman index Samsung, 24.4% Powerchip, 6.4% DRAM sector gross margin 30% 1500 -5% -10% 2006 1000 2007 2008 2009 2010 Industry weighted gross margin 2011 2012 2013 2014E Herfindahl-Hirschman index Companies included: Elpida, Hynix, Micron, Nanya, Promos, Samsung Source: Gartner, Goldman Sachs Global Investment Research Goldman Sachs Global Investment Research Source: Company Data, Goldman Sachs Global Investment Research 14 February 12, 2014 Global Similar to US Airlines, a large deal that pushed the HHI price deep into consolidation territory has sparked the stocks. DRAM stocks broadly lagged the market since the end of 2006 as the industry was plagued by chronic oversupply and fierce competition. Micron’s acquisition of Elpida, announced in July 2012, seems to have led to an inflection point for the stocks which began rising in earnest a few months later in late 2012. Since the announced Elpida acquisition, the group has outperformed the MSCI ACWI by 117%. Exhibit 21: Industry stock prices broadly lagged until the Micron-Elpida deal helped to catalyze investor enthusiasm Exhibit 20: … with the same story for industry return on capital DRAM sector CROCI since the end of 2006 DRAM stock performance (indexed) vs. MSCI ACWI 3500 25% July 2012- Micron announces intent to acquire Elpida. 20% 160 140 3000 Jan 2009 Qimonda files for bankruptcy 2500 2000 10% 5% 1500 0% 12/31/2006 1000 Price return (indexed) Jan 2009 Qimonda files for bankruptcy 15% Herfindahl-Hirschman index DRAM sector CROCI 120 100 July 2012- Micron announces intent to acquire Elpida. 80 60 40 20 12/31/2007 12/31/2008 12/31/2009 12/31/2010 Industry weighted CROCI 12/31/2011 12/31/2012 Herfindahl-Hirschman index 12/31/2013 12/31/2014 0 12/31/2006 12/31/2007 12/31/2008 12/31/2009 DRAM sector (equal weight) 12/31/2010 12/31/2011 MSCI All Country World Index 12/31/2012 12/31/2013 Companies included: Hynix, Micron Companies included: Elpida, Hynix, Micron, Nanya, Promos Source: Datastream, Goldman Sachs Global Investment Research Goldman Sachs Global Investment Research Source: Datastream, Goldman Sachs Global Investment Research 15 February 12, 2014 Global Wireless exception? – Unique industry dynamics can overwhelm consolidation benefits The sector has seen significant consolidation... Since 1998, there have been ten notable deals in the US wireless industry (see Appendix for detail), nearly all of which involved a large national carrier (e.g., AT&T, Verizon) acquiring a smaller regional-focused carrier for its customer base, spectrum or both. In 2014, consensus estimates forecast that the largest four companies in the sector – AT&T, Verizon, Sprint and T-Mobile – will command over 98% of the US wireless market, up from roughly 60% in 2003 (Exhibit 22). The most aggressive consolidator during this period has been AT&T, whose share has increased from 17% a decade ago to 33% in 2013, followed by Verizon (37% share in 2013 vs. 22% in 2003). The industry’s HHI is expected to top 2,900 by the end of this year, which would classify the market as highly consolidated. … yet industry margins have flattened due to the unique competitive dynamics of a network-centric business. While industry-weighted EBITDA margins moved significantly higher between 2003 and 2006/7 (see Exhibit 23), they have largely flattened out in the face of the greater part of industry consolidation that has taken place since that time. This has been in part due to the effect of subsidies during the rapid adoption phase for smartphones. More recently, while the HHI score for the overall industry has continued to move higher, it is arguable that the industry has in fact become more competitive for the industry’s top two companies, as #3 and #4 players Sprint and T-Mobile have strengthened their competing nationwide networks with ongoing buildouts and spectrum acquisitions (i.e., T-Mobile’s acquisition of MetroPCS and Sprint’s acquisition of Clearwire). This has enabled them to be more competitive vs. Verizon and AT&T in key urban markets than previously, a dynamic that could continue to keep a lid on industry margins near term despite a very high level of consolidation. Exhibit 22: National carriers have consolidated regional players… Exhibit 23: … yet industry margins have been largely held in check US Wireless market share HHI vs. 3-year rolling industry weighted EBITDA margin 2003 (HHI = 1,414) 40% 2014E (HHI = 2,934) 3000 Other , 2.1% Sprint Corporation, 12.7% AT&T, 17.2% 36% 2400 34% 2200 32% 30% 28% AT&T, 34.1% 24% 2003 1800 Apr 2013- TMobile completes acq'n of Metro PCS for $6.7 bn. Aug 2005Sprint completes acq'n of Nextel for $42.7 bn. 26% Cingular, 15.6% 2000 Jan 2009Verizon completes acq'n of Alltel for $28.1 bn. 1400 1200 1000 2004 2005 2006 2007 2008 2009 2010 3-year rolling industry weighted EBITDA margin Source: FactSet, Goldman Sachs Global Investment Research Goldman Sachs Global Investment Research 1600 Herfindahl-Hirschman index Verizon Wireless, 37.6% Sprint Corporation, 15.2% Nextel, 10.8% 2600 T-Mobile US, 11.0% Verizon Wireless, 22.3% Sector EBITDA margin (aggregate) T-Mobile US, 7.9% 2800 38% Alltel, 4.9% 2011 2012 2013E 2014E Herfindahl-Hirschman index Source: FactSet, Goldman Sachs Global Investment Research 16 February 12, 2014 Global Total shareholder returns have broadly kept pace with the S&P 500. Total shareholder returns (TSR) for the wireless industry have done well, keeping pace with the S&P 500 on an equal-weighted basis, though not outpacing the index to the extent of the other industries in our analysis over the last decade. That said, the two largest companies in the space – AT&T and Verizon – have significantly outpaced the broader market in TSR, returning 118% and 153%, respectively, versus the market return of 65%, assuming dividend reinvestment. This is despite relatively limited multiple expansion for both companies, which have traded in a range of approximately 0.8x and 1.2x the S&P 500 multiple over the past decade. Together, AT&T and Verizon combine for over 80% of profits in the sector and have been the most aggressive in terms of adding smaller providers to their networks, reaping the greatest benefits from increased scale, which has led to outperformance. While TMobile’s margins have lagged slightly compared to its larger counterparts, the company did see a very strong 2013 on the back of network reinvestment and new devices, as well as refreshed marketing initiatives. Sprint could also be positioned to get more aggressive vs. the #1 and #2 players as its network investment progresses and it looks to leverage spectrum acquired from Clearwire. Exhibit 24: Sector relative multiples have been rangebound for the market leaders despite significant industry consolidation Exhibit 25: Total shareholder returns for the top four players have only kept pace with the broader market as consolidation has progressed, though the largest consolidators have outperformed HHI vs. S&P-500 relative P/E for AT&T and Verizon US Wireless (total return index) vs. S&P 500 (total return index) 3000 1.4x 200 180 2500 2000 0.8x 1500 0.6x 1000 0.4x 500 0.2x Total return (indexed) 1.0x 160 Herfindahl-Hirschman index S&P relative price to earnings (NTM) 1.2x 140 120 100 80 60 Oct 2012- T-Mobile announces intent to acquire Metro PCS 40 20 December 2004- Sprint announces intent to acquire Nextel Jun 2008- Verizon announces intent to acquire Alltel 0 0.0x 12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007 12/31/2008 12/31/2009 12/31/2010 12/31/2011 12/31/2012 12/31/2013 Wireless market-relative P/E Herfindahl-Hirschman index Companies included: AT&T and Verizon Source: FactSet, Goldman Sachs Global Investment Research Goldman Sachs Global Investment Research 0 Wireless sector (total return index) S&P 500 (total return index) Companies included: AT&T, Sprint Corporation, T-Mobile, Verizon Wireless Source: FactSet, Goldman Sachs Global Investment Research 17 February 12, 2014 Global A word on areas to watch Our analysts continue to focus on these areas as potential avenues for consolidation, and we offer the following brief synopses as food for thought: Cable Matthew Niknam The Cable industry is relatively concentrated, with the largest four firms (Comcast, Time Warner Cable, Charter and Cox) controlling over 75% of Cable video subscribers and nearly 80% of broadband subs. Yet despite the relatively high levels of concentration, Cable operators continue to face aggressive competition from: (1) two national satellite video providers (DISH, DirecTV), (2) Telco video competition across large swaths of the country and Telco broadband competition nationwide, as well as (3) risk of new online multichannel entrants and potential broadband overbuilders (i.e. Google). Furthermore, Cable companies continue to grapple with high-single digit programming cost inflation and video gross margin pressure, driven by sports content and broadcast retransmission fees (with limited relief expected near-term). Investors have looked towards broader scale as a potential source of combatting these pressures; that said, within the last five years, only a handful of sizable Cable acquisitions have been consummated, with most serving as small-scale tuck-ins for larger providers. However, large-scale consolidation has come back into focus since press reports (WSJ, Bloomberg) from June 2013 indicated Liberty Media, which owns a 27% stake in Charter, was interested in further consolidating the industry. Since then, Charter has announced a public offer to acquire Time Warner Cable. While we don’t take a view on the likelihood of a deal, we believe the regulatory environment also appears more accommodative, with a federal appeals court in late 2009 removing the 30% ownership cap that limited a single Cable operator from serving more than 30% of industry subscribers nationwide. Aggregates/Cement Jerry Revich, CFA The US nationwide aggregates market appears fragmented at first glance with the top 10 companies accounting for only 40% of production. However, aggregates’ high weight to cost ratio drives outsized transportation costs on shipments over 15-20 miles, effectively creating numerous small markets and a wide dispersion in pricing between consolidated and unconsolidated markets. Over the course of the construction downturn, the aggregates industry has continued to move toward a rationalized market structure with Vulcan Materials, Martin Marietta, Lafarge, Texas Industries, and others participating in asset swaps that have improved individual market structures. Over the past 15 years, Martin Marietta and Vulcan Materials have added ~70% to their aggregates production capacity through acquisitions. In the US cement industry, we see potential for continued consolidation as producers look toward new 2015 EPA regulations that are expected to increase cement plant replacement costs by 15-20%. Industry capacity utilization is on track to hit sold out levels by 2015, with lack of capacity additions and a robust private non-residential construction recovery contributing to a significant acceleration in pricing. Major recent industry consolidation and acquisition moves have included (1) Cementos Argos’ acquisition of Vulcan Materials cement business in Florida, (2) Eagle Materials’ acquisition of two Lafarge plants in Oklahoma and Missouri in 2012, and (3) MLM’s recently proposed merger with Texas Industries (7.4 mn tons of cement capacity). Generic Pharma Jami Rubin There are two key driving forces behind future consolidation in the generic space. First, the generic drug industry is mature, with the largest opportunities (blockbuster small molecule drugs going off patent) having already passed into the background (e.g. Lipitor and Zyprexa in 2011, Lexapro in 2012, Cymbalta in 2013). Second, the generics industry is transitioning to specialty branded pharmaceuticals (e.g. urology, dermatology, women’s health, gastrointestinal medicine) where drugs/formulations are more difficult Goldman Sachs Global Investment Research 18 February 12, 2014 Global to make thereby creating more pricing power, higher barriers to entry and longer product cycles. These two forces have driven business development and acquisitions in the generic space. Deals have included product deals for injectable generics, respiratory generics, topical generics and other specialty drugs. They also include deals to gain access to certain high-growth geographies (e.g. Japan, Emerging Markets) as well as adding leverage, share repurchases and tax inversions. We expect the high level of activity to continue. Hospitals Brian Zimmerman The hospital industry is witnessing an increasing number of M&A transactions as individual hospitals become part of larger healthcare systems. Key drivers for the increase in M&A activity in the hospital space include reimbursement pressure, benefits of economies of scale and higher penalties for low-quality delivery of care. In addition, we expect healthcare reform to accelerate consolidation moving forward, and this could lead the way for more nontraditional alliances. The increased hospital M&A activity is involving (1) consolidation of community hospitals with regional and national hospitals, (2) alignment of regional not-for-profit systems with other regional systems, and (3) out-of-industry participants entering the market. M&A activity increased to a historically high level in 2012 – to 109 deals, up from 92 in 2011. Similarly, the number of facilities involved in the deals increased significantly in 2012 to 352 – the highest in the last 10 years – from 212 in 2011, and robust deal activity continued in 2013. Food Jason English If you cannot build it, then buy it. Staples firms remain platform businesses that offer cost-cutting synergy opportunity through mergers; a source of growth when organic opportunity is scarce. We believe there is potential for M&A activity with the domestic US food industry to rise in 2014, as sellers may be attracted by recent high multiples compared to historical averages, and buyers are incentivized by low cost of capital and investors’ recent tendency to reward the stock of the acquiring firm on accretive M&A. In this context we view investment in consolidators with stable core businesses as an opportunity to drive outperformance in 2014. We favor SMID-cap consolidators for investment against this theme. We have seen a scarcity of large assets coming to market which limits the likelihood of needle-moving acquisitions for large-cap firms. However, there have been a plethora of small transactions that have proven to have material accretion potential for SMID-cap firms. Trucking Tom Kim The less-than-truckload industry is highly consolidated at the national level, with the top 20 carriers representing approximately 80% of the market in 2012, up from 67% in 2005. On a regional basis, the space is more fragmented with many small players vying for business. Industry dynamics have made it more difficult for local carriers to operate, which has stimulated further consolidation. Regulatory concerns have led to tighter capacity, as uncertainty and stricter financing terms have forced carrier to push out capex cycles, driving increased costs for smaller carriers (i.e., maintenance). Higher diesel fuel prices, driver shortages and new hours-ofservice rules have also caused operating expenses to surge, which we think places a greater burden on smaller operators with less scale to compete against larger players. Goldman Sachs Global Investment Research 19 February 12, 2014 Global How to calculate a Herfindahl The Herfindahl-Hirschman Index (HHI) is a measure of market concentration recognized by bodies such as the US Federal Trade Commission and the European Commission. The HHI is calculated by summing the squares of each competing firm’s market share. The HHI approaches zero when a market is occupied by a large number of firms of relatively equal size, and maxes out at 10,000 in a pure monopoly. US regulatory agencies generally consider markets with an HHI of 1,500 to 2,500 as moderately concentrated, and markets with an HHI in excess of 2,500 as highly concentrated. Exhibit 26: Calculation methodology for Herfindahl-Hirschman Index 2013E (HHI = 3,921) Data Company Western Digital Seagate Toshiba Toshiba, 13.6% Western Digital, 44.2% Seagate, 42.3% Market Share 44.16% 42.27% 13.56% HHI Calculation Industry HHI = 44.162 + 42.272 + 13.562 = 3,921 Source: FactSet, Goldman Sachs Global Investment Research Goldman Sachs Global Investment Research 20 February 12, 2014 Global Appendix Exhibit 27: Select M&A transactions in US Airlines Acquirer Company Name Target Company Name AMR Corp. US Airways Group, Inc. Southwest Airlines Co. UAL Corp. Announcement Date Closing Date Enterprise Value ($ mn) EV/EBITDA 14-Feb-2013 09-Dec-2013 $13,134 10.7x AirTran Holdings, Inc. 27-Sep-2010 02-May-2011 1,592 7.8x Continental Airlines, Inc. 03-May-2010 01-Oct-2010 6,497 11.1x Delta Air Lines, Inc. Northwest Airlines Corp. 14-Apr-2008 29-Oct-2008 7,287 5.0x Northwest Airlines Corp. Midwest Air Group, Inc. 12-Aug-2007 31-Jan-2008 375 60.1x Sky West, Inc. Atlantic Southeast Airlines, Inc. 15-Aug-2005 07-Sep-2005 1,734 10.8x US Airways Group, Inc. America West Holdings Corp. 19-May-2005 27-Sep-2005 2,082 33.2x American Airlines, Inc. Trans World Airlines, Inc. 10-Jan-2001 09-Apr-2001 3,585 - Source: FactSet Goldman Sachs Global Investment Research 21 February 12, 2014 Global Exhibit 28: Select M&A transactions in Global Beer Acquirer Company Name Target Company Name Announcement Date Closing Date Enterprise Value ($ mn) EV/EBITDA Constellation Brands, Inc. Compania Cervecera de Coahuila SA de CV 14-Feb-2013 07-Jun-2013 $2,900 - Anheuser-Busch InBev SA Grupo Modelo SAB de CV 29-Jun-2012 04-Jun-2013 36,045 17.0x Heineken NV Asia Pacific Breweries Ltd. 19-Sep-2012 25-Sep-2012 24,214 44.3x Molson Coors Brewing Co. Starbev Management Services sro 03-Apr-2012 18-Jun-2012 3,525 - Anadolu Efes Biracilik ve Malt Sanayii A.S. 19-Oct-2011 06-Mar-2012 1,573 - SABMiller Plc SABMiller Plc /Russian & Ukrainian Beer Businesses/ Foster's Group Ltd. 21-Jun-2011 16-Dec-2011 13,125 - Kirin Holdings Co., Ltd. Jadangil Participacoes e Representacoes Ltda. 03-Nov-2011 03-Nov-2011 1,347 - Kirin Holdings Co., Ltd.; Kirin Holdings Investment Brasil Participacoes SA Heineken NV Aleadri-Schinni Participacoes E Representacoes SA 01-Aug-2011 02-Aug-2011 2,604 - Cuauhtemoc Moctezuma Holding SA de CV 11-Jan-2010 30-Apr-2010 9,693 12.2x Kirin Holdings Co., Ltd. Lion Nathan Ltd. 27-Apr-2009 21-Oct-2009 5,797 14.0x SABMiller Plc Kompania Piwowarska SA 14-May-2009 17-Jun-2009 3,948 - Kirin Holdings Co., Ltd. San Miguel Brewery, Inc. 20-Feb-2009 22-May-2009 2,759 - InBev SA Anheuser-Busch Cos., Inc. 11-Jun-2008 18-Nov-2008 59,676 15.1x Heineken NV; Carlsbergfondet; Carlsberg A/S; HEINEKEN Holding NV; Sunrise Acquisitions Ltd. SABMiller Plc Scottish & Newcastle Plc 25-Jan-2008 28-Apr-2008 18,784 19.3x Royal Grolsch NV 19-Nov-2007 21-Feb-2008 1,284 14.2x SABMiller Plc Bavaria SA 28-Oct-2005 24-May-2006 6,842 10.5x Altria Group, Inc.; SABMiller Plc Bavaria SA 19-Jul-2005 12-Oct-2005 6,894 10.7x 03-Sep-2004 29-Mar-2005 11,978 13.2x 22-Jul-2004 09-Feb-2005 4,105 10.1x InBev SA Companhia de Bebidas das Americas - AMBEV Adolph Coors Co. Molson, Inc. InBev SA Braco SA 03-Mar-2004 27-Aug-2004 3,989 - Companhia de Bebidas das Americas - AMBEV Labatt Breweries of Canada Ltd. 03-Mar-2004 27-Aug-2004 7,843 - Carlsberg A/S Carlsberg Breweries A/S 19-Feb-2004 08-Mar-2004 7,221 - Source: FactSet Goldman Sachs Global Investment Research 22 February 12, 2014 Global Exhibit 29: Select M&A transactions in US Containerboard Acquirer Company Name Target Company Name Announcement Date Closing Date Enterprise Value ($ mn) EV/EBITDA Packaging Corp. of America Boise, Inc. 16-Sep-2013 25-Oct-2013 $1,980 KapStone Paper & Packaging Corp. Longview Fibre Paper & Packaging, Inc. 10-Jun-2013 18-Jul-2013 1,025 7.8x - International Paper Co. Temple-Inland, Inc. 06-Jun-2011 13-Feb-2012 4,245 10.1x 7.5x Rock-Tenn Co. Smurfit-Stone Container Corp. 23-Jan-2011 27-May-2011 4,159 International Paper Co. Weyerhaeuser Co. /Packaging Business/ 17-Mar-2008 04-Aug-2008 6,000 Koch Forest Products, Inc. Georgia-Pacific Corp. /Old/ 13-Nov-2005 23-Dec-2005 20,321 8.5x Smurfit-Stone Container Corp. St. Laurent Paperboard, Inc. 23-Feb-2000 31-May-2000 1,381 22.8x International Paper Co. Union Camp Corp. 24-Nov-1998 30-Apr-1999 6,348 11.8x Smurfit-Stone Container Corp. Stone Container Corp. 11-May-1998 18-Nov-1998 6,647 - Jefferson Smurfit Corp. Stone Container Corp. 01-May-1998 01-May-1998 6,703 - - Source: FactSet Exhibit 30: Select M&A transactions in HDDs Acquirer Company Name Target Company Name Announcement Date Closing Date Enterprise Value ($ mn) EV/EBITDA Seagate Technology Samsung Electronics HDD Operations 19-Apr-2011 20-Dec-2011 $1,539 - Western Digital Hitachi Global Storage Technologies 07-Mar-2011 08-Mar-2012 4,250 - Toshiba Fujitsu HDD Operations 17-Feb-2009 01-Oct-2009 304 Seagate Technology Maxtor Corp. 21-Dec-2005 22-May-2006 2,017 13.4x - Closing Date Enterprise Value ($ mn) EV/EBITDA 31-Jul-2013 $6,761 20.7x Source: FactSet Exhibit 31: Select M&A transactions in DRAM Acquirer Company Name Micron Target Company Name Elpida Announcement Date 02-Jul-2012 Source: FactSet Goldman Sachs Global Investment Research 23 February 12, 2014 Global Exhibit 32: Select M&A transactions in US Wireless Acquirer Company Name Target Company Name Announcement Date Closing Date Enterprise Value ($ mn) EV/EBITDA Sprint Nextel Corp. Clearwire Corp. 17-Dec-2012 09-Jul-2013 $11,386 - T-Mobile USA, Inc. MetroPCS Communications, Inc. 03-Oct-2012 30-Apr-2013 6,699 - AT&T, Inc. Centennial Communications Corp. 07-Nov-2008 06-Nov-2009 2,834 7.3x Verizon Communications Alltel Corp. 05-Jun-2008 09-Jan-2009 28,100 11.0x Verizon Communications Rural Cellular Corp. 30-Jul-2007 07-Aug-2008 2,669 12.1x T-Mobile USA, Inc. Suncom Wireless Holdings, Inc. 17-Sep-2007 22-Feb-2008 2,515 15.4x AT&T, Inc. Dobson Communications Corp. 29-Jun-2007 15-Nov-2007 4,882 10.3x Alltel Western Wireless Corp. 10-Jan-2005 01-Aug-2005 4,481 9.2x Sprint Corp. Nextel Communications, Inc. 15-Dec-2004 12-Aug-2005 42,684 7.5x Cingular Wireless AT&T Wireless Services 17-Feb-2004 26-Oct-2004 47,627 10.8x Source: FactSet Goldman Sachs Global Investment Research 24 February 12, 2014 Global Disclosure Appendix Reg AC We, Robert D. Boroujerdi, Derek R. 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