Market Activity There was a strong finish in the 2010 M&A market with the highest monthly transaction volume, $69.2 million, and highest number of transactions, 856. For all of 2010, transaction volume for deals between $1 million and $500 million was approximately $689.6 million for 9,073 deals versus $565.5 million for 7,018 deals completed in 2009, an increase of 21.9% and 29.3%, respectively. The market appears to have turned the corner from the dismal levels of both transaction volume and number of transactions experienced in the second half of 2008 and majority of 2009.

The second half of 2010 accelerated on the trends which emerged earlier in the year. As noted above, the year ended with December 2010 having the highest monthly level of activity measured in dollars or number of deals than any other month in 2010. This was a great way to finish 2010 and begin 2011. Continued improvements in a number of factors have contributed to an improving deal market, specifically:

• Relatively low interest rates
• Significant cash balances in both the strategic buyer and financial buyer communities
• Gradually rising company valuations, which are still low enough to attract strong buyer interest but high enough to motivate sellers
• A continuation of the favorable tax environment (the so called “Bush Tax Cuts”) for at least another two years

The last factor, the “Bush Tax Cuts,” may have contributed to the escalation of deal activity in late 2010 as many deals were expedited to close “under the wire” by year end. The extension of these tax rates for another two years will undoubtedly lead to more robust M&A activity in 2011 and 2012. However, the rush to the finish line in December has pulled some of the deal volume “forward” into 2010 and as a result, somewhat reduced the M&A activity in January 2011.

While new deal activity has been soft in the first couple of months of 2011, we remain optimistic that the overall business and economic environment points to a very good year for the M&A market in 2011.

Valuations M&A valuations for both LBO (the LBO valuation multiples are a proxy for what the financial buyers can pay) transactions and strategic transactions have shown modest improvement during 2010 when compared to 2009. The spread between the Strategic and LBO lines was pretty wide in early 2010. It appears as though the strategic buyers may have gotten ahead of the market in early 2010 and pursued acquisitions with vigor to achieve growth and earnings objectives. The Strategic community bid up company prices and dramatically exceeded the valuations paid by financial buyers.

Coming out of the recession, strategic buyers were anxious to increase both revenues and earnings. Acquisitions are one of the quickest ways to extend product and service offerings, acquire new customers, diversify revenue streams, or expand capacity. Strategic buyers can pay more for a company in a merger because of the cost savings in eliminating redundant functions, achieving purchasing efficiencies, and other synergistic savings. These strategic buyers must be careful not to “pay” the seller for the cost savings and synergies that they, as buyers, bring to the table. In theory, a strategic buyer should determine the maximum value a financial, or LBO, buyer can place on the company and then pay “one dollar more” to win the auction. Obviously, this theoretical strategy is far more difficult to implement in practice, particularly when a good investment banker has executed a well orchestrated sales process. This widening spread between strategic and financial buyers is pretty typical in the early phases of a post-recession M&A market. A similar, although less dramatic, Strategic/LBO valuation spread occurred during the early 2000s in the early phases of the economic recovery after the technology bubble recession.

Overall, we expect continued improvement in company valuations as corporate earnings improve, debt used to make acquisitions becomes more plentiful, and the economy shows further stability and improvement. We also expect the gap between strategic and financial buyers to narrow somewhat in 2011 and into 2012.

Financing Markets

The pricing compression and credit metric relaxation that characterized the first half of 2010 stalled out in the second half of the year. However, the number of credit market participants at all levels of the capital structure continued to expand providing ample liquidity to drive a significant increase in transaction activity. In early 2011, pricing compression and credit metric relaxation resumed for larger middle market borrowers as hedge funds re-entered the primary loan market as major buyers of bank debt.

Mezzanine investors are actively seeking investments. With increased competition for deals, we are seeing downward pressure on investor return targets.

Senior Bank Debt Middle market loan issuance for the fourth quarter of 2010 registered a record $58 billion, which exceeded the $57 billion issued during the second quarter of 2007. Loan issuance for all of 2010 came in at $150 billion versus $72 billion in 2009, an increase of 108.3%. Over 90.0% of respondents to the Thomson Reuters LPC Quarterly middle market survey have raised middle market lending budgets and in some cases believe deal flow will fall short of their demand.

Middle market sponsored loan issuance for the fourth quarter of 2010 equaled $21.9 billion, the second highest quarterly figure on record behind the $24.7 billion raised during the second quarter of 2007. Total issuance for 2010 reached $52.7 billion versus a dismal $13.5 billion in 2009, an increase of 290.4%.

LBO issuance reached $6.5 billion in the fourth quarter of 2010 and $17.2 billion for all of 2010 versus $3.4 billion for all of 2009, an increase of 405.9%.

In early 2011, bank loan activity accelerated from the torrid pace of late 2010. Pricing and terms for a particular borrower are a function of specific facts and circumstances. However, in general, we are seeing the following broad bank lending market conditions:

Over $15 million in EBITDA Borrowers (club or non-broadly syndicated deals)

Under $10 million in EBITDA Borrowers (club or non-broadly syndicated deals)

• 2.5x to 3.5x senior debt / EBITDA and 3.0x to 4.0x total debt / EBITDA levels
• Cash flow pricing of: (i) 1.50% to 2.50% up front; (ii) 400 to 700 bps credit spread; and (iii) 1.00% to 2.00% LIBOR floor
• Asset based pricing of: (i) 0.50% to 1.00% up front; (ii) 225 to 400 bps credit spread; and (iii) no LIBOR floor to a 1.00% LIBOR floor

Traditional Private Placements Private placement volume for all of 2010 came in at $44.4 billion, up significantly from the 2009 total of $29.3 billion. While this market will continue to focus on stronger credits, over 987 of transactions in 2010 were NAIC1 or NAIC2 (BBB or better), investor appetite for this credit quality is strong. For borrowers looking to extend private placement maturities, the traditional market is an attractive alternative, particularly given the bank market’s preference for shorter maturities.

Mezzanine According to Thomson Buyouts, mezzanine fundraising dramatically improved in 2010 versus 2009 with $7.4 billion raised in 2010 versus $3.4 billion in 2009, an increase of 117.6%. Investor sentiment, although remaining disciplined from a credit risk perspective, has strengthened and broadened. As a result, competition among investors for deals has increased producing downward pressure on returns. However, credit metrics and covenants remain stable, which leaves pricing as the key differentiating factor among investors.

Investment Grade Bonds According to Thomson Reuters, investment grade volume rose 2.3% to $728.3 billion in 2010, up from $711.7 billion in 2009. The number of issues was up 19.5% to 3,163 in 2010 from 2,646 issues in 2009. The increase was fueled primarily by all-time record low spreads.

High Yield Bonds High yield debt issuance in 2010 increased considerably, 76.8%, versus 2009, to an all-time record of $259.0 billion. The number of issues also improved dramatically, 66.4%, from the levels experienced in 2009 as investors began to show increased appetite for risk and demand for higher returns.

Private Equity According to PitchBook News, 1,498 private equity transactions totaling approximately $132.0 billion closed in 2010 topping the 1,349 transactions totaling approximately $61.0 billion in 2009, an increase of 11.0% and 116.4%, respectively. Private equity firms deployed the bulk of their funds to companies that showed strong year-over-year performance. In 2011, we expect private equity deal flow to improve due to the improvement in the financial markets, strengthening company performance, and improving valuations. In addition, private equity firms have owned nearly 6,000 companies for longer than five years and need to begin to show realized returns for their LPs.

Fundraising continued to be difficult with 95 funds closed for a total of $84.0 billion in 2010 versus 115 funds closed in 2009 for a total of $148.0 billion, a decrease of 17.4% and 43.2%, respectively. Several factors contributed to the slowdown in fundraising, including the $485.0 billion private equity overhang, LPs being at the top of their allocations, and LPs looking for liquidity on current investments before pursuing new funds. That said, the one shining spot for fundraising was the middle market, capturing over 90% of total funds raised in 2010. In 2011, fundraising is expected to be stronger versus 2010 with over 660 firms looking to raise new funds, improvement in the overall market driving increased valuations of current investments and thus easier exits, as well as two years of depressed fundraising leading LPs to deploy their caches of dry powder.

Initial Public Offerings The IPO market recovered dramatically from the dismal levels experienced in 2008 and 2009. According to Bloomberg, 194 IPOs were priced in 2010 versus 80 IPOs in 2009 and just 58 IPOs in 2008, an increase of 142.5% and 234.4%, respectively. Total proceeds for 2010 came in at $48.2 billion, up 138.6% from $20.2 billion for 2009 and up 67.9% from $28.7 billion for 2008.

Economic Conditions

While the general economic environment is beginning to “feel” better, we appear to remain in a lower growth uncertain economy with many risks including continuing increases in federal government spending, increasing levels of government debt, many state and local governments in distress, geopolitical issues, rising energy prices, continuing real estate market problems to name just a few. The Fed is watching the economy closely and appears to continue to be in a holding pattern.

• The Fed continues to keep interest rates at historic lows
• The Fed continues to keep liquidity in the financial system by maintaining the size of its investment in treasuries and mortgage backed securities and has implemented QE1 and QE2
• Unemployment remains stubbornly high at 8.9% with little prospect of dramatic declines anytime soon
• There has been little growth in private sector employment

The U.S. economy continues to show some signs of gradual improvement. Corporate earnings in 2010 showed improvement over the depressed levels experienced in 2009. These earnings increases led to a dramatic increase in the public market indices in 2010, with the Dow Jones Industrial Average up 11.0% and the NASDAQ Composite up 16.9% in 2010. The S&P 500 was up 12.5% in 2010 bringing the total rally from the low of 2009 to 86.5%, the largest market rally for a comparable time period since 1935. However, much of the “easy growth” in corporate earnings is behind us. Many companies are running out of costs to cut leading to expectations of flat or even declining profit margins in 2011.

Revenue growth will be the key component to increased earnings in 2011. Part of the growth in 2010 revenues was supported by large increases in U.S. exports. However, much of this revenue growth has leveled off so it is increasingly necessary for the U.S. consumer to increase consumption to ramp up corporate revenue growth. Increasing revenue will be challenging in 2010 as many companies are currently expecting low single digit growth.

The National Federation of Independent Businesses (“NFIB”) Index of Small Business Optimism rose in January 2011 to 94.1. This level is higher than the 89.0 level in June 2010, but still below the levels achieved in the last decade.

The same NFIB report indicated that most small business owners remained in “maintenance mode” when it came to capital spending and employee hiring. Consumer demand is beginning to pick up, but will have to improve even more to provide corporate revenue growth that will lead to dramatic increases in corporate investment and employment.

In our opinion, this will be a long slow moving economic recovery with some sectors having better performance than others at different points in the recovery. There will be many twists and turns along the way which will require nimble flexible business management. If ‘change is opportunity with risk” then there will be many opportunities for business success in the next several years.

Conclusions

The overall market sentiment has improved since the depths of the recession. The appetite for M&A and financing transactions continues to exhibit positive trends. The large balances of investable cash held by strategic and financial buyers have created a “demand” for acquisitions and a need for financing. Furthermore, the narrowing of the gap between “value expectations of sellers” and the “reasonable purchase price” of buyers is leading to more deal activity. We believe the current market conditions could represent an opening of the window which will lead to greater deal activity in 2011.