Intel Acquisition of McAfee

Deal Evaluation
SMGT 6050: Mergers, Acquisitions & Strategic Alliances
Adam Wexler Ebube Anizor Nasir Zulfeqar Gondal Prodip Saha Vijay Ranganathapura 12/6/2010

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TABLE OF CONTENTS
Table of Contents ....................................................................................................................................................... 1 Executive Summary .................................................................................................................................................... 2 Introduction and Strategic Overview ......................................................................................................................... 3 Strategic Analysis ................................................................................................................................................................ 3 Valuation .................................................................................................................................................................... 7 Valuation 1: Comparable Companies ................................................................................................................................. 7 Valuation 2: Comparable Transactions ............................................................................................................................... 7 Valuation 3: Discounted Cash Flow..................................................................................................................................... 9 Valuation Summary........................................................................................................................................................... 11 Negotiations ............................................................................................................................................................. 12 Details................................................................................................................................................................................ 12 Overall Assessment ........................................................................................................................................................... 15 Integration ............................................................................................................................................................... 16 Strategy ............................................................................................................................................................................. 16 Product Portfolio ............................................................................................................................................................... 17 Management ..................................................................................................................................................................... 18 Operations ........................................................................................................................................................................ 18 Sales and Marketing .......................................................................................................................................................... 19 Timeline............................................................................................................................................................................. 19 Alternatives and Conclusion .................................................................................................................................... 20 Make or Buy ...................................................................................................................................................................... 20 Conclusion and Recommendation .................................................................................................................................... 21 Appendix A: Forecasts, Trends and Ratios ............................................................................................................... 23 Device Market Forecasts................................................................................................................................................... 23 Appendix B: Valuation Using Comparable Companies ............................................................................................ 28 Appendix C: Valuation Using Comparable Transactions .......................................................................................... 29 Other Deals ....................................................................................................................................................................... 29 Appendix D: Valuation Using Discounted Cash Flows ............................................................................................. 30 Base Case (As Is) Cash Flow ........................................................................................................................................... 30 Sensitivity Analysis ............................................................................................................................................................ 34 Valuation Including Improvements................................................................................................................................... 35 Valuation including Intel Synergies and Future options ................................................................................................... 36 References ............................................................................................................................................................... 37

Executive Summary

EXECUTIVE SUMMARY
Our evaluation found that the McAfee acquisition is in line with Intels strategy to acquire firms that can take advantage of Intels great silicon-based technology and strong market position. Intel and McAfee complement each other in an environment where the significant growth of net-connected devices and related security threats give hardware-integrated security and Intel a strategic advantage worth several billion dollars. Our valuation was consistent with the $7.7 billion offer currently awaiting regulatory and McAfee shareholder approval, even though it represents a high share premium and is larger than comparable deals. Using a weighted average of comparable transactions, our valuation was $3.5 billion based on revenues and $4.7 billion on net income. Using comparable companies, a value of $3.4 billion was derived on a market/book basis and $7 billion on P/E. The DCF valuation is where we have proven the most accurate appraisal lies, as much of the value of this deal is in the potential revenue and future options synergies. On an As-Is basis, McAfee is valued at $6.5 billion, whereas the Improvements, Synergies and Future Options were valued at $7.8 billion, $10.6 billion and $14.1 billion. respectively. Because there are no cost-synergies a final valuation incorporating any revenue synergies would be inappropriate. Consequently the suggested negotiated price should be under $7.8 billion. Given that the average premium for security firms acquisition was 38% of stock, we concluded Intel could have paid 50% and still received a lock out as opposed to the 60% premium and saved $600 million. Moreover, given current market conditions, in particular McAfee shares being at a twelve month low, a more attractive price could have likely been negotiated and more risk of failure shared with McAfee. Integrating McAfee with Intel Product Development and Sales and Marketing will be key to unlocking synergies ahead of expectations. As McAfees products intersect with most lines of Intels business, product development from the ground up must be started quickly and leverage the companies existing relationship and familiarity with each other. Also, because both companies products are used by PC manufacturers, Sales and Marketing efforts can be streamlined and bargaining power increased. McAfee will provide Intel access to a broader base of corporate customers who appreciate the value proposition and are more likely to purchase a bundled product as performance and security in the enterprise, mobile and cloud domains increase in importance. The long-term potential of this deal may in fact represent a move to strengthen Intels processor business as opposed to a move to diversify away from it. The acquisition reflects that security is now a fundamental component of online computing. Todays security approach does not fully address the billions of new Internet-ready devices, as well as the accompanying surge in cyber threats. The strategic partnership has laid the ground for what we believe will be a smooth integration, especially given McAfees relative autonomy. We do believe, however, that Intel could have been more aggressive in its negotiations and shared some of the risk of failure. Notwithstanding, the negotiated price was appropriate for the valuation. That being said, integrating security with the CPU represents a large bet and unless the noted synergies are realized by Intel, its shareholders will not receive an acceptable return on its investment.

Introduction and Strategic Overview

INTRODUCTION AND STRATEGIC OVERVIEW

On August 19, 2010, Intel Corporation (Intel), the worlds largest computer chip-manufacturer, announced that it had entered into a definitive agreement to acquire antivirus and security software maker McAfee, Inc. (McAfee) for USD$7.68 billion in cash1, or $48 per share. This price represented 60% premium on the closing share price for McAfee on the day. The deal was approved by the board of directors of both companies, and will be finalized after shareholder approval and regulatory clearance in the first quarter of 2011. Under the deal, McAfee will operate as a wholly-owned subsidiary, and report to Intels Software and Services Group.2 Prior to its announcement, the companies had been working collaboratively for nearly 18 months, and Intel expects the technology acquired from the acquisition to be integrated into its chipsets in early 2011.3 This report will analyze the strategic rationale behind the deal, provide an overview of the valuation of McAfee, review the negotiation strategy for the companies, and then recommend how Intel can best realize the synergies from this deal by successfully integrating McAfees operations. STRATEGIC ANALYSIS Company Backgrounds McAfee, founded in 1987, had revenues of $1.93 billion in 2009, with a net income of $173.42 million. McAfees business involves developing, marketing, distributing and supporting computer security software for large enterprises, governments, small and medium-sized businesses and consumers either directly or through a network of distribution partners. The company has two revenues sources: (i) service, support and subscription for security software, and (ii) product, which includes revenue from perpetual licenses (those with a one-time license fee) and from hardware product sales. In 2009, service, support and subscription revenue accounted for 90% of net revenue and product revenue accounted for the balance4. The company employs about 6,100 people and its major competitors are: Symantec Corp, Kaspersky Lab ZAO, Trend Micro, and Cisco Systems. Intel, founded in 1968, had revenues of $35.13 billion and net income of $4.37 billion in 2009. The company designs and manufactures microprocessors, motherboards, and semiconductor components that are used in computers, servers, and networking and communication products. Intel

1 2

All financial figures presented will be in US dollars Intel Corporation (2010). Intel to Acquire McAfee. Retrieved from http://newsroom.intel.com/community/intel_newsroom/blog/2010/08/19/intel-to-acquire-mcafee 3 Network World (2010). Intel drawn to vibrant security software market. Retrieved form 4 McAfee Inc (2010). 2009 Annual Report. Retrieved from http://investor.mcafee.com/annuals.cfm

Introduction and Strategic Overview

is the world's largest supplier of microprocessors, with a 2009 market share of 80.7% in the PC/Server segment. Its major competitor Advanced Micro Devices (AMD) had a microprocessor market share of 19%.5 The company employs about 80,000 people and has operations across North America, Latin America, Asia Pacific, Europe, Middle East and Africa6. Rationale for Intel The major strategic reasons for Intels acquisition of McAfee are the rapid rise of mobile computing, an increase in security spending, and the emerging trend of hardware-assisted security.
Rapid Rise of Mobile Computing

Intel has traditionally been the dominant player in the microprocessor market for desktop and notebook computers. However, desktop and notebook PC have reached the maturity phase of the business cycle. Appendix A). Instead the use of computing power is shifting towards mobile communication devices, including smartphones, tablets and netbooks (See Figure 1 below, and Figures A1 and A2 in

Figure 1: Forecast Global Device Market Size (source: Business Insights, Datamonitor, Euromonitor)

According to Gartner, mobile phones will overtake PCs as the most common method of accessing the Internet by 2013. Additionally, the number of smartphones shipped worldwide will equal the shipments of notebooks and desktop by 2013, and surpass that mark the following year (See Figure A1a in Appendix A). The same survey shows that over 3 billion of the world's adult population will be able to transact electronically via mobile or Internet technology. This trend in the ubiquity of the

PCWorld (2010). AMD Takes Processor Market Share From Intel, IDC Says. Retrieved from http://www.pcworld.com/article/187671/amd_takes_processor_market_share_from_intel_idc_says.html 6 MarketLine (2010). Retrieved from http://www.marketlineinfo.com/library/DisplayContent.aspx?R=E82C088A-0488-4DB5-89539E316C2B44D1&N=4294834270

Introduction and Strategic Overview

Internet and shift in computer power from PCs to mobile devices puts the long-term growth of Intel under threat for two key reasons: 1. No Mobile Presence: Although Intel has consistently owned 80% of the PC/Server CPU market at has no presence in the Mobile CPU market (See Figures A4a and A4b in Appendix A). The respective markets are worth $25 billion and $23 billion globally. This reality could be changed with Intels pending purchase of Infineon, and its 5.5% market share, in 2011. 2. Concentration of Revenue: 75% of Intel Revenue is derived from the PC segment; and of those revenues, nearly 40% is from Dell and HP.7 As a result, there is a need to diversify Intels business from a chip-maker to one that provides a full platform solution (hardware, software and services). With the power of current processors already at a sufficient level for most users, the strategic focus for Intel has shifted form increasing processing powers to more towards providing chipset technologies catering to mobile computing and Internet connectivity. As a result, security has become a priority for Intel a third pillar of Intels strategy in emerging segments8. Thus the acquisition of McAfee represents an opportunity for Intel to gain a foothold in the growing security market in the mobile computing segment.
Increase in Security Spending

Spending on security by consumers and enterprises is likely to grow, driven by a growing number of threats from malware and viruses, new devices, regulatory requirements, and increasingly sophisticated hackers and cyber-criminals (see Figure A3b in Appendix A). According to Gartner, the market for security software is expected to reach $41 billion by 20149 . The acquisition of McAfee will allow Intel to diversify its revenues by tapping into this growing security market. As an indication of the robust nature of security spending, McAfees revenue in the corporate sector grew dramatically through the recession: 25% in 2008 and 26% in 2009. The consumer sector grew at 18% and 12% respectively (see Figure D2 in Appendix D).
Hardware-Assisted Security

Intel also has the opportunity to integrate McAfee's security software into its PC, server and mobile chips. Not only is spending on security likely to grow, there is merit in combining silicon and software

7 8

Intel 2009 Annual Report Intel Coporation (2010). Intel to Acquire McAfee. Retrieved form http://newsroom.intel.com/community/intel_newsroom/blog/2010/08/19/intel-to-acquire-mcafee 9 Gartner (2010). Forecast: Security Service Markets, Worldwide, 2009-2014.

Introduction and Strategic Overview

capabilities to create a truly differentiated product. Although many security features can be implemented entirely in software, hardware-assisted solutions have the potential to offer better performance and additional features over software-only solutions10. This is especially true in mobile devices where performance (i.e. user experience) and battery life are priorities. One possible architecture for integrating hardware and software is through using a dual processor model. A second processor could independently maintain an updated version of all known security threats and assist the main processor in identifying threats when they occur. The tight coupling of hardware with realtime updated versions of security software should result in better performance and easier manageability of the security software11. This security integration will allow Intel to differentiate its chips from its main competitor, AMD, who is coupling graphics and processing power to gain share. Rationale for McAfee McAfee is not immune to the earlier noted decline in PC sales. McAfee has traditionally generated 40% of its revenue from consumers. This revenue is put at risk as growth in the PC market declines and consumers continue to opt for cheaper or free security solutions. By becoming a part of Intel, McAfee can enhance its brand value, and leverage the financial resources of Intel and compete more effectively against its main competitor Symantec. According to its 2009 Annual Report, one of the strategic priorities of McAfee was to "pursue new solution opportunities that build upon our multi-platform strategy of PCs, cloud, internet and mobile security"12. In line with this strategy, in 2009, McAfee acquired MX Logic, provider of cloud-based email and Web security, for $140 million13. The acquisition was intended to enhance cloud-computing security capability for McAfee. Thus McAfees strategy is also to capitalize on the growing need for security in the mobile computing market (also evident by its acquisition of Trust Digital, the provider of smartphone security software, in May 201014). By combining its security solution with Intel chipsets in mobile devices, McAfee can also tap into revenues streams from Internet and mobile security. McAfee can also leverage processor level security by integrating its software into the market-leading Intel chipsets and, hence, gain sustainable competitive advantage over its rivals.

10 11

Thompson Research. Credit Suisse investor report: McAfee complements x86. Yahoo! Finance. Intel and McAfee: Annuity Models, Mobile Security and the Elephant in the Room. Retrieved from http://finance.yahoo.com/news/Intel-and-McAfee-Annuity-indie-2889376917.html?x=0&.v=1 12 McAfee Inc(2010). Annual Report. Retrieved from http://files.shareholder.com/downloads/MFE/1077637405x0x363412/C7FDC5BED33F-4FAD-9AC2-D5F257ED50BE/2009_10K_AR_Feb26_2010.pdf 13 McAfee Corp (2009). McAfee acquires MX Logic. Retrieved from http://www.mcafee.com/us/about/corporate/mcafee_mxlogic.html 14 McAfee Inc. McAfee acquires Trust Digital. Retrieved from http://www.mcafee.com/us/about/corporate/mcafee_trustdigital.html

Valuation

VALUATION
Three methods were used ascertain an appropriate valuation for McAfee: comparable companies,

comparable transactions, and discounted cash flow. The relevant assumptions used in the valuation
are detailed below and in the accompanying appendices. VALUATION 1: COMPARABLE COMPANIES In using the comparable companies valuation methodology, three firms in particular exhibit lines of business very similar to that of McAfee: Trend Micro, Check Point and Symantec. However, when assessing the market/sales, market/book, and market/net income of the companies, not all ratios landed within an acceptable range to make a comparison meaningful (see Table 1 below and Table B1 in Appendix B).
Trend Micro Market/Sales Market/Book Market/Net Income (P/E) 5.15 26.99 28.13 Check Point 7.70 3.53 19.90 Symantec 2.32 3.05 19.44

Table 1: Comparable Company Ratios

As can be seen in Table 1, there is a large range in the market/sales ratios across all companies and market/book and p/e ratios for Trend Micro. For this reason, only the market/book and p/e ratios for Check Point and Symantec were used to form a valuation. The average multiple for the former equals 3.29x while the latter is 19.67x. When applied to McAfees 2009 year end financials, the resulting valuation is $7 billion (based on book value of equity) and $3.4 billion (based on net income). VALUATION 2: COMPARABLE TRANSACTIONS The use of the comparable transactions valuation method considered computer hardware companies that engaged in M&A activity with security software providers. The basis upon which the multiples were derived involved looking at both trailing twelve month revenues and net income of the target companies. The logic behind this is that depending on whether one is the buyer or target, the use of either measure of wealth can have different advantages. A multiple derived from net income can be considerably more than that from revenues, providing obvious advantages for the target. Furthermore, only deals with values in excess of $750 million were considered so as not to skew the results and to provide the best comparison to the Intel-McAfee deal. See Table C1 and Figure C1 in Appendix C.

Valuation

IBMs acquisition of Internet Security Systems (ISS) and Symantecs acquisition of Verisign were the most relevant deals of publicly traded companies to that of Intel and McAfee. Because in the Intel case a hardware company is buying a software security provider, whereas with Symantec it was the opposite, the IBM merger was given the most weight as it bears the closest resemblance to IntelMcAfee. The IBM deal was weighed at 0.5 and generated a multiple based on revenues of 3.94x or 33.73x based on net income. The acquisition by Symantec, however, is given a weight of 0.3 and resulted in a multiple based on revenues of 1.24x or 5.21x based on net income. In order to give a wider range to the sample size, two general hardware and software transactions have been included in the valuation: Oracles acquisition of Sun and HPs acquisition of Palm. However, due to their indirect resemblance to the Intel-McAfee transaction, they have only been given a weight of 0.1 each. Notwithstanding, Oracle paid 0.53x revenues, or 18.36x net income for Sun Microsystems. HP, meanwhile, paid 1.6x revenues or -1.6x net income. Taking into account the comparable transactions referenced above, the weighted average revenue multiple is 2.44x while the weighted average net income multiple is 20.22x (see Figure 3). McAfees 12 month trailing revenues leading up to the August 19, 2010 acquisition were approximately $1.93 billion, while its net income was $173.42 million. Using the weighted average multiples, a total value using the comparable transactions approach of either $4.7 billion (based on revenues) or $3.5 billion (based on net income) was determined. This approach suggests that Intel paid a premium of either 64% or 119% based upon the comparable transactions method.

Figure 3: Comparable Transaction Ratios

Valuation VALUATION 3: DISCOUNTED CASH FLOW

Given the multitude of variables affecting McAfees performance as both an independent firm and a merged entity using a Discounted Cash Flow (DCF) allows for a more granular and accurate approach to valuating the firm. Of particular note is the need to model the varying growth rates in the segments in which McAfee operates (e.g. PC, server, mobile, etc.) and its combined effect on McAfee revenue over the evaluation period. Consequently the DCF model used is a 9 year projection to better account for the maturing of the traditional segments and growth of the emerging. Figure 4 summarizes the findings. Full details of the valuation and its variations are provided in Appendix D.
As-Is Improvements Synergies Options

$16,000 $14,000 $12,000 $10,000

Offset decline in maturing segments with new offerings in mobile & cloud

Form hardware partnerships and reduce COGS to fall in line with competitors

Security integrated CPUs to gain traction in mobile & cloud and maintain revenue in core segments

$8,000 $6,000 $4,000 $2,000

$0

$6.5B

$7.8B

$10.6B

$14.1B

Figure 4: DCF Valuations

Base Case The Base Case (or As-Is) valuation incorporates several key parameters such as a short, mid, and longterm revenue growth rates, WACC, and several costs as a percentage of sales as detailed in Table D1. McAfee revenue has been growing at double-digit rates since 2006 (averaging 18.4%) and was strongest during the recession of 2008-2009 (see Figure D1). In forecasting growth from 2010 forward more modest rates, ranging from 4.8% to 8.9%, were incorporated under the assumptions that McAfees super growth is not sustainable and the decline in PC sales will not be fully offset by the growth in mobile or other net-connected devices on a dollar basis. More details are provided in

Revenue Growth Projection (2010-2018) in Appendix D. McAfees valuation under the Base Case
scenario as presented in Figure D4 is $6.5 billion.
Key Factors

A sensitivity analysis (Figure D5) was performed on the Base Case was to determine what factors most effected McAfees valuation. The analysis revealed that McAfees valuation was most influenced by lowering COGS, slowing SG&A growth, and reducing net working capital and WACC. As would be

Valuation

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expected adjusting the long term growth rate was also a significant lever given its impact on terminal value. Shortterm growth rates, mid-term growth rates and CAPEX only moderately affected the valuation price. These key factors formed the basis of determining how McAfee could independently make improvements and where Intel could benefit from synergies. McAfee Improvements With the above in mind, actions that McAfee could undertake to improve mid-term (2014-2018) revenue growth and costs have been identified to improve its valuation by $1.3 billion to $7.8 billion. More specifically, introducing mobile security software offerings to the consumer segment and partnering with hardware manufacturers in the PC/Server segment could improve revenue 2 percent or $462 million in present dollars. On the cost side, reducing its COGS to be more in line with that of its top competitors15 generates a present value of $818 million. See Table D6 for details. Synergies and Future Options While acquiring McAfee is deemed as a strategic and complementary business there are no overlaps in the separate businesses that could produce any near or mid-term costs synergies. As such any synergies that McAfee would generate would be based on opportunities created for Intel in the growth segments and protection of revenue in mature segments. Table D7 outlines the details of the projected synergies McAfee could provide. First, with Intels pending entry into the Mobile CPU market with the purchase of Infineon, it instantly gets a 5.5% (or $1.3 billion) stake. With McAfees security integration, Intel differentiates itself from competitors and could conservatively increase its share by 1% in this growing, but currently fragmented, market (see Figure A4b). Secondly, McAfee has proven its ability to grow revenue in difficult times and with Intels market power, McAfees long term growth could reasonably be expected to grow slightly above the estimated 3.3% GDP rate to 4%. Combined these synergies raise the valuation by $2.8 billion above Improvements to $10.6 billion. Synergies generated from future options include a more aggressive growth in the mobile space (taking Intels share to 7.5%) and stabilizing McAfees SG&A growth rate taking advantage of some cost synergies with Intel in the long term. In aggregate these options are valued at $3.4 billion. Future options estimates are admittedly less reliable and are speculative in nature. Nonetheless these options bump McAfees valuation to $14.1 billion. See Table D8 for details.

15

McAfees SG&A and Net Working Capital costs are already in line with competitors, so improvements were not factored in these areas were not included in its valuation.

Valuation VALUATION SUMMARY

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The valuation of McAfee using comparable transactions produces a valuation range that, even at the top end, is not aligned with other results (see Table 2). This method is generally very useful because it uses actual executed transactions in the market to estimate future deals. However, most of the deals in the security space were relatively small in magnitude or private in nature (See Table C1). The deals that were used in the analysis (see Figure 3) did vary in similarity to Intel-McAfee, and thus had to be weighed accordingly. But the reality is, this proposed acquisition is nearly unprecedented in the security software space. Given these challenges, the relatively low valuation can be discarded as providing little insight, but perhaps a floor, to a potential value for McAfee. The comparable companies approach likely represents a more accurate valuation than the comparable transactions. Both Trend Micro and Check Point are comparable to McAfee in terms of age, similarity of products and relevance given recent trends in the market place. However the method produced valuations that differed from each other by 100%. Because the valuation produced using the p/e multiple reflects what investors are willing to pay for future earnings, the $7 billion dollar figure is deemed to provide the most insight to pricing McAfee. Because no apparent cost synergies were found in the analysis, a valuation that accounts for the synergies in the DCF are to be discarded in the negotiations because of their speculative nature. Consequently a valuation that accounts for McAfee As-Is and with Improvements is appropriate. Therefore a negotiated deal, with a final price not exceeding $7.8 billion is recommended.
Valuation Method Comparable Companies Comparable Transactions Discounted Cash Flow (without synergies) Discounted Cash Flow (with synergies) Table 2: Valuation Methods Summary Valuation (billions) $3.4 to $7 $3.5 to $4.7 $7.8 $14.1

Negotiations

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NEGOTIATIONS
In light of the fact that a negotiated deal has been already been accepted by the respective boards and is pending shareholder and regulatory approval, the following analyzes several aspects of the negotiation context and outcome in retrospect and provides an assessment of the results. DETAILS Market Values McAfee had been trading at a yearly low for almost 3 months prior to the acquisition announcement. Since the announcement of the deal, McAfee stock has been selling at a significant premium (as is the norm for target firms). This could signal that the market is very confident in the ability of Intel to keep McAfee profitable post merger or that Intel had overpaid to the delight of its shareholders. At an offer price of $48 per share, Intel was paying a 60 percent premium on McAfees share price of $30 on August 19. As shown in Figure 5 the McAfees share price reflected this valuation almost immediately and has since remained at that level.

Figure 5: McAfee Share Price Six Months (Source: Yahoo)

McAfees share value had been trending lower due to its announcement on April 30, 2010 that it is expecting a weaker-than-expected outlook in IT spending.16 This caused a selling spree that also brought down Intels price by 2 percent. Given overall trends, Intel had the opportunity to purchase McAfee at a lower price while still lining up with a fair valuation.

16

Tech Stocks Slip As McAfee Shares Fall. http://ca.advfn.com/news_TECH-STOCKS-Tech-Stocks-Slip-As-McAfee-SharesFall_42613941.html.

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Intel also had troubles of its own starting in August. There were concerns that IT spending would slow in the near future and as is typical with acquiring firms, Intels stock continued to trend downward as a result of the McAfee announcement (see Figure 6). Intels stock has since recovered to its pre-announcement price as the investor community has shown confidence that the IT industry may soon be on the upswing.

Figure 6: Intel Share Price Six Months (Source: Yahoo)

The confidence in Intels, and subsequent rise in share price, is likely from two possible scenarios. One scenario is that investors are starting to believe in the possible synergies. The second scenario is that with Intel being such a large company, an all-cash transaction of $7.68 billion will not hinder Intel given its 2009 net income of $10.57 billion. If the latter is true, investors may be rewarding Intel for making a bold move and signalling that the technology industry is in now in recovery. Control Premium McAfee was a likely target for acquisition due to its high growth through the recession and comparatively low share price. Potential acquirers were Dell and HP - as part of their continued Given its current investment in the strategic diversification away from the PC industry and IBM.

partnership, Intel had to re-orient its relationship to that of an acquirer and would likely have to pay a control premium to lock out competitors (and ensure that any other bidders would overpay should Intel not win)17. This reality is reflected in the premium baked into the accepted offer.

17

Intel, McAfee, and Matching Rights http://lawprofessors.typepad.com/mergers/2010/08/intel-mcafee-and-matching-rights.html

Negotiations Transaction and Integration Costs

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Potential integration costs would be minimized because of the moderate change to the organizational structure as McAfee will be given relatively full autonomy to operate with a reporting channel to Intel open via the Software and Services division. the long term. Because McAfee will continue to operate under its brand and was not required to shelve any products under the agreement any loss of customers that is typical of acquisitions is minimized. Allocation of Value The fact that McAfees stock skyrocketed after the deal was announced suggests that McAfee is taking a significant part of the value. However, this is partly neutralized by an all cash acquisition. The gain by McAfee is a onetime transfer of value and Intel will benefit from all future value added with no dilution to their shareholders. McAfee is in a high growth field with zero debt on their books. This makes it easier for Intel to recover its investment. Value of Synergies Intel is most certainly a strategic buyer in this scenario as there is no operational overlap or competition with McAfee. For Intel, McAfee supports the third pillar, security, in its overall business strategy. As presented in the DCF valuation above, the synergies and future options relative to this deal are revenue based, and reflect an unproven proposition that hardware accelerated security is valuable to the market. For reasons stated earlier these synergies should not be a component of the negotiated acquisition price. Competing Bids McAfee is at a disadvantage by not having a bidding war. Bidding wars generally drive the price higher and transfers more value of the M&A process to McAfee as the seller. However, Intel is paying a high premium for the deal to be exclusive so the end result is effectively the same. Prevailing Stock Market/Economic Conditions The market and economic conditions at the time of the announcement reflect uncertainty. The economy was (and still is) showing very small signs of recovery with a potential for a dip back into recession. This is generally reflected by the large cash balance corporations are currently holding and overall reluctance to make large investments. In fact, Intels deal announcement served as almost a The staff will essentially remain the same except where overhead can be reduced by sharing supporting activities like finance and IT in

Negotiations

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bellwether for M&A activities. Shortly after the McAfee announcement other major players like Dell displayed confidence in the market and started a bidding war with HP for 3PAR, a data storage firm. OVERALL ASSESSMENT With all of the above taken into consideration, Intel could have bid for a lower price. The economy was weak, McAfees shares were performing poorly, and the general consensus was that IT spending would continue to be slow. The average premium for security firm acquisitions over the past 10 years was 38%18; Intel could have paid 50% premium and still received lock-out privileges. This would have amounted to a $45 per share offering and $7.2 billion overall deal a savings of $600 million. As point of reference, HP was able to pay only a 24% stock price premium for 3PAR. Sharing of Risks With the earlier noted benefits of an all cash deal notwithstanding, a partial equity based deal could help to incent McAfee to ensure continued strong performance. Overall there appears to be little to no concessions made by McAfee or great disruptions to their business so Intel and its shareholders bare the majority of risk. Figure 7 summarizes the findings of the negotiation from the perspective of McAfee. Highlighted are the aspects of the deal that were in McAfees favour (and conversely, in Intels favour).
In Favour of McAfee Market Value Control Premium Transaction/Integration Cost Transaction Structure Allocation of Value Potential Synergies Competing Bids Stock Market/Economy

Figure 7: Negotiation Results (from perspective of McAfee)

18

HP Shows Proclivity for High Premiums With ArcSight, http://www.businessweek.com/news/2010-09-15/hp-shows-proclivity-forhigh-premiums-with-arcsight.html.

Integration

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INTEGRATION
By revenue, Intel is nearly 18 times the size of McAfee so integration needs to be focussed on Intel realizing the revenue synergies earlier noted and valued between $3 billion and $6 billion and future opportunities provided by broadening Intels access to McAfees corporate customers. STRATEGY Considering the outcry from investors and analysts about possible merger proposition of two different industries leading to the disruption of business and operations, Intels management has strategically chosen to operate McAfee as a wholly owned subsidiary of Intel, reporting into its Software and Services Group (SSG) (see Figure 9). McAfee will maintain its primary operations in North America and continue to operate under its brand. McAfee will still be headquartered in Santa Clara, California (under a mile from Intel) and continue to employ 6,100 personnel. 19 Intel will maintain its primary operations in Taiwan, China, and the US. It will be headquartered in Santa Clara, California and retain all current 79,800 employees. 20 With the addition of McAfee, revenue for Intels Software and Services group will more than double to $3 billion (based on 2009 figures) and both the companies are going to operate without any significant change in their business model. Intels focus will remain on developing advanced integrated digital technology products, primarily integrated circuits, for computing and communications industries. The company can leverage its new acquisition to launch new products and to reach a broader customer base. McAfee will continue to engage in developing, marketing, distributing and supporting computer and network security solutions for large enterprises, governments, small and medium-sized businesses and consumers, as well as resellers and distributors.21 Since both companies have reached the mature phase in their business cycle, Intels investment in McAfee diversifies its revenue stream and mutually leverages the customer base to increase sales by cross selling. Since there are no significant cost synergies, all value resides in potential new product offerings and entering new segments.

19

http://www.marketlineinfo.com.ezproxy.library.yorku.ca/library/DisplayContent.aspx?R=6A6B0B0C-E672-4A27-852508752E646A77&N=4294839237&selectedChapter=IDAJDAKB#IDAJDAKB 20 IBID 21 IBID

Integration PRODUCT PORTFOLIO

17

Intels acquisitions of McAfee Inc. will enhance the companys ability to deliver products that offer more effectively counter the increasingly sophisticated security attacks happening on a broad range of Internet-connected devices.22 McAfee has a suite of software-related security solutions, including end-point and networking products and services that help in protecting internet-connected devices and networks from malicious content, phony requests and unsecured transactions and communications. McAfee's products include McAfee Total Protection, McAfee Antivirus, McAfee Internet Security, McAfee Firewall, McAfee IPS as well as an expanding line of products targeting mobile devices. The acquisition of McAfee enables Intel to offer antivirus and anti-spam software across a multitude of platforms.23 McAfee with the support of Intel will undertake organic growth initiatives and further expand its reach and market position in the coming years.24 As an example, in partnership with Intel, the company's Endpoint Encryption for PC product incorporates unique functionality taking advantage of Intel's AES-NI technology in their new Westmere chipset to provide increased, high-speed security capabilities. 25
Netbooks Notebooks Desktops
Personal Computer Server

Cloud Enterprise

Embedded

Mobile

Digital Home Auto

Tablet Smartphones

Figure 8: Intersection of Product Portfolios

22

http://newsroom.intel.com/community/intel_newsroom/blog/2010/09/13/intel-innovating-to-deliver-seamless-experiences-acrosssmart-connected-devices 23 Marketline, IBID 24 IBID 24 Wilson, D, (August 10, 2010), http://www.bestsyndication.com/?q=20100810_stock_market_today_intel_amd_share_price.htm 25 Marketline, IBID

Integration MANAGEMENT

18

SSG operates in more than 20 countries, and is headed by Renee James. Ms. James is the Senior Vice President and General Manager, Software and Services Group at Intel. She is the Chairman of two Intel subsidiaries: Wind River Systems and Havok. Ms. James enjoys the ardent support of internal staff and leadership along with full support of McAfee CEO David DeWalt, who will now be reporting to her. All senior McAfee managers have committed to staying with Intel-McAfee post-acquisition, helping to ensure a successful integration.
Intel

PC Client

Data Center

Embedded

Digital Home

UltraMobility Wind River Software Software and Services McAfee

NAND Memory

Digital Health

Figure 9: Organization Structure

OPERATIONS Since McAfee and Intel will operate independently, there is no significant change in organization structure other than McAfee being brought under Intels SSG. There exist opportunities for both parties in sales and marketing to leverage the combined customer base from cross-selling. Since both firms operate primarily in US and there are no layoffs, there will be neither disruption of operations nor any culture bash. All financial reporting will be centralized and will align with Intel, reporting into SSG. McAfees employees will be brought under Intels HR practices.

Integration SALES AND MARKETING

19

Intel primarily sells to PC manufacturers. McAfee uses the same manufacturers as a sales channel to consumers via pre-installed security software. The combined company increases it bargaining power. More importantly, McAfee provides Intel access to a broader base of corporate customers. In the mobile and cloud segments a bundled offering is even more valuable, as security increases in importance and performance/power efficiency remains integral. TIMELINE Intels early focus should be on corporate customers in the server and PC segments. This is because these customers have shown an increase willingness to pay for security (even through the recession) and the Intel-McAfee proposition will be of more value to them. Secondly, a strong push has to follow in the consumer and corporate mobile space because the value-proposition will be harder to sell (see Figure 10).

Figure 10: Broad Timeline

Alternatives and Conclusion

20

ALTERNATIVES AND CONCLUSION

BATNA Intels primary aim was to get a strong position in the security market and to re-invigorate the IT industry. Intels fortune depends on people believing that the IT industry is going strong and in new purchasing in IT (hardware and software). Should the McAfee acquisition not close Intel could seek other large players like Avast, AVG and Kaspersky who provide multi-platform products. Considering the premiums that Intel is willing to pay, most of these firms would have a difficult time turning Intels offer down considering their smaller market share. However, Intel should go for the largest competitor of McAfee that is available for sale. The argument being, that the larger the firm the harder it is for that company to lose money even if it had poor management in place. Buying only the best and largest in the field has always been Intels strategy. Alternatively Intel could continue with the strategic partnership and release its slated combined product offerings to the market. This will allow for customer and investor reaction to dictate the appropriate next steps. This may of course, lead to greater interest in McAfee and raise its price, but it also reduces the risk of acquiring without market acceptance. This could be structured in a semi-binding deal that is triggered based on customer and market acceptance. MAKE OR BUY One of the arguments against the deal is the make vs. buy choice; meaning that Intel could have just licensed security technology, instead of spending over $7 billion to buy McAfee. However, Intel has previously failed to benefit from similar arrangement in the virtualization (a technique allows operating system and software to run across different machines) space. Although virtualization capability was built in the processor, software makers such VMWare, were able to gain most of the benefits of virtualization by creating software products
26

. Incorporating hardware-assisted

functionality for security based on licensed technology entails similar risks; thus it makes sense for Intel to own the security software to fully benefit from both hardware and software capabilities of the processor and the acquisition of McAfee allows that to happen.

26

Thompson Research. Credit Suisse investor report: McAfee complements x86. Retrieved from http://research.thomsonib.com/gaportal/ga.asp

Alternatives and Conclusion CONCLUSION AND RECOMMENDATION

21

The acquisition of McAfee is consistent with Intels strategy to move into non-PC-computing, and builds on its acquisition of Wind River, the company that makes operating systems for mobile phones and in-car entertainment systems. In summary the benefits of the deal are: Security Spending: corporate spending on security grew at McAfee 25% during the recession and research indicates that spending will increase Growth of Enterprise Mobile: while much of the attention is given to consumer mobile the projected growth in the enterprise mobile space is similarly attractive. Furthermore, security is an inherently greater concern for corporations, so the Intel-McAfee value proposition will have greater traction for enterprise customers Differentiation: Chip differentiation via software integration for Intel is important especially in the mobile/embedded space where performance and battery life is key to adoption Customer Access: Intel now gains direct access to McAfees corporate customers should it want to further diversify its product offering Revenue Growth and Diversification: The Mobile CPU market is nearing the size of the PC CPU market. The McAfee acquisition represents substantial revenue growth opportunities in this space as earlier noted. The valuation was consistent with the $7.6 billion offer currently awaiting regulatory and McAfee shareholder approval, even though it represents a high share premium and is larger than comparable deals. Using comparable transactions, firm value ranged between $3.5 billion and $4.7 billion, providing a floor on the final valuation. Using comparable companies, firm values ranging between $3.4 billion and $7 billion were generated. With the latter being based on p/e and providing insight into a final valuation. The DCF valuation appraised McAfee as high as $7.8 billion with improvements and $14.1 billion with future options. Because there are no cost-synergies a final valuation incorporating any revenue synergies would be inappropriate. Consequently the suggested negotiated price should be under $7.8 billion. Given current market conditions, in particular McAfee shares being at a twelve month low, a more attractive price could have likely been negotiated and more risk of failure shared with McAfee. With the average premium for security firm acquisition being 38%, even if Intel paid a 50% premium on McAfee shares $600 million would have been saved.

Alternatives and Conclusion

22

Integrating McAfee with Intel Product Development and Sales and Marketing will be key to unlocking synergies ahead of expectations. As McAfees products intersect with most lines of Intels business, product development from the ground up must be started quickly and leverage the companies existing relationship and familiarity with each other. While McAfee has been a historical low risk company (as measured by its BETA, lack of long term debt and lower than industry WACC) it has underperformed both its competitors and Intel on invested cash and equity return (see Figure A7). Should the acquisition not realize any synergies and the investment is evaluated from an ROI or ROE perspective Intel shareholders will clearly not have received value.

Appendix A: Forecasts, Trends and Ratios

23

APPENDIX A: FORECASTS, TRENDS AND RATIOS

DEVICE MARKET FORECASTS

Figure A1a: Forecasted Global Device Shipments, millions (source: Business Insights, IT Jungle, IDC Gartner)

1,600 1,400 Units Shipped (millions) 1,200 1,000 800 600 400 200 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 Figure A1b: Forecasted Global Device Shipments (source: Business Insights, IT Jungle, IDC Gartner) Enterprise Server Tablet Netbook Desktop PC Notebook PC Smartphone

Appendix A: Forecasts, Trends and Ratios

24

Figure A2: Forecast Global Device Market Size, billions (source: Business Insights, Datamonitor, Euromonitor)

70,000 60,000 50,000 Traffic (PB) 40,000 30,000 20,000 10,000 0 2009 2010 2011 2012 2013 2014 Mobile Data Managed IP Internet

Figure A3a: Internet Traffic Growth (Source: Cisco)

Appendix A: Forecasts, Trends and Ratios

25

Figure A3b: Count of Unique Malware in McAfee Labs Database (Source: McAfee)

Via, 0.3%

AMD, 19.0 %

Intel, 80.7 %

Market Size: $24.7B (2009)

Figure A4a: Market Share in Desktop, Notebook and Server CPU Market, August 2010 (Source: TechEye)

Appendix A: Forecasts, Trends and Ratios

26

Other, 34%

Qualcomm, 25. 7% Texas Instruments, 12 .3%

Infineon, 5.5% Media Tek, 10.9% STM, 12.0% Market Size: $23.2B

Figure A4b: Market Share Mobile CPU Market, 2009 Figures (Source: Yahoo, AP) Note: in August 2010, Intel made a $1.4 billion offer for Infineon. Expected to close in Q1 2011.

Mobile+, 4%

Others, 3%

Data Centre, 18%

PC, 75%

2009 Revenue: $35.1B Figure A5: Intel Revenue by Segment, 2009 Figures (Source: Intel)

Appendix A: Forecasts, Trends and Ratios

27

Symantec, 22.0 % Others, 50.9%

McAfee, 10.9%

Trend Micro, 7.0% IBM, 5.1% EMC, 4.0% Market Size: $13.5B Figure A6: Market Share in Global Consumer and Corporate Security Market, 2008 Figures (Source: Gartner)

35% 30% 25% 20% 15% 10% 5% 0% Competitors (Intel) Intel McAfee Competitors (McAfee) WACC 11% 11% 8.2% 11% D/E 30% 2% 0% 11% ROE 8% 9% 2% 4% ROIC 8% 5% 4% 8% CFM 4% 11% 18% 13%

Figure A7: Intel, McAfee and Competitor Risk/Reward Ratios, 2009 (Source: WikiWealth.com)

Appendix B: Valuation Using Comparable Companies

28

APPENDIX B: VALUATION USING COMPARABLE COMPANIES

Trend Micro market/sales market/book market/net income (P/E) revenue book value net income stock close on Dec. 31 2009 shares outstanding 5.15 26.99 28.13

Check Point 7.70 3.53 19.90

Symantec 2.32 3.05 19.44

Avg. 5.06 11.19 22.49

Avg.

McAfee Valuation $6,968,701,288 $3,411,494,963

3.29 19.67

$1,036,682,960 $197,833,360 $189,784,880 38.06 140,293,004

$924,417,000 $2,015,856,000 $357,523,000 $33.88 210,000,000

$5,985,000,000 $4,548,000,000 $714,000,000 $17.89 776,000,000

Figure B1: Comparable Companies

Appendix C: Valuation Using Comparable Transactions

29

APPENDIX C: VALUATION USING COMPARABLE TRANSACTIONS

Figure C1: Comparable Transactions

OTHER DEALS
Target Acquirer HP Verisign IBM Symantec McAfee McAfee Verisign Symantec HP Fortify Guardent Ounce Labs Inc. Sygate Trust Digital Ten Cube Network Solutions Veritas Arcsight Deal Size N/A $140M $25M N/A N/A N/A $17B $13.5B $1.5B Announcement/ Close Date Aug. 2010 Dec .2003 July 2009 Aug. 2005 June 2010 July 2010 March 2000 Dec. 2004 Sept. 2010 Notes private Too small Too small private private private NS mainly a domain name registration business Veritas specialized in storage management announced after Intel-McAfee

Table C1: Discarded Transactions

Appendix D: Valuation Using Discounted Cash Flows

30

APPENDIX D: VALUATION USING DISCOUNTED CASH FLOWS

BASE CASE (AS IS) CASH FLOW The parameters detailed in Table D1 indicate the parameters used in the Base Case valuation of McAfee. The parameter values inform the model used to build the 9 year projected cash flow statements for the Base Case and other scenarios in which McAfee performance both improves as a result of its own efforts, industry trends and potential synergies with Intel. Each scenario is separately addressed.
Parameter Short Term Revenue Growth Rate (2011-13) Value 8.5% Rationale/Source Combined across both corporate and consumer segments. This variable also incorporates the various endpoints (PC, mobile, server, TV, etc) accounting for growth in each respective area. Average of Base Case from 2011 to 2013. See Figure D3. Similar to short term rate, but for different periods. Average of Base Case from 2014 to 2018. See Figure D3. US Average GDP growth (1947-2010). Similar to short term rate, but in perpetuity. COGS between 2006 and 2009 was 21.6%, 23.4%, 24%, 25.2% respectively; average of 23.5%. Keeps in line with competitors. Keeps in line with competitors. McAfees current rate Keeps in line with competitors. Split into two terms to account for acquisitions in emerging areas like cloud, mobile and embedded. Keeps in line with competitors. McAfee traditionally does not carry any long-term debt, so its WACC is equivalent to its Cost of Equity (see Table D2)

Mid Term Revenue Growth Rate (2014-18)

6.7%

Long Term Growth Rate (2019 forward) Cost of Goods Sold (% of Sales) SG&A Growth (% of Sales) D&A Decrement (% of Sales) Tax Rate CAPEX (% of Sales) NWC short term (% of sales) (2011-13) NWC mid term (% of sales) (2014-18) WACC

3.3% 23.5% 1.0% 7.6% 28.0% 3.2% -3.7% -1.4% 8.18

Table D1: Model Parameters (values shown for Base Case)

Appendix D: Valuation Using Discounted Cash Flows McAfee Projected Cash Flow
As of December 31, 2009 (in millions)

31

Figure D1: McAfee Cash Flow Projection Assumptions: See Table D1 Revenue growth projections used in model explained below

Appendix D: Valuation Using Discounted Cash Flows McAfees Cost of Capital

Market Return Risk Free Rate McAfee BETA Cost of Equity Value 10.55% 2.65% 0.70 8.18% Rationale/Source S&P average monthly return from for past twelve months. US 10 year treasury bond yield. Average of BETA as determined by Google Finance and Yahoo Finance COE = Risk Free + Beta*(Market Return Risk Free Rate)

32

Table D2: McAfees Cost of Capital (CAPM, as of Nov 11, 2010)

McAfee has held no long term debts since at least 2005. Therefore the WACC used in the cash flow projections is simply McAfees cost of equity (determined using CAPM) as shown in Table D2. Revenue Growth Projection (2010-2018) The revenue growth projections used in the Cash Flow forecast (Figure D1) was based on market growth across all devices in which McAfee currently has an offering in both the corporate and consumer segments (See Figures A2a and A2b). McAfee revenue between corporate and consumers segments have approximated a 60/40 split since 2007 (see Figure D2). The forecast adheres to the traditional split under the assumption that the decline in the PC consumer segment will not be fully offset by growth in other consumer segments. This assumption is based on two key premises: In addition to a drop in PC shipments, and thus security software sales, consumers are increasingly opting for cheaper or free basic versions of security software27, and Should consumers be willing to pay for security on mobile devices, the price will likely be less than for their PC, given the higher relative price of the PC, number of users and sensitivity of data.
2007 769.8 15% 539 13% $1,308.3 14% % sales 59% 41% 100% 2008 963.8 25% 636.4 18% $1,600.2 22% % sales 60% 40% 100% 2009 1,213.9 26% 713.5 12% $1,927.4 20% % sales 63% 37% 100%

Corporate growth Consumer growth Total rev. growth

Figure D2: McAfees Revenue by Segment 2007-2009, in millions (Source: McAfee)

27

McAfee 2009 Annual Report

Appendix D: Valuation Using Discounted Cash Flows

2010* 1246.4 773.9 2020.3 4.8% 2011 1357.8 843.1 2200.9 8.9% 2012 1465.4 909.9 2375.3 7.9% 2013 1591.2 988.0 2579.2 8.6% 2014 1717.1 1066.2 2783.3 7.9% 2015 1837.2 1140.7 2978.0 7.0% 2016 1957.5 1215.4 3172.9 6.5% 2017 2077.2 1289.8 3367.0 6.1% 2018 2197.1 1364.2 3561.3 5.8%

33

Corporate Consumer Total Revenue growth

Figure D3: McAfees Forecasted Revenue by Segment 2010-2019, in millions (*McAfee actuals to September 2010)

Discounted Cash Flow (DCF) The terminal value of McAfee (in 2003 forward) following the 10 year cash flow projections is determined as follows:
In millions Future Growth Rate 2019 Free Cash Flow Terminal Value Net Present Terminal Value Value 3.3% $405 $8,332 $4,107 Rationale/Source US Average GDP growth (1947-2010) The 2018 FCF determined in Figure D1 Determined by discounting the 2019 FCF by COE Growth Rate (i.e. 8.2% - 3.3%). Terminal Value Discounted 9 years from 2018 to 2010 at rate of 8.2%

Table D3: McAfees Terminal Value

Figure D4: McAfee DCF Valuation As Is

As indicated in Figure D4 McAfee, as is, is valued at just under $6.5 billion based on free cash flow. Taking excess cash into account McAfees valuation increases to approximately $7.4 billion or $46 per share based on figures as of December 31, 2009 (see Table D4).
in millions Equity Value +Excess Cash (2009) - Debt Equity Value (NPV) Value $6,475 $893 $0 $7,368 Source From Figure D4 Cash and cash equivalents. McAfee 2009 Annual Report. McAfee has not carried long term debt since at least 2005 Terminal Value Discounted 9 years from 2018 to 2010 at rate of 8.2%

Shares Outstanding Value per Share

159 $46

McAfee 2009 Annual Report. Intel announced offer was at $48 per share.

Table D4: McAfee Valuation

Appendix D: Valuation Using Discounted Cash Flows SENSITIVITY ANALYSIS

Short Term Revenue Growth Mid Term Revenue Growth Long Term Revenue Growth COGS (% of sales) SG&A Growth (% of sales) D&A Decrement (% of sales) Tax Rate CAPEX (% of sales) NWC mid term (% of sales) -1% WACC Valuation

34

Valuation (from base)

Effect on valuation

Initial/Base Case variable variable 3% 23.5% 1% 7.6% 28% 3.2% 8% $ 6,475.20 --

Change in Short Term Revenue Growth (from average in base case) (+2%, -2%) 10.5% 6.5% ------------------$ 6,800.87 $ 6,157.09 5.0% -4.9%

Change in Mid Term Revenue Growth (from average in base case) (+2%, -2%) --8.7% 4.7% ----------------$ 6,937.01 $ 6,041.40 7.1% -6.7%

Change in Long Term Revenue Growth (+2%,-2%) ----5.3% 1.3% --------------$ 9,454.74 $ 5,213.54 46.0% -19.5%

Change in COGS (+2%,-2%) ------25.5% 21.5% ------------$ 5,689.49 $ 7,293.34 -12.1% 12.6%

Change in SG&A Growth (+0.5%,-0.5%) --------1.5% 0.5% ----------$ 5,592.25 $ 7,304.92 -13.6% 12.8%

Change D&A Decrement (+1%,-1%) ----------8.6% 6.6% --------$ 6,407.52 $ 6,526.49 -1.0% 0.8%

Change in Tax Rate (+1%,-1%) ------------29.0% 27.0% ------$ 6,397.50 $ 6,531.34 -1.2% 0.9%

Change in CAPEX (+0.5%,-0.5%) --------------3.7% 2.7% ----$ 6,195.30 $ 6,733.49 -4.3% 4.0%

Change in NWC mid term (+2%,-2%) ----------------0.6% -3.4% --$ 5,462.95 $ 7,465.88 -15.6% 15.3%

WACC (+1%,-1%) ------------------9.18% 7.18% $ 5,398.66 $ 8,069.38 -16.6% 24.6%

Figure D5: Sensitivity Analysis = major effect on valuation, = moderate effect on valuation, = minor effect on valuation

Appendix D: Valuation Using Discounted Cash Flows VALUATION INCLUDING IMPROVEMENTS

35

Based on the sensitivity analysis provided in Figure D5 several levers are available to both positively and negatively effect McAfees valuation. Outside of a strong long term revenue growth rate (which highly influences terminal value) McAfees valuation is most effect by managing costs; in particular COGS, SG&A and NWC. Short and mid-term revenue growth has a smaller effect on valuation and other variables are virtually negligible. The extent to which these levers are available to McAfee as a standalone entity compared to the synergies and future options that could be realized as a merged entity are detailed in the following sections. Improvements (McAfee Standalone)
Type Revenue Description Increase offerings and penetration in growing consumer mobile and tablet markets (without hardware integration). Current offerings in this space target enterprise customers. Conservative revenue growth because as consumers are showing an increasing reluctance to pay for PC anti-virus (opting for free versions) this may extend to mobile devices that a) cost less than a PC and b) contain typically less sensitive material Mid-term revenue growth from 6.7% to 7.7% Same as above but partner with other hardware manufacturers (e.g. chips, motherboards, hard disk ) to better integrate security and pass on cost to consumer / bundle with cost of hardware to increase penetration. Mid-term Revenue growth from 6.7% to 8.7%. Reduce COGS (as a % of sales) to levels in-line with competitors. McAfee has been historically between 17% and 25%. In 2010 forward Base Case projects 23.5%. CA has been historically between 13% and 16%. In 2010 forward analysts project an average of 14.9%. Symantec has been historically between 17% and 24%. In 2010 forward analysts project an 28 average of 21.1%. Reduce COGS from 23.5% to 21.5%. Total Financial Impact $1,280 Financial Impact (millions) $226

Revenue

$462 (incorporates above)

Cost

$818

Table D6: Value of McAfee Improvements

Based on the above, the base valuation can be increased by $818 million based on cost improvements and $1,280 billion should McAfee successfully capture the revenue opportunities.

28

Wikiwealth. http://www.wikiwealth.com/research:ca and http://www.wikiwealth.com/research:symc

Appendix D: Valuation Using Discounted Cash Flows VALUATION INCLUDING INTEL SYNERGIES AND FUTURE OPTIONS
Type Revenue Description Increased revenue in mobile and embedded space. In 2009, of Intels $35 billion in revenue, $1.4 was attributed to its embedded, digital home and mobility group. Intels pending acquisition of wireless CPU maker Infineon will add another $1.3 billion in revenue; giving Intel a 5.5% share in the highly fragment market (see Figure A4b). Integrated services is a key trend in this space (e.g. graphics and processing, security and processing, communications and processing) so combining security features in its chipset could grow its market share. Given the high fragmentation in the market (i.e. no over-dominant player) McAfee could help boost Intel share from 5.5% to 6.5% in the wireless space alone. An increase of 1% in share (based on 2009 market figures) effective 2012 generates an NPV $2,14 billion. See Figure D6 for NPV calculation that incorporates market growth over valuation period. Terminal rate is based on 3.3 GDP growth. Increase long term growth rate. Currently 3.3% based on GDP. Will be difficult to beat in perpetuity, however should McAfees market power improve based on Intels current PC and Server dominance and potential growth in connected devices a modest growth from 3.3% (in Base Case) to 4% is possible. Total Financial Impact

36

Financial Impact (millions) $2,136

Revenue

$710

$2,846

Table D7: Value of Intel-McAfee Synergies

Figure D6: Incremental Revenues in Wireless Space via McAfee Synergies

Type Revenue Cost Description More aggressive growth in wireless space due to McAfee synergies. Extend incremental growth from 1% to 2%. NPV grows to $3.93 billion an increase of $1.8 billion (see Table D7) SG&A structure for McAfee much higher than Intel (50% vs. 20%). Keep SG&A growth flat as a result of some backend cost synergies (IT, HR, etc.). A conservative drop from 1% to 0% growth given a) different cost structure of the two businesses/industries and b) McAfee was not intended to be fully integrated into Intel (i.e. little overhead savings). Total Financial Impact Financial Impact (millions) $1,797 $1,639

$3,436

Table D8: Value of Intel-McAfee Future Options

Based on the above, an increase in valuation of $2.8 billion (Table D7) can be attributed to revenue synergies. A further increase in valuation of $3.4 billion (Table D8) can be attributed to future options. Revenue projections are by nature soft; actual growth could exceed or fall short of estimates.

References

37

REFERENCES
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