PROJECT DALLAS
FAIRNESS OPINION CONSIDERATIONS
FEBRUARY 2004
DRAFT FOR DISCUSSION
[KPMG LOGO] [HEMOSOL LOGO]
INTRODUCTION
MANDATE
- - KPMG to provide an opinion to the Committee as to the fairness of the
proposed transaction, from a financial point of view, to the
shareholders of Hemosol other than MDS (the "Fairness Opinion").
- Retained by way of engagement letter dated November 24, 2003.
CREDENTIALS & INDEPENDENCE
- - KPMG is one of the world's largest professional services organization,
offering a broad range of services. KPMG's valuation professionals have
significant experience in valuing a broad range of companies for
various purposes, including securities law compliance, fairness
opinions, mergers & acquisitions, corporate income tax purposes, and
litigation matters, amongst other things.
- - KPMG has disclosed to the Committee any past, present or anticipated
relationship between KPMG, Hemosol, MDS or an interested party (within
the meaning of OSC Rule 61-501), and that it is independent for the
purposes of OSC Rule 61-501 in connection with the Proposed
Transaction.
[KPMG LOGO] Draft for Discussion 2 [HEMOSOL LOGO]
SCOPE OF REVIEW
In forming our opinion, we performed the following:
- - Reviewed the Memorandum of Understanding dated October 28, 2003 between
Hemosol & MDS.
- - Reviewed a detailed steps memorandum outlining the proposed
transaction.
- - Had various discussions with management and other advisors.
- - Reviewed Hemosol's income tax position to confirm status of losses (as
to nature and amount).
- - Discussed with senior management the history, current operations and
future prospects of Hemosol.
- - Discussed with of MDS the history, current operations and future
prospects of the Ontario Labs business.
- - Reviewed transactions involving tax losses.
- Included those publicly-announced and confidential
transactions in which KPMG advised.
- Held discussions with other KPMG tax professionals with
respect to the market for and factors considered in estimating
the value/price of tax attributes.
- - Reviewed other expressions of interest which Hemosol received regarding
the monetization of their tax attributes.
- - Reviewed trading multiples for companies somewhat comparable to the
OLP.
- - Attended and participated in a meeting with John Anderson and PWC in
regards to their approach to the valuation of the BPP, OLP and the tax
attributes.
- - Reviewed documents prepared by Hemosol management.
[KPMG LOGO] Draft for Discussion 3 [HEMOSOL LOGO]
SCOPE OF REVIEW (CONT'D)
- - Reviewed draft copies of the following agreements, including:
- Arrangement Agreement;
- Lab Services Limited Partnership Agreement;
- Blood Products Limited Partnership Agreement;
- Labs Management Agreement; and,
- Newco Share Provisions.
- - Participated in various telephone calls in regards to the potential tax
effect of the proposed transaction to US shareholders.
[KPMG LOGO] Draft for Discussion 4 [HEMOSOL LOGO]
GENERAL TERMS OF PROPOSED TRANSACTION
TRANSFERS FROM MDS:
- - $15.0 million to be received on closing plus an additional $1.0
million payable one year thereafter assuming satisfactory comfort on
assumption of Dallas liabilities.
- - 0.5% indirect interest in the equity of the OLP in the form of Class A
shares of old Hemosol to be traded OTC.
- - Forgiveness of 2.5 million warrants (out of a total of 4.0 million
warrants) to be earned evenly by MDS over the twelve month period from
May 25, 2004 to April 25, 2004 so long as the current loan facility is
in place.
- We understand that management expects the current loan
facility to remain in place for most of, if not all, of the
remaining period of time.
TRANSFERS TO MDS:
- - 7% indirect interest in the equity of the BPP.
- - All tax attributes estimated at approximately $324 million, except a
portion of the undepreciated capital cost ("UCC") balance.
[KPMG LOGO] Draft for Discussion 5 [HEMOSOL LOGO]
VALUATION SUMMARY
DCF APPROACH MARKET CAP. APPROACH
A B C D
------------------ --------------------
Transfers from MDS
Cash (represents 93% of cash to be received) 14,880 14,880 14,880 14,880
0.5% in OLP (1) 2,843 2,955 2,843 2,955
Warrants (2) 2,900 2,900 2,900 2,900
------- ------- ------- -------
Total 20,623 20,735 20,623 20,735
------- ------- ------- -------
Transfers to MDS
7% of BPP (3) 4,012 2,972 6,042 6,042
Tax attributes (implied) 16,611 17,763 14,581 14,693
------- ------- ------- -------
Total 20,623 20,735 20,623 20,735
------- ------- ------- -------
Tax attributes (implied in transaction) 16,611 17,763 14,581 14,693
Tax attributes 324,000 324,000 324,000 324,000
------- ------- ------- -------
Cents per dollar 0.051 0.055 0.045 0.045
------- ------- ------- -------
SEE SUMMARY NOTES ON NEXT PAGE AND DETAILED NOTES IN REMAINDER OF REPORT.
[KPMG LOGO] Draft for Discussion 6 [HEMOSOL LOGO]
SUMMARY NOTES TO VALUATION SUMMARY
DCF APPROACH MARKET CAPITALIZATION APPROACH
A B E F
------------------ -------------------------------
(1) Value of OLP calculated as follows:
OLP (without tax attributes) 472,500 495,000 472,500 495,000
Tax attributes (a) 96,000 96,000 96,000 96,000
------- ------- ------- -------
OLP 568,500 591,000 568,500 591,000
------- ------- ------- -------
(a) Based on tax attributes, estimated OLP profitability
and a discount rate of 10%.
(2) Based on 2.5 million warrants and a volatility of 100%.
(3) Value of BPP calculated as follows:
BPP (DCF) 50,200 34,200 - -
Debt (20,000) (20,000) - -
Redundant assets 2,500 2,500 - -
Pipeline products 8,000 8,000 - -
Tax losses 16,611 17,763 - -
------- -------- ------- -------
57,311 42,463 86,313 86,313
Implied value per share / recent average share price 1.06 0.79 1.60 1.60
======= ======== ======= =======
SEE DETAILED NOTES IN REMAINDER OF REPORT.
[KPMG LOGO] Draft for Discussion 7 [HEMOSOL LOGO]
OLP VALUATION
APPROACH
- - Based on a capitalized EBITDA approach.
- - Net present value of the tax attributes separately considered.
CAPITALIZED EBITDA APPROACH
- - Revenues and expenses are relatively predictable/constant in this type
of business.
- - After normalization adjustments, EBITDA has been in the range of $46
million to $48 million during the last three years. Normalized EBITDA
for 2004 is projected at $45 million.
- EBITDA is based on information provided to us by MDS via PWC
and includes additional costs related to the carve out of the
OLP of approximately $275,000 per annum.
- - Public companies multiples are currently in the range of 10.5x to 11.0x
EBITDA on a trailing-twelve month basis.
- - Valuation based on normalized EBITDA of $45 million and observed public
company multiples is as follows:
- $ 45 million x 10.5 = $472.5 million
- $ 45 million x 11.0 = $495.0 million.
TAX ATTRIBUTES
- - Based on a pre-tax profit of about $41 million, net present value using
approximately $315 million in tax attributes and a discount rate of 10%
is approximately $95 million.
[KPMG LOGO] Draft for Discussion 8 [HEMOSOL LOGO]
WARRANTS VALUATION
TERMS
- - Vest at 333,333 per month (based on 4 million warrants) between May 25,
2004 and April 24, 2005.
- Consideration in proposed transaction relates to 2.5 million
of the 4.0 million on a pro-rata basis.
- - Exercisable at $1.00 per warrant and expire three years after vesting.
INTRINSIC VALUE
- - Intrinsic value = Current share price - exercise price
- - Based on a stock price of $1.60, warrants have an intrinsic value of
$0.60 per share or $1.5 million in aggregate (i.e., 2,500,000 @$0.60).
FAIR MARKET VALUE
- - Used Black-Scholes option pricing model adjusted to account for the
dilutive impact of the warrants.
- - Valuation highly sensitive to volatility used.
- Volatility used in pricing of warrants in the past for
accounting purposes has been 100%.
- - At $1.60 share price, warrants have a fair market value of
$1.18/warrant or total of $2.9 million using 100% volatility.
[KPMG LOGO] Draft for Discussion 9 [HEMOSOL LOGO]
BPP VALUATION
APPROACHES
- - Considered both the discounted cash flow ("DCF") approach and market
capitalization approach.
- More emphasis should be placed on discounted cash flow
approach, since:
- Less information available in the market place
(i.e., projections not made publicly-available).
- No analyst followings; unlikely value based on
intrinsic valuation; very speculative
DISCOUNTED CASH FLOW APPROACH
- - Based on the following:
- Projections provided by management and a discount rate of 25%
to 30%.
- KPMG modeled cash taxes, including $60 million of
UCC that would remain with BPP.
- Redundant assets of $2.5 million
- An assumed value relating to other products in the pipeline of
$8-10 million.
- Value of the existing tax losses assumed to equal implied
value of tax attributes in the proposed transaction.
- Outstanding debt of $20 million.
MARKET CAPITALIZATION APPROACH
- - Based on a $1.60 share price and 54 million shares, value implied in
market for BPP business is approximately $86 million.
[KPMG LOGO] Draft for Discussion 10 [HEMOSOL LOGO]
TAX ATTRIBUTES
GENERAL
- - On a weighted-average basis, there exists approximately $324 million of
tax attributes as at the end of 2003 available to be effectively
transferred to MDS under the proposed transaction. Key assumptions are
as follows:
- We have assumed that $60 million will be assigned to the
assets of the BPP. As a result, this amount will not remain in
old Hemosol and, therefore, will not be effectively
transferred to MDS.
- We have excluded $10 million in financing costs since we
understand that MDS has indicated that there is significant
risk associated with the validity of a certain portion of
these costs.
- - Statutory tax rates are as follows:
- Federal - 22%
- Provincial - 14%
FEDERAL PROVINCIAL
------- ----------
Non-capital losses 22,625 76,639
SR&ED 211,855 211,855
Financing costs 17,153 17,153
Investment tax credits 38,392 38,392
Undepreciated capital cost 96,321 61,487
------- -------
Subtotal 386,347 405,527
Less: Assumed portion to be transferred to BPP (60,000) (60,000)
------- -------
Tax attributes to remain in old Hemosol 326,347 345,527
Less: Financing costs (10,000) (10,000)
------- -------
316,347 335,527
======= =======
[KPMG LOGO] Draft for Discussion 11 [HEMOSOL LOGO]
TAX ATTRIBUTES (CONT'D)
VALUATION OF TAX ATTRIBUTES
- - Based on our review of publicly-announced transactions and confidential
transactions, tax attributes have recently transacted in the range of
5-8 cents per dollar of tax attribute.
- Confidential transactions include those in which KPMG has
advised. Through discussions with E&Y in the capacity as tax
advisors to Hemosol, we understand that above range is also
consistent with that observed by them.
IMPLIED VALUE OF TAX ATTRIBUTES
- - Based on value assigned to other consideration, the proposed
transaction implies a value for the tax attributes as follows:
- Under DCF approach (arrow) $16.6 million to $17.8 million, or
5.1-5.5 cents per dollar of tax attribute
- Under market capitalization approach (arrow) $14.6 million to
$14.7 million, or 4.5 cents per dollar of tax attribute.
- - Based on the above, the implied value of the tax attributes is at the
low end of the range observed in other transactions.
- As indicated earlier, more emphasis should be placed on the
valuation derived under the DCF approach.
[KPMG LOGO] Draft for Discussion 12 [HEMOSOL LOGO]
OVERALL CONSIDERATIONS
OVERALL CONSIDERATIONS IN ASSESSING THE FAIRNESS OF THE PROPOSED TRANSACTION
- - As previously indicated, the value implied by the tax attributes
appears to be at the low end of observed transactions. However, we note
the following:
- The proposed transaction involves the monetization of over
$300 million in tax attributes - a very significant amount
rarely observed in transactions. Given the limited number of
potential users of attributes of this magnitude and/or the
period of time it would take a company to use up this amount,
we would expect the price per dollar of tax attribute to be at
or near the low end of observed transactions.
- The proposed transaction involves the monetization of all of
Hemosol's tax attributes (except a portion of the UCC balance)
in a single transaction. Alternate tax monetization structures
could involve more than one transaction, would likely be more
costly to Hemosol and entail completion risk with respect to
future deals. These factors would likely cause the price of
the Hemosol shares to trade at a discount to the price that
would otherwise exist should the proposed transaction close.
- Unlike potential alternative tax monetization structures,
Hemosol will receive cash and invest it in the existing
operations with the expectation of earning profits sometime in
the future. Alternative transactions may involve the
discontinuance of the existing operations and the use of the
cash to fund the acquisition of unrelated businesses.
- - The fact that the Class A shares to be received in respect of the
equity interest in the OLP are not to be traded on an active market,
but instead will be traded OTC.
- As a result, it may take longer for a shareholder to dispose
of their interest.
- It is expected, however, that the Class A shares will pay a
dividend on a not less than annual basis, therefore providing
some liquidity to shareholders. Dividends on the Class A
shares are to be declared on a pro-rata basis with the Class B
shares (which are to be held by MDS).
[KPMG LOGO] Draft for Discussion 13 [HEMOSOL LOGO]
OVERALL CONSIDERATIONS & CONCLUSION
OVERALL CONSIDERATIONS IN ASSESSING THE FAIRNESS OF THE PROPOSED TRANSACTION
(CONT'D)
- - The fact that the forgiveness of the warrants reduces the potential for
further dilution of Hemosol in the future. Should additional cash be
required in the future, the shares that would have otherwise been
issued under these warrants could be used to obtain more financing
and/or financing on a less costly and/or non-dilutive basis.
- - We understand that the proposed transaction may give rise to a taxable
dividend to U.S. shareholders equal to their pro-rata share of any
earnings & profits ("E&P") generated, assessed or reported for 2004.
- In the worst case, we understand that this dividend will be
approximately 20 cents per share - a 6-7 cents tax impact
assuming a 30-35% personal tax rate.
- We further understand, however, that there is a very low risk
of actual E&P being generated, assessed or reported.
CONCLUSION
- - Based upon and subject to the foregoing and such matters as we
considered relevant, KPMG is of the opinion that the proposed
transaction is fair, from a financial point of view, to the
shareholders of Hemosol other than MDS.
[KPMG LOGO] Draft for Discussion 14 [HEMOSOL LOGO]