Master in Finance - Investment Banking & Financial Institutions PDF

Master in Finance INVESTMENT BANKING AND FINANCIAL INSTITUTIONS Damián Rubianes Adjunct Professor of Finance IBFI |Damián Rubianes 1  HSBC Holdings PLC Building a Global Wholesale Banking Capabi...

Master in Finance INVESTMENT BANKING AND FINANCIAL INSTITUTIONS Damián Rubianes Adjunct Professor of Finance IBFI |Damián Rubianes 1  HSBC Holdings PLC Building a Global Wholesale Banking Capability IBFI |Damián Rubianes 2  Studs leaves (2006) IBFI |Damián Rubianes 3  Westerman leaves (2017) News report (FT) The Goldman Sachs veteran brought in to shake up HSBC’s investment banking business is leaving the lender only 18 months after he was hired to lead a significant push in growth. Matthew Westerman, co-head of HSBC’s global banking division, is stepping down by the end of the month, the bank told staff on Thursday morning. His departure marks another setback to HSBC’s faltering attempts to break into the top ranks of global investment banking, a position it has pursued since hiring John Studzinski from Morgan Stanley in 2003. At HSBC he quickly became known internally for his demanding work ethic, including convening meetings before six o’clock in the morning, and a style variously described as “abrasive” and “direct”. IBFI |Damián Rubianes 4  HSBC Case Think about it Given its powerful global commercial banking franchise, why does HSBC want to become a major force in global wholesale and investment banking as well? Does it own the “must haves” to compete? What are the main risks to HSBC shareholders in creating a global investment banking business? Why has HSBC failed in its initiative so far, despite a global banking platform that is second to none? With respect to its investment banking ambitions, what do you suggest HSBC should do next? Source: https://www.gfmag.com/magazine/may-2003/newsmakers-banking-coup-for-hsbc. IBFI |Damián Rubianes 5  Introduction to the course IBFI |Damián Rubianes 6 COURSE OVERVIEW An overview of the different players operating in capital markets as well as in the financial and advisory industries. Introduction to Investment Banking Structured Finance 1 Services, business lines, clients; competitive 4 Project Finance, Leveraged Finance, LBOs, Debt Structuring. positioning. Corporate Finance Sales & Trading I 2 Deal types, origination, execution; advisory entities. 5 The trading floor; Market Making; Salespersons, Traders. Underwriting Sales & Trading II 3 ECM, DCM. 6 Cash Equities, FICC, Exchanges and Trading platforms. Source: Syllabus. IBFI |Damián Rubianes 7 COURSE OVERVIEW An overview of the different players operating in capital markets as well as in the financial and advisory industries. Financial services industry Asset Management firms 7 Retail banks, regulators, insurance firms, development banks. 10 Institutional investors, hedge funds, insurance firms, pension funds. Corporates Specialized (Alternative) investors 8 Corporates as issuers, investors, and hedgers. The Finance 11 Private debt funds, private equity firms, venture capital firms, division. mezzanine debt funds. Professional services firms Exam and Submission 9 Advisory firms, rating agencies, financial services media. 12 Individual exam and submission of group report. Source: Syllabus. IBFI |Damián Rubianes 8  Individual final exam 40% In session 12. Submission 30% Group work on IB industry Evaluation criteria Forums + Group work + Quizzes Class participation 30% In forums and F2F sessions. Source: Syllabus. IBFI |Damián Rubianes 9 Goal of the course: overview of institutions Corporate Sales & Structure ECM/DCM Research Finance Trading Finance Commercial Development Institutional Private Debt Private Equity Banking Banks Investors Investors Consultancy Rating Hedge Funds Corporates Big 4 firms Firms Agencies Private Development Central Market Regulators Central Banks Banking Banks Platforms Source: Syllabus. IBFI |Damián Rubianes 10  INVESTMENT BANKING AND FINANCIAL INSTITUTIONS SESSION 1: INTRO TO IBs Damián Rubianes Adjunct Professor of Finance IBFI |Damián Rubianes 11  Session 1: INTRO TO IBs ▪ Introduction to investment banks’ products, services and business lines; competitive positioning. ▪ The role of banks in financial markets. ▪ Clients: corporates, issuers and investors. ▪ Current trends in the industry. ▪ Appendix: Regulation; Historical perspective; Bibliography ▪ Articles: The aura of Goldman Sachs. IBFI |Damián Rubianes 12  Question: What is an investment bank? and what does it do differently? IBFI |Damián Rubianes 13  Investment banks In the middle of the game A financial intermediary that performs a variety of services such as underwriting, acting as an intermediary between a securities issuer and investors, facilitating mergers and other corporate reorganizations, and acting as a broker, arbitrager, market maker, liquidity provider and/or financial adviser for institutional clients. Source: Investment banks’ websites. IBFI |Damián Rubianes 14  Example We offer comprehensive financial advisory, capital raising, Banking financing and risk management services for corporations, governments and financial institutions worldwide. We serve our institutional investor clients by helping them to understand developments in global markets and offering Markets execution and risk management tools across each major asset class. Source: Barclays. IBFI |Damián Rubianes 15  Right in the middle Issuers Intermediaries Investors Supply Investment Banks Demand Companies Financial institutions Governments/Agencies Securities IBFI |Damián Rubianes 16  Question: Can you name other participants in the market place? IBFI |Damián Rubianes 17 Participants in the marketplace Participants Intermediaries Broadly speaking, the Issuers Arrangers Investors marketplace has three major Underwriters groups of participants, which are fairly typical in most ▪ Investment securities markets. ▪ The buy side. banks arrange ▪ A diverse group Other market participants are: deals and ▪ The sell side. of potential – Rating agencies provide liquidity investors in – Law firms ▪ Corporations. in secondary traditional or – Auditors ▪ Governments markets. alternative, ▪ They are also – Advisors/Consultants ▪ Financial cash or investors. – Banks institutions. synthetic ▪ They may take – Regulators financial risks – Private markets investors instruments. (underwrite). – Central Market Platforms Source: How the Trading Floor Really Works, Kindle Edition, Terri Duhon. IBFI |Damián Rubianes 18  Question: What are investment banks’ most important services? IBFI |Damián Rubianes 19  Investment banks’ services: Investment Banking: Principal Investments: - Advisory: M&A, Corporate - Corporate Banking reorganisations - Long-term investments - Underwriting: Capital Markets (ECM, DCM) Securities (Markets): Investment - Trading, Brokerage, Management: Arbitrage - Equity, FICC, Securities - Asset Management services - Wealth Management Sources: Investment banks’ websites. Thomas. The Business of Investment Banking: A Comprehensive Overview. Wiley. IBFI |Damián Rubianes 20  Investment banks’ services (i): This segment is organized along regional, product, and industry groups. The main services are underwriting and financial advisory. Investment 1. Underwriting includes public offerings and private placements of equity Banking and debt securities. 2. Financial advisory covers mergers and acquisitions, divestitures, corporate defence activities, restructuring, and capital structure. This division facilitates trades on behalf of institutional clients and invests the bank's own capital (trading). 1. Fixed-income, Currency, and Commodities: Facilitates trades in fixed- Securities income instruments, currencies, and commodities contracts. This group Services seeks opportunities to profit from movements in interest rates and credit (Markets) products. 2. Equities: Facilitates trades in equities. This segment is also involved in proprietary trading and derivatives. 3. Securities Services: Earns fees by providing financing, lending, as well as clearing and settlement of securities for clients. Sources: Investment banks’ websites. Thomas. The Business of Investment Banking: A Comprehensive Overview. Wiley. IBFI |Damián Rubianes 21  Investment banks’ services (ii) 1. Long-term investments. This portfolio consists of privately negotiated transactions such as acquisitions, equity, debt and hybrid securities, Principal buyouts, and investments in external funds. Investments 2. Corporate Banking (some): provides loans to clients. It may include some of the following: structured finance (leveraged, project and asset finance), trade and export finance, leasing, cash management. The Investment Management division manages assets for large institutional investors such as pension plans, endowments, and trusts. This includes providing a range of investment strategies and advice to these organizations. Investment 1. Asset Management: The traditional investments cover mutual funds, Management separately managed accounts, unit investment trusts, and variable annuities. Alternative investments offer private equity, hedge funds, fund of funds, managed futures, and real estate. 2. Wealth Management: Provides private banking services to high net worth individuals. Sources: Investment banks’ websites. Thomas. The Business of Investment Banking: A Comprehensive Overview. Wiley. IBFI |Damián Rubianes 22  Additional services offered by universal banks Services typically NOT offered by investment banks: Provides banking services to corporate and individual customers. 1. Retail Banking: It covers online services, checking and savings, cards, investment management, specialized banking, and additional services. 2. Small and Mid-sized Businesses: provides services in account access, Commercial checking and savings, loans and credit lines, leasing, cards, merchant Banking services, payroll and tax, and investment and retirement. Additional services include insurance, wholesale mortgage lending, and trade services. 3. Full Corporate Banking services: provides loans to large organizations, including finance, project and asset finance, leasing, cash management and trade and export finance. Treasury services provide treasury and cash management, trade finance, Treasury payment, and liquidity management services for multinational Services corporations, banks and non-bank financial institutions, and governments. Sources: Commercial banks’ websites. Thomas. The Business of Investment Banking: A Comprehensive Overview. Wiley. IBFI |Damián Rubianes 23  Key terms Need to know Underwriting has two meanings: – It refers to the bank taking the securities placement’s risk, i.e. it acquires or guarantees buying the securities in a placement. – It may refer only to the distribution of shares on a “best efforts” basis only. Capital Markets: – Refers to trades in primary markets, i.e. equity or debt capital raising. Financial Markets: – Refers to trades in secondary markets, i.e. execution and brokering of listed securities (trough central market platforms or dark pools). Risk Management: – Refers to designing derivatives to hedge IR, FX or other market risks. Source: Prof. Rubianes IBFI |Damián Rubianes 24  Question: What types of investment banks can you think of? IBFI |Damián Rubianes 25  Industry segmentation (American view) Full-service Universal investment banks banks Boutique houses IBFI |Damián Rubianes 26  Industry segmentation (American view) Source: Bloomberg. IBFI |Damián Rubianes 27  Industry segmentation (European view) American / International Investment Banks European /Asian Investment Banks Domestic Banks Boutiques, Specialists, Big 4… Note: please see the appendix for further information. IBFI |Damián Rubianes 28 Universal banks vs “Pure” investment banks Universal banks vs “Pure” investment banks From a legal point of view, there are no differences between pure investment banks and universal banks, as in 2008 GS and MS converted to commercial bank charters. Often, GS leads in M&A, whilst MS in Equity. Universal banks take advantage of its Loan activity vs. to gain Bond business. Pure investment banks lack their competitors credit capacity, affecting their revenue generation capacity both in Loans and Bonds (quite linked). From a historical point of view, JPM and then MS were the leading investment banks globally. Up until 2004, MS typically outperformed GS in terms of Revenues, Net Income and ROE. IBFI |Damián Rubianes 29 “Must haves” to compete To achieve and maintain a leadership position in investment banking, a firm must have: 1. Deep, long-term client relationships to obtain a flow of businesses. 2. A strong product line to offer the best products and services. 1 3. The ability to provide clients with an integrated solution. 4. A strong global presence and local knowledge. 5. A strong financial strength to establish the confidence of clients. 6. An effective risk management process to ensure the firm's financial soundness and profitability. 7. A solid governance structure to ensure compliance with internal policies and regulations. 8. Integrity and professionalism to create trust and provide superior services. 9. A performance and risk-based compensation system that attracts and retains talents. Source: Liaw, K. Thomas. The Business of Investment Banking: A Comprehensive Overview. Wiley. IBFI |Damián Rubianes 30  Global league tables Some questions: ✔ Is Goldman Sachs always the leading investment bank? ✔ What is the best bank in M&A? ✔ What banks are good in bonds (DCM)? ✔ What banks can leverage on Loan relationships with clients? IBFI |Damián Rubianes 31 Goldman Sachs The Goldman Sachs’ aura By tradition, GS makes risky financial wagers and stays icy cool under pressure. This attitude almost killed it back in 1986 after a bad trade on Treasury bonds. It was relatively recently when the bank started to be considered as “the” investment bank. In 2005 it started to significantly outperform competitors and lead While outsiders think that the most relevant transactions globally. Goldman’s alumni run the world, on Wall Street the Back when it was a partnership, Goldman was more profitable than firm’s aura has dimmed. Facebook is now, with a ROE of 38% in 1998. Rival banks view it with Goldman’s glory years took place between 2006 and 2013, when its indifference, not awe. After shares traded on a notably superior multiple of book value. shining in the years after the crisis, since 2012 its total This was partially due to its “big short” in early 2007, when it bet that return has lagged behind the subprime securities would tumble, what helped it to book profits of average of its four big $14bn in 2008-09 and to perform relatively well during the worst American rivals by 36%. financial crisis for 80 years. Source: Goldman Sags, The Economist, Schumpeter. IBFI |Damián Rubianes 32  Global league tables Source: https://markets.ft.com/data/league-tables/tables-and-trends IBFI |Damián Rubianes 33  Question: What is an investment bank’s main role in financial markets? IBFI |Damián Rubianes 34  Intermediating and providing liquidity At what price securities are traded Banks play a crucial role in financial markets which is often summarized as: – “intermediating” or “facilitating” access to the financial markets for their clients in debt and equity primary markets. – “liquidity provider” in secondary markets, and in currency markets, Picture: Busy UBS Trading floor. commodity markets and derivative markets. Source: How the Trading Floor Really Works, Kindle Edition, Terri Duhon. IBFI |Damián Rubianes 35  Question: What are an investment bank’s clients? IBFI |Damián Rubianes 36  Clients (i) These clients act as issuers of securities. Corporations They demand financing, specialized or structured financing, risk and financial management products and treasury services for their operations. institutions Companies can also issue though an SPV (Special Purpose Vehicle) to “encapsulate” assets and improve rating and pricing (as with project or green bonds). Examples: Unilever, RBS, Securitization fund. These clients can act as issuers, demand financing, risk management Governments products, and specialized or structure finance, or act as investors. Apart from national governments, they can be regional governments (municipality, city, state, province). Other government-related clients: national or supranational agencies, government-backed firms, banks or organisations, social security funds, ministries, central banks, sovereign funds… IBFI |Damián Rubianes 37  Clients (ii) Typically non-banks organizations that sell investment products to the public and trade Institutional securities in large amounts. investors Run by professional, knowledgeable managers and have Research capacity, therefore they qualify as professional investors and are therefore less protected by regulation. Served by investment Banks and securities services firms and enjoy preferential treatment and lower commissions. Traditional institutional investors (long-only), alternative asset managers, broker dealers. Traditional institutional investors include mutual funds, asset managers, pension funds, insurance companies, and banks. They can also be Governments and government- related organisations. Alternative asset managers include hedge funds, infrastructure funds, real estate funds, private equity investors, ABS investors… They are affluent individuals and families. High Net Worth They demand fully integrated wealth management service, encompassing portfolio Individuals management, tax advisory, inheritance planning, and philanthropic advisory services. Invest large amounts and are served by private bankers and can set up a family office. IBFI |Damián Rubianes 38  Tip: Use LinkedIn as a source of information IBFI |Damián Rubianes 39  Follow accounts that share information IBFI |Damián Rubianes 40  Follow IBs and Asset Managers IBFI |Damián Rubianes 41  Follow specialized journalists IBFI |Damián Rubianes 42  Follow specialized journalists IBFI |Damián Rubianes 43  Follow News and Inshights from companies IBFI |Damián Rubianes 44  Follow News and Inshights IBFI |Damián Rubianes 45  Thank you! Any questions, please email me: [email protected] IBFI |Damián Rubianes 46  Appendix Session 1 Please study for the Exam IBFI |Damián Rubianes 47  Competitive positioning Business models in investment banking IBFI |Damián Rubianes 48 Competitive environment Universal banks Pure investment banks These financial holding They compete based on full- companies have a major service offering, advantage over other specialisation, global reach, investment banks because tradition-reputation, sector they can offer clients large and product expertise. sums of credit. Main income source is not They typically are leading Investment Banking but firms in the countries they Securities, Trading and operate. Principal Investment. Concept of one-stop shop. Boutique houses Focus on particular segments: M&A, financial institutions, technology, mid-market... Some complement their revenues with less-volatile investment management services. They highlight independent advisory, entrepreneurship, and partnership. IBFI |Damián Rubianes 49  Regulatory overhaul Please study for Exam IBFI |Damián Rubianes 50  Question What, in your opinion, were the causes of the 2008 financial crisis? What investment banks did wrong? IBFI |Damián Rubianes 51  Causes of the financial crisis Failure of Excess credit rating dependency of agencies Excessive borrowing Dramatic breakdowns S-T funding and risk-taking by in corporate households and banks governance and risk management Ignored Widespread Non- warnings failures in financial understood regulation and risks supervision Low mortgage- Systemic breaches in Poor preparation of Lack of lending accountability and policy makers, transparency standards ethics at all levels regulators and banks for the crisis Source: US Financial Crisis Inquiry Commission. IBFI |Damián Rubianes 52  Regulatory overhaul Main regulation changes affecting investment banking IBFI |Damián Rubianes 53  Need for more effective regulation One important lesson from the financial crisis is the need for more effective regulation. The financial reform legislation, most notably the Dodd-Frank bill, aims at: o setting standards for financial operations and o preventing another crisis. IBFI |Damián Rubianes 54  No more days of wine and roses Practitioners and managers know the good old days are gone and nothing will be the same. Restrictions on new businesses, principal investments, underwritings, proprietary trading, hiring, expenses, risk-taking, bonuses, bank’s capital use, etc. are having an impact of profits and bonuses. IBFI |Damián Rubianes 55  Regulatory overhaul Dodd-rank bill Volcker rule IB operations For the exam: Please read constrained and study the by new appendix covering these regulation 4 rules in detail. Basel III MiFID II IBFI |Damián Rubianes 56  Regulatory overhaul (i) The reform focus on several essential areas: Dodd-Frank 1. To end “too big to fail” (systemically important banks) and taxpayers protecting shareholders and bill bondholders in recapitalizations. 2. Practice consistency across all financial institutions to value and account for assets in a similar fashion. 3. Set a dynamic, comprehensive and strong regulation that can identify and constrain excesses in markets, before they can threaten the broader economy. The principal impacts on investment banks include: 1. SEC to examine and improve sales practices and disclosure by broker-dealers and advisors. 2. It provides the SEC with authority to adopt rules establishing fiduciary duties for broker-dealers. 3. Financial Stability Oversight Council (FSOC) to coordinate the efforts of all the primary U.S. financial regulatory agencies in establishing regulations to address financial stability issues. 4. Federal banking agencies requires to force structurers of ABS transactions to retain a portion, generally at least 5%, of the credit risk. 5. Increased regulation and restrictions on OTC derivatives markets and transactions. 6. “Derivative pushout” provisions that prevent investment banks from conducting swaps-related activities through their insured depository institution subsidiaries. 7. Provisions designed to increase transparency in OTC derivatives markets by requiring registration of all swap dealers, and clearing and execution of swaps through regulated facilities. Source: Liaw, K. Thomas. The Business of Investment Banking: A Comprehensive Overview. Wiley. IBFI |Damián Rubianes 57  Regulatory overhaul (ii) The Volcker rule: Volcker rule o prohibits proprietary trading (other than certain risk mitigation activities) and o limits the sponsorship of, and investment in, hedge funds and private equity funds by banks. Proprietary trading, defined mainly as engaging in short-term trading using the banks’ own capital. Prohibition to prop trading is subject to several exceptions that allow a banking entity significant leeway to engage in some short-term trading, including trading: 1. In U.S. government, state, and municipal obligations 2. In connection with underwriting or activities related to market-making 3. In connection with certain risk-mitigating hedging activities 4. In any security or instrument on behalf of customers. The exception for regulation on hedge funds and private equity funds is for funds that are organized or offered by the banking entity, subject to: 1. The banking entity owning no more than 3% of the fund. 2. An overall limit of 3 percent of the entity's Tier 1 capital invested in private funds. Source: Liaw, K. Thomas. The Business of Investment Banking: A Comprehensive Overview. Wiley. IBFI |Damián Rubianes 58  Regulatory overhaul (iii) Basel III is the new global regulation on bank capital adequacy Basel III and liquidity. It introduces new capital, leverage, and liquidity standards. The regulation package is designed to improve the banking sector's ability to deal with financial and economic stress. It calls for increased capital requirements, reduced leveraged levels and higher liquidity. o It has a clear impact on banks’: o Impact on business models and profitability. o Impact on financing sources: o New equity o Lower dividends o Hybrid securities IBFI |Damián Rubianes 59  Regulatory overhaul (iv) MiFID II Source: FT. For further information, please visit: https://www.ft.com/content/ae935520-96ff-11e7-b83c-9588e51488a0 and https://www.ft.com/content/8c7e9ef0-996e-11e8-88de-49c908b1f264 IBFI |Damián Rubianes 60  Historical perspective Is investment banking something new? History of investment banking and financial innovation IBFI |Damián Rubianes 61 Innovation in financial markets Stockbreeding and agriculture in Neolithic produced Prehistory surplus: wealth and trade are created. Medium of exchange: Bartering of produce and cattle. 5000 BC: shell money is created. 4000-2500 BC: Credit born with Mesopotamian tables recording ancient loans and interest paid. 2500 BC: Insurance is created with Babylonian goods transport insurance. 1700-1100 BC: First recorded annuities (purchased by Egyptian prince). Source: JP Morgan Asset Management. “Alternatives: An evolving and expanding investment universe”. 2011. IBFI |Damián Rubianes 62 Innovation in financial markets Merchant banks* were the first modern banks. Middle Emerged in Middle Ages from the Italian grain and cloth merchants Ages-XIX (commodity traders). Bonds start trading in Renaissance Italy (14th Century). First publicly traded stock: Dutch East India Company on Amsterdam Stock Exchange (1602). Merchant banks leading financial innovation for centuries. They were traders, as well as loan, equity capital and advisory services providers. Modern era: Active in UK since XIX (first was Barings). Investment Banking golden era. XIX-1929 Innovations, domestic and international expansion of industries, infrastructure development. Prolonged bull market. JP Morgan saving the country in 1907. Excess speculation during the Roaring Twenties before Market Crash. (*) “Merchant bank”, in the UK, has a similar use to the term Investment bank. Differently, in the US, merchant banking is reserved to equity capital investments (proprietary or principal investment). Man picture: John Pierpoint Morgan. IBFI |Damián Rubianes 63 Innovation in financial markets After a 9-year run, Market crash in 1929 (Black Tuesday, October 29) 1929- sparking Great Depression from 1930 to 1939. 1939 Glass-Steagall Act in 1933 prohibits commercial banks to engage in underwriting or brokerage. JPM splits into JPM and MS. Great economic growth following WW II. II WW-1973 Secondary mortgage market: Fannie Mae establishes secondary market for US mortgages (1938). Private equity firms established in United States (1946). Hedge funds appeared with Absolute Return or “hedged fund” created by Alfred Winslow Jones. Modern Portfolio Theory by Henry Markowitz (1950’s). Successful companies turning into multinationals and then into holding firms, following strategic consultancy firms advise (1960’s-1970’s). Development of FX futures exchanges in NY and Chicago (1972). Black-Scholes model (1973) launches modern derivatives industry. Woman picture’s author: Dorothea Lange. Man picture: Henry Markowitz. IBFI |Damián Rubianes 64 Innovation in financial markets 1973: oil and inflation crisis; high inflation-interest rates era follows. 1973-1999 Early 1970’s: IBM launches POS (Points of sale) terminals linked to mainframe. Automated clearing houses (ACH) replaced paper routines for electronic payments processes. 1975: Interest rates futures. Starts research on microfinance. Late 1970’s: High Yield and Leverage Finance industry develops, together with M&A and hostile take-over bids wave. Liberalisation policies in fashion in Anglo-Saxon countries and then into the European Union. 1981-82: CHIPS, Clearing House Interbank Payment System (same day settlement). First consumer trading system. Stock index futures appeared. 1987-88 Fed permits subsidiaries to underwrite and deal in securities (limit 5% of revenues). Limits increased from 1989-1997. Basel I (International capital requirements). 1994: JP Morgan structures 1st CDS. JP Morgan published VaR methodology. Weather derivatives starts trading. Gramm-Leach-Bliley Act sets limits eliminated: universal banks (one stop shops). Dot.com bubble. Man picture above: Ronald Reagan. Man picture below: Gordon Gekko (Wall Street film). IBFI |Damián Rubianes 65 Innovation in financial markets Dot.com crisis in 2001. 1999-2008 World stocks and emerging markets growth. Commercial banks engage in IB. Investment Banks engage in complementary activities such as lending, securitization, prop trading, investment management and principal transactions. The real estate bubble explodes and then the ABS securities 2008-Today markets collapsed impacting banks’s balance sheets worldwide and drying liquidity in many markets. The Great Recession turning into a double dip recession. Lehman, Merrill, Bear Stearns disappeared. GS and MS converted to commercial banking charter. Dodd-Frank bill (regulatory overhaul and regulation on OTC derivatives). Volcker rule prohibits prop trading. Basel III sets stricter global regulation on bank capital adequacy and liquidity. Animal picture: Bull market. Man picture: Trader having a bad day. IBFI |Damián Rubianes 66  Recommended bibliography IBFI |Damián Rubianes 67 Bibliography Recommended bibliography “Mastering Private Equity, Transformation via Venture Capital, Minority Investments & Buyouts”, Kindle Edition. Claudia Zeisberger, Michael Prahl, Bowen White, Wiley, ISBN 978-1-119-32797-4, 2017. “The Business of Investment Banking: A Comprehensive Overview”, 3rd Edition. K. Thomas Liaw. ISBN: 978-1-118-00449-4. Nov 2011. IBFI |Damián Rubianes 68 Bibliography Recommended bibliography “How the Trading Floor Really Works”, Kindle Edition. Terri Duhon. ISBN: 1119962951. Bloomberg Financial, 2012. “A pragmatist’s guide to Leveraged Finance - Credit Analysis for Bonds and Bank Debt”, by Robert S. Kricheff. ISBN: 0133552764. FT Press, Pearson, 2012. “Investments”, by Bodie, Kane, Marcus. Kindle edition. McGraw-Hill Education, 2013. IBFI |Damián Rubianes 69 Bibliography Recommended bibliography A comprehensive corporate finance manual: “Principles of corporate finance” by Richard A. Brealey, Stewart C. Myers. McGraw Hill. (ISBN-10: 0077151569 for the 11th Global Edition). A worldwide leading textbook on corporate finance that describes both, theory and practice. If you have no previous experience of capital markets: “An Introduction to International Capital Markets: Products, Strategies, Participants” by Andrew A. Chisholm. Wiley Finance Series, Wiley John & Sons (ISBN-10: 9780470758984 for the 2009 edition). IBFI |Damián Rubianes 70 Bibliography Other readings Financial Press: Students will be expected to read the main news on the cover of the Financial Times on a daily basis. In addition, reading some articles from The Economist is also recommended. Websites: The websites of the major private equity firms, consulting services firms, banks and investment banks should be explored. Investopedia: A website that explain thousands of financial concepts, theory and jargon. For careers in private equity, consulting and investment banking: See “Wetfeet Insider Guide” or “Vault” latest editions. Other books, novels, films, articles and reading materials will be recommended throughout the course. IBFI |Damián Rubianes 71  Thank you! Any questions, please email me: [email protected] IBFI |Damián Rubianes 72  Master in Finance INVESTMENT BANKING AND FINANCIAL INSTITUTIONS Damián Rubianes Adjunct Professor of Finance IBFI |Damián Rubianes 1  INVESTMENT BANKING AND FINANCIAL INSTITUTIONS SESSION 2: INVESTMENT BANKING: CORPORATE FINANCE Damián Rubianes Adjunct Professor of Finance IBFI |Damián Rubianes 2  Session 2: INVESTMENT BANKING: CORPORATE FINANCE ▪ Deal types: mergers, acquisitions, take-over bids, corporate defence strategies, divestitures, restructuring, capital structure advisory. ▪ The Corporate Finance and Financial Advisory division. ▪ Deal origination and execution ▪ A day in the life of a CF Analyst. IBFI |Damián Rubianes 3  Deal types in M&A IBFI |Damián Rubianes 4 What is M&A? M&A definitions are not set on stone M&A involves many activities, such as search, analysis, deal design, negotiation, integration, and process management. M&A is not only mergers and acquisitions, but also incorporates restructuring. This can take place in a variety of ways to enhance its efficiency and create value. – Key alternatives are divestiture, spin-off, carve-out, split-off, tracking stock, and liquidation. Typically, though, M&A is related to growth: firms can grow organically (by internal investment) or inorganically by mergers, acquisitions, joint ventures, alliances, and contractual agreements. – The right choice of the method of inorganic growth depends on the need for a business relationship, the need to be in control, and the need to manage risk exposure. Source: Bruner, R. F. Applied mergers and acquisitions, John Wiley & Sons. IBFI |Damián Rubianes 5 M&A decisions are derived from strategy M&A to materialize strategy Strategy influences M&A outcomes. It should be the engine driving M&A. Before analysing potential deals, we have to understand the firm’s strategy, its resources and competitive position. To do so, numerous tools and frameworks help assess the firm’s SWOT, such as Growth-share matrix, PESTEL, Porter model, Learning curve (, strategic maps… As a result, we should summarize the business strategy in a SWOT analysis. Out of the three generic types of strategy (low cost leadership, differentiation or focus), we can combine a variety of M&A tactics that extend from transactions that grow (expand) or diversify the firm to transactions that restructure or focus the firm. Source: Bruner, R. F. Applied mergers and acquisitions, John Wiley & Sons. Learning curve is a graph that depicts the decline in costs as cumulative volume grows. IBFI |Damián Rubianes 6 Range of Transactions Range of Transactions in a Decision Framework Note: A spinoff is a new, separate company whose shares are offered by a parent company to its shareholders. A carve-out is the partial divestiture of a business unit in which a parent company sells a minority interest of a subsidiary to outside investors. Source: Bruner, R. F. Applied mergers and acquisitions, John Wiley & Sons. Note: In a split—off, the the parent company offers shareholders the option to keep their current shares or exchange them for shares of the divesting company. A tracking stock is a special equity offering issued by a parent company. IBFI |Damián Rubianes 7 Deal types in Corporate Finance Corporate Financiers have fun In a Corporate Finance department, bankers advice on a wide number of transactions: Mergers: two (or more) firms negotiate a merger, with the goal of generating synergies. Investment banks advice to one firm to identify cost and revenues savings and negotiate the terms of the deal (mainly the final equity stake in the merged firm). Acquisitions (buy-side mandates): banks help companies to identify potential targets that fits the acquiror’s strategy. Divestitures (sell-side mandates): bankers will look for other firms or investors that could be potentially interested in acquiring assets that are no longer part of the strategy. Take-over bids: when a company or investor makes an offer for a public firm’s shares to the target company's shareholders. These deals can be friendly or hostile. Defence strategies: in hostile takeover bids, investment banks advice the target firm’s managers to defeat an outstanding takeover proposal or to increase the price offered. Restructuring: it implies an number of actions and transactions to align the company’s assets to its strategy, to improve or adjust risk and leverage levels or reduce tax expense. Capital Structure advisory: investment banks advice managers on their firms’ adequate capital structure, investing and financing strategies and dividend policy. Source: Streets of Wall, CFI, Bruner, R. F. Applied mergers and acquisitions, John Wiley & Sons. IBFI |Damián Rubianes 8  Mergers Source: Streets of Wall. IBFI |Damián Rubianes 9  Identifying synergies Source: Deal Room, “Corporate Finance” by Ross. IBFI |Damián Rubianes 10  Synergies: estimating cost savings Source: McKinsey&Co. IBFI |Damián Rubianes 11  Price paid for synergies defines winners Source: JP Morgan. IBFI |Damián Rubianes 12  Timeline of operating synergies Source: JP Morgan. IBFI |Damián Rubianes 13 Motives for inorganic growth Reasons from a conceptual framework Strategists and scholars point to five main reasons why firms pursue inorganic growth: Maturing product line Value creation through horizontal and vertical integration Acquisition of resources and capabilities Value creation through diversification Regulatory or antitrust limits Source: Bruner, R. F. Applied mergers and acquisitions, John Wiley & Sons. IBFI |Damián Rubianes 14  Reasons for M&A Primary business purpose of the M&A According to executives (not strategists or scholars), their main reasons for M&A are: Source: Accenture Serial M&A Survey. Please see explanations on “Motives for inorganic growth” in the Appendix. IBFI |Damián Rubianes 15 M&A or agreements? Transactions or deals? Executives enjoy a wide range of tactical alternatives for inorganic growth. M&A are often the focus of financial advisers seeking to generate fee income by assisting firms on M&A. But the executive should consider at least four other avenues before embarking on an M&A effort. These include: – contractual relationships (Licensing agreements, Co- marketing agreements, Co-development agreements, Joint purchasing agreements, Franchising, Long-term supply or toll agreement) – strategic alliances, – joint ventures, – and minority investments. Source: Bruner, R. F. Applied mergers and acquisitions, John Wiley & Sons. IBFI |Damián Rubianes 16 Reasons for M&A failures Getting divorce or loosing money In many cases, the selling shareholder is the only one happy, after a while. Source: Streets of Wall. IBFI |Damián Rubianes 17  Don’t forget to visit IBFI |Damián Rubianes 18  Don’t forget to visit IBFI |Damián Rubianes 19  Don’t forget to visit IBFI |Damián Rubianes 20  Case study The different Corporate Finance desks IBFI |Damián Rubianes 21  Discussion: Same activity but different You answer Students will explain the difference between Corporate Finance departments at: a bulge bracket investment bank, a European or Asian commercial bank, a "boutique" investment bank, a multinational firm, a strategic consultancy firm and a "big four" firm (or other examples). You will analyse one single institution per person and we will discuss your views in class. What is it different? What type of deals or advisory they do? Pros and cons of each? Would you rank them (as per your preference)? Can you explain a typical transaction? What skills do you need to work there? IBFI |Damián Rubianes 22  Visit IBFI |Damián Rubianes 23  Investment Banking The Corporate Finance and Financial Advisory division IBFI |Damián Rubianes 24  The investment banking division Financial advisory Underwriting Mergers & Acquisitions: Works with Equity Capital Markets: Helps clients with corporations and institutions of all sizes to every stage of raising equity capital, from structure and execute deals to further their valuation to distribution such as initial public growth plans, make strategic exits or offerings and follow-ons/rights issues. respond to activist shareholders. Debt Capital Markets: Develops debt Corporate Finance Advisory: Offers financing for investment grade companies product-agnostic advice on nearly all areas from simple bank loans to multi-billion-dollar of corporate finance, including capital capital raising across asset classes. structure, risk management, deal Leveraged Finance: Arranges leveraged loans structuring, credit ratings and liquidity. and high yield bonds to help companies achieve strategic objectives, including making an acquisition or executing a leveraged buy- out for a private equity client. Source: JP Morgan. IBFI |Damián Rubianes 25  Mergers and acquisitions M&A M&A Advisory Our bankers provide mergers and acquisitions GS is a longstanding market leader in M&A advice and services to our clients on some of advice, including sell-side advice, raid and their most important strategic decisions and activism defences, cross-border M&A, special transactions. committee assignments and complicated merger transactions. Its clients are located across the globe and include businesses, private investors, government agencies, private individuals and families. We provide advice on a full range of transactions, including mergers, sales, acquisitions, leveraged buyouts, joint ventures, raid defences, spin-offs, divestitures and other restructurings. Source: Goldman Sachs. IBFI |Damián Rubianes 26 Rothschild & Co. M&A and Financial Advisory Debt Advisory, Restructuring Equity Advisory Public mergers and takeovers Refinancing existing debt IPOs Defence preparation and bid Supporting acquisitions and Share issues defences funding development Block trades and sell-downs Bank, bond, alternative and Demergers and spin-offs Spin-offs and demergers structured finance Business disposals and Convertible bonds Credit ratings acquisitions Derivatives and hedging Crafting the equity story Joint ventures and strategic Lender negotiations Strategic Capital alliances Recapitalisations Equity Marketing, via Scott Privatisations Capital raising Harris Shareholder reorganisation Exchange offers Investor Perceptions Distressed M&A and special Corporate Shareholder Advisory Fairness opinions, and US Special Committee and situations In-court and out-of-court fiduciary matters transactions Corporate governance matters Creditor representation Source: Rothschild & Co. IBFI |Damián Rubianes 27 Transaction Advisory Services Source: EY. IBFI |Damián Rubianes 28  Deal origination and execution IBFI |Damián Rubianes 29  Career Structure Roles MD – Customer relations, deal origination, management of people and MD resources, cross-selling ED Director – Customer relations, 5 years Director origination (more weight) and execution Associate Director in deals 4 years VP VP –Customer relations, origination and execution (more weight) in deals 3 años Associate Associate –Analysis and coordination, assistance to the most senior team 3 years Analyst members Analyst - Research and analysis of information, assistance to the most senior team members IBFI |Damián Rubianes 30 Activities and Functions Origination Execution Daily customer relationship during Build a relationship with the customer execution Markets analyses and comparable Modeling and valuation companies Coordination with managers, lawyers, Macro, corporate and strategic analyses auditors, regulators, etc.. Profiles of potential investors and targets Negotiation IBFI |Damián Rubianes 31  Thank you! Any questions, please email me: [email protected] IBFI |Damián Rubianes 32  Appendix Session 2 IBFI |Damián Rubianes 33  A day in the life Corporate Finance Investment Banking IBFI |Damián Rubianes 34 Activities and functions - Analyst Role Preparing business presentations Preparation of documents Analysis of macro and strategy and presentations Valuation and financial modeling Analysis of market transactions Communicate and coordinate with other offices and "Junior" member of an employees execution team Cooperate closely with the "senior" team members Keep documents and files organized Monitoring of markets and Analysis of trends in the markets and indutries industries Individual analysis of companies and results IBFI |Damián Rubianes 35 Activities and functions -multiprocessing Development of financial and Knowledge acquisition of technical, analytic tools companies, sectors and markets Valuation models and analyses Analysis of industries and companies Learning transactions’ processes Identification of opportunities Management of teams and Accelerated personal development individuals Continuous learning Process management with other Career Plan professionals (lawyers, accountants) Responsibility for the outcome Constant contact with the customer Negotiating with the counterparty IBFI |Damián Rubianes 36 Career - Pros & Cons Benefits Costs Exponential learning curve Hard work and stress Top level, complex job Top ranked, talented work Results pressure mates Long hours and weekends Job opportunities in the Personal life affected sector and beyond Hardly sustainable in the long Clients are largest firms term Good knowledge and understanding of how economy works High wages Bonus (30%-150%) IBFI |Damián Rubianes 37 Professional profiles Top, talented professionals Professional Skills Interpersonal Skills Characteristics Leadership skills Optimistic Complex and quantitative Positive analysis capacity Team player Resourceful Enthusiastic Solving problems capacity Empathy Sense of humour Understanding of businesses Mentally and physically and markets functioning Capacity to get on well with strong work mates Critical judgment and Assertive Communication skills wisdom Diligent Structured Speech Intellectual maturity Full Good education Motivated Attention to detail Good presence Disciplined IBFI |Damián Rubianes 38  Appendix Motives for inorganic growth IBFI |Damián Rubianes 39 Motives for inorganic growth Maturing product line Regulatory or antitrust limits High growth tends to attract imitators, who may Simply reinvesting in the core business may not sap the growth of the leader. be feasible if the firm operates under regulatory Also, all the forces of turbulence such as constraints. technological innovation, demographic change, For instance, at various times broadcasters and deregulation, and globalization render products banks have been limited in the scope of their (and industries) obsolete. operations. A common response is to acquire new The CEO must ask, “Is the shareholder better off businesses, still early in their life cycles, to create if we return the cash through a dividend, and a total growth trajectory. stop this growth program?” Source: Bruner, R. F. (2004). Applied mergers and acquisitions, John Wiley & Sons. IBFI |Damián Rubianes 40 Motives for inorganic growth Horizontal or vertical integration Improving economic efficiency may be served by integration of the firm with peers, or with suppliers and customers. The first two large waves of M&A activity in the United States were waves of integration. Horizontal integration Vertical integration It entails combination with peer firms in an It combines firms along the value chain. For industry. instance, a steel manufacturer might acquire This may exploit economies of scale, which will upstream operations (such as iron ore mines) reduce costs, and increase market power, which and downstream operations (such as fabricators may result in higher profits. of steel products). Antitrust regulation seeks to forestall monopoly Vertical integration can create value if it power in horizontal combinations. improves economic efficiency by cutting out intermediaries and reducing overhead expense and redundant assets Source: Bruner, R. F. (2004). Applied mergers and acquisitions, John Wiley & Sons. IBFI |Damián Rubianes 41 Motives for inorganic growth Acquisition of resources / capabilities Diversification If it is not possible, more expensive or The classic motive for diversification is to create sufficiently fast to create internally required a portfolio of businesses whose cash flows are resources, firms can buy them. imperfectly correlated, and therefore might be In fields such as biotechnology, computer able to sustain one another through episodes of software, defense electronics, and filmed adversity. entertainment, large corporations regularly It is not clear what value this kind of portfolio reach beyond their internal operations to management adds to shareholders’ wealth. acquire intellectual property, patents, creative Nevertheless, it might create value if: talent, and managerial know-how. – Promotes knowledge transfer across divisions, – Reduces costs, where the diversification is into related fields. – Aggregates resources that can be shaped into core competencies that create competitive advantage. Source: Bruner, R. F. (2004). Applied mergers and acquisitions, John Wiley & Sons. IBFI |Damián Rubianes 42  Different valuation methods IBFI |Damián Rubianes 43  Intrinsic valuation (income based) DESCRIPTION PROS & CONS Discount unleveraged Discounted projected FCF at Company’s ↑ Theoretically, the most sound method of valuation. cash flows cost of capital to obtain PV ↑ Less influenced by temperamental market conditions analysis of assets. or non-economic factors. Subtract market value of ↑ Can value components of business or synergies outstanding net debt and separately from the business. preferred capital from the ↓ Present value obtained are sensitive to assumptions PV of assets to get PV of and methodology. equity. ↓ Terminal value represents significant portion of value, FCF is aftertax operating and is highly sensitive to valuation assumptions. earnings plus non-cash ↓ DCF value may need to be adjusted for non-operating charges less increases in items such as environmental liabilities and the value of working capital less capital saleable assets, as well as seasonality of key variables. expenditures. ↓ Need realistic projected financial statements over one Sensitivities on discount business cycle or until CF are “normalized”. rates, terminal value, ↓ Operating assumptions and discount rates are key to assumptions and operating value. scenarios. Source: J.P. Morgan (M&A Reference Manual). IBFI |Damián Rubianes 44  Relative valuation (market based) DESCRIPTION PROS & CONS Comparable Compare the current ↑ Market efficiency means that trading values in theory company trading level of a Company should reflect industry trends, business risk, market trading to its peers. growth, etc. analysis Determine how the market ↑ Values obtained can be a reliable indicator of the value of the Company for a minority investment (i.e., a values earnings, cash flow, non-control investment). NAV, assets or other metrics ↑ Useful technique for assessing vulnerability: when of similar companies. fundamental vs. market value gap is large, The trading level does not vulnerability may be high. include a control premium ↓ Always comparing apples to oranges. Truly or synergy value associated comparable companies are rare and differences are with strategic acquisitions. hard to account for. ↓ Thinly traded, small capitalization or poorly followed Explaining value gaps stocks may not reflect fundamental value. between the Company and ↓ Many people feel that the stock market is “emotional” its comparables can involve and that it sometimes fluctuates irrationally (i.e., the extensive use of judgment. market can be wrong). Source: J.P. Morgan (M&A Reference Manual). IBFI |Damián Rubianes 45  Relative valuation (market based) DESCRIPTION PROS & CONS Comparable Determine the value ↑ Recent comparable transactions can reflect supply and transactions demand for saleable assets. and offered in past acquisitions ↑ Realistic in the sense that past transactions were premium of similar companies. successfully completed at certain multiples or analysis Specifically, determine the premiums. Indicates a range of plausibility for pricing of past deals as premiums offered. compared to the target’s ↑ Trends, such as consolidating acquisitions, foreign financial performance. purchasers, or financial purchasers appear. ↓ Past transactions are rarely directly comparable – Interpretation of the data always comparing apples to oranges. requires familiarity with the ↓ Public data on past transactions can be scarce or industry and the properties misleading. involved. ↓ Public data seldom discusses deal protection put in Premiums and appropriate place by acquirer and target. multiples can (and often do) ↓ Values obtained often vary over a wide range and thus can be of limited usefulness. change over time. ↓ Prevailing market conditions can lead to significant distortions. Source: J.P. Morgan (M&A Reference Manual). IBFI |Damián Rubianes 46  Net asset value (asset based) DESCRIPTION PROS & CONS The value of a company is ↑ Easy to apply, substituting book value by the fair- obtained from the book market value of the company’s total assets minus its Net asset value of the ownership total liabilities. value interest in the equity ↓ This method does neither consider the Company’s potential value creation, nor intangible assets not adjusted by potential off- reflected in the BS (e.g. assets such as internally balance sheet capital gains developed products and proprietary methods of or losses. conducting business). Estimate the value of the ↑ Easy to apply. Effectively an extension of trading and Asset value of Company’s reserves (coal, transaction multiples. reserves oil, gas, gold, etc.). ↑ Many natural resource companies’ earnings fluctuate Compare how public natural with the prices of the commodities they sell. Highly resource firms trade as a cyclical earnings make earnings-based analysis multiple of reserve value (or problematic. by transactions that have ↓ Accurate asset values are difficult to determine from occurred as a multiple of public disclosure due to differences in recovery reserve value). economics and reckoning conventions. Source: J.P. Morgan (M&A Reference Manual). IBFI |Damián Rubianes 47  Net asset value (asset based) DESCRIPTION PROS & CONS The value of a company is ↑ Easy to apply. Net NAV obtained from the gross ↑ Useful for holding companies and real estate firms. market value of its assets ↑ Listed RE firms release regularly the market value of (GAV). their assets. NAV is GAV minus net ↓ If value of RE assets or subsidiaries is not known, it has financial debt. to be estimated. Net NAV is NAV minus taxes applied to the company’s assets capital gains. Source: J.P. Morgan (M&A Reference Manual). IBFI |Damián Rubianes 48  The sale process Orientation The sale process Strategy Marketing Negotiations Execution Market Analysis Controlled Controlled Strategic Transaction Management Refine Structure Auction Release of Assessment Strategy Presentation Additional Shareholder’s Negotiated Information Data Room Objectives Transaction Preliminary Identify Buyer List Negotiations Candidates Preliminary Pricing Final Due Analysis Diligence Assess Value Information Prepare Memorandum Package Preliminary Structuring Confidentiality Agreement Contact Buyers Evaluate Options Evaluate Binding Negotiate Letters of Interest Offers Solicit Letters of Contract Acquisition Interest Agreement Preliminary Select Letter of Intent Test the Market Evaluate Initial Feedback Preferred Offers Purchaser Proceed Proceed Select Buyer Cash Close Other Considerations IBFI |Damián Rubianes 49  The sale process A range of value-added services from buyer identification and valuation assessment, to price advisory and deal structuring Strategy Marketing Negotiations Execution ▪ Assess Strategic ▪ Formulate Transaction ▪ Conduct Due Diligence/ ▪ Refine Structure Alternatives Strategy Buyer Due Diligence ▪ Co-ordinate ▪ Identify Targets and ▪ Identify Potential Buyers ▪ Assist in Negotiations Final Due Diligence develop criteria to ▪ Approach Potential ▪ Structure Preliminary Deal ▪ Negotiate Contract Screen them Buyers ▪ Solicit Final / Binding ▪ Close ▪ Identify and evaluate ▪ Execute confidentiality Proposals objectives agreements ▪ Evaluate Binding Offers ▪ Prepare preliminary ▪ Prepare and Distribute valuation Information Memorandum ▪ Determine Level ▪ Solicit Non-Binding of Interest Indications of Interest ▪ Evaluate Initial Offers ▪ Set-up Data Room/ Management Presentations IBFI |Damián Rubianes 50  Advisor assistance Strategy Marketing Negotiations Execution ▪ Review with management ▪ Preparation of ▪ Evaluate deal structure ▪ Advise on deal structuring benefits and drawbacks of information memorandum and ▪ Coordinate final Due options available, in light ▪ Use global network alternatives relative to Diligence of market conditions to identify and contact management’s objectives ▪ Assist in closing the ▪ Provide a preliminary potential buyer candidates ▪ Move negotiations transaction valuation assessment that fit criteria and could forward ▪ Test the market optimise value in an expeditious and ▪ Manage the overall constructive manner transaction process to accelerate time to market, to preserve confidentiality, and to maximize value ▪ Provide business insights to help management evaluate initial offers IBFI |Damián Rubianes 51 The acquisition process Orientation The acquisition process Determine Strategy Create Deal Go to Market Financing Discussion with Understanding of Formulate Letter of intent Determine Strategic Expectations Selected Targets Preliminary Financing Assessment Proposal Strategy Challenge Develop Acquisition Criteria Target Information Assumptions Acquisition Preliminary Due External Pricing Criteria Diligence Financing Prepare Package Memorandum Identify & Screen Targets Financial Due Diligence Preliminary Modelling Identify Source List Valuation on Target Financing Pricing Analysis Sources Approach Pro Forma Assess Potential Financials Contact Targets Fine-Tune Synergies Financing Valuation Financial Sources Modelling