Investment Banking at a Crossroads Prof Ian Giddy New York University.
Investment Banking at a Crossroads Prof Ian Giddy -...
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Investment Bankingat a Crossroads
Prof Ian GiddyNew York University
Copyright ©2000 Ian H. Giddy www.giddy.org Investment Banking 2
Investment Banking
Sales
CapitalMarkets
CorporateFinance
Customer-DrivenSecurities
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What is Investment Banking?
l Sales and Tradingl Funds Managementl Underwriting and Distributionl Advisory Services, including M&Al Research
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Investment Banking’s Future
l Banks vs. Marketsl Relationships vs. Transactionsl On Balance Sheet vs. Offl Domestic vs. Regional vs. Globall Debt vs. Equityl Bricks vs. Bytes
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Banks vs. Markets
l Where are investors going?l What do today’s shareholders expect?l Where are corporate clients going?l Where is your bank going?
l Common theme: “The end of entitlement” (which implies the end of special responsibilities)
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Relationships vs. Transactions
l Lower barriers to entry – more price competition
l Frequent re-calculation of benefits: “What will you do for me next?”
l Shareholder pressure weakens traditional relationships, obligations
l In business, the effect is toward alliances, contract manufacturing, out-sourcing
l Stability requires “new communities,” the more broadly-based the better
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Financial Innovation and the Shorter Product Life Cycle
l More financial innovationl But most innovations faill Fewer geographic barriers to entryl Fewer information barriers to entry
Excessreturns
Time
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Innovation as Value Creation
l Innovations are costly to develop and produce, and easily copied, so
l For an innovation to succeed, it must create differentiated value for issuer, investor, or risk manager, by:uUnbundling: create simple, more primitive
instruments to isolate risks, or
uBundling: create tailor-made instruments to reduce costs, minimize taxes, or circumvent restrictions or imperfections.
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On Balance Sheet vs. Off
l “All my assets are for sale, all the time”l Maximize ROE by increasing capital
turnover – become originators instead of lenders
5,4 5,71,6
5,39,1 6,9
33,135,4
38,8
61,7
0,0
10,0
20,0
30,0
40,0
50,0
60,0
70,0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999(YTD)
Market value of transactions in Europe (1990-present) Euro bn
Asset-BackedSecurities
Asset-BackedSecurities
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Domestic, Regional or Global?
l Which are more mobile?uGoods markets
uLabor
uServices
uFinancial services
l Even domestic institutions must be able to compete in the world arena
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Debt vs. Equity
0.1
1
10
100
1000
10000
1925 1935 1945 1955 1965 1975 1985 1995
Index ($)
$4,495.99
$33.73
$13.54$8.85
$1,370.95
Small Company Stocks
Large Company StocksLong-Term
Government Bonds
Treasury BillsInflation
Year-End
A $1 Investment in Different Types of Portfolios: 1926-1996
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Passive vs. Active Investors
l It’s an internet information agel Domestic shareholders want global
returns – asset managers must beat benchmarks
l Corporations or financial institutions which cling to underperforming assets will have lower ROE and share prices
l Which makes them vulnerable to restructuring or takeover – Europe’s new market for corporate control
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Passive vs. Active Investors
uInvestors expect results or sell their shares; “friendly holdings” become too costly, opportunity costs become explicit
uVenture capital, private equity funds attract investors by offering higher returns
uMarket-based returns now expected by investors and lenders, and required of managers; local differences persist, but diminishing
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Bricks vs. Bytes
l It’s a Nasdaq world, and it’s moving at “internet time”
l The old economy needs the new economy to meet shareholder expectations
“To B2B, or not to be?”l E-business or m-business?l Equity, not debt, is financing the new
economy
Check your ownbank’s onlineand mobilefinancial services
Check your ownbank’s onlineand mobilefinancial services
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Whither European Financial Services?
l The Anglo-Saxon model of transparent financial markets is coming, at internet speed
l All assets must meet the test of the market – global shareholder return standards
l Otherwise…
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Example: Deutsche-Dresdner
l What is Deutsche’s strategy?l Does the Dresdner acquisition advance
that strategy?l What does it take to succeed in
investment banking?
Deutsche-Dresdner case study
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The Commercial Banking Model
Assets Liabilities
Loansn Net interest
revenues
Loansn Net interest
revenues
Depositsn Net interest
costs
Depositsn Net interest
costs
Goal: Add assets with positive net interest margin
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The Investment Banking Model
Sales
CapitalMarkets
CorporateFinance
Customer-DrivenSecurities
Goal: Originate deals and sell them in the capital marketas quickly as possible
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What Strategy?Client-Arena-Product Matrix
Pro
du
cts
off
ered
Clients servedMarkets covered
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Products
l Credit productsl Trading and positioningl Risk management productsl Financial engineering and structured
financel Underwriting and distributionl Asset managementl Retail and private client servicesl Transactions services
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Range of Financial Services
Firms FDICInsuredDepository
ConsumerLoans
CreditCards
MortgageBanking
Commercial Lending
MutualFunds
Securities Insurance
American Express • • • • • • • •
AT&T • •
Bankers Trust • ¤ • • • •
Citicorp • • • • • • • •
Ford • • • • • •
General Motors • • • • •
General Electric • • • • • • • •
ITT • • • • • •
John Hancock • • • • • • • •
J.P. Morgan • ¤ • • •
Merrill Lynch • • • • • •
Primerica • • • • • •
Prudential • • • • • • • •
Sears, Roebuck • • • • • • • •
Transamerica • • • • •
¤ minor involvmentSOURCE: The National Journal, the American Financial Services Associationand Annual Reports.
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NatWest Bank?
NatWest BankClients
Corporations Government Institutions High net worth RetailProductsSecurities custody x xAsset Management x x xPrivate Equity xInsurance x xLending x x x xDeposits x x x xSecuritization/Structured and Project Finance x xEquity underwritingBond underwritingMergers and AcquisitionsCredit cards x x xTrading - Money market x x - FX and derivatives x x - Interest rate derivatives x x - Bonds x x - Securitized products x x- Futures x xMortgages xStock brokerage x xCorporate Advisory xPrivate Banking x
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Product Profitability Cycle
Excess returns
Time
n Do you want to be a Nescafe bank?
n Or a Starbucks bank?
n Do you want to be a Nescafe bank?
n Or a Starbucks bank?
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Client-Arena-Product Matrix
Pro
du
cts
off
ered
Clients servedMarkets covered
Build versus buy?
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Client-Arena-Product Matrix
Pro
du
cts
off
ered
Clients servedMarkets covered
Deutsche Bank in USA
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Client-Arena-Product Matrix
Pro
du
cts
off
ered
Clients servedMarkets covered
Sell?
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Using Industry Structure Analysis
COMPETITIVE
ADVANTAGE
SUBSTITUTESQuestions:l Do substitutes exist?l What is their price/
performance?
Potential Action:l Fund venture capital and
joint venture to obtain key skills
l Acquire position in newsegment
CUSTOMERSQuestions:l Is the customer base
concentrating?l Is value added to
customer end product high,changing?
Potential Actions:l Create differentiated
productl Forward - integrate
BARRIERS TO ENTRYQuestions:l Do barriers to entry exist?l How large are the barriers?l Are they sustainable?
Potential Actions:l Acquire to achieve scale in
final product or critical component
l Lock up supply of critical industry input
SUPPLIERSQuestions:l Is supplier industry
concentrating?l Is supplier value/cost
added to end product high,changing?
Potential Actions:l Backward - integrate
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Complementarity and Cross-Selling
WholesaleRetail
Insurance
Asset Management
Citigroup?
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The Future of Banking:Where Do You Want To Go Today?
l Banks vs. Marketsl Relationships vs. Transactionsl On Balance Sheet vs. Offl Domestic vs. Regional vs. Globall Debt vs. Equityl Bricks vs. Bytes
Raising Moneyfor Companies
Prof Ian GiddyNew York University
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Corporate Finance
CORPORATE FINANCEDECISONS
CORPORATE FINANCEDECISONS
INVESTMENTINVESTMENT RISK MGTRISK MGTFINANCINGFINANCING
CAPITAL
PORTFOLIO
M&ADEBT EQUITY
TOOLS
MEASUREMENT
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The CFO Questions
l How fast can we grow? What criteria for spending money? Acquisitions? Divestitures?
l How should we finance our growth? What kind of equity? What’s our exit plan? Private or public?
l How much (cheap) debt should we have?
l What kind of debt should we have? Maturity? Fixed/floating? Currency? Asset-backed? Hybrids, such as convertibles?
l How should we manage our financial risks?
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Financing X Inc
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Financing X Inc
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Financing X Inc
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Corporate Financing Life-Cycle
Growth companies Mature companies
Leverage
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Firm Characteristics as Growth Changes
Variable High Growth Firms tend to Stable Growth Firms tend toRisk be above-average risk be average risk
Dividend Payout pay little or no dividends pay high dividends
Net Cap Ex have high net cap ex have low net cap ex
Return on Capital earn high ROC (excess return) earn ROC closer to WACC
Leverage have little or no debt higher leverage
Earnings
Gearing
0
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Financing Growth Companies:The Agenda
l Where can we get the initial equity financing we need to grow?
l Do we want money, management, or more?
l When do we want to sell out, and how?l When is the right time for debt for a
growth company? What kind?
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First, Why Equity?
l Benefits of EquityuFlexibility: cannot afford to have fixed
obligations
uStrategic partners
uInterventionist partners
l DisadvantagesuNo tax shield
uExpensive!
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What Kind of Equity?
l Sources of EquityuPrivate investors
uStrategic investors
uInterventionist investors
uPublic market
l And KindsuCommon stock
uStock with restricted voting rights
uHybrids, including convertibles
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.comfax
l Started in September 1997, .comfax enables users to send faxes and receive faxes over the internet at a low cost.
l By June 1998 the company had expanded its services and was signing up subscribers at the rate of 100,000 a day.
l Initial funding was “Angel” finance, but now the expansion was exceeding the company’s financial, physical and managerial capacity. On two occasions it had literally run out of money.
l What form of equity financing would be appropriate for .comfax?
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Pre-IPO Equity Financing
l Friends and familyl Angell Venture capitall Strategic partners
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Pre-IPO Equity Financing
l Friends and familyl Angell Venture capitall Strategic partners
asiajack.com
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Private Equity Funds
l Private equity funds are generally structured as partnerships specializing in venture capital, leveraged buyouts, and corporate restructuring.
l The private equity fund mobilizes funds, selects and monitors investments, eventually exiting the investment and paying back the investors.
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Silipos Inc
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Silipos Inc, 1999
Where do you want
to go?
Debt?Debt?
Acquisition?Acquisition?
IPO?IPO?
Sell?Sell?
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IntraLinks
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IntraLinks’ Choices
Ø Issue debt, either by borrowing from one of the big New York banks keen to get more involved in promising Internet businesses, or by means of a private placement of debt notes, possibly with “sweeteners” such as warrants to attract a lender.
Ø Seek out one or more private equity investors, ones who believed in the company’s product and its management.
Ø Do an initial public offering (IPO).Ø Find another corporation who would be willing to
acquire IntraLinks.
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Why Venture Capitalists Prefer Preferred
l Senior status in bankruptcyl Does not put a value on the sharesl Is convertible into common stock before
the IPOl Conversion price is set such that if there
is a liquidation all the money goes to the preferred shareholders (equity is worth zero)
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Case Study: Photronics
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Case Study: Photronics
Photronics is the world's leading and fastestgrowing manufacturer of photomasks.Photomasks are high precision quartz plates thatcontain microscopic images of electroniccircuits. A key element and enabling technologyin the manufacture of semiconductors,photomasks are used to transfer circuit patternsonto semiconductor wafers during the fabricationof integrated circuits. They are produced inaccordance with circuit designs provided bycustomers at strategically located manufacturingfacilities in North America, Europe and Asia.
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Case Study: Photronics
Sales, 1994-99
Balance Sheet, end-1999USD millionsAssets Liabilities & EquityCash 7.6 Current liabilities 50.2Other current assets 59.9 Long term liabilities 132.7Long term assets 319.6 Shareholder's equity 204.2Total 387.1 Total 387.1
Market capitalization 720 P/E 26xEBIT/Int cost 5.77
Book MarketD/E 0.90 0.25D/(D+E) 0.47 0.20
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The Company’s Debt
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Should Photronics Have More Debt?
l Benefits of DebtuTax Benefits
uAdds discipline to management
l Costs of DebtuBankruptcy Costs
uAgency Costs
uLoss of Future Flexibility
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How Much Debt? Relative Analysis
The “safest” place for any firm to be is close to the industry average
l Subjective adjustments can be made to these averages to arrive at the right debt ratio.uHigher tax rates -> Higher debt ratios (Tax benefits)uLower insider ownership -> Higher debt ratios
(Greater discipline)uMore stable income -> Higher debt ratios (Lower
bankruptcy costs)uMore intangible assets -> Lower debt ratios (More
agency problems)
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The CFO Questions
l How fast can we grow? What criteria for spending money? Acquisitions? Divestitures?
l How should we finance our growth? What kind of equity? What’s our exit plan? Private or public?
l How much (cheap) debt should we have?
l What kind of debt should we have? Maturity? Fixed/floating? Currency? Asset-backed? Hybrids, such as convertibles?
l How should we manage our financial risks?
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Raising Equity: The Investment Banker’s Job
l Market conditionsl Corporate needsl Valuationl Informationl Distribution
TelekomTelekom
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Deutsche Telekom: The Sequence
l See case Exhibit 2
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What’s a Company Worthto Investors?
l Required Returnsl Types of ModelsuBalance sheet models
uDividend discount & corporate cash flow models
uPrice/Earnings ratios
uOption models
l Estimating Growth Rates
TelekomTelekom
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Equity Valuation: From the Balance Sheet
Value of Assetsn Bookn Liquidationn Replacement
Value of Liabilities
n Bookn Market
Value of Equity
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Deutsche Telekom: Book Value
l See case Exhibit 3
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Relative Valuation
l Do valuation ratios make sense?• Price/Earnings (P/E) ratios
q and variants (EBIT multiples, EBITDA multiples, Cash Flow multiples)
• Price/Book (P/BV) ratiosq and variants (Tobin's Q)
• Price/Sales ratios
l It depends on how they are used -- and what’s behind them!
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Deutsche Telekom:Ratios and Comparables
l See case page 9
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Discounted Cashflow Valuation: Basis for Approach
uwhere
u n = Life of the asset
u CFt = Cashflow in period t
u r = Discount rate reflecting the riskiness of the estimated cashflows
Value = CFt
(1+r)tt =1
t =n∑
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Deutsche Telekom: Earnings
l See case page 8
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Valuing a Firm with DCF: An Illustration
Historical financial results
Adjust for nonrecurring aspects
Gauge future growth
Adjust fornoncashitems
Projected sales and operating profits
Projected free cash flows to the firm (FCFF)
Year 1 FCFF
Year 2 FCFF
Year 3 FCFF
Year 4 FCFF
Terminal year FCFF
Stable growth model or P/E comparable
Present value of free cash flows
+ cash, securities & excess assets
- Market value of debt
Value of shareholders equity
…
Discount to present using weighted average cost of capital (WACC)
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Next
l Bond Marketsl Equity Marketsl Domesticl International
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Ian H. Giddy
Stern School of Business
New York University
44 West 4th Street, New York, NY 10012, USA
Tel 212-998-0332; Fax 917-463-7629
http://giddy.org