investment banking, private equity & subprime crisis
DESCRIPTION
Basics of Investment Banking, Private Equity & Subprime CrisisTRANSCRIPT
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Investment Banking
&
Private Equity
&
Subprime Crisis
by
CA. Sunny Sabharwal
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Today’s Points of Discussion
1. Investment banking
2. Private Equity
3. Sub-prime Crisis & Indian Markets
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Today’s Points of Discussion
1. Investment banking
2. Private Equity
3. Sub-prime Crisis & Indian Markets
3
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Defining IB (if possible!)
No clear definition as such
Deal with securities
Question – What are securities?
Answer – A fungible, negotiable instrument representing financial value
Service Corporates, Government, Institutions and HNIs
Commercial banks primarily cater to general public
Not as regulated as Commercials (Why?)
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Organizational structure of an I-bank
Corporate Finance
Underwriting
Strategic Advisory
― Mergers & Acquisitions
― Private Placements
― Divestitures
Sales & Trading
Institutional & Private Clients
Pitching & cold calls
Research
Recommend “buy”, “sell” or “hold”
Guess what “Contrarians” do!5
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Organizational structure of an I-bank
Activities classified in nature:
Origination –
― Getting Business (have knowledge of products, business)
― Finding Investors
Execution –
― Due Diligence
― Documentation : Agreements, term sheets
― Financial Analysis (Valuation)
― Prepare Materials for Internal Committees
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Organizational structure of an I-bank
Industry Coverage
focus on a specific industry such as healthcare, industrials, or technology
Product Coverage
focus on financial products, such as mergers and acquisitions, leveraged
finance, equity, and high-grade debt
Region Coverage
focus on particular geography (-ies)
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IB G
am
ut
of
Se
rvic
es
INVESTMENT BANKING
Initial Public
Offering (IPOs)
Mergers & Acquisitions
Private Equity
Placements
Qualified Institutional Placements
(QIPs)
Follow-on Offerings
Buyback of Equities
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Types of Stock Issues
Issues
Public Issue
IPO
FPO
Rights Issue Bonus IssuePrivate
Placement
Preferential Issue
Qualified Institutional Placement
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IB Gamut of Services
Initial Public Offering
Do we need a primer!!!
But why go public?
― Fund the growth – purchase another firm using own stock as currency
― Exit option for Promoters
― Ease in raising finance
Underwriting or Best Efforts
― Most offerings underwritten
― In very small, risky deals on best efforts basis
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IB Gamut of Services
Initial Public Offering
Pricing
― Since firm going public, no established price
― Banker and company project the company’s future earnings & cash flows
Normalize the data
― Market data on similar listed companies
― Price set to place the firm’s P/E and M/B ratios in line with publicly traded
firms in the same industry having similar risk and growth prospects
― Conflict of interest - because Banker has an incentive to set a low price :
to make brokerage customers happy
to make it easy to sell the issue
Firm would like price to be high
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IB Gamut of Services
Initial Public Offering
Process
― Hiring Managers –
Who gives the best bet!
Reputation of IB
Type of Clients – Institutional or Retail
Support in the post-IPO secondary market
» Reputation of analyst covering the stock
― Due Diligence & Legal
― Marketing
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IB Gamut of Services
Follow-on offerings
Additional Capital
Exit option for large shareholders
Since more shares mean dilution (EPS effect), stock price usually falls on
news of secondary offering
Less complicated and lengthy than IPO
― Valuation is provided by the market
― Usually same managers/underwriters used
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IB Gamut of Services
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Mergers & Acquisitions (buy Vs build)
Why
― New market, new product
― Vertical or Horizontal Integration
― Additional capital
― Reduce competition (when you can’t fight them, join them)
― Strategic Reasons
Loss-making company having valuable assets
Process
― Target identification
― Determination of appropriate price
― Structuring the finance
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IB Gamut of Services
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Mergers & Acquisitions
Mode of Acquisition
― Pure Equity
Equity & Preference
Special Class (Differential voting rights, dividends or otherwise)
― Leveraged Acquisitions
Due Diligence
― Approval rights of financiers
― Title to Properties & Assets
― Statutory Dues
― Litigations
― IPR protection
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Growth of IB
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IB Gamut of Services
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Private Equity Placements
Private sale of unregistered securities by a public company to a select
group of individuals or institutions
SCRA provides that
― When issuer issues securities to a select group of persons not exceeding 49
Types:
― Preferential allotment: Listed issuer issues shares to a select group
― Qualified institutions placement (QIP): Listed issuer issues shares to
Qualified Institutions Buyers (Public financial institution, Banks, Mutual funds,
FIIs, Venture capital funds, Pension Funds, etc.)
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Today’s Points of Discussion
1. Investment banking
2. Private Equity
3. Sub-prime Crisis & Indian Markets
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Private Equity
Definition – equity securities in operating companies that are not
publicly traded on a stock exchange
Why –
Long investment horizon
Building businesses and teams
Facilitating outpacing of competition – through global networks
Ensuring high standard of Corporate Governance – disclosures, etc.
Average investment horizon 7-10 years
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Private Equity
Private equity activity
Fund raising
Investment
Divestments
Structure of PE Funds –
Usually Limited Partnerships
Managers : General Partners (GPs); Investors : Limited Partners (LPs)
LPs – Corporates, Pension Funds, Other PE Funds, HNIs
Compensation of GPs –
Management fee - 1-2% of invested capital
Carry - 20% of excess return on fund
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Private Equity
Venture capital – investment in companies that have undeveloped
or developing products
Types –
Seed stage – Financing provided to research, assess and develop initial
concept
Start-up stage – Financing for product development and initial
marketing
Expansion stage – Financing for growth and expansion
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Private Equity
What do VCs look for:
Strong management team
― Good people management and business development skills
― Prior relevant experience
― Commitment – risks taken / capital invested
Sound business model
― What’s different / USP
― Large customer base
― Sustainable & profitable growth after fully funded
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Private Equity
Exit Options:
Selling stake to strategic investors
― Competitors
Initial Public Offering (IPO) in India or overseas
Sale to any other private equity fund or venture capital fund
Merger with an existing listed company
Management / Company buy-backs
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Valuation Methods
Income-based Approach
― Discounted Cash Flows
― Dividend Discount Model
Asset-based Approach
― Net Asset Valuation
Market Approach
― Relative Valuation
P/E, P/BV, EV/EBITDA, EV/Sales
SUBJECTIVITY
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Private Equity
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Discounted Cash Flows
Premise : ownership is essentially a claim on the cash flows
Process :
― Estimate free cash flows available to all investors
Historical performance
Company projections
Equity research analyst estimates
Industry data
― Normalize earnings
― Estimate terminal value (TV)
― Using WACC, determine the appropriate discount rate
― Calculate Enterprise Value
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Private Equity
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Today’s Points of Discussion
1. Investment banking
2. Private Equity
3. Sub-prime Crisis & Indian Markets
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Sub-prime Crisis
Description – Pick any newspaper!!!
Let’s start with the basics
What is Sub-prime?
― which is not PRIME
What is Securitization?
― Bundling of securities
― Payments to investors from mortgage payments by borrowers
― Further sold as Collateralized Debt Obligations (CDOs)
Tranches – maturity, security, rating
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Sub-prime Crisis
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Introduction of exotic loans and relaxed
standards ―> increase in sub-prime
mortgage lending
Low interest rates encouraged Wall
Street investors to back sub-prime loans in greater quantities
Hedge funds worldwide borrowed
money to invest heavily in sub-prime mortgages
Prices go beyond FED’s tolerance limit. Interest rates rise and housing
prices fall
Lenders, rating agencies, and investors
underestimated the number of loans that
would default.
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Who’s fault is it anyway
Lenders: for their predatory lending practices focused on subprime
mortgage candidates
Rating Agencies: Overrate the MBS and other derivatives with underlying
securities of little value
Mortgage brokers: for steering borrowers to unaffordable loans
Wall Street investors: for backing subprime mortgage loans without first
verifying the security of the portfolio
Borrowers: for overstating income levels on loan applications and entering
into loan agreements they could not afford
Government: for lack of oversight
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Sub-prime Crisis
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Sub-prime Crisis
A Typical Securitization Process
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Impact of crisis on Indian market –
In India, the closeted financial system is not heavily exposed to the
financial crisis
PM: None can be immune from a global melt down
But,
― FII Outflows
― SENSEX plunges
― High Inflation
― Liquidity crunch
Affecting all industries across the board
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Sub-prime Crisis
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Requisites for Professionals
Financial knowledge (a must!) – understanding financial statements
Financial Economics – GDP, Inflation, Money Supply, etc.
Understanding and tracking markets – Indian & global
About the industry – industry cycle, major players, business
models, entry/exit barriers, regulatory issues, etc.
Valuation Methods
Other skills –
Networking & Personal Communication
Computer skills - Financial modeling, Presentations
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Books / Sources / Links
“The Intelligent Investor” by BENJAMIN GRAHAM
“Investment Banking Explained – An insider’s guide” by MICHEL FLEURIET
“Principles of Private Firm Valuation” by STANLEY J. FELDMAN
Any financial newspaper
www.vccircle.com – For latest in PE world
www.stockmarketguide.in – For keeping abreast of Stock Market Events
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Let’s discuss
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Thank You
CA. Sunny Sabharwal
+ 9 1 9 9 5 8 6 7 7 7 6 6
www.sunnysabharwal.blogspot.com