Advanced Corporate Finance

Video Conference 3: A Framework to Think about ACF

What we learned from USX “Cheap” financing is a very slippery concept

“Where’s the poop?” Key difference between undervaluation and

restructuring Triggers Information v. action

Some financial innovations can mimic the “best” effects of business transactions, if details are designed carefully

Great debate on this issue Kudos to Ana, Cheryl, Daniel, Manuel, Michael and

Gabriela Worry about another “synthetic storage” /

Metallgesselschaft fiasco (https://www0.gsb.columbia.edu/faculty/fedwards/papers/DerivativesCanBeHazardous.pdf)

The Framework

Step-by-step Advanced Corporate Finance① Model firm performance Main Excel model② Identify sensitivity to different factors Data

Table③ Separate risk factors by:

Sensitivity Importance Maturity / Milestones

④ Classify potential audiences Bankers, etc.⑤ Calculate agency costs derived from structures⑥ Recognize constraints and objective⑦ Mix and match and price to create most value

Monte Carlo

GrowthExpectations

TurnoverExpectations

Margin Expectations

Expected Cashflows

Opportunity Cost of Capital

Intrinsic Value

Willingnessto Pay

AgencyCosts

Players to consider Management Individual v. Institutional investors

Reallocation v. New money Investment horizon Bulls v. Bears Debt v. Equity

Corporates Related: Competitors, clients, suppliers Unrelated: Conglomerate issues

Banks Economic v. Institutional Exposure

Issues idiosyncratic to some players Reasons for bundles to fetch a premium

Hiding strategic plays from competitors within an apparently financial transaction

Big institutional investors because it reduces their high transaction costs

Some players (especially institutions) are restricted in what securities they can own

Monitoring Cost of information acquisition and processing Career concerns of intermediaries

Investor size Ease of renegotiation – commitment v. flexibility

“Free-riding”

Investment Stories

How to identify and describe risk strands

Player niches with respect to risk factors Insure Diversify Contract away

Summary….

Risk Factors Maturities

A. Macro

B. Strategy

C. Execution

Nominal

Probable Most high-yield bonds

never make it to maturity and we know it!

Risks have milestones

The art of weaving different risk threads Underlying correlation between structural

sources of risk

Exposure to shifts in structural source of risk (leverage, i.e. relative volatility)

“Vertical” splitting of risk Seniority

Exposure to “macro” factors “Macro”: outside management control factors Player niches based on their directional view

on the issue Unsophisticated: view restricted to outcome (bulls

v. bears) Sophisticated: care only/also about the reasons Holding certain securities may “hone-in” in the

reason they are betting on, regardless of final outcome

When splitting exposures consider whether player niches are correlated across issues or not There may well be fewer audiences available than

you may think

Management Actions “Micro” factors usually have milestones Risk can be dealt with through multiple

channels Covenants Change in management Different strategies

Information is key Availability Bias Cost

Examples: Strategy as Corporate Finance An LBO need for early cash may require a

delay in CapEx This will prompt a shift in the distribution of

expected cash flows of different shape if it was growth or maintenance capex

The most likely driver of this volatility is breakdown risk

Operational cost-savings May backfire and have an impact on top-line

performance changing the distribution of cash flows

Most likely driver of this risk depends on internal operation of the firm / industry

Agency problems Related to investment decisions

Turnover NPV

Related to operational efficiency Margin

Related to strategic mistakes Growth Market share Pricing power

The Kerr-McGee Case

Trial by Fire

Admin Group Formation First week: November 3 – 5 Final write-up : Midnight Saturday, November

8 Final week: November 10 – 13

Suggestions: Develop analytical framework early Make model dynamic so you can change it after

discussion Do not just ignore discussions Ask for help during the next two weeks in the Help

forum

Roadmap Discuss players Delimit main issues/risk strands to be focusing

on Agree on a set of scenarios Clarify potential conceptual pitfalls

Clarify constraints and objective

Write-up Concise Convincing Straight-shooting

Quantitative as well as qualitative Appendices

Imagination will be rewarded! Wishful thinking will be punished

Share Buy-backs v. Dividends An issue often problematic with students In the vast majority of cases, common

perception is really wrong Barring differential tax treatment, the

economic effect of share buy-backs at market price and dividend payment is identical

In both cases Money leaves the firm to go to shareholders Shareholders have more of their wealth in money

than in stock What differs is the distribution amongst

shareholders and voting implications