investment banking, private equity & subprime crisis
DESCRIPTION
Basics of Investment Banking, Private Equity & Subprime CrisisTRANSCRIPT
Investment Banking
&
Private Equity
&
Subprime Crisis
by
CA. Sunny Sabharwal
Today’s Points of Discussion
1. Investment banking
2. Private Equity
3. Sub-prime Crisis & Indian Markets
2
Today’s Points of Discussion
1. Investment banking
2. Private Equity
3. Sub-prime Crisis & Indian Markets
3
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?)
4
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
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
6
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)
7
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
8
Types of Stock Issues
Issues
Public Issue
IPO
FPO
Rights Issue Bonus IssuePrivate
Placement
Preferential Issue
Qualified Institutional Placement
9
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
10
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
11
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
12
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
13
IB Gamut of Services
14
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
IB Gamut of Services
15
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
Growth of IB
16
IB Gamut of Services
17
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.)
Today’s Points of Discussion
1. Investment banking
2. Private Equity
3. Sub-prime Crisis & Indian Markets
18
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
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
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
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
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
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
24
Private Equity
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
25
Private Equity
Today’s Points of Discussion
1. Investment banking
2. Private Equity
3. Sub-prime Crisis & Indian Markets
26
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
27
Sub-prime Crisis
28
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.
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
29
Sub-prime Crisis
30
Sub-prime Crisis
A Typical Securitization Process
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
31
Sub-prime Crisis
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
32
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
33
Let’s discuss
Thank You
CA. Sunny Sabharwal
+ 9 1 9 9 5 8 6 7 7 7 6 6
www.sunnysabharwal.blogspot.com